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The Promise and Peril of Central Bank Digital Currencies

With China and others venturing into a realm once inhabited by private cryptocurrencies, there will be increasing pressure on the United States, Europe, and others to follow. But before everyone rushes in, policymakers would do well to consider the foreseeable risks and how they should be managed.

WASHINGTON, DC – Bitcoin and other privately issued cryptocurrencies have generated a frenzy of excitement, with most of the analysis focused on their appeal and apparent drawbacks. But relatively less attention has been paid to an even more important development: the increasing likelihood that countries will shift partly or entirely to a central bank digital currency (CBDC).

Economists have long recognized that money performs three functions. As a medium of exchange, it enables transactions that otherwise would require difficult bartering (as in trading chickens for a car). As a unit of account, it allows one to know whether one has saved or dissaved over the past year. And as a store of value, money enables current income to finance future purchases.

There is an emerging consensus that Bitcoin and other privately issued cryptocurrencies can serve as a (speculative) store of value, and hence as an asset class. But whether these instruments can develop into a medium of exchange or unit of account remains dubious. In Bitcoin’s case, the currency has no anchor, and will forever have a fixed quantity of 21 million tokens. While this might permit some hedging against inflation, Bitcoin’s wildly fluctuating value and lack of any backing raises doubts about its stability. The Bitcoin mania has rightly been compared to the tulip mania in seventeenth-century Holland – only without the bulbs.