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Cashless: Is Digital Currency the Future of Finance?

If the U.S. wants to future-proof banking, then a digital dollar could be a solution.

April 17, 2024

Finance experts like Darrell Duffie see digital currency as an inevitability. “It’s hard to imagine that 100 years from now, people will be reaching into their pockets and pulling out grubby bits of paper,” he says.

As the Adams Distinguished Professor of Management and Professor of Finance at Stanford Graduate School of Business, Duffie ’s research centers on banking, financial market infrastructure, and fintech payments. And with digitization already transforming the way money moves around the world, Duffie is particularly interested in how digital currency, whether developed privately or issued by governments, promises to revolutionize finance even further. In this episode of If/Then: Business, Leadership, Society , he explores how it could even expand economic opportunity for people left out of the current financial system.

Duffie’s research has tracked countries’ development and rollout of central bank digital currencies (CBDCs). In contrast to cryptocurrencies like Bitcoin, a CBDC is backed by a central bank and is essentially a digital version of a country’s fiat currency. “Virtually all countries are exploring a central bank digital currency for potential use,” he says, and some, like China and the Bahamas, have already implemented them. This shift, Duffie believes, could offer significant benefits over the current financial system by sidestepping the high fees and inefficient timelines associated with moving money, particularly across borders.

Duffie notes that a well-designed CBDC could also address the issue of financial inclusion. “Millions of Americans do not have a bank account. They’re off the grid in terms of payments,” he says. “Maybe this technology would allow many underprivileged Americans to get access to the payment system.”

Despite the political challenges of transitioning away from traditional currencies, Duffie believes digital currencies are on the horizon. The challenge, he says, is striking the right regulatory balance between fostering innovation and mitigating risks. As this episode of If/Then explores, if the U.S. wants to future-proof banking, then a digital dollar could be a solution.

Senior Editor, Stanford GSB

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If/Then is a podcast from Stanford Graduate School of Business that examines research findings that can help us navigate the complex issues we face in business, leadership, and society. Each episode features an interview with a Stanford GSB faculty member.

Full Transcript

Note: Transcripts are generated by machine and lightly edited by humans. They may contain errors.

Kevin Cool: If the U.S. wants to future-proof banking, then a digital dollar could be the solution.

Dawn Sands: You travel to the states, you hear your friends or family members talking about various wallets. These Venmos, these cash apps that they use and transfer money, and you’re like, oh, okay. And then you hear a sand dollar and you’re like, okay, now The Bahamas is catching up.

Kevin Cool: Dawn Sands owns a restaurant in Nassau called NRG Nutrition ready to go in 2020. She was one of the first businesses to start using the country’s new digital currency. That’s a way of paying for transactions electronically, a little like Bitcoin, but backed by the country’s central bank in The Bahamas. It’s called the sand dollar.

Dawn Sands: I did not operate in the cryptocurrency space whatsoever. In the beginning. I was very confused about that. I was more trying to understand the technology behind it. It was a blockchain for me, the sand dollar, it just took a shape and form in my brain. Just the way I hold my credit card. I’ll hold my phone as a wallet and my money is boxed by the Central Bank.

Kevin Cool: Dawn has a good reason to want an alternative to conventional banking.

Dawn Sands: I don’t know if it’s the same where you’re from, but in The Bahamas, banking is a challenge from opening. An account can take you days, and when I say days, you can sit at the bank for literally six to eight hours and then get an account number days from there. My money sits in the bank and my bank is always being hacked. Yeah, my bank account was just hacked the other day. It got hit $4,000 and I’m still waiting to be paid.

Kevin Cool: Her frustrations with banks make her excited about the sand dollars benefits.

Dawn Sands: For example, if you’re going to allow me to receive a sand dollar, I don’t have to pay a fee. Literally, there’s a bank over here that charges $5 for every a hundred I think it is that you deposit. If I can use more than I can deposit less of the bank, I guess that’s what the future is going to look like. If we continue on the path.

Kevin Cool: The United States isn’t getting its own digital currency anytime soon, but its proponents say it will come with many consumer benefits. If it does, it’s already a reality in 11 countries, including China and 130 countries are exploring it. What do these developments mean for the future of banking and finance? Will the U.S. dollar keep its status as the world’s standard if it lags behind on a digital currency? This is if then a podcast from Stanford Graduate School of Business where we examine research findings that can help us navigate the complex issues facing us in business, leadership, and society. I’m Kevin. Cool. Senior editor at the GSB. Today we speak with finance professor Daryl Duffy.

Darrell Duffie: It’s hard to imagine that a hundred years from now, people will be reaching into their pockets and pulling out grubby bits of paper.

Kevin Cool: The focus this episode, if the U.S. wants to future-proof banking than a digital dollar, could be the solution. What do we mean, first of all by a digital currency? How do we differentiate that, say from Bitcoin?

Darrell Duffie: So Bitcoin, because it’s expensive and takes time to use for making payments, it’s not really a very good form of money for making payments, and most importantly, if I promise to pay you for whatever, a cup of coffee or a new car, the money that I send may be worth less than what we agreed by the time it gets to you, because Bitcoin is moving around a lot.

Kevin Cool: It’s a lot of volatility. Yeah.

Darrell Duffie: Price volatility is very high. It’s not that reliable. We, for many years will probably continue to just use our bank accounts for those things, but people are now talking about going to a new world of central bank digital currency or what’s sometimes called a digital dollar. What does that mean? First of all, it means that instead of paying money out of your own bank account at wherever you bank Chase or Wells Fargo, you’ll be paying money out of your account with the Fed, the Federal Reserve Bank. That basically is the central bank for the United States.

Kevin Cool: Let me just clarify. When you say you would be paying from your account, I don’t have an account with the Federal Reserve right now. How would that work?

Darrell Duffie: Well, you don’t have an account at the Federal Reserve now because we don’t have digital dollars right now. The only actors in our economy that have accounts at the Federal Reserve are large financial institutions. Now, we’re not going to knock on the door of the Federal Reserve Bank of San Francisco and ask them for an account. They’re going to delegate that operational side to a commercial bank or to another payment service provider like PayPal or somebody else. So we’ll call Wells Fargo or PayPal and say, would you provide us with some digital dollars that you’ll hold on our behalf at the Fed?

Kevin Cool: What advantage would there be to having a digital dollar rather than just having my bank account at Wells Fargo where I have dollars that I can access digitally?

Darrell Duffie: Well, the question you asked has been the central question under debate for the last five years or so in the us, but there are advantages and disadvantages. Let’s run through a few of them. The Fed doesn’t go bankrupt as opposed to some banks.

Kevin Cool: I certainly hope not.

Darrell Duffie: Well, Silicon Valley Bank went bankrupt, and if you had your account at Silicon Valley Bank rather than at the Fed, you might’ve lost money. Another reason might be that the digital dollar be built on a blockchain like Bitcoin that would allow you to buy things automatically and not fear that you wouldn’t get what you bought. For example, if you were to buy Euros with your digital dollars, doing it on a blockchain means that code software can guarantee that you will receive your Euros if your dollars are taken, as opposed to the current world in which your dollars go somewhere and maybe the Euros that you bought don’t come back to you. Currently, banks are not providing a service that guarantees those payments.

Kevin Cool: What are the impediments? Is it a philosophical policy difference that would be getting in the way here, or what would be the impediments for the United States to do this right away or in the short term?

Darrell Duffie: I think there are two major impediments. Both are partly political. One of them is the concern about privacy. There’s a suspicion by some that if your money is held on account at the Fed rather than your commercial bank, that you will lose privacy over your payments. It’ll be a so-called Big brother situation in which the government could it’s suggested spy on your payments and take advantage of that information to your detriment

Kevin Cool: Because the government has visibility now into essentially all of your transactions, right?

Darrell Duffie: Well, today, they’re not supposed to get access to your transactions unless you’re doing something suspicious, and in that case, your bank is supposed to report you. Last year there were 4 million of those suspicious activity reports or SARS sent to the government by banks. Now, a small fraction of those were actually illegal payments, but the government already has access whenever there’s some potential for a suspicious payment. It’s suggested that by some, not me actually, that if there were a digital dollar, the situation would be much worse because instead of asking banks to send that information, the government supposedly would have direct access to it. There’s a misconception there. First, it’s not necessary that that technology provides information to the government that it couldn’t already get, and secondly, the way that U.S. politics work, the Fed would almost certainly need to guarantee that it couldn’t access all of your payment information or give it to the government, which is a different proposition. So there is a reason to be concerned about privacy, but that’s one of the reasons that Central Bank digital currencies in some countries are going to be delayed until people are confident.

Kevin Cool: So would you say this is inevitable at some point, or not necessarily?

Darrell Duffie: It’s hard to imagine that a hundred years from now people will be reaching into their pockets and pulling out grubby bits of paper.

Kevin Cool: Well, I hope pennies at least are gone by then. Don’t give me to start it on pennies.

Darrell Duffie: I imagine eventually we’ll be using digital dollars and not using paper money to the extent that we use any government currency.

Kevin Cool: Why don’t you just give us sort of a lay of the land in terms of what countries are doing this, how far along are they and so on.

Darrell Duffie: Virtually all countries are exploring a central bank digital currency for potential use. Some of them have gotten to the point where they’ve actually developed or in the course of developing the technology, which is not easy. Some of them have gotten further to the point of piloting a central bank digital currency, and some very few have actually released a central bank digital currency for general use. Like Bahamas is one example, but Bahamas is a small country, and even in Bahamas, a small fraction of money is held in the form of their digital currency, which is called the sand dollar

Kevin Cool: Appropriately.

Darrell Duffie: The largest country that’s well along the way with a central bank digital currency is China. In around 2020, China began piloting a major piloting of its central bank digital currency. It’s only a fraction of 1% of the total amount of money issued by the central bank. Most of it is in paper form. People in China already had access to a really whizzbang electronic payment systems, the two most popular of which are called Alipay and WeChat Pay, which are private sector payment systems put up by two of their largest tech companies. It would be as though Amazon or Google or Facebook or Microsoft were to make available digital payment accounts to everyone and allow you to pay into and out of those accounts. You can imagine that would be quite a powerful option in the United States as well. But in China, those two payment systems account for more than 90% of urban payments.

Kevin Cool: Now, the dollar historically has been essentially the reserve standard for global business. Is the fact that the Chinese government is pursuing this, an effort to encroach on the dollar as that standard.

Darrell Duffie: That’s the central question of a report that I worked on as part of a large committee of experts a few years ago. China’s new central bank digital currency does not threaten the dominance of the U.S. dollar as you described it. It remains and will remain for decades. The go-to currency for international finance, whether it’s central banks holding dollars in their foreign exchange reserves or it’s banks making cross-border payments to each other or invoicing for goods and services or in the foreign exchange market, trading one currency for another, the dollar is by far and away dominant and will remain dominant for decades.

Kevin Cool: For decades. You are listening to if then a podcast from Stanford Graduate School of Business will continue our conversation after the break. The broader experience with cryptocurrency is quite volatile, obviously. I mean, we just saw the whole implosion with FTX and there’ve been other bad actors in this space. What have we learned about cryptocurrency at this point, about its effects on society, its potential advantages in the future? What are we supposed to think about cryptocurrency right now?

Darrell Duffie: It’s very early stages, Kevin. It’s kind of like the Wild West or the beginning of the.com era where the potential is great, but it’s a bit unruly. The U.S. government is lagging relative to other countries and setting out the rules for cryptocurrencies and digital assets more generally. And until those rules are laid down pretty clearly, you can expect a very bumpy ride. In terms of adherence to the law or what is the law, the questions about what is the law that is, you can expect lots of litigation, you can expect some collapses like the ones that we’ve seen, and FTX was only the most spectacular example, but there have been many others. What we should be thinking about is what are the applications of this new technology that could help Americans or people generally, and how can those be safeguarded? How can we avoid losing those opportunities either by failing to regulate or by overregulating?

It’s a balance, but consider the opportunities. Like I mentioned earlier, if you can make payments on a blockchain, you can assure the safety of payments. You can arrange for payments automatically without fear. If the software is reliable, you could potentially provide payments much more broadly in the economy. That issue is called financial inclusion. The United States suffers from millions of Americans who do not have a bank account. They’re off the grid in terms of payments. Maybe this technology would allow many underprivileged Americans to get access to the payment system. Right now, if you’re, let’s say making a remittance, you’re taking a huge loss off the top where the remittance company will hack off whatever, six, 8% to send your money to your family and wherever it is, Philippines, Mexico,

Kevin Cool: Because you don’t have a bank account,

Darrell Duffie: Because you don’t have a bank account or because you’re afraid of your bank, or maybe you don’t want somebody to know that you’re making a payment. So I mentioned there’s a balance. You want the government to be able to stop illegal payments. You want the government to protect you from payment service providers that would take advantage of you. You want the government to be making sure that your money is safe and your payments will go safely to their destination, and at the same time, you don’t want the government to get unduly involved in your private affairs. U.S. government is grappling with these issues right now. There have been a number of acts floated in Congress draft bills that have not yet passed. Europe has moved ahead with its regulatory framework for this. So has the United Kingdom, Hong Kong, Singapore, a number of other countries around the world are moving ahead to provide a path for entrepreneurs to develop these technologies safely and in the knowledge that their capital will not get wiped out by an unexpected change in regulation or the explosion of a piece of infrastructure because it wasn’t properly regulated and the ability to make cross-border payments, which I don’t know if you’ve tried it lately, Kevin, but for me, it’s a nightmare trying to get or make a cross-border payment of one currency for another these days.

A very expensive, very slow, very mistake prone. The technologies we’re discussing could address that and doesn’t need to be a digital dollar in the sense of a government money. It could be some bright entrepreneur that finds a way to do it in the private sector. Now, digital dollar is another approach, and we’ll see whether that turns out to be the winning approach

Kevin Cool: For all the attention they’ve gotten. As an alternative to government backed money, Bitcoin and other cryptocurrencies are not a useful way to buy and sell goods and services, but the blockchain technology behind them has opened the door for a digital currency that’s more versatile and more secure than traditional money. As Daryl Duffy says, the days of pulling out grubby bits of paper to pay for something are numbered when or if the United States introduces a digital dollar, its possibility could bring about the innovation the banking system needs. If that doesn’t happen, the rest of the world may race ahead.

If/Then is produced by Jesse Baker and Eric Nuzum of Magnificent Noise for Stanford Graduate School of Business. Our show is produced by Jim Colgan and Julia Natt. Mixing and sound design by Kristin Mueller. From Stanford GSB: Jenny Luna, Sorel Husbands Denholtz, and Elizabeth Wyleczuk-Stern. If you enjoyed this conversation, we’d appreciate you sharing this with others who might be interested and hope you’ll try some of the other episodes in this series. For more on our professors and their research or to discover more podcasts coming out of Stanford GSB visit our website at gsb.stanford.edu. Find more on our YouTube channel. You can follow us on social media @StanfordGSB. I’m Kevin Cool.

For media inquiries, visit the Newsroom .

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• Cryptocurrency

Digital Currency: The Future Of Your Money

Updated: May 13, 2024, 2:22pm

Digital currency has the potential to completely change how society thinks about money. The rise of Bitcoin (BTC), Ethereum (ETH) and thousands of other cryptocurrencies that exist only in electronic form has led global central banks to research how national digital currencies might work.

What Is Digital Currency?

Digital currency is any currency that’s available exclusively in electronic form. Electronic versions of currency already dominate most countries’ financial systems. What differentiates digital currency from the electronic currency that’s already in Americans’ bank accounts is that digital currency never takes physical form.

You can go to an ATM right now and easily transform the electronic record of your currency holdings into physical dollars. Digital currency, however, never leaves a computer network, and it is exchanged exclusively via digital means.

There are three main varieties of digital currency: cryptocurrency, stablecoins and central bank digital currency, known as CBDCs.

Blockchain technology, which provides the foundation for cryptocurrency, is the most common form of distributed ledger used by digital currencies. According to CoinMarketCap, there are more than 9,000 cryptocurrencies available.

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What Is a Central Bank Digital Currency (CBDC)?

A central bank digital currency is a digital currency that is issued and overseen by a country’s central bank. Think of it like Bitcoin, but if Bitcoin were managed by the Federal Reserve and had the full backing of the U.S. government.

More than 100 countries are exploring CBDCs at one level or another, according to the IMF. But as of 2022, only a handful of countries and territories have CBDC or have concrete plans to issue them.

Some places CBDC is already available include the Central Bank of The Bahamas (Sand Dollar), the Eastern Caribbean Central Bank (DCash), the Central Bank of Nigeria (e-Naira) and the Bank of Jamaica (JamDex), to name just a few.

The Federal Reserve issued a report earlier this year that “a CBDC could fundamentally change the structure of the U.S. financial system.

Currently, the Federal Reserve Bank of Boston and the Massachusetts Institute of Technology’s Digital Currency Initiative are jointly conducting research into a CBDC through Project Hamilton. They describe it as a “multiyear research project to explore the CBDC design space and gain a hands-on understanding of a CBDC’s technical challenges and opportunities.”

Despite the joint venture, the Fed has still not indicated that they are in any hurry to launch a CBDC.

“The Fed will probably not launch a CBDC except under the explicit authority of Congress,” says Jonathan Dharmapalan, CEO and founder of eCurrency. “The law has to support the existence of a digital dollar just like the law supports the existence of a physical dollar.”

How Would a CBDC Work?

While the U.S. CBDC may be far off, Jim Cunha, executive vice president and interim chief administrative officer, shared how a CBDC or a digital dollar might work in the U.S.

CBDC would function similarly to actual cash. “If I gave you CBDC, it’s as if I’m handing you physical money, like a $100 bill. You’d have that money in your account and, it’s yours. I couldn’t take it back,” Cunha said.

This is a key difference from other electronic payments, such as ACH transfers or PayPal.

“If I send you money through PayPal, it’s just a promise that money is coming. Your balance may show the funds, but money hasn’t actually moved between banks yet,” according to Cunha.

Because of that, the transactions are not irrevocable, and the other party can reverse them. There are 60 days when an ACH transfer can be potentially unwound. With transfers through CBDC, the funds would be sent close to instantly and the other party couldn’t cancel after.

Another key advantage of CBDC is that it could be deemed legal tender. That means all economic actors must accept it for any legal purposes. You can pay your taxes with it, and anyone lends you money is legally required to accept it for repayment.

This contrasts with other digital currencies, which are not legal tender in the U.S. Only certain vendors accept crypto directly, so people may need to convert their cryptocurrency into U.S. dollars before making most transactions.

When you use crypto as a form of payment, you also create a taxable event , which means you may owe capital gains taxes each time you purchase something with Bitcoin or Ethereum’s Ether token. This is in addition to any sales taxes. With CBDC, you would only owe any applicable sales tax, just like using a physical currency.

How Have Digital Currencies Worked Around the World?

Despite the potential benefits of a U.S. CBDC, it remains a concept for now. Around the world, other countries are a little further along with digital currencies.

According to the Atlantic Council’s GeoEconomics Center’s Central Bank Digital Currency (CBDC) Tracker, 10 countries have fully launched a digital currency, and China is on course to expand from its pilot CBDC in 2023.

China’s digital yuan, one of the largest CBDC programs, launched its pilot project in 2014.

“They are testing a pilot in five cities. They gave out millions in currency through lotteries just to prove it works,” according to Cunha. People who win the lottery receive free CBDC, which they can spend at local shops that accept it.

While it’s not at a national scale yet, once China has the platform ready, it will expand through banks and mobile providers like Alipay.

The central banks of China and the United Arab Emirates are also working on a project to use blockchain and CBDC for regional payments between nations. If these projects are a success, they could give more motivation to other nations to create their own CBDC.

Because of these trends, Lilya Tessler, head of Sidley’s FinTech and Blockchain group, is optimistic about the future use of digital currencies. “We certainly will see mass adoption of digital currencies, but it is difficult to predict how it will look. CBDC may replace the paper version of the U.S. dollar. At the same time, society may focus on mainstream adoption of a decentralized cryptocurrency.”

How Would Digital Currency Affect You?

If the U.S. adopts a digital currency, it would work as an alternative to cash but would also have the built-in advantage of quick money transfer since it’s electronic.

Cunha has a few ideas on what this would look like for consumers. “Our presumption is that it will be free or near free, like cash. Other private sector players may innovate on top of it and possibly additional fees, but that has to be fleshed out more,” he says.

Even though a digital currency would be electronic, it still needs to be as accessible as cash.

“Anyone should be able to use it, not just those with the latest smartphones,” Cunha said, suggesting chip-based cards, point-of-sale systems and web accounts as alternative ways to access the CBDC. He also believes a way to handle transactions offline will need to be developed, so two people can exchange CBDC even if they aren’t on a cell or WiFi network.

There’s a lot to be done and a lot of industry input needed, but it could be well worth the investment.

“While no decision has been made to move past this research, I truly believe CBDC should be fully investigated and holds great potential,” he said. “Just think of the internet and how far it’s come since the early days. With CBDC, the possibilities are endless.”

Benefits of Digital Currency

• Faster payments. Using digital currency, you can complete payments much faster than current means, like ACH or wire transfers, which can take days for financial institutions to confirm a transaction.
• Cheaper international transfers. International currency transactions are very expensive. Individuals are charged high fees to move funds from one country to another, especially when it involves currency conversions. Digital assets could disrupt this market by making it faster and less costly.
• 24/7 access. Existing money transfers often take more time during weekends and outside normal business hours because banks are closed and can’t confirm transactions. With digital currency, transactions work at the same speed 24 hours a day, seven days a week.
• Support for the unbanked and underbanked. More than 7 million American households do not have a bank account, according to the FDIC in a 2019 survey. They end up paying costly fees to cash their paychecks and send payments to others through money orders or remittances. If the country launched a CBDC, unbanked individuals could access their money and pay their bills without extra charges.
• More efficient government payments. If the government developed a CBDC, it could send payments like tax refunds, child benefits and food stamps to people instantly, rather than trying to mail them a check or figure out prepaid debit cards.

Disadvantages of Digital Currency

• Too many options. The current popularity of cryptocurrency is a downside. “There are so many digital currencies being created across different blockchains that all have their own limitations. It will take time to determine which digital currencies may be appropriate for certain use cases, including whether some are designed to scale for mass adoption,” Tessler says.
• Steep learning curve. Digital currencies require work on the part of the user to learn how to perform fundamental tasks, like how to open a digital wallet and properly store digital assets securely. The system needs to get simpler for digital currencies to be more widely adopted.
• Expensive transaction. Cryptocurrencies use blockchain, where computers must solve complex equations to verify and record transactions. This takes considerable electricity and gets more expensive as there are more transactions. However, this would probably not exist for CBDC since the central bank would likely control it and complex consensus processes are not needed.
• Price volatility. Cryptocurrency prices and values can change suddenly. Cunha believes this is why businesses are reluctant to use it as a medium of exchange. “As a business, do I want to accept something volatile? What if I hold a Bitcoin for a week and it loses 20% of its value?” With CBDC, though, the value is much stabler, like paper currency, and cannot fluctuate like this.
• Slow progress. A U.S. CBDC is still hypothetical, and if the government decides to create one, there will be costs associated with its development.

How to Invest in CBDC?

CBDCs are no different than an issuing nation’s existing monetary supply. This means the only way to invest in a CBDC is to hold the currency in your account. In other words, investing in CBDCs is just like holding a nation’s physical cash in your hand today.

However, right now, foreign nationals can’t hold the CBDCs of any other government in their digital wallets. In other words, a U.S. citizen can’t currently access Bahaman “sand dollars.”

You need a verified username and bank account to hold a CBDC from any nation today, you need a verified username and bank account. This means citizens of different countries can’t have a foreign nation’s CBDC distributed to them. Most experts believe, though, that this will change as more CBDCs are implemented worldwide.

Digital Currency FAQs

What’s the difference between cryptocurrency and digital currency.

Cryptocurrency is a form of decentralized digital currency. The reason it’s referred to as a “crypto” currency is that it requires cryptography rather than a central authority to manage its ledgers and balances since the currency is decentralized. Today, the most common form of ledger system for cryptocurrencies to use is blockchain technology.

Digital currency, on the other hand, is any form of currency that exists solely in digital form.

How many types of digital currency are there?

There are three types of digital currency: cryptocurrency, stablecoins and CBDCs.

Cryptocurrency is a form of decentralized digital currency that isn’t pegged to any fiat currency. It uses cryptography to manage its ledger systems, and the market determines its value. Bitcoin was the first cryptocurrency.

Stablecoins are similar to cryptocurrencies; some experts even consider them a subset of cryptocurrency. They have no central authority to keep track of their ledgers. However, the major difference between stablecoins and cryptocurrencies is that stablecoins are usually pegged to a fiat currency.

On the other hand, CBDCs are a form of digital currency issued by a nation’s central bank. This makes them a form of digital currency controlled by a central authority. Governments issue them, and the particular nation’s monetary policy sets their value.

How do you buy digital currency?

You can buy most digital currencies (cryptocurrencies and stablecoins) on the world’s existing crypto exchanges. However, not all exchanges offer every cryptocurrency. So you’ll want to research the exchange to ensure it offers the currency you’re interested in.

As far as CBDCs go, those are currently only available to residents of the countries where the specific CBDC is offered. In other words, only citizens of the Bahamas can access that nation’s sand dollar, and only Chinese citizens can access the digital yuan.

Cryptocurrencies are highly volatile investments. It’s recommended that investors speak with a financial professional before committing their money to these or any other asset classes.

How to create digital currency?

CBDCs can only be authorized and created by the world’s governments. A central bank must issue them with the full backing of that government’s treasury. Private individuals and corporations cannot create CBDCs.

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David Rodeck specializes in making insurance, investing, and financial planning understandable for readers. He has written for publications like AARP and Forbes Advisor, as well as major corporations like Fidelity and Prudential. Before writing full time, David was a financial advisor. That added a layer of expertise to his work that other writers cannot match.

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The Crypto Question: Bitcoin, Digital Dollars, and the Future of Money

• Since the creation of bitcoin in 2009, cryptocurrencies have exploded in popularity and are today collectively worth more than $1 trillion.
• Critics say a lack of oversight has contributed to volatility in the nascent industry, but regulators have begun to catch up.
• M eanwhile, many governments are seeking to capitalize on the technology that powers cryptocurrencies by investing in their own digital currencies.

Introduction

In just over a decade, cryptocurrencies have grown from digital novelties to trillion-dollar technologies with the potential to disrupt the global financial system. An increasing number of investors now hold bitcoin and hundreds of other cryptocurrencies as assets and use them to buy a swath of goods and services, such as software, digital real estate, and illegal drugs.

To their proponents, cryptocurrencies are a democratizing force, wresting the power of money creation and control from central banks and Wall Street. Critics, however, say that cryptocurrencies empower criminal groups, terrorist organizations, and rogue states while stoking inequality, suffering from drastic market volatility, and consuming vast amounts of electricity. Regulations vary considerably around the world, with some governments embracing cryptocurrencies and others banning or limiting their use. As of January 2024, 130 countries, including the United States, are considering introducing their own central bank digital currencies (CBDCs) to compete with the cryptocurrency boom.

What are cryptocurrencies?

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So called for their use of cryptography principles to mint virtual coins, cryptocurrencies are typically exchanged on decentralized computer networks between people with virtual wallets. These transactions are recorded publicly on distributed, tamper-proof ledgers known as blockchains . This open-source framework prevents coins from being duplicated and eliminates the need for a central authority such as a bank to validate transactions. Bitcoin, launched in 2009 by the pseudonymous software engineer Satoshi Nakamoto, is by far the most prominent cryptocurrency, and its market capitalization has peaked at more than $1 trillion. Numerous others, including Ethereum, the second-most popular, have proliferated in recent years. 

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Cryptocurrency users send funds between digital wallet addresses. These transactions are then recorded into a sequence of numbers known as a “block” and confirmed across the network. Blockchains do not record real names or physical addresses, only the transfers between digital wallets, and thus confer a degree of anonymity on users. Some cryptocurrencies, such as Monero , claim to provide additional privacy. However, if the identity of a wallet owner becomes known, their transactions can be traced. 

Bitcoin “miners” earn coins by solving complex math problems to organize these blocks, thereby validating transactions on the network; the process requires a system known as “ proof of work .” Many cryptocurrencies use this method, but Ethereum and some others instead use a validation mechanism known as “ proof of stake .” In bitcoin’s case, a transaction block is added to the chain every ten minutes, at which point new bitcoin is awarded. (The reward decreases steadily over time.) The total supply of bitcoin is capped at twenty-one million coins, but not all cryptocurrencies have such a constraint.

The prices of bitcoin and many other cryptocurrencies vary based on global supply and demand. However, the values of some cryptocurrencies are fixed because they are backed by other assets, thus earning them the name “stablecoins.” While these coins tend to claim a peg to a traditional currency, such as $1 per coin, many such currencies were knocked from their pegs during a spate of volatility in 2022.

Why are they popular?

Once dismissed as a fringe interest of tech evangelists, cryptocurrencies—particularly bitcoin—have skyrocketed to mainstream popularity and trillion dollar valuations . In November 2021, the price of bitcoin surged to more than $60,000 for the first time, though it has since fallen. As of mid-2023, an estimated 17 percent of U.S. adults polled by the Pew Research Center had invested in, traded, or used cryptocurrency.

Different currencies have different appeals, but the popularity of cryptocurrencies largely stems from their decentralized nature: They can be transferred relatively quickly and anonymously, even across borders, without the need for a bank that could block the transaction or charge a fee. Dissidents in authoritarian countries have raised funds in bitcoin to circumvent state controls, including to avoid U.S. sanctions on Russia . 

Some analysts say that digital assets are primarily tools for investment. People buy cryptocurrencies “because of a speculative belief that these tokens are going to go up in the future, because a new future is being built on the blockchain,” says CFR Senior Fellow Sebastian Mallaby. Some bitcoin proponents view the cryptocurrency as a hedge against inflation because the supply is permanently fixed, unlike those of fiat currencies, which central banks can expand indefinitely. However, after bitcoin plummeted amid stock market volatility in 2022, many experts questioned this argument . The valuation of other cryptocurrencies can be harder to explain, though many are associated with a larger project within the digital asset industry. Some cryptocurrencies, such as Dogecoin, were created as jokes, but have retained value and garnered investment from high profile investors.

In countries with historically weak currencies, including several Latin American and African countries, bitcoin has become popular with populist leaders. In 2021, El Salvador made waves by becoming the first country to make bitcoin legal tender (residents can pay taxes and settle debts with it), though less than 15 percent of people had used it for that purpose in 2023, according to a poll by Central American University. 

The price of bitcoin and other cryptocurrencies fluctuates wildly, and some analysts say this limits their usefulness as a means of transaction. (Most buyers and sellers don’t want to accept payment in something whose value can change dramatically from day to day.) Nevertheless, some businesses accept bitcoin.

Experts say stablecoins could be more effective than other cryptocurrencies as a form of payments. The value of stablecoins is, as their names implies, relatively stable, and they can be sent instantly without the transaction fees associated with credit cards or international remittance services such as Western Union. In addition, because stablecoins can be used by anyone with a smartphone, they represent an opportunity to bring millions of people who lack traditional bank accounts into the financial system. However, they have drawn increased scrutiny from regulators, especially after several stablecoins sunk below their $1 pegs during 2022’s market volatility. 

What is “DeFi”?

Cryptocurrencies and blockchains have given rise to a new constellation of “ decentralized finance ” or DeFi businesses and projects. Essentially the cryptocurrency version of Wall Street, DeFi aims to offer people access to financial services—borrowing, lending, and trading—without the need for legacy institutions such as banks and brokerages, which often take large commissions and other fees. Instead, “ smart contracts ” automatically execute transactions when certain conditions are met. 

Most DeFi apps are built on the Ethereum blockchain. Because of its usefulness in tracking transactions, blockchain technology has a range of potential applications beyond cryptocurrency, experts say, such as facilitating international trade [PDF].

“You can imagine a new kind of financial system being constructed out of blockchain-based tokens that have advantages over the old, centralized kinds of money,” says CFR’s Mallaby. “You trust the code, and you trust the blockchain and the decentralized ledger, and it’s a new way of organizing finance.”

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Are Cryptocurrencies Still the Future of Money?

What challenges has this created.

Cryptocurrencies have also given rise to a new set of challenges for governments to contend with, including concerns over criminal activity, environmental harms, and consumer protection. 

Illicit activities. In recent years, cybercriminals have increasingly carried out ransomware attacks, by which they infiltrate and shut down computer networks and then demand payment to restore them, often in cryptocurrency . Drug cartels and money launderers are also “increasingly incorporating virtual currency” into their activities, according to the U.S. Drug Enforcement Agency (DEA). U.S. and European authorities have shut down a number of so-called darknet markets—websites where anonymous individuals can use cryptocurrency to buy and sell illegal goods and services, primarily narcotics. Critics say these enforcement efforts have fallen short , exemplified by the theft of more than $1 billion in cryptocurrency by a North Korean hacking group in 2022.

Terrorism and sanctions evasion. The primacy of the U.S. dollar has provided the United States unrivaled power to impose crippling economic sanctions—which states including Iran, North Korea, and Russia are increasingly using cryptocurrency to evade. Meanwhile, terrorist groups such as the self-proclaimed Islamic State, al-Qaeda, and the military wing of the Palestinian organization Hamas also traffic in cryptocurrency. 

Environmental harms. Bitcoin mining is an enormously energy-intensive process: the network now consumes more electricity than many countries . This has sparked fears about the cryptocurrency’s contribution to climate change. Cryptocurrency proponents say this problem can be solved using renewable energy; El Salvador’s president has pledged to use volcanic energy to mine bitcoin, for example. Environmental concerns reportedly prompted Ethereum’s move to a proof of stake model, which uses less energy.

Volatility and lack of regulation. The rapid rise of cryptocurrencies and DeFi enterprises means that billions of dollars in transactions are now taking place in a relatively unregulated sector, raising concerns about fraud, tax evasion , and cybersecurity , as well as broader financial stability. If cryptocurrencies become a dominant form of global payments, they could limit the ability of central banks, particularly those in smaller countries, to set monetary policy through control of the money supply. 

After high levels of volatility diminished the value of several prominent cryptocurrencies in 2022, a handful of crypto firms were unable to pay back their lenders, which were primarily other crypto firms. Many borrowers and lenders declared bankruptcy, including FTX, at the time the world’s third-largest cryptocurrency exchange. The collapse of FTX and other firms resulted in tens of billions of dollars in losses to investors and led some experts to call for a complete crypto ban , though traditional financial firms were relatively unscathed.     

What are governments doing about this?

Many governments have taken a hands-off approach to crypto, but its rapid ascent and evolution, coupled with the rise of DeFi, has forced regulators to begin crafting rules for the emerging sector . Regulations vary widely around the world, with some governments embracing cryptocurrencies and others banning them outright. The challenge for regulators, experts say, is to develop rules that limit traditional financial risks without stifling innovation. 

In the United States, policymakers have moved to regulate some cryptocurrencies and the emerging DeFi sector. In January 2024, the U.S. Securities and Exchange Commission (SEC) approved the first set of exchange-traded funds (ETF) that include bitcoin, granting the cryptocurrency entry into the traditional securities market. However, cryptocurrencies do not fit neatly into the existing regulatory framework, creating ambiguity that lawmakers will likely have to resolve. SEC Chairman Gary Gensler has called the cryptocurrency sector a “Wild West,” and compared it to the 1920s, before the United States had securities laws; he has urged Congress to give the SEC greater oversight over bitcoin and other cryptocurrencies. Federal Reserve Chairman Jerome Powell and Treasury Secretary Janet Yellen have both called for stronger regulations of stablecoins. But regulators have thus far been reluctant to extend crypto investors the same protections that exist in more traditional finance, such as deposit insurance. “If you buy crypto-assets and the price goes to zero at some point, please don’t be surprised and don’t expect taxpayers to socialize your losses,” the Federal Reserve Board of Governors’ Christopher J. Waller said in 2023.

To limit illicit activities, authorities have targeted the exchanges that allow users to convert cryptocurrencies to U.S. dollars and other national currencies. Under pressure from regulators , major exchanges including Coinbase and Gemini adhere to “know your customer” and other anti–money laundering requirements. Law enforcement and intelligence agencies, meanwhile, are learning to leverage the traceability of most cryptocurrencies by using blockchains to analyze and track criminal activity. For example, some of the ransom paid to the Colonial Pipeline hackers was later recovered by the FBI. In August 2022, the Treasury Department announced a crackdown on so-called cryptocurrency mixers that criminals can use to anonymize transactions on the blockchain, calling them a “threat to U.S. national security.”

China, which accounts for most of the world’s bitcoin mining, has moved aggressively to crack down on cryptocurrencies. In September 2021, Chinese authorities announced a sweeping ban on all crypto transactions and mining, causing the price of some cryptocurrencies to fall sharply in the immediate aftermath. According to the Atlantic Council, at least eight other countries (Algeria, Bangladesh, Bolivia, Morocco, Nepal, Pakistan, Saudi Arabia, and Tunisia) have banned cryptocurrencies , while dozens more have sought to restrict adoption of digital assets. However, such restrictions are hard to enforce, and crypto exchanges have generated tens of billions in revenue from countries with cryptocurrency bans. Meanwhile, most other governments have so far taken a relatively limited approach.

What is a central bank digital currency? 

In an effort to assert sovereignty, many central banks, including the U.S. Federal Reserve , are considering introducing their own digital cash, known as a central bank digital currency (CBDC). For proponents, CBDCs promise the speed and other benefits of cryptocurrency without the associated risks. Scores of countries—together representing more than 98 percent of the global economy—are exploring CBDCs . Eleven countries have fully launched CBDCs. All are lower-income and ten are in the Caribbean (Nigeria is the eleventh). In 2023, China began counting its piloted CBDC in official currency circulation calculations, though the digital yuan represented just 0.1 percent of central bank cash and reserves. In the United States, there is reportedly disagreement among Fed officials over the need for a digital dollar. 

One way to implement CBDCs would be for citizens to have accounts directly with the central bank [PDF]. This would give governments powerful new ways of managing the economy—stimulus payments and other benefits could be credited to people directly, for example—and the central bank’s imprimatur would make CBDCs a safe digital asset to hold. But their introduction could also create new problems, experts say, by centralizing an enormous amount of power, data, and risk within a single bank and potentially compromising privacy and cybersecurity. 

Some experts say the potential for CBDCs to cut out commercial banks as intermediaries carries risks, because these banks perform a critical economic role by creating and allocating credit (i.e., making loans). If people chose to bank directly with the Fed, that would require the central bank to either facilitate consumer borrowing, which it might not be equipped to do, or find new ways of injecting credit. For these reasons, some experts say private, regulated digital currencies are preferable to CBDCs.

Recommended Resources

In this 2008 paper [PDF], pseudonymous engineer Satoshi Nakomoto proposes Bitcoin, the first cryptocurrency.

At this CFR event, SEC Chair Gary Gensler discusses cryptocurrencies and the role of U.S. capital markets in the global economy.

The Economist examines the potential benefits and risks of DeFi .

For Foreign Affairs , American University’s Hilary Allen makes the case for banning crypto.

The Atlantic Council tracks the status of CBDCs around the world.

Ankit Panda contributed to this Backgrounder. Will Merrow created the graphics for this Backgrounder.

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The Digitalization of Money

The ongoing digital revolution may lead to a radical departure from the traditional model of monetary exchange. We may see an unbundling of the separate roles of money, creating fiercer competition among specialized currencies. On the other hand, digital currencies associated with large platform ecosystems may lead to a re-bundling of money in which payment services are packaged with an array of data services, encouraging differentiation but discouraging interoperability between platforms. Digital currencies may also cause an upheaval of the international monetary system: countries that are socially or digitally integrated with their neighbors may face digital dollarization, and the prevalence of systemically important platforms could lead to the emergence of digital currency areas that transcend national borders. Central bank digital currency (CBDC) ensures that public money remains a relevant unit of account.

We are grateful to Joseph Abadi for his numerous contributions to this project and to Dirk Niepelt and Johnathan Payne for helpful suggestions. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.

Disclosures 2010-2017/12

As a guiding principle I follow the NBER Research Disclosure Policy: http://www.nber.org/researchdisclosurepolicy.html

Significant Remunerated Activities: Visiting Positions Lamfalussy Fellowship, Bank of International Settlement, 2016 Milton Friedman Institute, visiting scholar 2011 Speaking engagements and lectures Spinoza Foundation, 2019 Danske Bank, 2018 Ukrainian Financial Forum, 2017 Swiss Economic Forum, 2017 Fudan University, 2017 Danske Capital, 2017 Brookings, 2017 Trento Economic Festival, 2013 Stifterverband der Deutschen Wirtschaft, 2012 Ambrosetti – The European House, 2011 Center for Investor Education, 2011 Wim Duisenberg School of Finance, 2010 Handelsbanken, 2010 Deutsche Bank, 2010 FEBRABAN, Brazil, 2009 Central banks Reserve Bank of India, Central Bank of Chile, South African Reserve Bank, ECB, ESRB, Bank of England, National Bank of Austria, Swiss National Bank, Bank of Japan, Federal Reserve, New York Fed, Bank of Canada, Bank of Korea International financial institution IMF Academic Organizations Luohan Academy, Alibaba, 2018- Swiss Finance Institute, Research Council, 2012- No expert testimony for law suits or paid consulting work for private cooperations to date.

Research Grants: Sloan Foundation 2011-12 Guggenheim Fellowship, 2010-11 University of Chicago, T.W. Schultz Prize and Lecture, 2010 INQUIRE Europe, Research Grant Visiting Scholar and Other: American Economic Review, Journal of Finance, Associated Editorship Significant Non-Compensated Activities: American Finance Association: Director Financial Advisory Roundtable and Monetary Policy Panel, Federal Reserve Bank of New York, 2006 – present

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What Is a Virtual Currency?

• Understanding Virtual Currencies

Regulatory Environment

How virtual currencies are used.

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Virtual Currency: Definition, Types, Advantages & Disadvantages

Investopedia contributors come from a range of backgrounds, and over 25 years there have been thousands of expert writers and editors who have contributed.

A virtual currency is a digital representation of value. It is stored and transacted through designated mobile or computer applications. Transactions involving virtual currencies occur through secure, dedicated networks or the internet. They are generally issued by private parties or groups of developers and are mostly unregulated.

Key Takeaways

• Virtual currencies are digital representations of value whose transactions occur in online networks or the internet.
• All virtual currencies are digital currencies, but the opposite is not true.
• Virtual currencies are issued by private organizations or groups of developers and are mostly unregulated.
• Some virtual currencies strive to increase transaction speeds by removing intermediaries from the process.
• There are two types of virtual currencies: closed and open.

Understanding Virtual Currencies 

Virtual currencies are a form of digital currency . They are issued by private parties, such as a group of developers or organizations, and do not have a physical form like paper money. They include cryptocurrencies and other tokens that hold value.

They differ from officially issued digital currencies called central bank digital currency (CBDC) .

Virtual currencies have been around for many years, but it's only since Bitcoin was introduced that it became important to define the different types of digital currencies. These definitions may change over time as regulators, academics, and interested parties learn more and become more familiar with them.

As of June 2024, regulations covering virtual currencies, tokens, and assets are still emerging around the world. For example, in 2023, The European Union published a broad definition in its Markets In Crypto Assets (MiCA) regulation. "Crypto-assets are digital representations of value or of rights that have the potential to bring significant benefits to market participants, including retail holders of crypto-assets." According to this rule, a virtual currency may not fall under MiCA jurisdiction in the EU, but it might if it meets this very vague definition.

The Internal Revenue Service (IRS) in the United States describes virtual currencies as "digital representations of value, other than a representation of the U.S. dollar or a foreign currency ("real currency"), that function as a unit of account, a store of value, and a medium of exchange." It also taxes trades involving certain virtual currency types, such as cryptocurrencies.

The market watchdog, the Securities and Exchange Commission (SEC) , has brought U.S.-based cryptocurrency exchanges under its supervision and continues to scrutinize all crypto-related products, services, and providers.

Virtual currencies have many forms, so there are endless ways that they can be used. Cryptocurrency is most commonly purchased and sold by investors and traders on cryptocurrency exchanges to profit from price fluctuations and increases.

However, they are also used in some countries by people who don't have access to other payment methods or financial services. In its 2023 Geography of Cryptocurrency Report, blockchain and crypto-assets analysis firm Chainalysis reported that cryptocurrency adoption is down from previous years; however, lower-middle-income countries are adopting these currencies at a much higher rate than others.

Many video games offer virtual currencies you can buy with real money and use to purchase items in-game. Most of these in-game currencies and tokens are not usable outside the game and cannot be transferred. However, there are blockchain-based games that use in-game currency which can be purchased with cryptocurrency. In this case, both currencies are virtual currencies because real-world value is being transferred.

Types of Virtual Currencies 

Depending on their operating network, virtual currencies are classified as either closed or open. 

Closed Virtual Currency

As the name suggests, a closed virtual currency operates in a controlled and private ecosystem. It cannot be converted into another virtual currency or a real-world fiat currency. Examples of closed virtual currencies are currencies in gaming systems. Though such currencies can be used in their respective environments (in this case, games), they cannot generally be converted into real-world cash.

Airline miles, while not typically thought of as currency, are closed virtual currencies. They are issued by private parties, can only be used to redeem specific items, and cannot be converted into an associated monetary value. 

Open Virtual Currency 

Open virtual currencies operate in open ecosystems and can be converted into another currency within or outside the platform. Examples of open virtual currencies are stablecoins and cryptocurrencies. Bitcoin and Ethereum, the two biggest cryptocurrencies by market capitalization, can be converted into other cryptocurrencies or certain fiat currencies . This conversion process can trigger taxes, depending on how long you hold your cryptocurrency and its market value when you purchased and sold it.

Though most open virtual currencies have a decentralized setup, some cryptocurrencies might be centralized in design, meaning a central agency is responsible for their production and distribution.

The in-game currency used in blockchain-based games might be considered an open virtual currency if it can be sold back to the game or to another user.

Advantages of Virtual Currencies 

The advantages of virtual currencies are as follows: 

• The technology behind virtual currencies can eliminate geographical boundaries.
• Decentralized virtual currencies can eliminate intermediaries during monetary transactions and establish a direct connection between two transacting parties.
• Some virtual currencies can be programmed to complete automated transactions. For example, smart contracts on Ethereum's blockchain can hold and release money in escrow accounts without human intervention.
• Virtual currencies are digital repositories of value and can assign value to disparate sets of objects, from gaming tokens to artwork.

Disadvantages of Virtual Currencies 

The disadvantages of virtual currencies are as follows:

• Virtual currencies are attractive targets for hackers. There have been several cases of cryptocurrency theft by hackers.
• Virtual currencies can be used in scams. Several initial coin offerings (ICOs), which became popular after a runup in cryptocurrency prices, were scams in which private developers sold worthless tokens for hypothetical networks.
• Unregulated virtual currencies do not offer legal recourses to investors or users because they are issued by private entities and, for the most part, are not regulated by financial authorities.
• Virtual currencies with market value can be subject to highly volatile price swings.

Differences Between Digital Currencies, Virtual Currencies, and Cryptocurrencies

Even though they sound alike and function in a similar manner, digital, virtual, and cryptocurrencies are, in fact, different. Listed below are the main points of difference between the three types of currencies:

• Digital currency is the group of currencies all virtual currencies, stablecoins, and CBDCs belong to.
• Virtual currencies generally encompass cryptocurrency, gaming tokens, or other types of tokens.
• Cryptocurrencies are virtual currencies that use cryptographic techniques.

Is Virtual Money Real Money?

If something is generally accepted as a means of exchange, a store of value, or a unit of account, it is considered by most to be money. Virtual money can meet this definition, but not always. For example, virtual money earned in a video game used to purchase in-game items is likely not real money. But if it transitions somehow to being exchanged for money that meets this definition, it could become real money.

Is Virtual Currency the Same As Cryptocurrency?

Definitions are constantly changing, but by the most currently used ones, cryptocurrency is a form of virtual currency.

What Is the Most Valuable Virtual Currency?

Bitcoin is by far the most valuable and popular virtual currency. It took the market by storm in the mid-2010s and has held the top spot for price and market cap ever since.

The Bottom Line 

Virtual currencies are digital representations of value that can exist only electronically. Their transactions occur on online networks or the internet. Examples of virtual currencies include tokens and cryptocurrencies.

Virtual currencies are a novel form of currency and, as such, are mostly unregulated. But that situation is changing, and an increasing number of government agencies and countries are considering the implications of introducing virtual currencies into their economies.

  The comments, opinions, and analyses expressed on Investopedia are for informational purposes only. Read our   warranty and liability disclaimer  for more info.

Eur-Lex. " Regulation (EU) 2023/1114 of the European Parliament and of the Council of 31 May 2023 on Markets in Crypto-Assets, and Amending Regulations (EU) No 1093/2010 and (EU) No 1095/2010 and Directives 2013/36/EU and (EU) 2019/1937 (Text With EEA Relevance) ."

Internal Revenue Service. " FAQs About Virtual Currencies ."

Chainalysis. " The 2023 Geography of Cryptocurrency Report ," Page 7. Requires entering an email account and downloading a file.

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Digital Currency

The emerging technology of digital currency may affect and change how we see, use, and save money in the years to come.

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When you think of “currency,” you are probably thinking of the cash you hand over at a store, or the credit cards or money transfers that can be used in place of physical money. In general, currency is a system of money backed by a government. Typically made up of coins and paper notes, currency is a medium of exchange, meaning that it is the basis for various kinds of trade and transactions. As technology has grown more sophisticated, digital currencies (which have no physical form) have grown as more financial transactions have gone online. Digital currency is simply a payment method that does not exist outside of its electronic form. Within the past decade, a new particularly popular kind of digital currency has emerged: cryptocurrency . Although this new system is unlikely to replace the more traditional forms of currency any time soon, it has made a significant impact in less than 10 years. What is Cryptocurrency? The prefix “crypto” originally comes from the Greek word meaning “hidden.” This does not mean that cryptocurrency is secret, but rather that this “hidden” money is digital, and is kept secure with digital-code encryption. These digital currencies are the heart of systems that allow secure, direct payment for online transactions. “Crypto-” actually refers to the cryptographic data encryption that keeps the transactions protected from hackers or other digital eyes. It also makes cryptocurrency difficult to counterfeit. Cryptocurrency has gained popularity because it offers a straightforward way to transfer funds entirely online, without involving third parties like banks or credit card companies (and paying the fees they often charge for processing transactions). Instead of physical coins or paper notes, cryptocurrencies have digital “tokens,” or different digital denominations (think of one- or five-dollar bill, etc.). For example, one bitcoin is equivalent to 100,000,000 satoshis, the smallest denomination of a bitcoin and named for bitcoin ’s supposed inventor, Satoshi Nakamoto. This enables transactions smaller than a full coin. The transfer of funds involves “public” and “private” keys, which are lines of code that need to match on both sides, so the transaction can be completed. Cryptocurrency is saved in the user’s “wallet,” or a URL or internet account address that can only be accessed by the owner. The wallet has a public key, and the private key is used to sign a transaction, much like you would sign a check or a credit card slip. Would-be cryptocurrency users can use particular websites to exchange different currency types (like euros or dollars) for cryptocurrency tokens. The system that supports cryptocurrencies online is called blockchain , which is essentially a digital ledger that tracks transactions across the internet. There is a blockchain for each kind of digital cryptocurrency , which records all transactions using that particular cryptocurrency . What helps make cryptocurrency unique is that there is no central bank or processing center. Instead, the blockchain is made up of “distributed ledger” technology, which is a database shared across a network of sites and servers. By involving a collection of different networks throughout a transfer, it creates a traceable trail, and reduces the chances that the transactions can be disrupted by a cyberattack or data breach by adding “witnesses” along the way. Different types of cryptocurrency (sometimes also referred to as “altcoin”) include bitcoin , Litecoin, Ethereum, Zcash, Dash, Ripple, Monero, NEO, Cardano, and EOS. Because of the high-tech nature of cryptocurrency , new forms are emerging all the time. The Bitcoin Revolution The most popular form of cryptocurrency is bitcoin , created by a developer (or group of developers) under the pseudonym “Satoshi Nakamoto” in 2009. Bitcoin ’s origins are shrouded in mystery—no one has been able to confirm the identity (or identities) of programmer Satoshi Nakamoto. Like most digital currencies, bitcoins are not issued or regulated by a government. Instead of a central point of creation (like the United States Mint), bitcoins are created by “mining,” or allowing individuals to contribute their own computers to the transaction network in exchange for bitcoins and access to bitcoin transactions. The supply of bitcoins available is fixed by its developers at 21 million, with the value and the mining rate adjusted with that cap in mind. Bitcoin is by far the most popular cryptocurrency in circulation, although it is not considered legal tender (issued or backed by a government). Currency of the Future? The benefits and drawbacks of digital and cryptocurrencies (particularly bitcoin ) have become a hot topic of debate. The security and anonymity of these digital-only currencies and the blockchain make it an appealing option for users who want to make discreet transactions, or avoid the fees and bureaucracy of traditional banks and financial systems. Still, some experts believe that the popularity of these cryptocurrencies is more of a trend than a sure bet for the future. There are also legal and security issues at play here, with anonymous cryptocurrency transactions potentially being used to cover up criminal activity. However, it is likely that the unregulated, Wild West days of cryptocurrency are numbered, with governments looking for ways to regulate and monitor cryptocurrency transactions much like standard financial transactions.

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Related Resources

Essay on Digital Currency

Students are often asked to write an essay on Digital Currency in their schools and colleges. And if you’re also looking for the same, we have created 100-word, 250-word, and 500-word essays on the topic.

Let’s take a look…

100 Words Essay on Digital Currency

What is digital currency.

Digital currency is money that exists only in the digital world. It’s not physical like coins or notes. Instead, it’s stored on computers. It’s a type of currency that you can use to buy things online. Bitcoin is a famous example of digital currency.

How Does Digital Currency Work?

Digital currency works through technology called blockchain. This is a type of computer system that keeps track of all digital money transactions. It’s like a digital ledger. This system ensures that the digital currency is safe and can’t be copied or faked.

Types of Digital Currency

There are many types of digital currencies. Bitcoin is the most well-known. Others include Ethereum, Ripple, and Litecoin. Each one works in slightly different ways, but they all use blockchain technology.

Advantages of Digital Currency

Digital currency has many advantages. For example, it can be sent anywhere in the world quickly and cheaply. Also, it’s secure because of the blockchain technology. It’s also easy to carry around because it’s not physical.

Disadvantages of Digital Currency

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250 Words Essay on Digital Currency

Digital currency is money that is available only in digital form. It is not like the physical money that we can touch or see, such as coins and notes. It exists only on computers and the internet. Examples of digital currencies are Bitcoin, Ethereum, and Ripple.

Digital currency works using technology called blockchain. Think of blockchain as a digital notebook. This notebook keeps a record of all transactions made with digital currencies. This record is public and can’t be changed, making digital currency safe and secure.

The Use of Digital Currency

Digital currency can be used to buy goods and services online. Some online stores and even some physical stores accept digital currencies like Bitcoin. People also use digital currencies for investment. They buy these currencies when their prices are low and sell them when their prices go up.

The Future of Digital Currency

Digital currency is becoming more popular. More people are learning about it and starting to use it. Some experts believe that digital currencies could replace traditional money in the future. This means we might not use coins and notes anymore and only use digital money.

500 Words Essay on Digital Currency

Digital currency is like money but in electronic form. It’s not something you can touch or feel, but you can use it to buy things online. It’s like the money you see in your bank account when you check it on your phone or computer.

There are many types of digital currencies. Some of them are called cryptocurrencies, like Bitcoin and Ethereum. These are special because they use a technology called blockchain to keep them safe and secure. Other types of digital currencies are created by governments, and these are often called Central Bank Digital Currencies (CBDCs).

Why Do People Use Digital Currency?

People use digital currencies for many reasons. Some like it because it’s quick and easy to send money around the world. Others like it because it can be more secure than traditional money. And some people like it because they hope the value of the digital currency will go up and they can make money.

Are There Risks with Digital Currency?

Yes, there are risks with using digital currency. One risk is that the value of the digital currency can go up and down a lot. This means if you own some, you might lose money. Another risk is that if you lose access to your digital wallet, you could lose all your digital currency. Also, because it’s still pretty new, the rules around using digital currency can change quickly.

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The Cryptocurrency Concept Analysis Essay

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Introduction

Ethical swot analysis, historical context and ethical questions, literature review, equity impact assessment, code of ethics, recommendations.

Cryptocurrency is a means of exchange designed around the digital use of encrypted figures. The term cryptocurrency derives from cryptography, which implies a secret means of sending information to the correct persons without a third party. The basis of cryptocurrency operations is essential codes that allow the private exchange of business. Even though many governments view it as a disruption to the traditional banking systems, this emerging issue has gained significant traction over the last few years. Today, there are over 15,000 cryptocurrencies that exist around the world, with a total market capitalization of about $300 billion (Russell, 2020). This method of exchange is used in various fields, including ATMs, electronic commerce, and passwords.

An American cryptographer first introduced the idea of cryptocurrency by inventing digital cash in 1989. Since then, various programmers have created algorithms central to the encryption of codes. However, the first transaction using cryptocurrency was recorded on 12th January 2009. Today, numerous cryptocurrencies operate, gaining popularity through their secure and cost-effective properties (Russell, 2020). Cryptocurrencies like Bitcoin and Coinbase make transactions easy for people with limited technical knowledge trading with digital coins. Bitcoin is the world’s largest digital currency and is known for its fair rates of exchange.

Cryptocurrencies lacked value in their early years of operation and were rendered worthless. With time, the coins gained merit, and several people started making thousands of dollars by trading.

Cryptocurrency uses blockchain technology, a decentralized method that is easy, transparent, and safe, making it suitable to apply by many people. This technology prohibits the involvement of a third party during the transaction process. This implies that transactions happen quickly and faster and with minimal or no interference from government organizations. Blockchain technology really boosts the economic turmoil for many cryptocurrency users. In addition, cryptocurrency trading is fully anonymous and 100% untraceable (Al-Amri et al., 2019). Blockchain technology makes this network private; hence the users’ financial data is fully hidden. Every crypto trader receives a unique PIN upon signing up, which masks the user’s identity. The PIN changes once the currency is sold, and only the sender and the buyer get access. Because of this increased security, many people have joined cryptocurrency trading activities (Billah & Atbani, 2019). The transaction processes are simple, and the settlement fees are close to zero, making it favorable for many people.

During the first few years of its discovery, trading in cryptocurrency was faster. Today, transactions are not as fast as they used to be due to the flooding of the blockchain network. With the expanding market, transaction speeds are expected to be even slower (Billah & Atbani, 2019). Until this problem is solved, it is unlikely that cryptocurrency will usurp the fiat system. The encryption of transactions makes it hard to recover a lost wallet password (Al-Amri et al., 2019). Many people who forget their account passwords lose their transaction details and access to their accounts. In addition, the value of cryptocurrencies has shifted in the past few years. The reliability of cryptocurrencies is too questionable; it looks like a very volatile investment. The prices can crash anytime since the currency has not proved itself a long-term investment. It is worth noting that they have only been around for a decade.

Opportunities

We must appreciate that we are moving away from physical money usage into cashless currencies as a society. Big institutions like Amazon have started accepting payments in terms of Bitcoins. With growth and adaption ratio, cryptocurrency can become a global reserve currency (Al-Amri et al., 2019). In recent years there have been increased cases of data breaches in banks and financial institutions, raising the question of the safety of the client’s information. Many people are looking for alternatives, and blockchain technology promises the safety of customer information. The transactions are encrypted and provide a very high solution to data protection. Cryptocurrency networks can allow investors to reduce bureaucracy and increase trade efficiency.

The anonymity of banks and other government organizations poses a big threat to the operation of cryptocurrencies. Knowing that a transaction is untraceable provides a good environment for criminal activities. If more criminals purchase and use illegal cryptocurrencies, this will be a problem for the government and law enforcement agencies. It will be hard for the government to trace and prosecute such acts. Although it may be difficult to control cryptocurrency operations due to anonymity, the government will still try (Al-Amri et al., 2019). The government will understand the huge profits in this market and increase attention to imposing taxes. The values of the latest coins skyrocket, and every coin will try to compete favorably in the market, leading to unhealthy competition and the destruction of the market. Criminals are taking advantage of the cryptocurrency leading to threats with unknown identities. The issue of environmental degradation has made this activity banned in several countries.

Historically, the idea of cryptocurrency started in the year 1989. However, the first transaction with cryptocurrency occurred in 2009 using Bitcoin. After its discovery, Bitcoin prices stayed relatively low, with users unsure of its trajectory. In 2013 there was a sudden projection of its price from $1 per coin to around $1,250.00 per coin (Wang et al., 2022). This increase in the price of Bitcoin brought about attention to the crypto market, and many crypto coins started flooding the market with promises of different levels of usability. The most serious development of this market was witnessed at the beginning of the year 2020 with the outbreak of COVID-19.

The year 2021 was characterized by an increased surge in this market as more pension funds and financial institutions started showing the legitimacy of the crypto market. The amount of money that these organizations were making started to increase rapidly. Another move that helped this market draw attention was the intention of the US government to tax activities involving cryptocurrency (Wang et al., 2022). The government estimated an approximately $10,000.00 to tax from trading with Crypto monthly.

There are various ethical issues surrounding the trading activities of cryptocurrencies. One major issue is the anonymous nature of the currencies. While many people who trade Crypto see this as an added advantage, it creates a loophole for criminal acts. Various research works prove a positive connection between criminal acts and cryptocurrency transactions in the pacific region (Al-Amri et al., 2019). Even though the United Nations has continuously focused on curbing the potential for funding human and weapons trafficking, the anonymous nature of the crypto market makes this process impossible.

Another ethical question regarding cryptocurrency is the fear of legitimizing the currency market. The users of cryptocurrency cannot allow governments and banks to have control of their activities. This question has been discussed over the past few weeks, with some countries thinking of creating government-based crypto coins. Various governments have adopted the changes in technology to design and attempt to use national cryptocurrencies (Russell, 2020). However, this idea faces a dilemma as the International Monetary Fund (IMF) pushes various governments to avoid Crypto-based activities, which would destabilize the international monetary system.

The ethical issues surrounding the cryptocurrency trade bring both positive and negative aspects. The activity, however, has brought more advantages to the people with its legitimacy and widespread use. Locals can now trade peer-to-peer without interference from the government and intermediaries. The transaction can remain anonymous, and the market can have the opportunity to control inflation rates. While it is argued that it promotes illegal activities, the current tender systems have always allowed for illegal activity (Yue et al., 2021). Changing the form of the legal tender will not necessarily worsen the crime. We are sitting on the edge of a new international monetary system.

A narrative literature review aims to understand and evaluate knowledge relevant to a particular topic. It also works to reveal the strengths and weaknesses or claims that deserve further research. The use of a narrative literature review in this study enables us to investigate how cryptocurrencies have been conceptualized in recent studies and assess the theoretical underpinning of this emerging trend in technology.

Vilkov and Tian attempted to analyze the future growth of Bitcoin and other cryptocurrencies using the SWOT analysis technique. They concluded that cryptocurrency revolutionizes the digital currency market with free flow and zero transaction fees. The increased advancement in technology has contributed to the increased use of these digital currencies. However, it is worth noting that digital currency cannot fully replace the fiat system (Vilkov & Tian., 2019). Some recent events and movements also influence that Bitcoin can contribute to a shift in economic paradigms.

Ajmi and Arfaoui tried to use the SWOT analysis to analyze the effects of cryptocurrency on politics. The study concluded that digital currency is the new model for the global economy and influences major political decisions in countries during the campaign. Within ten years, the digital currency has won the hearts of many investors. The future potential is the weakness of the cryptocurrency movement (Ajmi & Arfaoui, 2020). Russell had presented the effects of cryptocurrency on the country’s banking systems and monetary policies. The study concluded that the advancement of technology and openness to accept Bitcoin circulation and government intervention by creating laws are future strengths of digital currency (Russell, 2020). This has greatly affected the circulation of money through the central bank. The study also included the weaknesses, strengths, threats, and opportunities of Bitcoin and other cryptocurrencies.

In their study, al-Amri et al. proved that the use of digital currencies would rise to become self-regulated money free from government control. The SWOT analysis proved that the reoccurrences had opportunities and strengths with the rapid growth of capitalization and great people’s interest (Al-Amri et al., 2019). The results concluded that cryptocurrency adoption is scalable throughout the research period, and there is furthermore scope on factors influencing cryptocurrency. Yue et al., in the year 2021, studied the effects of cryptocurrency on the economy. The research reported that the use of crypto in the economy had shifted the economic model.

The sources identified in this paper were relevant as they focused on cryptocurrency as a major technology trend. The sources had a minor and major focus on cryptocurrencies, and they presented opportunities for using Crypto. These sources provided insights into the challenges of adopting cryptocurrencies in today’s financial systems.

Since the discovery of cryptocurrency in 2009, the impact of these activities has been felt in all aspects of life. Socially, Cryptocurrencies have created a more affordable and reliable remittance payment method (Wilson, 2019). Cryptocurrencies have promoted social impact programs globally, and various beneficiaries of these programs have realized maximum profits and benefits (Wang et al., 2022). This has eliminated the issues of corruption and waste while conducting these programs. Today, the United Nations Food program uses blockchain technology to deliver cash-based transfers, saving millions of dollars and helping numerous people.

Cryptocurrencies facilitate the aspect of foreign donations and funding to political parties. 56% of countries globally do not accept the sponsorship of political candidates during campaign activities. Since there is no oversight on cryptocurrencies, they seem to fund many parties. For example, the 2016 USA elections appear to have been facilitated by the influence of cryptocurrency. According to various sources, funds from the Russian government were transferred through Crypto into the USA during this election period (Ajmi & Arfaoui, 2020). In Ukraine, research has it that 57 government officials have declared over 21,000 bitcoins.

Since its discovery, blockchain technology has improved financial institutions across borders for transactions. Currencies like Bitcoin have created a unique and unmanageable market, making it impossible for the global economic market to thrive (Yue et al., 2021). The low transaction cost of cryptocurrencies makes them superior to the traditional monetary system. The years 2016 and 2017 were characterized by an increased number of people working using blockchain technology; since then, the number has increased drastically (Wilson, 2019). The technology is automated and digitized; therefore, the figures can never be changed and altered.

The main environmental effects of cryptocurrencies come from the high amount of energy required in the transaction process. Mining new coins require tremendous energy, ranging from one cryptocurrency to another. The most popular cryptocurrency that requires incredibly energy-intensive is Bitcoin which requires an estimated 2100 kilowatt-hours of energy to mine (Wang et al., 2022). It is estimated that Bitcoin mining activity generates 97.2 megatons of carbon dioxide, which is dangerous to the environment. Mining cryptocurrencies threatens fragile energy grids in countries with weaker infrastructures. Many cities worldwide have experienced power loss due to Bitcoin mining. Countries like China, Iran, Algeria, Egypt, and Morocco have moved to ban cryptocurrencies and outlawed these activities altogether.

A code of ethics refers to the legal framework through which an organization and its employees should follow. It describes the ethical behavior expected of the company and its operations. The rise in the crypto market has led to increased attention, and the activities have to be regulated using codes of ethics. All crypto companies must comply with the laws, rules, and regulations of municipalities, states, and countries in which they operate. All crypto companies must comply with the securities laws prohibiting insider trading ( Ajmi & Arfaoui, 2020). The companies must also comply with laws concerning disclosure requirements, anti-bribery laws, payments, and health and safety rules.

In addition, all companies trading in cryptocurrencies should address the issues of conflict of interest. A crypto associate is not allowed to work for other competitor firms as this will give rise to a conflict of interest. The associates should also cease using business assets and opportunities for personal gain. The assets of works should be protected and ensure efficient use. Loss of assets affects the profitability of cryptocurrencies (Yue et al., 2021). Family members of crypto traders should never receive gifts or offers from trading activities.

The emergence of cryptocurrency technology has dramatically impacted the social, economic, and political environment. Several people appreciate the transparency, viability, and speed of transactions through cryptocurrencies. Various people have invested in crypto mining activities, making a considerable sum daily. In addition, the move has led to a new global market independent of financial institutions (Al-Amri et al., 2019). People can now transact businesses over a significant geographical distance without delays or government interference.

While many people appreciate the benefits of cryptocurrency, this technology’s ethical dilemma is still questionable. The fact that this market is not regulated makes it vulnerable to cyber-attacks leading to a loss of investments (Al-Amri et al., 2019). Investing in cryptocurrency is a risk-taking activity, and only financially stable people can do this. In several other countries, governments are still delaying its implementation. Many people feel the adverse effects of the activities surrounding the mining of crypto coins. The processes involved in mining activities negatively impact the environment.

In conclusion, the growth analysis of cryptocurrencies shows that the adoption process of cryptocurrency is high in the global world. Lack of enough knowledge and information is the major drawback to this market. However, with well-regulated policies, the crypto market can grow faster. Moreover, the cryptocurrency market analysis shows that not many people would invest in it due to its volatile nature. Many investors prefer to use bonds, shares, and stocks as they have stayed for a long and are trusted by huge organizations. Though profitable, cryptocurrency is a volatile market and a risky investment for starters.

Ajmi, H., & Arfaoui, N. (2020). Effects of the political risk on bitcoin return and volatility: Evidence from the 2016 US presidential election . Journal of Financial Economic Policy , 13 (1), 94-115.

Al-Amri, R., Zakaria, N. H., Habbal, A., & Hassan, S. (2019). Cryptocurrency adoption: Current stage, opportunities, and open challenges. International Journal of Advanced Computer Research, 9(44), 293-307.

Billah, M. M. S., & Atbani, F. M. (2019). SWOT analysis of cryptocurrency and ethical thought. Journal of Islamic Banking & Finance , 36(1), 204-432.

Vilkov, A., & Tian, G. (2019). Blockchain as a solution to the problem of illegal timber trade between Russia and China: SWOT analysis. International Forestry Review , 21(3), 385-400.

Wang, Y., Lucey, B., Vigne, S. A., & Yarovaya, L. (2022). An index of cryptocurrency environmental attention (ICEA) . China Finance Review International , 34-51.

Wilson, C. (2019). Cryptocurrencies: The future of finance? In Contemporary Issues in International Political Economy (pp. 359-394). Palgrave Macmillan, Singapore.

• The US Dollar as the Main International Currency
• Ethical Implications of the Use of Bitcoin
• Cryptocurrency and Its Impact on the Banking Industry
• Aspects of Bitcoin and Cryptocurrency
• Rise of Cryptocurrency
• Traditional vs. Modern Forms of Money
• A Weak Dollar vs. a Strong Dollar
• Money Laundering Through Cryptocurrencies
• Analysis of Solana Cryptocurrency
• Minting Coins, Incentives for Commerce, and Promissory Notes
• Chicago (A-D)
• Chicago (N-B)

IvyPanda. (2023, April 19). The Cryptocurrency Concept Analysis. https://ivypanda.com/essays/the-cryptocurrency-concept-analysis/

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IvyPanda . (2023) 'The Cryptocurrency Concept Analysis'. 19 April.

IvyPanda . 2023. "The Cryptocurrency Concept Analysis." April 19, 2023. https://ivypanda.com/essays/the-cryptocurrency-concept-analysis/.

1. IvyPanda . "The Cryptocurrency Concept Analysis." April 19, 2023. https://ivypanda.com/essays/the-cryptocurrency-concept-analysis/.

Bibliography

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Digital currencies: Five big implications for central banks

Subscribe to the hutchins roundup and newsletter, vivien lee and vivien lee senior research assistant - hutchins center on fiscal & monetary policy, the brookings institution david wessel david wessel director - the hutchins center on fiscal and monetary policy , senior fellow - economic studies.

May 21, 2018

The widely noted rise of bitcoin and other digital currencies could have profound impacts on financial systems and on the practices of the central banks.  Will paper currency finally become obsolete? Will bitcoin and its siblings replace the dollar or the euro or the yen? Should central banks issue their own e-currencies? What opportunities do digital currencies present? What risks?

This post discusses answers offered by Agustin Carstens , General Manager of the Bank of International Settlements; Stefan Ingves , Governor of Sveriges Riksbank; Urjit Patel , Governor of the Reserve Bank of India; and Benoit Coeure , member of the Executive Board of the European Central Bank, to these and other questions. It draws primarily from a conference, “ Digital currencies: Implications for central banks ,” hosted by the Hutchins Center on Fiscal and Monetary Policy in April 2018 and a report, “ Central Banking in a Digital Age: Stock-Taking and Preliminary Thoughts ,” by our Brookings colleague, Eswar Prasad .

1. A lot of money is already electronic.

Although physical currency is still widely used in most countries (with the exception of Sweden, where the use of cash is shrinking rapidly), consumers around the world routinely conduct transactions without physical currency, using credit cards or mobile phones to pay.  Further, much of the money that central banks (bank reserves) issue exists only in electronic form. So in some sense, the idea of digital currencies is not completely new.

Carstens:  “When they introduced credit cards, we had to learn how to deal with credit cards. And nothing happened…we survived it. So I think that we will do the same [with digital currencies].”

Ingves:  “[M]ost of the central bank money produced is wholesale central bank money, and all of that wholesale money is already electronic. So when we’re referring to cash, that’s…a tiny, tiny fraction of what’s going on in the system.”

2. Cryptocurrencies aren’t likely to replace government-backed currency soon.

Bitcoin and other cryptocurrencies are popular, but most people don’t trust them the way they trust the U.S. dollar, the euro, or the Japanese yen, all of which are backed by a central bank. Despite the erosion of confidence in government institutions, most people still prefer money backed by a central bank, and this is unlikely to change anytime soon.

Patel:  “[O]n scalability, actually, some of the things that were promised have not happened. Bitcoin networks handle very few transactions per second, while, for example, an interbank Visa system handles a hundred times that. One reason…is because there is lopsided investment. That again underscores that you need a coordinator because you are getting parts of this whole system where a lot of money goes into the mining part [of bitcoin], and very little goes into everything else.”

Ingves:  “What is very much underestimated when we talk about the technologies here is why people use central banks and like to use central bank payment systems…[I]f one bank pays another bank, and…it is not passed through the payment system of the central bank, the only thing that happens is that one bank ends up with a claim on another bank. And bankers don’t trust each other. And that’s why you have central banks transferring the money, because that’s the only safe way of transferring money.”

What is very much underestimated when we talk about the technologies here is why people use central banks and like to use central bank payment systems

Carstens:  “[S]uddenly we have a new form of technology, and can we expect that that new technology will substitute for all these centuries of creating good practices that in a way generates the trust that society has on the currency that we know today? Will precisely another currency substitute for all of that? My answer is, with absolute certainty, no…[T]echnology cannot substitute for all what central banks do to make trustworthy currencies.”

3. Still, digital currencies could change the financial system in big ways.

Digital currencies and other innovations in payment systems could increase the speed of domestic and cross-border transactions, reduce transaction costs, and eventually broaden access to the financial system by poor and rural households.

Prasad:  “Certainly, payment systems are going to become much more efficient. In China, in India, one can conduct very small micro-transactions with street vendors using payment systems that have been decentralized and that are intermediated, not through the traditional banks but through other platforms. And one can see this very easily catching on.”

Ingves:  “New technologies make it easier for money to reach everybody, and that means that essentially what we’re talking about is sending money from one cell phone to another real time.  And that’s a worthy vision for the future.”

New technologies make it easier for money to reach everybody…

Prasad:  “[O]ne of the reasons why…we are seeing certain…political forces gaining power is because many people don’t feel connected to the economy. Connection to the financial system is a very important part of it. If you feel that the reforms in a country are going to benefit the elite who are connected and most of the others are left out, this is, I think, a very important part of that [frustration. Digital currencies] will give people more access to the financial system…So I think that is at some level a really transformative power in the new technologies.”

4. But these new technologies bring some big challenges too.

Digital currencies and related technologies are likely to reduce transactions costs and decrease the price of acquiring and sharing information, which sound good but can destabilize financial markets and intensify contagion from one market to another. They could undermine the business models of conventional banks and their role in the financial system, making it hard for central banks—which operate largely through the banking system—to maintain financial stability.

Prasad:  “If one thinks about information flowing much more freely with the new technologies, that is certainly a compelling argument for why financial markets should work a lot better.  But as we know from work that many academics have done…you might end up with certain information aggregators becoming very powerful in an economy where there is a lot of information but not very good processing ability, and that can actually lead to situations where, in fact, you have informational cascades, and herding and contingent behavior becomes worse, not because of limited information, but because there is too much information but not enough signal extracting and processing capability. So in terms of financial institutions and regulation, I think there are many challenges ahead.”

So what banks look like and whether they will still play a powerful role in the creation of money in this very broad sense is a critical issue.

Prasad:  “[A]s many of the inefficiencies in the financial system are eroded away, the traditional competitive rents or anti-competitive rents that banks could collect are going to erode. So what banks look like and whether they will still play a powerful role in the creation of money in this very broad sense is a critical issue…[I]f traditional commercial banks play a much less important role in finance, if the central banks’ role in terms of settlement and facilitating payments across financial institutions starts eroding—that makes monetary policy implementation a lot more challenging.”

Prasad:  “[W]hat happens as we start thinking about a scenario where payment systems become very decentralized? [C]entral banks do need to be worried about whether this decentralization and the fact that the payment mechanisms are not going to be anchored by any official foundation could create problems in bad times…there is a crisis of confidence when these decentralized payment systems start coming into question or start breaking down for a variety of reasons. That could affect not just monetary stability but economic activity as a whole.”

5. Should central banks issue their own digital currencies?

Very few central banks are seriously considering issuing their own digital currencies—that is, allowing the public to have electronic deposits at the central bank—but many central banks are talking about this option. So far, only a couple central banks have issued their own digital currencies, Ecuador and Tunisia among them. Sweden, where the use of cash is evaporating faster than almost any other sizeable economy, is contemplating whether to issue an e-krona.

Issuing its own digital currency would prevent a central bank from losing market share to bitcoin, and it could make it easier for a central bank to pursue negative interest rates (charge a fee to depositors rather than pay interest) during an economic downturn. But an official digital currency could reduce the role of traditional banks as intermediaries and lenders, and could pose big problems during a financial crisis, if depositors pull money out of traditional banks to deposit it at the (safer) central bank.

Ingves:  “[T]he only remaining issue when it comes to this is to what extent it should be possible for the general public to hold an electronic claim on the central bank or not. Or whether we should instead have a system where only banks can have a claim on the central bank and all of this electronically.”

Patel:  “[O]ne benefit of a central bank-issued digital currency is that the costs do come down. And that is something that everyone wants, including the government.”

[O]ne benefit of a central bank-issued digital currency is that the costs do come down. And that is something that everyone wants, including the government.

Coeure (in a May 14, 2018 speech at the International Center for Monetary and Banking Studies):   “[A]lmost no euro area banks have passed these negative rates on to their household clients…if negative rates are not passed through, this [bank lending] channel will fail to develop to its full potential. An interest-bearing central bank digital currency may help overcome these constraints. This does not actually require cash to be abolished, but rather that it no longer acts as an effective competitor for large transactions. Under these conditions the central bank could gain greater control over the transmission of interest rates to households and businesses. In a deep recession, it could reduce interest rates by more than is currently possible and stabilize economic activity more quickly, reducing the need for other non-conventional measures. And in an upswing, the ability to pay positive interest rates on digital currency would put increased upward pressure on deposit rates provided by banks.”

Coeure:  “In a systemic crisis…households and businesses could seek to hold their wealth in the riskless central bank liability rather than the riskier private sector one. While this shift could also happen now between deposits and cash, a digital currency would make it cheaper and faster, making ‘digital bank runs’ more frequent and more severe.”

Carstens:  “Central bank digital currencies can facilitate wrongs against banks. They can attract resources to central banks [and] away from commercial banks. That opens a whole can of worms…the central banks are not created to intermediate financial resources.”

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When central banks issue digital money

Will banks survive the transition to a new monetary system.

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E AGLE-EYED BEACHCOMBERS may recognise the round white shells etched with a five-petal flower. These erstwhile homes of sea urchins resemble a silver dollar, earning them the nickname “sand dollars” and the myth that they are the money of mermaids or the long-lost city of Atlantis. They pile up on the shores of the 700 islands in the Bahamas, so its central bank picked the sand dollar as its logo. In October 2020, when the Bahamas launched the world’s first central-bank digital currency ( CBDC ), the authorities chose to adorn the app with the familiar floral pattern and call it the sand dollar.

CBDC s are a digital version of cash—the physical money issued by central banks. In most countries, their design will resemble existing online platforms, but with a difference: money held as a CBDC is equivalent to a deposit with the central bank. In China more than 100,000 people have downloaded a similar trial mobile-phone app, enabling them to spend small government handouts of digital cash, or “e-yuan”. The app, like the paper yuan, depicts Mao Zedong. European officials want to launch a digital euro by 2025. On April 19th the Bank of England and the British Treasury launched a taskforce to consider the idea. In America the Fed is also looking into it. A survey by the Bank for International Settlements finds a large majority of central banks researching or experimenting with CBDC s. They may be in use by countries with a fifth of the world’s population in as little as three years’ time.

Until recently the concept of a retail CBDC was the province solely of starry-eyed economists, an interesting but impractical idea. But “in just two years we have seen a dramatic change in the way people and authorities think and talk about money,” says Jean-Pierre Landau, a former deputy governor of the Banque de France. “I cannot think—in peacetime and outside of a crisis—of a recent period where so much has changed in the way people think about money.”

What has prompted the shift? Mr Landau thinks it was “the wake-up call that Libra represented.” Libra was the first name for a digital currency and payments network announced in June 2019 by Facebook, which planned to issue tokens backed by a basket of currencies. “This was a real shock for most of the international monetary community,” says Mr Landau. A second driver was the decline in the use of cash. If cash can no longer be used for transactions it loses much potency, as it has to be a means of exchange if it is to be a store of value.

Yet it is still a radical intervention to issue CBDC s, which threaten the traditional banking system. This underpins much lending, especially in poorer countries, so its displacement could undermine the provision of credit.For two centuries most monetary systems have relied on the framework of a lender-of-last-resort in the form of a government-backed body that can step in to save solvent financial institutions. The modern iteration of this is an independent central bank. It provides money both in cash and by creating bank reserves (cash deposits that banks hold with it).

The private bits of the monetary system are the banks. They provide banking services by collecting deposits and making loans. By holding only a portion of these deposits and lending the rest, banks create money: the original deposits remain ready to be called on in full, but there are now new deposits from the proceeds of the loans. All deposits can be used as money to make payments. But the new money is created by the mere stroke of bankers’ pens. “The process by which banks make money is so simple that the mind is repelled,” wrote J.K. Galbraith in 1975. “Where something so important is involved only a deeper mystery seems decent.”

The discovery that banks could create money “came early in the development of banking,” said Galbraith. “There was that interest to be earned. Where such reward is waiting men have a natural instinct for innovation.” Most money is created by banks. In America the quantity of broad money stayed the same as a share of GDP for 100 years (though the pandemic spurred a dash for cash). Some 90% of it is in private bank deposits. In other economies the share is higher: 91% in the euro area, 93% in Japan and 97% in Britain.

This system has flaws. Because loans are long-term illiquid assets, whereas deposits are short-term liquid liabilities, banks need a lender-of-last-resort in a crisis. This creates other concerns because it fosters moral hazard through greater risk-taking. Regulators may try to curb this through prudential oversight, but this has not always worked.

Facebook threatened all this, with its huge network of users potentially meaning that more than 2bn people could adopt a new currency. This made Libra instantly credible as a medium of exchange. Its network would have been cross-border. And in its original incarnation it would have introduced a new unit of account. This raised the prospect of citizens using currencies over which central banks had no control. Regulatory authorities duly resisted the idea. It has now been reimagined as Diem, pegged 1-for-1 with global currencies such as the dollar or euro. In the cryptocurrency world such tokens are called stablecoins. Diem has yet to launch, but “even if that project never sees the light of day it has changed the world dramatically,” says Mr Landau.

Parallel payment systems, especially supra-sovereign ones, threaten the usual channels for monetary policy, which run through the banks. “It really depends on what happens with regard to digital payments and whether those are entirely outside the banking system,” says one senior central banker. “To the extent that they are, I think that would create a real gap in terms of monetary-policy transmission. If digital payments are entirely done within the banking system, then the monetary-policy transmission mechanism would be retained, but I do not think that is the world we are headed into.”

The redundancy of cash makes matters worse. Cash is the safest form of money. “Confidence in the system rests on the ability of the holder to transfer their money into the safest asset, even though they may never do that. The fact that they know they can just anchors the whole system,” says Sir Jon Cunliffe, deputy governor of the Bank of England. “When stress really comes the knowledge that they could is what matters.”

The hard truth is that monetary authorities have long felt uneasy about the weaknesses of banks. These include the share of people that are unbanked, even in rich countries, the high costs of payment methods and the inordinate cost of cross-border transactions (which eats into remittances to poorer countries). The appeal of a cheaper, seamless system has accelerated faster payment projects around the world. These include the FedNow system, a real-time payment system for America due to enter into use in 2023.

Both fear and opportunity are key motivators for the Bahamas. It would be easy to envisage residents relying exclusively on a convenient currency like Diem, circumventing the ability of the central bank to regulate the money supply. “We want to provide an infrastructure in a very small country that may not be justified on just business considerations if left entirely up to the financial institutions and individuals,” said John Rolle, governor of the Bahamian central bank, in March. Because of its scattered island geography, the Bahamas has many remote communities with limited access to banking services.

Central-bank wallet apps may not sound revolutionary, but the idea of a central bank providing digital money directly to citizens is radical. If citizens can convert bank deposits into central-bank money with a simple swipe, the technology “has the potential to be run-accelerant,” said Lael Brainard, a Federal Reserve governor, in 2019. This could pull deposits out of the banking system and onto the central bank’s balance-sheet, disintermediating the banks.

Enter the bigger central bank

This might not be a problem if take-up of CBDC s were low. Bank deposits in America are worth $16.8trn. Banks hold more reserves with the Fed than they need, an excess of around $3.3trn. Any initial movement of deposits from a bank to the Fed would come from these. “You could get a significant amount of migration to the Fed in the current high-reserve environment really without affecting bank lending,” says Morgan Ricks, of Vanderbilt University in Nashville, Tennessee.

One idea proposed by researchers at the Bank of England and the European Central Bank is to limit how much can be held in a CBDC . But Sir Paul Tucker, formerly at the Bank of England, suggests this would face a credibility hurdle. “The hardest thing for the government or the state generally is to stick to a commitment of restraint.”

If CBDC s proved popular, they could suck all deposits out of the banking system. In America this would stretch the central bank’s balance-sheet from $8trn to a whopping $21.5trn. Who, then, would provide the $15trn of loans that banks now extend to the American economy?Perhaps a central bank could simply pass the funds back to the banks by lending at its policy interest rate. But it is hard to see the idea of the Federal Reserve extending trillion-dollar loans to the likes of JPMorgan Chase or Bank of America as being politically uncontroversial.

A radically different world, at least in rich countries, would eliminate fractional-reserve banks as the source of most or even all lending. “Narrow banking” is the name for the idea that banks should be required to hold sufficient liquid assets to back all their deposits. It was put forward in 1933 as the “Chicago Plan”, after the devastation of the Depression. It would end the system of fractional-reserve banking by breaking the link between the extension of credit and the creation of money. As the monetary theorist Irving Fisher summed up the idea: “In short: nationalise money but do not nationalise banking.”

The appeal of narrow banking has continued, with support for the concept coming from the likes of Milton Friedman, James Tobin and Hyman Minsky. The idea of CBDC s has led to a further revival. Yet beyond the problem of transitioning from one system to another, narrow banking has its own difficulties. What banks do with fractional reserves is to turn short-term liquid funds into long-term illiquid loans. Deposits are not much good sitting idle, but they are when used as the basis for riskier lending. The benefits of linking savers, who prefer safety and liquidity, with borrowers, who like flexibility and security, are enormous.

Joseph Schumpeter wrote in the 1930s that it was “one of the most characteristic features of the financial side of the capitalist evolution to ‘mobilise’ all, even the longest maturities” so that they are financed by short-term borrowing. “This is not mere technique. This is part of the core of the capitalist process.” Banks liberate innovation and investment, the engines of Schumpeter’s creative destruction, from the “voluntary abstinence routine of the savers.”

If authorities were to curb liquidity and maturity transformation through narrow banking, they might damage growth. But if liquidity and maturity transformation is as useful as many claim, “I think you would just find it replicated elsewhere,” says Peter Fisher of Tuck School of Business at Dartmouth. And in such a case the central bank could find itself in the position of having to intervene in all sorts of institutions other than banks.

Although other institutions could lend to businesses and households, they could not promise to do so instantly. “The key credit facility is an on-demand facility or an overdraft facility. I am running a small business and I might need more working capital right now!” notes Sir Paul. Businesses now get this from banks, which offer it because they make money. “Because they can create money instantly, they can provide liquidity via credit facilities instantly. A pension or other fund cannot do that. For them it is resources in, resources out,” he says.

With diminished or no banks, it is hard to see how firms would retain access to immediate credit in times of crisis—as they did in March 2020, when corporate treasurers across America drew down billions of dollars-worth of credit lines overnight. That is the superpower of banks. In their absence the role of the central bank would have to swell further.

Mervyn King, a former governor of the Bank of England, has proposed that central banks should lend, with various haircuts, to anyone who could supply collateral, a “pawnbroker for all seasons” to replace the lender-of-last-resort. But existing collateral systems have become fraught with complexity. Europe has a collateral framework to enable refinancing operations. “This system told you what you could post and what the haircuts were,” says Stephen Cecchetti, of Brandeis University. “Over the past 15 years it has anywhere from 25,000-30,000 securities in it, many of which were fabricated in order to actually meet the requirements of the collateral policy.” It stretched to include many things. “At one point, somewhere deep inside, there was a security that included Lionel Messi’s contract.”

Mr Cecchetti argues that no central bank could cope with such variety, with securities in different buckets, each with a discount to their market value. “Collateral systems can end up distorting the price of credit. This could become a concern with a pawnbroker system.” Sir Paul thinks that “Deep in the political economy of the money and credit architecture there is a choice.” The choice most countries have made is to have fractional-reserve banks. “We choose, as a society, to have the financial-stability problem (which becomes an urgent priority) in order to keep the state out of or minimise the role of the state in credit allocation,” he says.

The provision of easier direct access to central banks, through CBDC s, is likely to pull more assets into the central bank. It is hard to see how this does not lead to more central-bank intervention in credit. And keeping distance between the state and credit allocation in a world without banks is only the start. “The three biggest problems I have [with CBDC s] are disintermediation of the banking system, privacy and currency substitution across borders,” says Mr Cecchetti. “China has fewer concerns about privacy, they have state-owned banks, and they have capital controls.”

The magnitude of these issues make the idea of introducing CBDC s one that central bankers cannot decide by themselves. Nor do they believe they should. “The bottom line is that to move forward on this we would need buy-in from Congress, from the administration, from broad elements of the public,” said Jerome Powell, the Fed chairman, in March. “That would ideally come in the form of an authorising law, rather than us trying to interpret our existing law to enable this.” A new era of public money would, in short, require public approval. ■

This article appeared in the Special report section of the print edition under the headline “Going public”

From the May 8th 2021 edition

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November 09, 2020

Central Bank Digital Currency: A Literature Review

Francesca Carapella and Jean Flemming

Technological advances in recent years have led to a growing number of fast, electronic means of payment available to consumers for everyday transactions, raising questions for policymakers about the role of the public sector in providing a digital payment instrument for the modern economy. From a theoretical standpoint, the introduction of a central bank digital currency (CBDC) raises long-standing questions relating to the provision of public and private money (Gurley and Shaw 1960), and the ability of the central bank to use CBDC as a means for transmitting monetary policy directly to households (Tobin 1985). The theoretical literature on CBDC to date relates to these questions by focusing on the effect of introducing a CBDC (i) on commercial banks, and (ii) on monetary policy and financial stability, and the resulting welfare implications. Policymakers have also taken a keen interest in these questions, among others (Bank for International Settlements 2018).

Broadly, the literature that studies CBDC considers it to be a means of payment that can pay interest and that does not necessarily need to be held in an account at a commercial bank. Though there is no universally agreed-upon definition of CBDC by policymakers or academics, thus far the literature has studied the implications of a central bank liability held directly by the public 1 . The models and assumptions in the literature so far provide streamlined frameworks to answer questions about the effects of CBDC at the micro- and macro-levels, while abstracting from many of the complex design issues of interest to policymakers. 2

CBDC's Effect on Commercial Banks

The first strand of the literature asks how CBDC will affect commercial banks. Fundamentally, CBDC can serve as an interest-bearing substitute to commercial bank deposits. Faced with such a substitute, commercial banks may respond by changing the deposit rates they offer to savers and, because of the resulting impact on banks' funding cost, the terms of the loans they offer to borrowers. As a result, both the quantity of bank deposits and the volume of bank-intermediated lending may change with the introduction of a CBDC. In this respect, this strand of the literature can speak to the concern of some policymakers that the introduction of CBDC may replace banks' main source of funding and cause disintermediation of commercial banks, which in turn may lead to a decrease in their lending.

Andolfatto (2018) studies these effects on a monopoly bank. In his paper, when the CBDC is interest-bearing, the bank, which makes positive profits in equilibrium, raises the equilibrium deposit rate to be equal to the interest rate on CBDC, thus making depositors indifferent. An important result is that because CBDC induces more favorable contractual terms for depositors, it increases the demand for deposits, both through an intensive margin (existing depositors are encouraged to save more) and an extensive margin (individuals who otherwise would choose to be unbanked are encouraged to pay the cost of accessing the banking sector). Hence, the competitive pressure exerted by CBDC could actually end up expanding banks' depositor base. It is, however, possible that CBDC remuneration erodes "banks' franchise value" (profits) but this does not necessarily result in higher loan rates. To this point, Andolfatto argues that as long as banks are able to borrow reserves from the central bank, which in any corridor system is done via the central bank's lending facility, disintermediation can be avoided as banks can still make loans. 3

Similar ideas to those in Andolfatto (2018) are further developed by Chiu et al. (2020), who also study the impact of CBDC on bank lending and model CBDC as an interest-bearing asset that competes with banks' deposits. The economic mechanism driving their baseline results is similar to that in Andolfatto (2018), as banks in their model are also imperfectly competitive. From a theoretical perspective, Chiu et al. (2020) go beyond Andolfatto (2018) in that they analyze the case where banks can hold CBDC to meet their reserve requirements and CBDC designs that consider policy tools different from fixing the rate of interest it pays. Calibrating their model to the US, Chiu et al. (2020) quantify the magnitude of the effect on lending from the introduction of a CBDC, finding it can increase by as much as 3.55% with a properly chosen remuneration rate. The specific change in lending depends on the region of the parameter space considered: if the interest rate on CBDC is below that on checkable deposits, there is no effect on banks' activities. If the interest rate on CBDC is higher than that on deposits, but not too high, then banks respond by increasing deposit rates and lending, as higher deposit rates result in a larger deposit base. If, however, the interest rate on CBDC is too high, banks scale down their deposits and loans.

Brunnermeier and Niepelt (2019) also consider CBDC as an asset with the same liquidity properties as bank deposits. As in Andolfatto (2018), assuming the central bank lends to commercial banks, the introduction of a CBDC need not affect the equilibrium allocation. They show that if households' deposits are exchanged for CBDC, then there is no effect on the equilibrium allocation as long as (i) deposit liabilities are replaced by central bank loans to commercial banks and (ii) there is no effect on the constraints faced by households or the wealth distribution across households. Intuitively, if CBDC does not affect households' payoffs nor relaxes or tightens the constraints they face, the portfolio choices of each household, and in turn the distribution of wealth across households, will be unaffected. From the perspective of private banks, the equilibrium is unaffected only if the level of liabilities is unchanged. Thus, the authors state that this could be achieved by "render[ing] the central bank's implicit lender-of-last-resort guarantee explicit."

Fernandez-Villaverde et al. (2020a) build a model of bank runs in the spirit of Diamond and Dybvig (1983) to derive a related equivalence result. The authors characterize conditions such that CBDC replaces banks' deposits entirely, and show that in normal times the set of allocations achieved under private bank deposits is the same as that achieved under CBDC. Differently, in times of bank runs, they show that if the central bank is able to commit not to liquidate its long-term assets, the presence of CBDC can decrease the likelihood of runs, leading all depositors to hold CBDC instead of deposits in equilibrium. Under the assumptions of their model, despite the elimination of commercial bank deposits, the presence of CBDC does not lead to a decrease in lending as the central bank is assumed to have (indirect) access to the same investment technology as commercial banks.

Keister and Sanches (2019) explore the trade-off introduced by a CBDC between reduced lending by commercial banks and increased trade in a model of decentralized exchange in the spirit of Lagos and Wright (2005). They show that if CBDC is widely accepted for transactions, buyers will hold more of it, increasing trade between buyers and sellers, leading to higher quantities exchanged, and in turn, higher consumption. At the same time, consumers' portfolio choice implies lower deposit balances and in turn lower lending by banks, reducing investment. If the consumption effect through increased acceptance is larger than the investment effect through decreased lending, the introduction of a CBDC will increase welfare.

CBDC's Effect on Monetary Policy and Financial Stability

The second strand of the literature asks what will be the effect of a CBDC on monetary policy and financial stability, and the resulting welfare implications. As a new form of central bank money, CBDC has the potential to affect central banks' wider policy objectives, either by acting as a new monetary policy tool or through its effects on the portfolio choices of households and the probability of bank runs. Crucial to these mechanisms is the flexibility provided by CBDC in responding to macroeconomic shocks.

Barrdear and Kumhof (2016) build a dynamic stochastic general equilibrium (DSGE) model with sticky prices and adjustment costs to study the long-run and cyclical effects of CBDC for the macroeconomy. Under the assumption that newly issued CBDC is exchanged one-for-one with government debt, they find that the introduction of CBDC decreases interest rates and distortionary taxes, thus increasing long-run GDP. Over the business cycle, counter-cyclical CBDC issuance can lead to a smaller fall in GDP in response to a liquidity demand shock. This shock leads to a flight to safety in which households demand more CBDC. If the central bank can increase the quantity of CBDC to satisfy this demand, the reduction in real economic activity is less severe, attenuating the decline in spending and therefore welfare.

Subsequent work by Fernandez-Villaverde et al. (2020b) considers a model of bank runs a la Diamond and Dybvig (1983) in which banks can offer nominal contracts. 4 In their paper, CBDC is modeled as deposits held at the central bank. Their framework highlights an important trade-off: if a run on CBDC occurs, the central bank internalizes the effect on prices, and thus real consumption, from liquidating its assets to pay depositors. By increasing the price level in the case of a run, the central bank can effectively reduce the real value of withdrawals, thus preventing bank runs from occurring. This increase in the price level, however, comes at the cost of sacrificing inflation targeting. Even if the central bank is mandated to maintain price stability, it cannot do so in the case of a large enough run. In this case, the authors show that there is a positive probability of runs, and that a negative interest rate on CBDC during financial panics is optimal to keep inflation in check.

Williamson (2019) studies the role of a CBDC not only as an interest-bearing asset, but also as a means of payment alternative to cash, which is subject to theft, and to bank deposits, which are subject to limited commitment of the bank to honor deposit repayment. When households endogenously select into banked (i.e. deposit users) and unbanked (i.e. cash users), the introduction of a CBDC, which pays interest and is assumed to be immune to theft, can be Pareto improving and always increases welfare of at least unbanked households. The economic mechanism driving the welfare implications focuses on the interaction between the new monetary policy tool introduced by an interest-bearing CBDC and banks' limited commitment. Because banks' assets serve as collateral to secure deposit liabilities and relax their commitment friction, collateral assets play a key role in limiting the amount of liquidity banks can offer households. Interest payments on CBDC which are financed by an open market purchase of government bonds effectively reduce the availability of collateral assets to banks, tightening their collateral constraint and reducing their ability to issue payment instruments in the form of deposits. Thus, despite increasing the welfare of unbanked households, who, by assumption, are no longer subject to theft, CBDC decreases the welfare of banked households unless they also choose to hold CBDC in their portfolios. With at least some households switching to CBDC, some of the transactions which were carried out with deposits and required banks to hold collateral are now carried out with CBDC. Banks' collateral assets are still available to issue deposits, hence, overall, the aggregate stock of collateral can support more transactions.

While also focusing on the liquidity properties of CBDC as a means of payment, Keister and Monnet (2020) study its effects on the set of feasible policies available to the government in periods of financial distress. If the financial conditions of banks are private information to each bank and its depositors, the introduction of a CBDC as an alternative means of payment to bank deposits but immune from the risk of bank runs (as the central bank does not perform maturity transformation) results in depositors withdrawing their funds from banks in times of stress and reallocating them into CBDC. By observing a large and sudden inflow of funds into its digital currency, the central bank can then infer the financial conditions of banks. This information might be crucial in designing an appropriate policy response in times of stress, the more so the faster a response is needed to be effective. By appropriately choosing the interest rate on CBDC to make it more attractive in times of stress, the central bank can more quickly infer the state of the financial system and respond more effectively. This allows the government to adopt policies that are welfare-improving over the best policies feasible without a CBDC.

Considerations for future research

As with any new literature, many questions remain. We believe the most crucial question is which intrinsic features of CBDC as a means of payment and a store of value are important for households' portfolio choices as to which monies to use. Indeed, empirical studies of consumer payment choice such as Koulayev et al. (2016) show that individuals' preferences across means of payment are heterogeneous and not fully explained by demographic characteristics such as income and age. In order to fully understand the macroeconomic and microeconomic effects of introducing a CBDC in a theoretical framework, it is imperative to first understand consumer payment choice as CBDC will, first and foremost, expand the set of payment and savings options available to households.

To understand how heterogeneity in consumers' choices across means of payment determines the adoption of CBDC, it is crucial to identify whether CBDC could be a substitute for physical currency, deposits, or both. Cash and deposits share several characteristics, such as (near) immediate settlement upon payment; however, they differ in the level of anonymity and privacy of transactions and the risks involved in holding each. Williamson (2019) highlights one such trade-off between cash and deposits: the risk that a bank absconds with deposits and the risk of theft for physical cash. Andolfatto (2018) considers a fixed cost of opening an interest-bearing deposit account, while the use of cash is free but pays no interest. Given these trade-offs, Andolfatto and Williamson, respectively, allow for heterogeneity in income or preferences as a driver of payment choice, leading to a share of the population to be unbanked, that is, to hold only cash. In these models, the introduction of a CBDC can lead to greater financial inclusion by making deposits, either at commercial banks or in CBDC, more attractive, lowering the share of unbanked. Chiu et al. (2020) and Keister and Sanches (2019) consider heterogeneity across sellers -- some accept only cash (say, for small purchases) while others accept only deposits (for larger purchases) -- leading buyers to hold different means of payment depending on which type of purchase they will make.

Avenues for future work include further exploring how the intrinsic features of CBDC as a means of payment and store of value affect the set of feasible allocations in the economy and, in turn, affect its value to heterogeneous households.

Adrian, T and T. Mancini Griffoli (2019). The Rise of Digital Money. FinTech Notes No. 19/001. International Monetary Fund.

Andolfatto, D. (2018). Assessing the impact of central bank digital currency on private banks. FRB St. Louis Working Paper (2018-25).

Bank for International Settlements (2018). Central bank digital currencies. Technical report, Committee on Payments and Market Infrastructures, Markets Committee.

Barrdear, J. and M. Kumhof (2016). The macroeconomics of central bank issued digital currencies. Staff Working Paper no. 605, Bank of England.

Brunnermeier, M. K. and D. Niepelt (2019). On the equivalence of private and public money. Journal of Monetary Economics 106, 27--41.

Chiu, J., M. Davoodalhosseini, J. Jiang, and Y. Zhu (2020). Bank market power and central bank digital currency: Theory and quantitative assessment. Bank of Canada Staff Working Paper (2010-20).

Diamond, D. W. and P. H. Dybvig (1983). Bank runs, deposit insurance, and liquidity. Journal of Political Economy 91 (3), 401--419.

Fernandez-Villaverde, J., D. Sanches, L. Schilling, and H. Uhlig (2020a). Central bank digital currency: Central banking for all? Working Paper no. 26753, National Bureau of Economic Research.

Fernandez-Villaverde, J., D. Sanches, L. Schilling, and H. Uhlig (2020b). Central bank digital currency: When price and bank stability collide. Technical report.

Gurley, J. G. and E. S. Shaw (1960). Money in a Theory of Finance. Brookings Institution, Washington DC.

Keister, T. and C. Monnet (2020). Central bank digital currency: Stability and information. Working Paper.

Keister, T. and D. R. Sanches (2019). Should central banks issue digital currency? Technical report.

Koulayev, S., M. Rysman, S. Schuh, and J. Stavins (2016). Explaining adoption and use of payment instruments by us consumers. The RAND Journal of Economics 47 (2), 293--325.

Lagos, R. and R. Wright (2005). A unified framework for monetary theory and policy analysis. Journal of Political Economy 113 (3), 463--484.

Tobin, J. (1985). Financial innovation and deregulation in perspective. Bank of Japan Monetary and Economic Studies 3 (2), 19--29.

Williamson, S. (2019). Central bank digital currency: Welfare and policy implications. Technical report.

1. See Adrian and Mancini Griffoli (2019) for a description of an alternative design, the "synthetic CBDC". Return to text

2. These include, but are not limited to, the choice between token and account-based CBDCs, ledger design and access, programmability, privacy, and handling of offline transactions. Return to text

3. In monetary policy implementation frameworks based on a corridor system, the target for the short-term interest rate is typically set within the corridor established by the discount rate (or interest rate charged by the central bank's lending facility) as the ceiling and the interest rate on reserves deposited at the central bank as the floor (or interest rate paid by the central bank's deposit facility). Return to text

4. Nominal contracts are promises to pay a future amount that is not indexed to the price level. Return to text

Carapella, Francesca, and Jean Flemming (2020). "Central Bank Digital Currency: A Literature Review," FEDS Notes. Washington: Board of Governors of the Federal Reserve System, November 09, 2020, https://doi.org/10.17016/2380-7172.2790.

Disclaimer: FEDS Notes are articles in which Board staff offer their own views and present analysis on a range of topics in economics and finance. These articles are shorter and less technically oriented than FEDS Working Papers and IFDP papers.

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Essay On Digital Currency In India | Advantages & Disadvantages

Essay On Digital Currency In India | Advantages & Disadvantages

Hello Friend, In this post “ Essay On Digital Currency In India | Advantages & Disadvantages “, we will read about “ Digital Currency and its advantages and Disadvantages as an Essay ” In Detail. So…

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Essay On Digital Currency In India

Introduction .

Digital Currency available in digital or electronic form and not in physical form. It is also known as electronic money, cyber-cash, electronic currency, or digital money . They are accessible with computers or cell phones. Digital currencies do not require an intermediary for a transaction. All digital currencies are not cryptocurrencies but all cryptocurrency is 100% digital currency .

What Are digital currencies?

Digital currencies are intangible. Transactions can be done only through computers, cell phones, or electronic wallets. Like any other fiat currency, it can also be used to purchase goods and pay for services.

Digital currency mainly worked for instantaneous transactions, When it linked to supported devices and networks, it can be seamlessly executed to make payments across borders.

As payments in digital currencies are made directly between the parties without the need for intermediaries the transactions are usually instantaneous and low cost. Transactions involving brings in necessary record-keeping and transparency in dealings.

David Chaum introduced the idea of digital cash through a research paper in 1983. In 1989, he founded Digicash an electronic cash company to commercialize the ideas in his research.

E-gold was introduced in 1996. In 1998 Paypal came into the picture. In 2009, bitcoin was launched which is a decentralized blockchain-based digital currency with no central server and no tangible assets held in reserve.

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Advantages Of Digital Currency

• Lower transaction costs and ability to make payments any time.
• Receiving funds more efficiently than by legacy financial institutions.
• It is easier for international customers to do business with you.
• Fraud protection, for e.g. In Cryptocurrency Trading, you don’t require to show your personal information.
• The cost of making currency becomes decreased due to digital currency
• Anyone can easily receive or send payment anywhere, anytime.

Disadvantages Of Digital Currency

• For Digital Currency strong technical mechanism required.
• lack of proper Internet connection across the country
• Lack of skilled users
• Lack of electronics, gadgets, such as mobile, laptop, etc. between poor’s person.
• Reduces the number of jobs in the banking sector.

Digital Currency in India

If a digital currency is regulated by a central bank. it is known as central bank digital currency( CBDC ).

Unlike crypto-currencies which are issued without a central bank backing and are issued and traded on exchanges, a CBDC is a digital currency that holds the same value as fiat currencies issued by a country’s central bank.

Conclusion  

At the end of the day, digital currencies have the potential to change the world of business as we know it.  In other words, the obstacles that digital currencies must overcome in order to become ‘mainstream’ are not just economic but mental, as well.

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Central Bank Digital Currency

• 24 Aug 2022
• 11 min read
• GS Paper - 2
• Government Policies & Interventions
• GS Paper - 3
• Growth & Development
• IT & Computers

For Prelims: Economic Development, Cryptocurrency, Blockchain, Central Bank Digital Currency (CBDC), Reserve Bank of India (RBI)

For Mains: Central Bank Digital Currency (CBDC) - Opportunities and Risks Associated

Why in News?

According to recent reports, the Reserve Bank of India’s (RBI) digital rupee — the Central Bank Digital Currency (CBDC) — may be introduced in phases beginning with wholesale businesses in the current financial year.

• RBI had proposed amendments to the Reserve Bank of India Act, 1934 , which would enable it to launch a CBDC.

What is Central Bank Digital Currency (CBDC)?

• CBDCs are a digital form of a paper currency and unlike cryptocurrencies that operate in a regulatory vacuum, these are legal tenders issued and backed by a central bank.
• A fiat currency is a national currency that is not pegged to the price of a commodity such as gold or silver.
• The digital fiat currency or CBDC can be transacted using wallets backed by blockchain.
• Though the concept of CBDCs was directly inspired by Bitcoin , it is different from decentralised virtual currencies and crypto assets, which are not issued by the state and lack the ‘legal tender’ status.
• The main objective is to mitigate the risks and trim costs in handling physical currency, costs of phasing out soiled notes, transportation, insurance and logistics.
• It will also wean people away from cryptocurrencies as a means for money transfer.
• Bahamas has been the first economy to launch its nationwide CBDC — Sand Dollar.
• Nigeria is another country to have rolled out eNaira in 2020.
• China became the world's first major economy to pilot a digital currency e-CNY in April 2020.
• Korea, Sweden, Jamaica, and Ukraine are some of the countries to have begun testing its digital currency and many more may soon follow.

What are the Benefits & Challenges of CBDC?

• CBDC can gradually bring a cultural shift towards virtual currency by reducing currency handling costs.
• The convenience and security of digital forms like cryptocurrencies
• The regulated, reserved-backed money circulation of the traditional banking system.
• CBDC can provide an easy means to speed up a reliable sovereign backed domestic payment and settlement system partly replacing paper currency.
• It could also be used fo r cross-border payments , it could eliminate the need for an expensive network of correspondent banks to settle cross-border payments.
• The increased use of CBDC could be explored for many other financial activities to push the informal economy into the formal zone to ensure better tax and regulatory compliance.
• It can also pave the way for furthering financial inclusion.
• This has serious implications given that digital currencies will not offer users the level of privacy and anonymity offered by transacting in cash.
• Compromise of credentials is another major issue.
• If sufficiently large and broad-based, the shift to CBDC can impinge upon the bank’s ability to plough back funds into credit intermediation.
• If e-cash becomes popular and the Reserve Bank of India (RBI) places no limit on the amount that can be stored in mobile wallets, weaker banks may struggle to retain low-cost deposits.
• Faster obsolescence of technology could pose a threat to the CBDC ecosystem calling for higher costs of upgradation.
• Operational risks of intermediaries as the staff will have to be retrained and groomed to work in the CBDC environment.
• Elevated cyber security risks, vulnerability testing and the costs of protecting the firewalls.
• Operational burden and costs for the central bank in managing CBDC.

Way Forward

• Then it can steer away from serving as a store of value to avoid the risks of disintermediation and its major monetary policy implications.
• Thus, it is important to employ the right technology that will back the issue of CBDCs.
• The RBI will have to map the technology landscape thoroughly and proceed cautiously with picking the correct technology for introducing CBDCs.
• This would require close interaction between the banking and data protection regulators.

UPSC Civil Services Examination, Previous Year Questions (PYQs)

Q. With reference to “Blockchain Technology”, consider the following statements: (2020)

• It is a public ledger that everyone can inspect, but which no single user controls.
• The structure and design of blockchain is such that all the data in it are about cryptocurrency only.
• Applications that depend on basic features of blockchain can be developed without anybody’s permission.

Which of the statements given above is/are correct?

(a) 1 only (b) 1 and 2 only (c) 2 only (d) 1 and 3 only

Explanation:

• A blockchain is a form of public ledger, which is a series (or chain) of blocks on which transaction details are recorded and stored on a public database after suitable authentication and verification by the designated network participants. A public ledger can be viewed but cannot be controlled by any single user. Hence, statement 1 is correct.
• The blockchain is not only about the cryptocurrency but it turns out that blockchain is actually a pretty reliable way of storing data about other types of transactions, as well.
• In fact, blockchain technology can be used in property exchanges, bank transactions, healthcare, smart contracts, supply chain, and even in voting for a candidate. Hence, statement 2 is not correct.
• Although cryptocurrency is regulated and needs approval of the central authorities, blockchain technology is not only about cryptocurrency. It can have various uses, and applications based on basic features of the technology can be developed without anybody’ approval. Hence, statement 3 is correct.
• Therefore, option (d) is the correct answer.

Q. Consider the following pairs: (2018)

Which of the pairs given above is/are correctly matched?

(a) 1 and 3 only (b) 2 only (c) 2 and 3 only  (d) 1, 2 and 3

• The Belle II Experiment is a particle physics experiment designed to study the properties of B mesons (heavy particles containing a bottom quark). Belle II is the successor to the Belle experiment, and is currently being commissioned at the SuperKEKB accelerator complex at KEK in Tsukuba, Ibaraki Prefecture, Japan. Hence, pair 1 is not correctly matched.
• CRISPR-Cas9 is related to genetic engineering. It is a unique technology that enables geneticists and medical researchers to edit parts of the genome by removing, adding or altering sections of the DNA sequence. Hence, pair 3 is not correctly matched.
• In simple terms, blockchain is a time-stamped series of immutable record of data that is managed by cluster of computers not owned by any single entity.
• Each of these blocks of data (i.e. block) are secured and bound to each other using cryptographic principles (i.e. chain). Blockchain technology allows market participants to keep track of digital currency transactions without central record keeping. Hence, pair 2 is correctly matched.
• Therefore, option (b) is the correct answer.

Q. What is Cryptocurrency? How does it affect global society? Has it been affecting Indian society also? (2021)

Central bank digital currency momentum growing, study shows

• Medium Text

• Growing number of countries piloting digital currencies
• Those already launched have seen usage finally pick up
• China could fully launch e-CNY next year, U.S. lagging

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US, Mexico resolve labor rights denial petition at Impro Industries

The U.S. and Mexico have resolved a Rapid Response Mechanism petition under the U.S.-Mexico-Canada trade agreement alleging workers' rights were denied at Chinese-owned manufacturer Impro Precision Industries , the U.S. said on Tuesday.