CRYPTOCURRENCY, MONETARY POLICY AND CENTRAL BANK

Abstract
Digital currency is an alternative currency free from the control of the central bank or government and guarantees high anonymity. Existing levels of cryptocurrencies are a fraction of the volume of major conventional currencies. There could be very large impacts on monetary policy if cryptocurrencies became a substitute for conventional currencies. It is possible that central banks could choose to develop their own cryptocurrencies with unknown consequences for legal money.

Cryptocurrency is a peer-to-peer version of electronic currency; the Bank for International Settlements (BIS 2015) offers a broad definition of cryptocurrency as a means of payment with the following characteristics:
- Electronic: Cryptocurrencies are stored and used in transactions digitally.
- Use of peer-to-peer (P2P) transactions: Cryptocurrencies can function like currency, in that any two people can transact directly with each other, but they differ from the typical electronic payments system, in which an intermediary financial institution facilitates the transaction.
- Not the liability of anyone: Cryptocurrencies are different from  all other paper or electronic money, which are obligations of the issuers. Conventional currency (also called “fiat currency”) is money issued and owed by a government or central bank, while deposits, which are often treated as money, are issued and owed by financial institutions. Note that gold, when viewed as a currency, and to some extent coins, does not represent a liability of anyone either.
There are hundreds of cryptocurrencies in circulation with different characteristics; digital coins, such as Bitcoin or Ethereum are an alternative currency free from the control of the central bank or government and guarantee high anonymity. They are issued with Initial Coin Offering – ICO; some cryptocurrencies are fully backed up by the U.S. dollar, and managed by financial operators, like BitCoin Cash and, in the coming future, Facebook Libra.
From a monetary point of view, cryptocurrencies are not considered as money since they are not legally accepted as means of payments; in fact, central banks do not guarantee cryptocurrencies, and trade can fail.
In December 2018 the owner of a Canadian based cryptocurrency portal (QuadrigaCX) died accidentally and the password to enter the platform were lost; all bitcoins stored in wallets by QuadrigaCX for an estimated amount of £145million have been lost and none could restore the system.
Cryptocurrencies can impact on the traditional financial system in various ways; first they can become larger and larger if investments can be denominated in cryptocurrencies, or they can substitute traditional financial and monetary means, by moving resources out of the traditional financial system.
Existing levels of cryptocurrencies are a fraction of the volume of major conventional currencies. The total estimated global value of the first ten most traded cryptocurrencies was $270 Billion in July 2019, after the peak of January 2018 at $800 (market capitalisation of cryptocurrencies is available at https://coinmarketcap.com/it/). World’s coins and banknotes amount to $7.6 trillion. Including checking accounts brings the figure to nearly $37 trillion, while adding in money market and savings accounts brings it to over $90 trillion.
There could be very large impacts on monetary policy if cryptocurrencies became a substitute for conventional currencies. The difference in scale becomes even bigger if cryptocurrency holdings used for non-monetary purposes are taken out.
According to Elliot et al. (2018) ‘in the immediate term, the biggest monetary policy challenges from cryptocurrencies would likely be for countries with exchange and capital controls’, like China. ‘This is because market participants could potentially bypass the need to purchase foreign currency through traditional payment systems, by using cryptocurrencies instead for capital transfers and foreign exchange transactions. This depends, of course, on whether, and how effectively, a government limits the ability to buy or redeem cryptocurrencies with their national currency’ (p.19).
The extreme price volatility they have experienced thus far represents a major barrier to their treatment by holders as a true currency. Volatility and risk are largely unknown, and Borri (2019) empirically verified that tail risk for cryptocurrency is high.
Central Banks, and their national governments, may also take further actions to limit adoption of cryptocurrencies, if they become large enough to threaten the dominance of legal currencies. Central bankers and treasury ministers at G20 summits have agreed on the need to identify common policies to manage digitalisation, artificial intelligence and restore trust. In the 2019 Osaka summit, leaders stated that “While crypto-assets do not pose a threat to global financial stability at this point, we are closely monitoring developments and remain vigilant to existing and emerging risks”. The leaders’ declaration adds to the joint statement by the G20 finance ministers and central bank governors at the end of their meeting in Fukuoka, Japan, on June 8 and 9 2019. The finance ministers and central bank governors specifically mentioned the risks from crypto assets relating to “consumer and investor protection, anti-money laundering (AML) and countering the financing of terrorism (CFT).”
According to Elliott et al (2018) ‘If cryptocurrencies become a much bigger factor on the world stage, they have the potential to create long-term challenges to monetary policy similar to some already experienced using conventional currencies. For example, economies that switch heavily from the use of their national currency to cryptocurrencies, either through government choice or households and businesses fleeing their unstable currency, would face issues similar to “dollarization.” Such economies would find price levels and interest rates to be determined more by external factors than by national fiscal and monetary policies’ (p. 19).
‘Similarly, if society loses faith in conventional money throughout the world, countries might face a situation similar to the gold standard era when the value of national currencies were fixed to gold. This would also be analogous to a global monetary union, with all their pluses and minuses, in addition to any purely cryptocurrency related issues. For instance, monetary policy could be simultaneously too loose for some countries and too tight for others, with a single policy having different effects in different nations’ (p.20).
It is possible that central banks could choose to develop their own cryptocurrencies, and some have considered it. Central banks cryptocurrency CBCC (BIS 2017) could spread in countries where cash is declining, like Sweden. This cryptocurrency could be ‘limited to financial institutions or it could be made widely available to the public. If limited to financial institutions, this would be similar to bank reserves, which are already electronic, but the underlying technology could enable peer-to-peer payment transactions and immediate settlement between banks’ (Elliott et al 2018, p.20). Central banks may eventually ‘have to decide whether issuing retail or wholesale CBCCs makes sense in their own context. In making this decision, central banks will have to consider not only consumer preferences for privacy and possible efficiency gains – in terms of payments, clearing and settlement – but also the risks it may entail for the financial system and the wider economy, as well as any implications for monetary policy. Some of the risks are currently hard to assess, like the cyber-resilience of CBCC’ (BIS 2017, p. 67).  Both the Bank of Canada and Singapore Monetary Authority have run pilot projects but concluded the technology is still too early to adopt.
Instead of limiting their own cryptocurrency to financial institutions, a central bank may choose to develop a universally accessible cryptocurrency with one-for-one convertibility with cash and reserves. This could provide new advantages to monetary policy, for example, greater visibility into monetary demand and the possibility of interest payments on the cryptocurrency (potentially including negative interest rates). However, many open questions remain, including whether it would be adopted (as some may express concerns around anonymity) and whether this would be too disruptive to the financial sector (as people may prefer to hold the central bank currency instead of holding bank deposits).

References
Bank for International Settlements (2015). Committee on Payments and Market Infrastructure. “Digital Currencies,” November 2015. https:/www.bis.org/cpmi/publ/d137.htm
Bank of International Settlements (2017). Central Bank Cryptocurrencies. BIS Quarterly Review, September 2017. https://www.bis.org/publ/qtrpdf/r_qt1709f.pdf
Borri Nicola (2019) Conditional Tail-Risk in Cryptocurrency Markets  https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3162038,