By Kensuke Nakazawa / Yomiuri Shimbun Deputy Economic News Editor Amid the rapid popularization of virtual currencies, including bitcoin (see below), central banks around the world are beginning to investigate the concept (see chart 1). Money, which has existed for over two millennia, is approaching a historic turning point.
The quarterly report released by the Bank for International Settlements on Sept. 17 devoted 16 pages to a feature on digital currencies issued by central banks, discussing the pros and cons of such currencies as well as issues that need to be addressed when introducing them. The report said all central banks may eventually be forced to consider whether to issue “central bank cryptocurrency.”
The fact that the BIS, which is called the “bank of the central banks,” gave this topic major coverage signifies the emergence of digital currencies as something that central banks can ill afford to ignore.
One entity that is taking a proactive stance is Sweden’s Riksbank, the world’s oldest central bank, established in 1668. Riksbank will decide whether to introduce the e-krona, its proposed digital currency, by the end of next year. In August, the digitally inclined northern European nation of Estonia began to consider introducing its own virtual currency, the estcoin, which could be used for online government services.
In addition to these countries, the Bank of Japan and central banks in the Netherlands, Canada, Britain, Russia and China have begun to investigate digital currencies and blockchains, the core technology enabling such currencies to function.
The rapid rise of virtual currencies (see chart 2) is the main reason central banks have lined up to promote such research.
As of Sept. 25, the total market value of virtual currencies stood at about $130 billion, or about ¥15 trillion, more than 10 times the level a year before. Bitcoin accounted for half this amount, with one bitcoin valued at $4,200, or about ¥470,000 — seven times the amount a year before.
However, central banks are not yet worried that currencies such as the yen and the dollar will be replaced by virtual money.
This is because virtual currencies lack three characteristics that currencies should have: (1) the capacity to store value, (2) the capacity to be used for payment and (3) the capacity to act as a measure of value. They are attractive to investors seeking to make a quick profit, but they are not appropriate for casual shopping in which there is no need to worry about fluctuations in value. In fact, those that now exist commonly experience fluctuations of over 10 percent in value over the course of a day.
Central bank-issued currencies are also in an advantageous position in terms of creditworthiness, as they are backed up by the strength of that country’s economy. Virtual currencies, on the other hand, lack any form of government backing.
Prof. Mitsuru Iwamura of Waseda University pointed out that bitcoin’s value is rooted in the scarcity of the currency, which is due to an upper limit on the number that can be issued, and the costs incurred in the “mining” that is required to acquire the coin. In these respects, it is similar to gold and silver. Iwamura also noted that central banks can issue the currency without incurring any significant costs — something that offers them an “overwhelming competitive advantage.”
The BIS’ recent quarterly report stated that virtual currencies are unlikely to replace central bank-issued currencies.
Effects on monetary policy
If this is the case, why do central banks have virtual currencies on their radar, and why are they researching them?
One reason is that digital currencies can increase the freedom of monetary policy.
In Japan and Europe, where commodity prices do not easily rise, interest rates are close to zero and have almost no room to drop. This kind of situation, in which standard monetary policy fails to stimulate the economy, is called a liquidity trap.
Although the Bank of Japan and the European Central Bank have imposed negative interest rates on some deposits made by financial institutions into these central banks, this monetary policy has become ineffective because money can be hidden away as cash, which does not attract negative interest rates.
If central banks began issuing digital currency, it would in theory become possible for them to directly apply negative interest rates to the money held by corporations and individuals. The idea is that the face value of the digital currency they are holding would gradually decrease with time.
Corporations and individuals would thus consume more to avoid the value of the currency declining, likely stimulating the economy and causing prices to rise. There are hopes that using digital currency would greatly increase the effectiveness of monetary policy.
Wary of potential for disorder
Another reason central banks are investigating digital currencies is their wariness over the potential for virtual currencies to cause disorder in the financial system.
Initial coin offerings (ICOs), a mechanism in which companies issue their own coins and procure business funds using virtual currency, are increasing rapidly worldwide. According to the information site Coinschedule, procurements in 2016 came to $96 million and exceeded ¥2.2 billion in 2017.
The mechanism is similar to raising funds by issuing stocks and corporate bonds, with one major exception — it falls outside the regulation of financial authorities. Shady cases in which ICOs exploit this absence of regulation to raise large sums of money despite a project’s lack of feasibility are rife.
Because ICOs are internet-based, even if governments were to start regulating the practice, ICOs can still be conducted with investors from around the world just by shifting the base of operations to another country. A sense of impending crisis is growing among central banks that, if left to its own devices, the practice may negatively impact the health of financial markets.
Kyoto University Prof. Naoyuki Iwashita, who served as the head of the FinTech Center at the BOJ, said: “While the central bank and stock exchange have been protected by domestic laws, we’re being forced to respond to something unknown, where we don’t know if existing methods will be workable. The appearance of bitcoin opened Pandora’s box.”
According to Iwashita, the viewpoint that major central banks should start issuing digital currency as soon as possible, to secure a firm position in the cyberspace of the internet, supports the digitization of central banks.
The emergence of virtual currencies has been forcing a shakeup of existing currencies. The situation is clear when one considers why virtual currencies have made such rapid progress.
Bitcoin began to get attention when the eurozone nation of Cyprus experienced a financial crisis in 2013. During the crisis, people used bitcoin to release their funds without the government noticing — a countermeasure to the government’s attempt to make depositors bear the losses resulting from the collapse of banks.
Distrust of existing currencies has lingered since the 2008 Lehman Shock, the underlying cause of the crisis in Cyprus. According to Iwamura’s analysis, the instability surrounding currencies is “the reason bitcoin came to be supported.”
Will central bank-issued currencies lose their position as they attempt to regain the public’s confidence? Or will they hold fast and eventually coexist with digital currency? Virtual currency is raising questions about the future of money.
A virtual currency traded on the internet that does not exist in the form of bills or coins. Its most characteristic feature is that it does not have issuers or administrators, unlike yen or dollars. Individuals and corporations around the world monitor the currency to ensure there are no problems with transactions and to safeguard its credibility. The currency has the advantages of allowing free trade across national borders and cheap remittance fees.Speech