What's the role of central banks in the face of cryptocurrencies' rise

José Manuel González-Páramo gave a presentation entitled 'The Digitization of Money’ as part of the Public Sector Investors and Issuers Seminar organized by BBVA Corporate & Investment Banking. The annual event held on June 20 in Porto (Portugal) attracted more than 75 representatives from public institutions. BBVA's executive board member began his talk with an overview of the history of money, beginning with the Neolithic period when the first human settlements recognized the need to trade among themselves and continuing with the appearance of the first coins in Asia Minor between 680 and 560 B.C. "We had to wait for approximately 1,300 years for a new form of money to emerge: paper money,” he explained. "It made its appearance in China in the ninth century, but Europeans didn’t learn of its existence until the thirteenth century when Marco Polo traveled to Asia.”

The next great milestone in the evolution of money occurred in the twentieth century with the emergence of electronic money, which cannot be considered cash per se, but it is backed by cash or deposits. And finally, the arrival of digital currencies based on blockchain technology.

As González-Páramo explained, there are four factors in the new digital world that have facilitated the development of digital currencies: hyperconnectivity, specifically the ability to transfer data at high speeds; greatly enhanced computing capacity – meaning, the decentralization of data storage and verification processes –; lower costs; and the data security and protection provided by cryptography.

The criticism that has been lodged against Bitcoin and other cryptocurrencies has focused primarily on their high volatility, which makes it difficult to consider them a unit of account; the fact that they are characterized by anonymity, which can contribute to their being used for illicit purposes; the associated operational risks and possible fraud or robbery; and the high electricity consumption required by their transactions and the associated complex cryptographic techniques.

Central banks are facing the fact that we are abandoning money.

In contrast, recent initiatives have developed stablecoins or stable digital currencies, which are primarily characterized by deliberately limited volatility and being indexed to some external collateral, which could be a currency – or basket of traditional currencies – (like the dollar or euro), a material asset (like gold), or an algorithm that controls the price by administering the amount of crypto-coins in circulation. The objective behind stablecoins is to manage volatility and instill confidence.

To provide examples of stablecoins, the BBVA executive referenced J.P. Morgan, the first bank to create and successfully test a cryptocurrency backed by a traditional currency (the dollar); and Facebook, which this week announced the creation of a cryptocurrency called Libra. Libra is entirely backed by a set of bank deposits and short-term government securities from stable governments with a low probability of default.

Digital currencies issued by central banks

José Manuel González-Páramo asserts that stablecoins are still in the initial phase of  development and lack the sufficient guarantees that would have them fulfill the three functions of money: to be a medium of exchange, to be a unit of account, to act as storage for value or wealth.  He also mentioned the possibility of central banks issuing digital currencies, a scheme that is currently being studied.

“I think cryptocurrencies are here to stay," added José Manuel González-Páramo. It is truly important for us to understand the difference between bitcoins and stablecoins and to also understand the difficult choice central banks must make, because now they are facing the fact that we are abandoning money. Money deteriorates, is expensive to manage, as are the logistics associated with money; all of this complexity is avoided with digital currencies, but new problems present themselves, which is why it is critical for central banks to be aligned when they decide how to deal with cryptocurrencies."