Bitcoin may fail the definition of money because of its volatility and central banks may be better to get behind digital currencies that have a fixed exchange rate into cash, says Reserve Bank of New Zealand senior economic analyst Amber Wadsworth.

In the first of three articles about digital currencies, Wadsworth defines ‘money’ as a token that can be used “as a unit of account, medium of exchange and store of value.” A medium of exchange means it can be used to buy goods and services.

The Bitcoin is the world’s largest crypto-currency with a market value of US$138.5 billion or a recent price of US$8,152.25 each. The value of the Bitcoin has soared 563 percent in the past 12 months, although that understates the size of its moves because it reached a record US$19,666 last December before declining over the last four months. (Interestingly, despite a host of negative news, it’s had a bit of rally over the last few days, rising 17 percent. That’s Bitcoin for you.)

The market value of Bitcoin is almost three times that of the No.2 crypto-currency, the Ethereum, at US$51.8 billion (US$523.40 each).

“Demand for Bitcoins appears to be driven by a belief that others will be prepared to buy Bitcoins at higher and higher prices,” Wadsworth says in the latest RBNZ Bulletin. “Bitcoin’s exchange rate fluctuations reduce its usefulness as a medium of exchange for real-world goods and services, and as a unit of account. If Bitcoin cannot be used as a stable medium of exchange then it would not be a reliable form of money.”

Her article references an RBNZ report last November by Aaron Kumar and Christie Smith: Cryto-currencies – An introduction to not-so-funny moneys. That report, using monthly data for the Bitcoin/US dollar exchange rate, showed a standard deviation of 73.1 percent, based on data from August 2010 to May 2017. By contrast, the equivalent for the kiwi dollar against the greenback was 3.6 percent.

Wadsworth uses a ‘Money Tree’ classification to show where crypto-currencies fit with other types of money and says it could provide a base to consider what kind of digital currency a central bank could issue. The Money Tree divides money into physical money or cash – such as the fiat currencies issued by central banks – and digital money. Digital money is then broken down into those that use conventional ledger technology, including individual bank accounts and mobile wallets, and crypto-currencies, which use distributed ledger technology (DLT) and cryptography and are either at a fixed or variable conversion rate to cash.

Wadsworth says digital currencies are nothing new because money has been available electronically via the banking system for several decades. Central banks issue digital currency to commercial banks through the provision of money into each bank’s account within the exchange settlement account system. More recently, a handful of central banks have trialed mobile wallets, where people without bank accounts can still hold and use a digital currency and money. Ecuador issued a mobile currency called dinero electronico and the Riksbank has issued an e-krona in Sweden.

As financial technology has evolved in the past decade, central banks have been considering their role of providing cash and in financial technology innovations, Wadsworth says. “One question that central banks are asking themselves is whether they should issue a digital currency to the public and what such a currency might look like.”

She concludes that a central bank could choose to issue a digital currency with a par value or variable exchange rate to cash but “it is conceptually easier to image a central bank issuing a digital currency that trades at par value to cash,” she says. “It appears that crypto-currencies that have fixed exchange rates to fiat currencies are a better unit of account, medium of exchange and store of value than crypto-currencies which do not have fixed exchange rates to cash.”

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