Digital Currencies

What are Cryptocurrencies?

Cryptocurrencies are digital tokens. They are a type of digital currency that allows people to make payments directly to each other through an online system. Cryptocurrencies have no legislated or intrinsic value; they are simply worth what people are willing to pay for them in the market. This is in contrast to national currencies, which get part of their value from being legislated as legal tender. There are a number of cryptocurrencies – the most well-known of these are Bitcoin and Ether.

Activity in cryptocurrency markets has increased significantly. The fascination with these currencies appears to have been more speculative (buying cryptocurrencies to make a profit) than related to their use as a new and unique system for making payments. Related to this, there has also been a high degree of volatility in the prices of many cryptocurrencies. For example, the price of Bitcoin increased from about US$30,000 in mid 2021 to almost US$70,000 toward the end of 2021 before falling to around US$35,000 in early 2022. Rival cryptocurrencies like Ether have experienced similar volatility. The extraordinary interest in cryptocurrencies has also seen a growing amount of computing power used to solve the complex codes that many of these systems use to help protect them from being corrupted. Despite the increased level of interest in cryptocurrencies, there is scepticism about whether they could ever replace more traditional payment methods or national currencies.

Is Cryptocurrency Money?

A frequently asked question is whether cryptocurrency can be defined as ‘money’. The short answer is that cryptocurrency is not a form of money. To understand why, we can ask whether the characteristics of cryptocurrencies match the key characteristics of money:

• Widely accepted means of payment – can cryptocurrencies be used to buy and sell things? Money generally comes in the form of a nation’s currency, and is widely accepted as a means of payment. While cryptocurrencies can be used to buy and sell things, they are not widely accepted as a means of payment, and surveys suggest that only a small fraction of cryptocurrency holders use them regularly for payments.
• Store of value – can the purchasing power of cryptocurrencies (their ability to purchase a similar basket of goods and services) be maintained over time? Large fluctuations in the price of many cryptocurrencies mean that their purchasing power is not maintained over time, reducing their effectiveness as a store of value.
• Unit of account – are cryptocurrencies a common way of measuring the value of goods and services? In Australia, the prices of goods and services are measured in Australian dollars. While some businesses may accept cryptocurrencies as payment, they are not commonly used to measure and compare prices.

So, while cryptocurrencies can be used to make payments, currently their use as a means of payment is limited and they do not display the key characteristics of money.

However, there is one type of digital currency that could be considered money – digital currency issued by a central bank.

What is Central Bank Digital Currency?

A Central Bank Digital Currency (CBDC) can most easily be understood as a digital form of cash. It can be issued by the central bank, accessible to the general public, and used to settle transactions between firms and households. The unit of account would be the national currency, and it could be exchanged at parity (i.e. one for one) with other forms of money, such as physical currency or electronic deposits with well-regulated financial institutions.

What are the main differences between cryptocurrencies and CBDCs? In other words, what makes a CBDC money? A central bank has the ability to ensure that a digital currency it issues exhibits the three main features of money – that is, a CBDC could function as a widely accepted means of payment, store of value and unit of account.

Because it is issued by a central bank, a CBDC would have legal tender status, making it widely accepted as a means of payment. A CBDC would also be an equivalent store of value to other forms of money, since it could be exchanged for an equal value of physical cash or electronic deposits. Finally, the unit of account for CBDC issued by the Reserve Bank would be the Australian dollar. This means it could be used to measure the value of goods and service. These and other key features have been summarised in the table below.

Surveys conducted by the Bank for International Settlements indicate that CBDCs are an active area of research for nearly all central banks. Despite this, only a few central banks have actually issued digital currencies – to date no high income country has issued a CBDC. The Reserve Bank remains cautious about whether issuing a CBDC would be in the public interest. Primarily, this is because many of the benefits of CBDCs have largely already been realised by existing technologies. In a 2021 speech, the Head of Payment’s said:

Reserve Bank staff have not been convinced to date that a strong policy case has emerged in Australia for a CBDC. The primary reason has been that Australia’s existing electronic payments system already provides households and businesses with a wide range of safe, convenient and low cost payment services.

What Are Some of the Public Policy Implications?

Some of the technology behind cryptocurrencies raises a number of considerations for public policymakers. Given the anonymity provided by cryptocurrency systems, and their worldwide reach, there are questions about how to limit the use of digital currencies for criminal activities. In addition, the current fascination with cryptocurrencies has potentially added to the speculative nature of these markets, and has raised concerns around consumer protection. If cryptocurrencies were to be more widely adopted, they could also present some challenges for the role of the banking sector and raise additional financial stability concerns in a crisis. Furthermore, the vast amounts of electricity used in the mining of cryptocurrency raise concerns about the allocation of resources and environmental consequences of these payment systems.

For more information about the risks involved with cryptocurrencies, see ASIC’s MoneySmart website.

In contrast, a CBDC could potentially support a number of public policy objectives, including safeguarding public trust in money and promoting efficiency, safety, resilience and innovation in the payment system. The Reserve Bank is continuing to closely examine the case for a CBDC and working with other central banks on this issue. The Reserve Bank is considering the relevant technical issues, as well as the broader policy implications.

While the Reserve Bank has not yet made a decision on whether to issue a CBDC, the Governor noted in his 2021 speech ‘Payments: The Future?’ that:

… the RBA is open to this possibility. To date, though, we have not seen a strong public policy case to move in this direction, especially given Australia’s efficient, fast and convenient electronic payments system. It is possible, however, that the public policy case could emerge quite quickly as technology evolves and consumer preferences change. It is also possible that these tokens could offer a lower-cost solution for some types of payments than provided by the existing technologies.

For more information on the Reserve Bank’s research, see: Central Bank Digital Currency.