By JP Schnapper-Casteras and Misha Guttentag
This season’s steep decline in the price of bitcoin and other digital assets has rekindled a fierce debate about their role in the global economy: opponents lambast them as a Ponzi scheme about-to-collapse and proponents promise they will replace government currencies entirely. The reality is that, at least in the short term, both extremes are highly unlikely, and policymakers, especially central bankers, are charting a course in between that recognizes that some form of digital money is here to stay. Notably absent from many of these discussions, however, is the biggest Central Bank in the world: the Federal Reserve.
After a year when bitcoin’s price dropped over 75%, this might seem to be a counterintuitive moment for these conversations — but they are already subtly starting. Just the other day, the Governor of the Bank of England, Mark Carney, expressed a remarkable openness towards digital money. “It is still early days for cryptoassets,” Carney explained, and despite their present shortcomings, they are “throwing down the gauntlet to the existing payment systems” to improve services. Last month too, the Managing Director of the International Monetary Fund, Christine Lagarde, made the case for central banks to explore, adopt, and issue digital currencies, because a “new wind is blowing” “and we are all in the process of adapting.”
Carney and Lagarde’s middle-ground approach stands in stark contrast with caustic criticism from some of their colleagues: two days after her speech, a member of the European Central Bank vilified bitcoin as “evil spawn of the financial crisis” and previously, an official at the Bank for International Settlements deplored it as “a combination of a bubble, a Ponzi scheme and an environmental disaster.”
Such categorical dismissals are belied by the growing recognition that digital money like bitcoin may offer a variety of advantages, including in terms of security, transferability, transparency, and inflation resistance. As Lagarde suggested, central banks could choose to issue their own digital currencies that compete with bitcoin in terms of monetary policy, payment privacy, or other features.
Although it may appear premature to imagine central banks managing a digital money alongside traditional reserve assets, the possibility is real enough for central banks to take it seriously, and several are. A major survey released last week reported that some 70% of central banks are engaged in work around digital currencies, and half have moved onto “hands on” proof-of-concept activities and other research. The Bank of Canada also quietly published a research paper examining how central banks might operate under a “bitcoin standard” similar to the gold standard of the late 19th century. The paper explained that a bitcoin standard would not mean the end of government money or central banks — but that backing national currencies with bitcoin reserves could offer several major benefits over current international monetary standards, due to the stability presented by bitcoin’s algorithmically-fixed inflation rate. The European Central Bank, Bank of Japan, and Reserve Bank of India are closely studying digital money as well.
Similarly, the U.S. Federal Reserve should formally explore the potential impact of digital money on U.S. economic interests. Although the current and prior Fed Chairs have been publicly tepid on the subject area thus far, Fed branches are engaging more straightforwardly. The other week, the Federal Reserve’s St. Louis branch suggested that a cryptocurrency might “eliminate” the core tension for the the U.S. dollar: being asked to function both as a stable global reserve currency while also meeting domestic needs (known as the Triffin dilemma). As a New York Times op-ed recently noted, the U.S. dollar’s position as the world’s reserve currency gives the United States a unique opportunity to lead — or stand to lose if other countries leave it behind.
The bottom line is that categorically dismissing bitcoin and other digital assets as irrelevant or “evil” for central banking purposes is increasingly out of step with the trends and tools at hand, not to mention widespread appetite for a potentially faster, fairer financial system. (Why does sending a check take 4 business days to clear, again?). The U.S. Federal Reserve should join its counterparts and start preparing its financial infrastructure for a fast-approaching new reality: where nation-backed moneys compete and co-exist alongside digital moneys settled with distributed ledgers, electricity, and math-driven consensus.