B

ank Indonesia (BI) has hinted at the possible implementation of a new regulation on electronic money (e-money) to be put in place starting in 2018. In a highly anticipated response, the central bank has also signaled the prohibition of transactions using cryptocurrencies, like Bitcoin, starting next year.

At the moment, while a specific regulation has not yet been introduced, BI seems to be distancing itself from the use of cryptocurrencies, rejecting the use of this medium of exchange and refraining from any responsibility in cases where users lose their stakes.

People might then question: Why has BI taken such a stance?

Cryptocurrencies have crossed the line between the virtual and real world using a technological platform called the blockchain. This technology is a digital peer-to-peer register that records and stores transactions between parties. Each transaction is communicated to peers instead of a central database.

This disruptive innovation has been extremely controversial since its creation eight years ago. So far, a worldwide consensus has not been achieved.

On one side, there are “the lovers” advocating the adoption of cryptocurrencies and the blockchain technology.

The G20 financial inclusion action plan of 2017, for example, is strongly supportive and hence recommends the use blockchain solutions in order to reduce international transactions costs and to integrate the 2.5 billion people currently still excluded from financial systems.

Moreover, several studies have also identified the benefits of the technology from various perspectives. Thomas Kim in his recent study discovered that using the data on Bitcoin quotes in 16 different currencies the transaction cost of Bitcoin is lower than that of retail foreign exchange markets. Bitcoin markets have, on average, 2 percent narrower bid-ask spreads.

A study by Bank Santander, the largest bank in Spain, also identified a whopping cost reduction in the banking system infrastructure of US$15-20 billion dollars until 2022 thanks to distributed ledger technology. Similarly, in his study just published in November 2017, Adam Hayes estimated that the value of all Bitcoins in existence represented an enormous $7 billion and more than $60 million of notional value changes hands each day. If these figures are not convincing, a study by Hileman also in 2017 stated there were about 2.9-5.8 million unique active users of cryptocurrency wallets around the globe creating at least 1,876 jobs in the industry globally.

On the other side of the coin, there are also “the haters” of cryptocurrencies especially because of the exposure to risks and their vulnerability in the absence of a clear regulatory framework.

From the theoretical point of view, a currency should possess three basic functionalities: as a medium of exchange, a store of value and a unit of account. Bitcoin largely fails to satisfy these criteria. Its volatility is substantially higher than the widely used currencies, imposing large short-term risk upon users.

Its daily exchange rates entail no correlation with widely used currencies, thus making it more unreliable for risk management.

To exemplify, Bitcoin faced a huge vulnerability in China after it had fallen for a fifth day in a row during the second week of September 2017, dropping as much as 27 percent. This was the longest losing streak in over a year forcing regulators to request the Chinese bitcoin exchanges to close.

From this landscape, the central banks have a serious concern since the emergence of cryptocurrencies might affect their ability to control some anchor indicators such as money in circulation and interest rates. As all variables go together in the transmission mechanism of monetary policy, macroeconomic variables such as economic growth, inflation and employment might also be in danger.

While neglecting the emergence of technology is not an option, several central banks are currently investigating the potential use of what is called a central bank digital currency (CBDC). This can be seen as an intermediary solution to allow the evolution of emerging technology while keeping the system under control.

The CBDC will go hand in hand with some more private blockchain-based digital currencies, such as Bitcoin, Litecoin, Dogecoin or Monero, which are already on release to the public. However, like in the case of the Bank of England, the public may only hold central bank money in physical form — as banknotes, thus leaving businesses as the main future users.

The economic impact has also been foreseen. The Bank of England has experimented that by spending 30 percent of gross domestic product (GDP) money in circulation in the form of a CBDC, it could permanently raise GDP by as much as 3 percent. This growth rate is attributable to the reductions in real interest rates, avoidance of tax distortions and transaction costs. Moreover, the policy would also substantially improve the central bank’s ability to stabilize the business cycle.

There are at least two aspects worth addressing by BI, the bank should identify what type of CBDC they want to release to the public. Do CBDC serve solely for interbank settlements or also act as a medium of exchange similar to cash? Both options will have their own consequences.

Second, the adoption rate of the technology as a pre-requirement should also be considered. There is currently a huge contrast between the developing and developed world regarding electronic payment to mimic the diffusion of cryptocurrencies. World Bank statistics in 2015 show that while electronic payments have been used by 50 percent of the population in high-income countries, only a mere 5 percent of the population use them in low-income countries.

To conclude, to achieve a greater financial inclusion stemming from the evolution of technology, particularly digital currencies, a comprehensive regulatory framework and a proper technological infrastructure provision are among the important pre-conditions.
______________________________

The writers are research fellows at the United Nations University (UNU-EGOV) based in Guimaraes, Portugal.