An upcoming crypto storm for central banks? Focus on enhanced digital currency According to Reuters

By Howard Schneider

NEW YORK (Reuters) – Digital currencies, a curiosity just a few years ago, are emerging as a fierce concern among central banks with their potential to erode the power of monetary policy. and even in the best cases there is the possibility of more difficult control over exchange rates, according to the new Federal Reserve and other studies.

A Fed symposium in New York this week raised puzzles central banks face in dealing with emerging digital technologies, from new ways to handle payments payments to new asset categories such as cryptocurrencies and stablecoins.

There are benefits to be seen in the underlying technology, including better transaction speeds, lower costs, and easier access to banking services, and even nearer crashes and fluctuations. Here, it is still supposed to continue to grow. In other words, ignore it, and systems developed by private emerging firms could take a larger financial stake and make “central bank cash” less relevant – reduce central bank control over interest rates.

Create a substitute in the form of central bank digital currency and new uncertainties could emerge – including the possibility of a digital dollar or euro replacing conventional bank deposits and compete with money market funds and other important financial instruments. During a crisis, this process can mimic the behavior of a bank, starving the system of liquidity and forcing the Fed, for example, to increase lending to commercial banks or increase its holdings. its own treasury bonds and similar securities to keep the system stable.

As a result, deposit-losing banks will have to compete for new funds and “depending on the intensity … the general level of short-term interest rates … may increase”, concludes one paper. of the Fed this week outlining possible outcomes for the US. central bank adopting a retail-level digital currency, open to households. “A retail CBDC could increase stress in the financial sector, forcing the Federal Reserve to provide more liquidity to banks through existing instruments… The long-term footprint of The Federal Reserve on certain asset markets, such as in US Treasuries, could become more visible.”

The Fed is debating whether to develop a digital currency, as are most central banks in the world. A decision has yet to be made, and officials say it will need congressional approval to proceed.

The point of tension seems far-fetched since the market value of cryptocurrencies and stablecoins is still a small part of the financial system. But payment processors, such as PayPal (NASDAQ:) and Apple (NASDAQ:) Pay, are growing rapidly and earlier this year processed transactions on the scale of credit card companies. great. Among cryptocurrencies and stablecoins, as was noted at the New York conference, several deals involving exotic lending schemes – credit creation – which, if extended, could lead to risks. greater risk.

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

“In some countries it is becoming a problem today. China, more and more India or Sweden – the use of central bank money in retail payments has decreased to essentially nothing” when private payment providers stepped in.

HIGH STORE

The impact of central bank digital currencies on monetary policy is just one part of a broader view by institutions like the Fed of how emerging technologies will change the financial system. As those technologies become more prominent, the implications for financial stability and the risk posed to individual investors have become a higher priority for research and regulation.

In the United States, President Joe Biden, citing a five-year growth in crypto assets from $14 billion to $3 trillion in November, issued an executive order in March regulating spending. Treasury and other agencies began to consider the best way to regulate the industry.

With equities, central banks around the world are rapidly moving to the sidelines.

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

More than a quarter are actively developing digital currencies or running pilot programs, the proportion nearly doubling between 2020 and 2021. The explosion of electronic payments as well as crypto investment in the The pandemic is accelerating work, respondents said, with about 60 percent of banks saying cash use is declining.

Adoption may not necessarily be disruptive.

In a presentation published ahead of the Fed conference in New York, Andrew Hauser, the Bank of England’s chief market officer, said that “while the technology for any future CBDC could be new … then the use of a central bank’s balance sheet to provide state-backed transaction money … is one of the oldest functions of central banks.”

But it can come fast.

Lorie Logan, executive vice president of the New York Fed and recently appointed head of Dallas Raised. “How things evolve from here is uncertain, and the impact of these innovations could be revolutionary, or more evolutionary.”