Bank of England: The economics of digital currencies

Digital currencies represent both innovations in payment systems and a new form of currency.

This article examines the economics of digital currencies and presents an initial assessment of the risks that they may, in time, pose to the Bank of England’s objectives for monetary and financial stability.

A companion piece provides an introduction to digital currency schemes, including some historical context for their development and an outline of how they work. From the perspective of economic theory, whether a digital currency may be considered to be money depends on the extent to which it acts as a store of value, a medium of exchange and a unit of account.

Digital currency price volatility

How far an asset serves these roles can differ, both from person to person and over time. And meeting these economic definitions does not necessarily imply that an asset will be regarded as money for legal or regulatory purposes. At present, digital currencies are used by relatively few people. For these people, data suggest that digital currencies are primarily viewed as stores of value — albeit with significant volatility in their valuations (see summary chart) — and are not typically used as media of exchange. At present, there is little evidence of digital currencies being used as units of account.

This article argues that the incentives embedded in the current design of digital currencies pose impediments to their widespread usage. A key attraction of such schemes at present is their low transaction fees. But these fees may need to rise as usage grows and may eventually be higher than those charged by incumbent payment systems.

Most digital currencies incorporate a pre-determined path towards a fixed eventual supply. In addition to making it extremely unlikely that a digital currency, as currently designed, will achieve widespread usage in the long run, a fixed money supply may also harm the macroeconomy: it could contribute to deflation in the prices of goods and services, and in wages.

And importantly, the inability of the money supply to vary in response to demand would likely cause greater volatility in prices and real activity. It is important to note, however, that a fixed eventual supply is not an inherent requirement of digital currency schemes. Digital currencies do not currently pose a material risk to monetary or financial stability in the United Kingdom, given the small size of such schemes. This could conceivably change, but only if they were to grow significantly. The Bank continues to monitor digital currencies and the risks they pose to its mission.

This article explores the economics of digital currencies — schemes that combine new payment systems with new currencies — and provides an initial view on the consequent implications for the Bank of England’s objectives to maintain monetary and financial stability in the United Kingdom. Any potential risks to monetary or financial stability posed by digital currencies will depend on how widely they are used, both today and in the future. The article therefore begins by examining the extent to which digital currencies are currently used as a form of money.

As part of evaluating the likely growth in digital currencies’ usage over time, it next examines the sustainability of the low transaction fees offered by digital currencies at present. In order to explore the macroeconomic implications of digital currencies, the article also considers a hypothetical — and extremely unlikely — scenario in which a digital currency with a fixed eventual money supply were to achieve dominant usage in an economy, supplanting the existing monetary system. The consequences of such an arrangement are examined, together with some possible responses.

Finally, this article provides an initial view on current and possible future risks to monetary and financial stability that might be posed by digital currencies.^₍₁₎

To read the full article click here

A short video explains some of the key topics covered in this article.

The post Bank of England: The economics of digital currencies appeared first on Payments Cards & Mobile.