Since the interest in blockchain technology grows every day central banks are stepping up efforts to be a part of the disruptive technology. To date, quite a few sovereigns have been noodling with an actual digital currency, including Estonia and Venezuela, which have actually produced a digital currency (of sorts), along with the UK, Russia, China and Canada, which are studying the viability.
But will it work? As with most things in economics, yes and no. “[B]lockchain technology behind digital currencies has the potential to improve central banks’ payment and clearing operations,” write authors Max Raskin and David Yermack in a paper from the National Bureau of Economic Research. On the other hand, the authors note, central bank digital currencies could disrupt the banking system, squeezing out commercial banks, which would lead to curtailed lending and other bank products:
“If a central bank digital currency did narrow the banking system by transferring the deposit-taking function away from commercial banks and into the hands of the central bank, the dangers to the commercial banking sector could be severe. Commercial banks would lose access to their main source of funds and would either have to cut back on lending or raise new capital by issuing securities to investors. The new financing would probably be far more costly and less stable than demand deposits. As a result, commercial banks might greatly reduce their lending activity to both businesses and private citizens, such as for mortgage loans or commercial lines of credit.”
This would all lead to a contraction in credit and probably tank the economy, the authors speculate, although there could be benefits that could help in the long run. Another problem is that central banks issuing digital currencies would be both judge and jury of the monetary system. That is, they would compete with commercial banks but would also end up serving as those banks’ regulatory overseers.
“A central bank controlling and tracking a national digital currency would have immense power to observe and potentially to control an individual’s finances. The government could determine how much currency each individual owned and on what and where he spent his money, without the need for any independent judiciary to subpoena the information.”
Many people prefer to hold hard cash and in fact deal in it exclusively. If governments issued digital currency, there would be a lot of concern that digital currency “would create a dangerous temptation for abuse,” and create scenarios much like Margaret Atwood’s Handmaid’s Tale, which depicts a cashless society where all women’s access to money frozen by the push of a button.
In addition, central banks that issued digital currencies could “hyperinflate in a costless manner simply by adding more zeros to accounts,” which might be used to control certain segments or areas.
What’s more likely, the authors write, is that central banks will adapt blockchain technology to use in payments processing and transaction clearing. “Even though the original goal of digital currency blockchains was to facilitate peer-to-peer value transfers that could bypass the interbank clearing process, the technology may ironically find its widest use in allowing central banks to move money more reliably and more cheaply between their depositors.” At that point, a central bank’s digital money would become a form settlement currency, much like gold did in the past. Ultimately, central banks in most mature economies will choose whatever is safes and most efficient way of doing business in order to create confidence in the banking system.
“As a disruptive new technology, digital currency forces governments and central banks to choose between banning, tolerating, or co-opting its innovations,” the authors write. “In most mature economies, central banks have taken the middle course, with a few openly examining the possibility of incorporating sovereign digital currencies into their operations.”