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Is there a crypto storm brewing for central banks? The focus on digital money is becoming more intense

Image: Reuters Berita 24 English - According to new Federal Reserve and other research, digital money , which was a novelty only a few years...

Image: Reuters

Berita 24 English - According to new Federal Reserve and other research, digital money, which was a novelty only a few years ago, is now a major source of concern among central banks, with the potential to weaken monetary policy's efficacy and, even in the best-case scenario, make interest rate control more difficult.

The conundrum that central bankers face in dealing with evolving digital technologies, which vary from new ways to process payments to new asset categories like cryptocurrencies and stablecoins, was put out at a New York Fed symposium this week.

The underlying technology offers advantages like as faster transaction speeds, reduced costs, and quicker access to banking services, and despite recent collapses and volatility, it is expected to continue to improve. Ignore it, and upstart private businesses' systems could acquire a larger part of finance, making "central bank currency" less relevant and weakening central bank authority over interest rates.

Create a substitute in the form of a central bank digital currency, and new instabilities could emerge, such as the possibility of a digital dollar or euro replacing traditional bank deposits and competing with money market funds and other critical financial products. In a crisis, the process might resemble a bank run, leaving the system cash-strapped and forcing the Fed, for example, to either increase lending to commercial banks or increase its own holdings of Treasury bonds and other assets to keep the system stable.

Banks losing deposits would have to compete for new ones, and "depending on the intensity...the general level of short-term interest rates...could rise" as a result, according to a Fed paper released this week outlining possible outcomes if the US central bank adopts a digital currency for use by individuals. "A retail CBDC might exacerbate financial sector stress, prompting the Federal Reserve to use existing measures to provide additional liquidity to banks...The Federal Reserve's longer-term footprint in certain asset markets, such as U.S. Treasuries, could become more evident."

The Fed, like most central banks throughout the world, is pondering whether to launch a digital currency A decision has not been made, and authorities stress that moving forward would require congressional approval.

Because the market value of cryptocurrencies and stablecoins is still a small part of the financial system, the point of stress may appear far away. However, payment processors like PayPal and Apple Pay are rapidly expanding, and at the start of this year, they were handling transactions on par with big credit card firms. Some of the arrangements using cryptocurrencies and stablecoins, according to the New York conference, involve exotic lending methods - credit creation - that, if expanded, could imply greater dangers.

"What happens if the central bank runs out of money that is relevant at both the retail and wholesale levels? In that event, according to Eswar Prasad, a Cornell University professor and author of the recent book "The Future of Money," the central bank's monetary policy "may start losing traction." "On the sidelines of the conference, he commented on the subject.

"It is currently a problem in various countries. The usage of central bank money in retail payments has virtually disappeared in China, India, and Sweden "as a result of private payment companies stepping in.


The implications of central bank digital currencies for monetary policy are just one aspect of the Fed's larger examination of how emerging technologies may alter the financial system. The implications for financial stability and the hazards posed to individual investors have been a bigger concern for research and regulation as such technologies have become more prevalent.

In the United States, President Joe Biden issued an executive order in March directing the Treasury and other agencies to begin investigating how best to regulate the business, noting a five-year increase in crypto assets from $14 billion to $3 trillion as of November.

Given the stakes, central banks all across the world are stepping up to the plate.

A recent poll by the Bank for International Settlements of 81 central banks from nations that account for virtually all global economic output indicated that more than 90% were considering a central bank digital currency.

More than a quarter are actively developing a digital currency or operating test programs, up from nearly a quarter in 2020 to over a quarter in 2021. During the epidemic, the rise of electronic payments as well as crypto investment has accelerated the work, according to respondents, with over 60% of banks claiming that cash usage is declining.

Adoption does not have to be disruptive.

"While the technology for any future CBDC may be new...the use of the central bank balance sheet to provide state-backed transactional one of the oldest functions of central banks," Andrew Hauser, executive director for markets at the Bank of England, said in a published presentation to the New York Fed conference.

However, it is possible that it will arrive quickly.

"Innovation in money and payments has the potential to transform the existing...monetary system on which present monetary policy implementation frameworks are constructed," said Lorie Logan, the New York Fed's executive vice president who was recently appointed to lead the Dallas Fed. "It's unclear where things will go from here, and the impact of these developments might be revolutionary or evolutionary."

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