By Markus K. Brunnermeier
Facebook's Libra initiative has been a wakeup call for regulators, central banks and market participants. As new actors emerge to challenge and destabilize existing monetary arrangements, it's becoming increasingly clear that digitalization could change money as we know it. Though talks of "currency wars" between official and private monies may be exaggerated, competition will certainly become more intense. And it will be different.
One thing we're already seeing is that digital currencies can be much more specialized than traditional ones. We shouldn't be surprised if, several years from now, the savvy consumer uses several currencies in the course of their regular week, each for a specific, tailored purpose. Bitcoin, for example, might be useful for exchanging money quickly across borders. But as an extremely volatile asset, I wouldn't trust it with my savings. This trend toward specialization will continue as tech companies, through the creation of new platforms, combine their currencies and tokens with functions that haven't been traditionally associated with money. In the case of Libra, that function is social media, but other platforms might pair a currency with data gathering services to tailor future purchase recommendations, or with "smart contracts" that automatically execute payments or transactions according to pre-specified rules I establish.
All of this will change how currencies compete. Over time, digital currencies may become tied to platforms and digital ecosystems, and payment platforms, not banks, will become consumers' main point of contact for most financial activities. This may result in the establishment of what my co-authors Harold James, Jean-Pierre Landau and I call "Digital Currency Areas," where the use of a currency is linked to a particular digital network rather than a specific country. Because Digital Currency Areas will naturally cross borders, governments will also be exposed to increased currency competition, which will have profound implications for the international monetary system.
Confronted with these challenges, governments and central banks may consider three possible approaches.
First, they can opt for a "laissez -faire" approach and let currency competition develop with no constraint. In the "Hayekian" tradition, such competition is beneficial as it disciplines governments and prevents them from abusing their monetary powers. But there are also risks. With demand for digital money increasing, private currencies may entirely replace some countries' official currency -- a phenomenon called "digital dollarization."Once a large share of economic and financial transactions become denominated in a private digital currency, governments may lose any monetary autonomy and sovereignty. Small- and medium-size open economies are especially exposed to that risk.
Second, regulators may seek to limit or prohibit any digital monetary innovation -- and it's certainly within their power to do so. Governments can decide which currency to make legal tender and have broad powers to regulate payments and financial intermediaries. If governments were to tax capital gains due to exchange rate movements, they would make new digital currencies that are not stable coins very unattractive.
But people today want to transfer money as they send emails: instantly, at no cost, and irrespective of borders. It's unwise to think governments can block such aspirations indefinitely, especially when doing so means missing out on the benefits of innovation. If my priority is saving money, or transferring money across borders, why not use a digital currency that's designed to help me do that as efficiently as possible?
This is why a third approach -- to embrace digital currencies -- is the best way forward. Of course, currently banks hold their reserves in digital accounts at the central bank. Many central banks are considering whether to issue their own digital currencies in the form of tokens rather than being account based. They are also considering to issue the digital tokens either to a broad set of financial institutions or even directly to citizens, as a form of "e-cash."
A Central Bank Digital Currency is the best way to prepare for a world where physical cash may progressively disappear and digital currencies compete with one another. True, a Central Bank Digital Currency may put some competitive pressure on banks as giving additional financial institutions or even the public access to their balance sheet can make traditional banks' funding less stable and more expensive. But it would also guarantee that money issued by public authorities is not crowded out of use as a result of technological progress. Of course, some regulation will be critical. Policymakers should ensure that consumers can convert digital currencies easily across platforms. They should also insist that data collection and processing are in line with their own preferences regarding privacy.
By embracing digital currencies and developing reasonable regulations around their use, central banks can avoid a world where Libra, or other similar initiatives, "rapidly establish a dominant position," to quote a recent statement from the Bank of International Settlements. By issuing a Central Bank Digital Currency, governments would not only preserve the necessary relationship between privately and publicly issued currencies in a modern economy, but ensure that their citizens reap the benefits of ongoing technological progress.
Markus K. Brunnermeier is the Edwards S. Sanford Professor at Princeton University and the director of Princeton's Bendheim Center for Finance.