Digitization has essentially changed the nature of social, economic and informational interconnectedness. In this sense, the financial system undergoes a fundamental change. Thus, for example, fintechs and bigtechs redefine the technological frontier, establishing new categories of business models and forcing banks to adapt to this context. And in parallel, new forms of money and alternative payment systems are emerging. Additionally, Alipay, Apple Pay, Bitcoin, and newer types of digital central bank money compete with traditional bank deposits. Viewed in this way, digitalization will transform the role of money and lead to the rise of “Digital Currency Areas” (DCAs) that could transcend national borders and may also cause a reorganization of domestic and international monetary systems.
In this context, the following questions have arisen: Will private digital money drive out cash? What role should central banks play in the ongoing digital revolution? Will central banks lose their grip on monetary policy? Brunnermeier, James and Landau (2021), henceforth BJL, comprehensively address this issue in “The Digitalization of Money” and emphasize the following key idea: “rethinking the concept of money in the digital age”. This conception revolves around the idea that the current digital revolution and the rise of large technology companies present the possibility of a radical departure from the traditional model of monetary exchange. So, for the development of this thesis, the authors discuss and analyze the economic implications of digital currencies. The main ideas on this topic, in particular around digital currencies, are detailed below:
The first important economic idea is the disaggregation of the roles of money. This means that the underlying structure and technology in digital currencies and networks, according to BJL, can lead to a separation of the roles that money fulfills, conceived as a) store of value, b) medium of exchange and c) unit of account. In this way, digital networks profoundly alter the nature of competition between among monies. Thus, the degree of competition among specialized currencies intensifies. So, digital currencies can specialize for certain roles and compete exclusively as means of exchange or exclusively as stores of value. For the development of this first idea, BJL categorize two types of competition.
The first type of competition consists of i) The full currency competition. In this type of competition, currencies compete including in their role as “unit of account”. Thus, this type of competition develops between monetary instruments denominated in different units of account, and with different price systems and inflation rates. ii) Reduced competition of monetary instruments. In this case, monetary instruments, denominated in the same unit of account, compete in their role as “medium of exchange”. Under this approach, with respect to this type of competition that already prevails in the countries, BJL point out that the deposits issued by different banks compete with each other and with electronic monetary instruments (such as tokens held in digital wallet). In this way, technology introduces new dimensions of currency differentiation.
On the other hand, the second important economic idea is that digital currencies, associated with large platform ecosystems, may lead to a “rebundling of money”. That is, digital money issuers will attempt to “differentiate the product” of their currency by grouping monetary functions with traditionally independent functions, such as data collection and social networking services. The result of this representation is that it encourages “differentiation” but discourages “interoperability” between platforms. Faced with this, BJL emphasize two crucial points to reduce barriers to trade and promote competition: i) The establishment of a strict regime of convertibility to an official currency. That is, convertibility among monetary instruments. ii) Establish the interoperability between platforms as a primary concern for policy makers. The importance of these two points lies in the fact that, although networks and platforms tend to create fractured markets, it is “integration” that is the critical point for the efficient functioning of an international monetary system. The reason is centered on the fact that digital platforms are uniquely adapted to the “role” of aggregator of mutually complementary activities. Given that, they can exploit the key input for those activities: the data. Thus, according to the authors, the use of data generates both economies of scale and economies of scope.
In this same line of evaluation, BJL emphasize that the importance of integration and digital connectedness which often replaces the function of macroeconomic links in the international monetary system Thus, according the authors these elements will lead to the establishment of “Digital Currency Areas” (DCAs). That is, the prevalence of systemically important platforms could lead to the emergence of shared digital currency areas, which transcend the national borders of each country. In this way, BJL highlight the importance to link the currency with the use of a particular digital network. However, it is worth mentioning that, the international nature of digital currencies will make emerging and advanced economies vulnerable to what they call “digital dollarization.” This means that the national currency is supplanted by a digital platform’s currency rather than another developed country’s currency.
Finally, the third important economic idea on this topic is that the rise of digital currencies, and they integration with widespread digital platforms and services, raise important questions about “competition” between public and private money. This means that the emergence and increase of digital currencies will have implications for the treatment of private money, the regulation of data ownership and the independence of the Central Bank. In this sense, BJL point out that in a digital economy, cash can disappear and may settle payments differently; and, that the payment system can focus on technological, social or economic platforms. The interest of this point is that the payment system would not focus on the provision of credit by the banks, thus weakening the traditional transmission channels of the Central Bank’s monetary policy. Faced with this dilemma, BJL emphasize that for monetary policy to influence the provision of credit and the distribution of risk, public money must, as a minimum condition, be used as a unit of account. In this context, BJL indicate that in an environment with digital currencies, central governments may need to offer the Central Bank Digital Currency (CBDC) to promote and preserve monetary independence. This means, the establishment of a regime in which all the money in the economy’s system is convertible to the CBDC, thus ensuring that public money remains a relevant unit of account. Thus, the CBDC may be a natural countermeasure to some of the effects of digitalization. So, this framework would open up a direct channel by which monetary policy could be transmitted to the public and also allow the central bank’s unit of account to remain relevant in a rapidly changing digital economy, and where the interoperability between CBDC and large digital platforms is essential in ensuring the success of CBDC.
To sum up, the ongoing digital revolution may lead to a radical change in the traditional model of monetary exchange. Thus, we may see a transformation of the role of money, an increase of the competition among currencies, and rising of “digital currency areas” in which, in particular, central governments need to offer the Central Bank Digital Currency (CBDC) to preserve monetary independence. In this context, digitalization and digital currencies can provide new paths to internationalize existing currencies and transform international monetary systems.
Notes based on:
[1] Auer R., Cornelli G. and J.Frost (2020), “Rise of the central bank digital currencies: drivers, approaches and technologies“. CEPR Discussion Papers 15363, C.E.P.R. Discussion Papers.
[2] Brunnermeier M., James H. and J. Landau (2021), “The digitalization of money“. BIS Working Papers 941, Bank for International Settlements.
[3] Ikeda, D. (2020), “Digital Money as a Unit of Account and Monetary Policy in Open Economies“. IMES Discussion Paper Series 20-E-15, Institute for Monetary and Economic Studies, Bank of Japan.
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