A Central Bank for Crypto Currencies

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Yes, you read that right: A central bank for crypto currencies. Considering the intrinsic nature of decentralization on most of the cryptocurrencies, this could sound like an oxymoron. But currently some institutions and governments are doing heavy research on this possibility. They are starting to realize that a passive position on cryptocurrencies is not an option; they cannot be ignored or mispriced anymore. Hence they are looking to take an active part in the ecosystem. Not by becoming another side actor, but by trying to apply their own, as well as traditional, rules on the current scenario. 

It is worth to pay attention to this increasing trend in order to know what’s happening on “the other side”.

As we already mentioned, positions are being taken. The future of the next monetary policy is being defined right now.

5 Key Issues

As discussed in a recent paper by A. Levin & M. Bordo, there are 5 key issues to pay attention to that will frame the design of this new monetary policy.

  1. Should internal money transfers within the central bank be executed on accounts held by the institution, or should they be executed straight via payer to payee? The layers of control and flexibility for the institution will be determined by which solution is chosen.
  2. What is the future of cash? This transition won’t be easy, particularly finding a solution as to how traditional paper currency will be dealt with during the transition to digital. Should the central bank set a fee schedule to transfer funds from the bank to traditional currencies, or should cash just be abolished?
  3. Another key factor to consider relies on the nature of the central bank itself, facing two possible scenarios: One, central banks would provide a constant nominal value like traditional currencies, or two, central banks would follow a regular interest payment or fix the value to an index.
  4. How would the central bank’s monetary policy strategies and operations be impacted? And, how would lawmakers adjust laws and regulations? This unfolds into a much bigger debate that we can’t cover here. It is, however, well worth taking time to read Ray Dalio’s article, “Paradigm Shifts”.
  5. Last, but not least, is how the existence of Central Banks would impact the fiscal authorities of the different regions and their sovereignty.

Ideal ScenarioThere are three pillars every currency needs to uphold in order to function successfully: efficient medium of exchange, security as a store of value, and stability as unit of accountability. Given this, the National Bureau of Economic Research highlights the following features for a solid Central Bank:

(NBER WP23711, August 2017)

A storm is slowly brewing, and the outcome is still uncertain. A central bank for crypto currencies is a feasible option that would enable the basics of a widely-recognized currency while gaining the advantages of the blockchain technology. The problem is how this piece fits in the macroeconomic puzzle, where policymakers fight to preserve their own sovereignty and influence while staying relevant on the international playing board.

One thing is sure, as we commented at the beginning, policymakers cannot have a passive attitude towards cryptocurrencies, there are too many risks involved. They will need to reach consensus decisions within their country and with their partners in order to avoid a potential loss of monetary control while giving oxygen to other side actors taking their share of power. A scenario that would cause macroeconomic instability and lack of trust opens the gates to potential economic downturns.
Game on.