Is a crypto storm coming? Focus on digital money intensifies: report

Digital money, which was a curiosity only a few years ago, is emerging as a serious concern among central banks with the potential to erode the strength of monetary policy, and even in the best of worlds it is likely to make controlling interest rates more difficult, according to the new Federal Reserve and other research.

A New York Fed symposium this week outlined the conundrum central bankers face in dealing with emerging digital technologies that range from new ways of processing payments to new asset classes such as cryptocurrencies and stablecoins.

There are benefits emerging in the underlying technology, including better speed of transactions, lower cost, easier access to banking services, and even with the recent crashes and fluctuations, it is assumed that it will continue to advance.

By ignoring this, in other words, systems developed by start-up private companies can take larger shares of funding and make “central bank cash” less relevant — reducing central bank control over interest rates.

Create an alternative in the form of central bank digital currency, and new instability may emerge – including the possibility that the digital dollar or euro will replace traditional bank deposits and competition with money market funds and other major financial instruments.

In the event of a crisis, the process could mimic the flow of banks, leaving the system hungry for liquidity, and forcing the Federal Reserve, for example, to either increase lending to commercial banks or boost its own holdings of Treasuries and similar securities to maintain a stable system.

Banks that lose deposits must compete for new deposits and “depending on the severity of…the general level of short-term interest rates…could rise” As a result, this week’s Fed paper concluded the likely outcomes should the US adopt The central bank is a digital currency at the retail level, open to households.

“Retail central bank digital currencies could amplify financial sector stress, forcing the Fed to provide more liquidity to banks through existing tools… The Fed’s long-term footprint could become in certain asset markets, such as US Treasuries. , Clearer.”

The Federal Reserve is debating whether to develop a digital currency, as is the case with most central banks around the world. No decision has been made, and officials say it will require congressional approval to move forward.

The flash point may seem remote as the market capitalization of cryptocurrencies and stablecoins is still a small slice of the financial system. But payment processors, such as PayPal and Apple Pay, are growing rapidly, and at the beginning of this year it handled transactions on the scale of major credit card companies.

Among cryptocurrencies and stablecoins, noted at the New York conference, some of the arrangements include exotic lending schemes — credit creation — which, if expanded, could entail greater risks.

“What if the central bank no longer has relevant money either at the retail or wholesale level? In that case the central bank could start to lose momentum,” said Eswar Prasad, professor at Cornell University and author of a recent book, The Future of Money” on the topic came on the sidelines of the conference.

“In some countries it has become a problem today. China, India or increasingly Sweden – the use of central bank money for retail payments has fallen to basically nothing” as private payment providers stepped in.

The stakes are high

The implications of central bank digital currencies for monetary policy are just one part of a broader view by institutions like the Federal Reserve on how emerging technologies are changing the financial system.

As these technologies become more prominent, the implications for financial stability and risks for individual investors have become a higher priority for research and regulation.

In the United States, President Joe Biden, citing five-year growth in crypto assets from $14 billion to $3 trillion as of November, issued an executive order in March detailing the Treasury and other agencies to begin looking at how best to regulate the industry.

Given the risks, central banks around the world are quickly moving away from the sidelines.

A survey last month by the Bank for International Settlements of 81 central banks in countries that account for nearly all of the world’s economic output, found that more than 90% were exploring the idea of ​​a central bank digital currency.

More than a quarter are either actively developing a digital currency or running beta software, a share that nearly doubled from 2020 to 2021.

Survey respondents said the explosion of electronic payments as well as investing in cryptocurrencies during the pandemic is accelerating work, with nearly 60% of banks saying that the use of cash is declining.

Adoption may not necessarily be devastating.

In a presentation published to the Federal Reserve Conference in New York, Andrew Houser, Executive Director of Markets at the Bank of England, said that “while the technology for any central bank digital currencies in the future may be new…the use of the central bank’s balance sheet to provide funds is considered State-backed transactions…one of the oldest functions of central banks.”

But it may come quickly.

said Laurie Logan, executive vice president of the Federal Reserve Bank of New York who was recently appointed to chair the Dallas-Fed Board of Directors.

“How things develop from here is uncertain, and the impact of these innovations could be revolutionary or more evolutionary.”

(Except for the headline, this story has not been edited by the NDTV crew and is published from a syndicated feed.)