Central banks and digital currencies

3 November 2017

Bitcoin closed at a record above US$7,000 on 2 November, up from US$702 12 months ago, serving as a stern reminder that digital currencies are on the rise.1 The advances of private cryptocurrencies have made central banks increasingly contemplating adopting official cryptocurrencies themselves in part also not to lose out against the digital currency rivals. The BIS recently argued that the decision for central banks to offer digital alternatives to cash is complex and not only about consumer preferences and efficiency gains amid concerns for payments, financial system, stability and monetary policy.2 This follows of course many central banks interventions on the topic notably by the Bank of England as early as 2015.3 While lately the Bundesbank argued that digital currencies are a long way off and the Bank of Estonia had to retreat from earlier hints it may support a digital currency, the Riksbank interim report on its e-krona project seems to conclude that adoption is possible in the near future and the People’s Bank of China announced that it completed key tests of its own digital currency.4 Yet, although the advantages of digital currencies in national transactions remain somewhat controversial hindering and possibly blocking prompt adoption, the benefits are clear in international payments. The adoption of any digital currency therefore will likely be driven in large part by perceived opportunities to make it big as a global digital currency on the nexus between technology and payments.

Leading economic historian Barry Eichengreen lately stressed that central banks should be considering issuing digital currencies.5 His newest co-authored book “How global currencies work” traces the history of international currencies highlighting the importance of Britain as a leading foreign lender with the deepest financial markets during the nineteenth century and the size of financial markets of the U.S. that brought lasting dominance to the dollar during the twentieth century until today. The book does not mention digital currencies once. At the same time, the book underlines the importance of technological change to describe the advances of new global currencies. Low barriers of entry, low transaction costs, low information costs reduce adoption costs, first mover advantages are no longer so strong and network effects no longer so important. While earlier views were that network effects were so dominant effectively providing a natural monopoly to a single currency, technology has changed that: “Several international currencies can coexist and they can come and go.” 6 No currency will benefit more from technological change than digital currencies. Technology seems set to define global currency success.

Technology as a driver for global currency success has a long history. Famously, the originally Austrian Maria Theresien Taler became one of the most widely used coins throughout the world from the eighteenth through the twentieth centuries. While the period importance of Austria may have played a role, the coin remained prominent longer after Austria’s relative decline and after it lost legal tender status in Austria in 1858. The coin was minted by different mints throughout its history and until the 1960s with the same 1780 design. The coin thrived when money was not naturally limited to a given national territory. The Maria Theresien Taler’s success rested largely in its character as commodity money but also on its standard features that were hard to counterfeit amid its ornate design and lettering on the edge preventing undetected clippings making it a major trading currency that circulated in particular in China, India, the Middle East and Africa.7 New technologies to produce consistent and standardised coins were seen as critical also to allow widespread introduction of the gold standard during the nineteenth century as new minting technologies based on screw presses and steam increased significantly the cost of counterfeiting.8

Figure. Maria Theresien Taler 1780——First global currency

Maria Theresa Thaler

Source: Münze Österreich

Sweden in the not-too-distant future may become a near cash-less society the Riksbank predicts. In Sweden, the proportion of cash payments in the retail sector has fallen from about 40 percent in 2010 to about 15 percent in 2016. The Riksbank has therefore initiated a project in March 2017 to explore the outlines of “digital central bank money made available to the general public.” The e-krona is meant to be direct claim on the Riksbank and based on a central register complemented by a card based system. The Riksbank concludes that it would probably supply e-krona as it does supply bank notes and coins today. It sees the risk that currency digitalisation could be dominated by private entities that could lead to undue concentration and undermine the safety of the payment system and constrain the channels for supplying currency promptly in times of distress. The Riksbank therefore sees the possible launch of its own digital currency also as a counterweight to the threat of total privatisation of payments.

Estonia may launch its own digital currency.9. The proposal is intriguing as, unlike Sweden’s deliberations, Estonia, being a tiny economy of 1.3 million residents, focuses seemingly entirely on the international dimension of it a digital currency. Following introduction of an e-residency programme, where non-residents could conduct business in Estonia as if they were residents based on the notion of a “location-independent company” and “borderless digital nation” the proposal for Estcoins represents a mere extension. The broad-based though ambitious proposal wants Estcoins to be a vehicle towards offering a currency and payment infrastructure globally. The idea that a small digitally savvy country may indeed offer a currency to the global economy rests entirely on the importance of technology as a success factor.

China may well become the first country to issue a digital currency as legal tender. The proposal comes amid widespread adoption of digital payments and also proliferation and trading of cryptocurrencies in China. In January 2016, the PBOC announced that it aims to launch its own digital currency and in June 2017 opened its Digital Currency Institute.10 The PBOC stressed that “with the rapid development of the Internet and the significant changes in the global payment systems, it is necessary to establish the issuance and circulation system of digital currency.” China is believed here to see digitalisation and internationalisation of the renminbi as highly interdependent. The renminbi may view technology as a means to compensate for the advantages of existing global currencies.

Technological superiority rather than monetary policy may well become the main determinant of global currency adoption. Replacing cash with digital currencies as a simple substitution though not trivial seems straightforward and uncontroversial despite some lingering concerns. The spoils of a global currency are far greater. In international transactions, cutting edge technologies to facilitate international payments could become the definitive success factors substituting for the mere size of financial markets as success factors of the past. Technology offers a new level playing field and the adoption of certain technologies such as blockchains or other may be decisive to determine the scope for future currency uses and hence their attractiveness as they were for the success of the Maria Teheresien Taler and the gold standard before. Central banks therefore rightly see technology as a new opportunity to shake-up the advantages in global currency dominance.

1 Source: Coindesk.

2 Morten Linnemann Bech and Rodney Garratt, Central bank cryptocurrencies, Bank for International Settlements, 17 September 2017.

3 Bank of England, One bank research agenda, Discussion Paper, February 2015.

4 Carl-Ludwig Thiele, member of the Executive Board of the Deutsche Bundesbank, From Bitcoin to digital central bank money - still a long way to go, speech at the OMFIF roundtable discussion, London 20 September 2017.

Politico, interview with Ardo Hansson, 12 October 2017.

Riksbank, The Riksbank's e-krona project, report 1, September 2017.

China Daily, PBOC inches closer to digital currency, 14 October 2017.

5 CNBC, The Fintech Effect, interview with Barry Eichengreen, 30 October 2017.

6 Barry Eichengreen, Arnaud Mehl, Livia Chitu (2017), How global currencies work, Princeton University Press, Princeton, NJ, page 9.

7 Adrian Tschoegl (2001), Maria Theresa's Thaler: A case for international money, Eastern Economic Journal, vol. 27, pp. 443-462.

8 Angela Redish (1990), The evolution of the gold standard in England, Journal of Economic History, vol. 50, pp. 789-805.

9Kaspar Korjus, Estonia could offer 'estcoins' to e-residents', E-residency Blog, 22 August 2017.

10 Caixin Weekly, interview with Xiaochuan Zhou, 14 February 2016.