The role of cryptocurrencies in the evolution of money remains a valid debate which has lingered for the best part of the last decade. How the emergence of digital assets will affect the existing monetary system that is upheld by central banks is a subject that is attracting a lot of attention.
Cryptocurrencies represent digital means of transaction in which encryption techniques are used to regulate the generation of units of currency and verify the transfer of funds, operating independently of a central bank.
An Evolutionary Process
While central banks emerged to introduce a credit-based relationship between the central bank and citizens (in the case of cash) and between the central bank and commercial banks (in the case of reserves), crypto assets are introducing a different narrative to the concept of money. Rather than credit relationships, or entities of liability, crypto assets are a representation of a kind of commodity money.
Based on the intrinsic qualities of digital assets and the various solutions that they tend to offer to the fintech industry, Deputy Director of the IMF’s Monetary and Capital Markets Department, Dong He perceives that crypto assets may one day reduce demand for central bank money.
“As a medium of exchange, crypto assets have certain advantages. They offer much of the anonymity of cash while also allowing transactions at long distances, and the unit of transaction can potentially be more divisible. These properties make crypto assets especially attractive for micro payments in the new sharing and service-based digital economy.”
The Challenges of Cryptocurrencies
There have been criticisms about cryptocurrencies in their capacity to function as a dependable medium of exchange. According to He, for the time being, crypto assets are too volatile and too risky to pose much of a threat to fiat currencies. He also notes that they do not enjoy the same degree of trust that citizens have in fiat currencies. The lack of trust is related to the fact that they have been afflicted by notorious cases of fraud, security breaches, and operational failures and have been associated with illicit activities.
The situation is not hopeless for crypto assets as technological innovations and continuous development could go a long way in addressing the above mentioned deficiencies. Such is the more reason why He believes that central banks must learn from the underlying properties of these crypto assets in order to fend off the competitive pressure from crypto assets.
IMF Director: Banks Need to Step up
Apparently, the reality of the existence of cryptocurrencies and the solutions that they bring is becoming more acceptable. Rather than the fierce resistance and negative energy that existed between the cryptosphere and traditional institutions, there appears to be an increased level of acceptance between both sectors.
As noted by He, the onus now lies on the central banks to rise up and take steps that will enhance the effective coexistence of both sectors of the monetary ecosystem. This he says can be achieved by striving to make fiat currencies better and more stable units of account, while government authorities work to regulate the use of crypto assets. Finally, He suggests that central banks also need to make fiat currency more attractive for use as a settlement vehicle while considering the issuance of digital tokens of their own to supplement physical cash and bank reserves.