Digital revolution: Will cryptocurrencies take over the world?
|Summary
The form that money takes has evolved over the centuries. Most recently, fiat money and bank deposits replaced gold and other precious metals as the predominant form of money. Will cryptocurrencies (a.k.a. digital currencies) supplant paper money and bank deposits?
According to most economics textbooks, money has three main functions: it is a medium of exchange, a unit of account, and a store of value.
Digital currencies are already being used as a medium of exchange, but their use as a unit of account is more limited at present. That is, prices of most goods and services continue to be expressed in national currencies, not in terms of digital currencies perse.
Cryptocurrencies can offer a store of value, at least in the long-run sense. However, the extreme price volatility of many digital currencies implies that individuals and businesses can experience meaningful short-term losses. Furthermore, there has been no issuance to date of crypto-denominated securities (i.e., stocks and bonds), to the best of our knowledge.
There are a number of benefits of digital currencies. Payments can be made essentially instantaneously via cryptocurrencies, and these transactions can be made secretly. They can also be good inflation hedges.
But digital currencies also possess a number of notable drawbacks. Secrecy can enable illicit activities and their limited supply could potentially lead to a deflationary situation.
Stablecoins, which are digital currencies whose prices are essentially tied to another asset such as the U.S. dollar, may offer some of the benefits of cryptocurrencies without some of their notable drawbacks. We will discuss so-called "stable coins" in part II before turning our focus to central bank digital currencies in Part III. We will offer conclusions in the fourth and final report in this series.
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