The International Monetary Fund (IMF) is all in favor of nations exploring digital currencies, but they are warning countries against making Bitcoin or any other digital currency of a nation’s legal tender.
The IMF, in its periodic blog post, does not name any specific country or region, however, it is well known that China, Japan, Canada, Australia, and the United States, have been, and continue to, explore potential implementations of a digital currency issued by their central bank.
The ECB is Preparing for a Digital Euro
In July, the European Central bank (ECB) announced plans to prepare for the introduction of a digital Euro. The planned digital currency issued by the European Central bank (ECB) would compliment cash as well as support digital transactions, this in light of changes in how transactions are made in light of the COVID-19 pandemic.
As has been widely reported, El Salvador made Bitcoin legal tender in June. However, the approach taken by the country is very much different than the potential digital Euro. The Monetary Department of the IMF is warning countries of making a similar move. One major issue is the volatility of Bitcoin prices.
Before a meeting with the president of El Salvador, the director of communications for the IMF, Jerry Rice, noted that adopting Bitcoin as a country’s legal tender brings to the fore several issues, both financial and legal, that require careful, in-depth analysis.
While the IMF does acknowledge the benefits of digital currencies such as Bitcoin for faster payments and cross-border transactions, they do take exception to countries that take a shortcut to enable digital currency transactions.
A Shortcut may be Tempting
To provide, and regulate digital currency, difficult policy decisions must be made. The role of crypto in the public and private sectors must be clarified.
There are sovereign nations that might be tempted to shortcut the adoption of cryptoassets as their national currency. Granted, many are secure and easy to access, but the IMF is of the opinion that in the majority of cases, the risks outweigh the possible benefits.
A primary concern is the extreme volatility of the value of crypto. Bitcoin, for example, peaked in April at $65,000. It has since crashed and is currently valued at less than half the April price. Bitcoin continues to survive, but perhaps only thanks to institutions and individuals who are willing to “roll the dice” on its future value. This approach is fine for individuals and institutions, but the risks associated with making it legal tender are very different to the nation in question and its central bank.
Cryptocurrencies are different than other forms of digital money and are unlikely to catch hold in countries with stable exchange rates, inflation, and credible financial institutions. There would be little incentive for individuals or businesses to price products or save in an asset such as Bitcoin, even if it was to become legal tender. The value of crypto is far too volatile and is far removed from the “real” economy.
Crypto Remains on the Fringe
Other than paying off ransomware gangs, few people use cryptocurrency to purchase anything. Bitcoin and its peers have, for the most part, remained on the fringe of finance and payments. Although this is the case, some countries are considering making crypto assets legal tender.
Some are even considering making crypto assets a second, and in some cases the first, national currency. Countries can go so far as to enact laws to encourage the use of crypto as their national currency as well as a mandatory way to pay for everyday purchases.
Those studying the potential of cryptoassets see the greatest risk being economic instability. The most powerful tools that a central bank possesses include establishing interest rates and exercising control over the money supply. The adoption of crypto would take the bite out of these powerful levers in the same way as countries that have adopted a foreign currency such as the U.S. dollar as its own.
Countries that do this by default, import the credibility of the monetary policy of the issuing nation, hoping to align its economy, and interest rates, with the foreign business cycle. In the case of widespread adoption of crypto, neither credibility nor economic alignment is possible. This would result in residents having to cope with wildly fluctuating prices due to the price of imported goods.
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