IMF’s Dong He: “Crypto Assets May Reduce Demand for Central Bank Money”

Dong He, Deputy Director of the IMF’s Monetary and Capital Markets Department, wrote a piece titled “Monetary Policy in the Digital Age”. He argues that cryptos may one day “serve as alternative means of payment and, possibly, units of account, which would reduce the demand for currencies or central bank money.”

He compares challenges posed by crypto to central banks to those presented by internet twenty years ago. Dong He notices that crypto assets are too volatile and risky to pose much of a threat to currencies, also, they do not enjoy the same degree of trust: “they have been afflicted by notorious cases of fraud, security breaches, and operational failures and have been associated with illicit activities.” In addition, according to Dong He, the value of crypto rests solely on the expectation that others will also value and use them. 

Cryptos lack three critical functions that stable monetary regimes are expected to fulfill, Dong He writes: “protection against the risk of structural deflation, the ability to respond flexibly to temporary shocks to money demand and thus smooth the business cycle, and the capacity to function as a lender of last resort.”

Cryptos can be used more widely in the future

Dong He says that the volatility of cryptos may be reduced in the future and refers to the appearance of stable coins that are pegged to existing fiat currencies.

Also, he mentions the following advantages of crypto compared to fiat money:

 - More anonymity while also allowing transactions at long distances, with the unit of transaction being more divisible. “These properties make crypto assets especially attractive for micro payments in the new sharing and service-based digital economy”.

 - Crypto asset transactions can be cleared and settled quickly without an intermediary, which means lower cross-border payment transactions and a smaller amount of time needed for cross-border payments.

Back to the Renaissance

“Such a shift could also portend a change in the way money is created in the digital age: from credit money to commodity money, we may move full circle back to where we were in the Renaissance!” 

Dong He reminds that in the 20th century, money was based predominantly on credit relationships, while crypto assets are not based on any credit relationships, they are not liabilities of any entities and are more like commodity money in nature. “If crypto assets indeed lead to a more prominent role for commodity money in the digital age, the demand for central bank money is likely to decline.”

How should central banks respond to challenges?

Dong He provides several tips on how central banks should respond to the threats posed by cryptocurrencies.

First, they should continue to strive to make fiat currencies better and more stable units of account. 

As IMF Managing Director Christine Lagarde noted in a speech at the Bank of England last year, “the best response by central banks is to continue running effective monetary policy, while being open to fresh ideas and new demands, as economies evolve.”

Dong He is confident monetary policy making can benefit from technologies, such as big data, artificial intelligence, and machine learning.

Second, government authorities should regulate the use of crypto assets to prevent regulatory arbitrage and any unfair competitive advantage crypto assets may derive from lighter regulation by preventing money laundering and financing of terrorism, strengthening consumer protection, and effectively taxing crypto transactions. 

Third, central banks should continue to make their money attractive for use as a settlement vehicle. For example, they could make central bank money user-friendly in the digital world by issuing digital tokens of their own.