Global cash alternatives and their impact on the implementation of monetary policy

I. Global cash alternatives and their impact on the implementation of monetary policy

Balázs István Horváth – Gábor Horváth

The study presents what happens when the settlement asset of a country used in its national and international payments becomes non-domestically issued. The history of central banks’ emergence will be described briefly, which gives a big picture about the aspects that are crucial in establishing an economy’s monetary sovereignty and stability. A couple of instances are listed for the gradual marginalisation of a country’s conventional currency as it was replaced by a dominant foreign currency (dollarisation).3 Then the discussion will turn to the large technological corporations, referred to as Big Tech, that have a profound influence over society’s social and economic relations, and the potential forms of the global money alternatives offered by them as well as such money alternatives’ significance in the transformation of the current financial system. Based on the potential ways for the expansion of the settlement systems built on Big Tech’s existing platforms and digital ecosystems and countries’ traditional dollarisation experiences, a new concept, digital dollarisation, is described. An important consequence may be that the monetary sovereignty of certain nation states is undermined, as the role of the dominant currency is increasingly taken over by one or more global digital alternatives (e.g. Libra). The main hypothesis of the paper is that a potential response to the appearance of the global money alternatives is to create a central bank digital currency and ensure that it is used widely by people, in terms of the number and volume of transactions.

3 The primary sense in which the concept is used here does not cover the conscious joining of a currency area.

1. The significance of money as a settlement asset in history

Over the course of history, the emergence of central banks is related to the issuance of top-quality financial liabilities used

for widespread clearing. A typical misconception in connection with the beginnings of central banking is that its history started with the Swedish or the English central bank. Bindseil (2020) shows that institutions already fulfilled public central banking functions in 16th-century Venice, Amsterdam and Hamburg, albeit not in terms of conventional interest rate policy. According to a definition by Potter (1650), one of the main functions of central banks is that they issue the highest possible quality of financial liabilities that are used widely by economic actors in the given empire for settlement.4 This was often underpinned by law, as discussed by Knapp (1905) in his State Theory of Money. Knapp’s initial statement is that money was created by the state, so its essence and real theory do not belong to the economy, but to law (Bánfi, 2015). This conforms to the view that money did not arise from barter, it rather coincided with the consolidation of the central power necessary for organising the first governments, empires and civilisations (see Hart, 2005; Graeber, 2011).

As the so-called inside money appeared, the significance of the ultimate settlement asset, outside money, also increased.

When the parties to a transaction start using each other’s debt as money, that is referred to as inside money. This can also be regarded as a natural part of the development of money (Kiyotaki−Moore, 2002), arising from the liquidity need entailing the surge in the number of real economy transactions, and increasingly enabled by the double-entry bookkeeping method that started to become popular towards the end of the Middle Ages. However, the stability of inside money relies heavily on

4 Cited by Bindseil (2020), in his book on the rehabilitation of central banking.

outside money, as attested by today’s financial system (Huber, 2017). Bank deposits, which are currently used as money and which increasingly dominate the monetary aggregates, in other words, banks’ liabilities, can be considered inside money (Table 1). Nevertheless, interbank settlements are conducted in central bank money: earlier in the form of giro deposits and cash, nowadays mostly in the form of central bank deposit money, i.e. liquidity. The stabilising effect exerted by this on financial and monetary developments5 was recognised early, in 1401 in Barcelona, 1407 in Genoa, 1580 in Naples and 16th-century Venice, for example when Banco di Rialto was established with similar central bank mandates as today (Roberds−Velde, 2014).

Table 1: Different features of inside and outside money

Inside money

Linked to private actor

Financial liability, debt

Its collateral is only partly held in reserves Created through lending

Outside money

Legitimised by the sovereign, the state or the central bank Precious-metal content or legally binding force High-quality ultimate settlement asset

Arising in a sovereign manner

Source: Authors’ work based on ECB (2015).

5 In itself, inside money, or private liabilities, can be considered stable depending on the quality of the assets side of the issuing institutions. However, when lending overheats, bank balance sheets expand procyclically, and the growth rate of credit and (inside) money exceeds that of the real economy (boom periods). These are typically followed by potentially dramatic downturns, with a credit crunch where the banking system struggles with liquidity and solvency problems amidst the numerous bankruptcies (bust periods). Yet an ultimate settlement asset supported by public confidence is vital for the functioning of the financial system and ensuring smooth payment transactions.

Following countless bank runs in 19th-century US and UK during the period of free banking, first the Peel Banking Act of 1844 was introduced with the cooperation of Ricardo, then half a century later, the Federal Reserve was established in the US, albeit by private institutions, and this improved the stability of money for a while.

Over the past 500 years, central banks have become the issuers of the highest-quality ultimate settlement asset, and they typically

have some public mandate attributable to the sovereign. In the past centuries, central banks have usually improved the efficiency and safety of certain financial areas, mainly by reducing the instability and unpredictability caused by private inside credit money. First, they helped clearing through account-keeping, using so-called giro deposits, and later they issued anonymous banknotes available to anyone to help economic actors. Without efficient and reliable clearing systems, the emergence of any other market or institution would probably have been more difficult. They also helped the state or the ruler of the region in reaching their goals, either directly, by creating money,6 or indirectly through their interest rate and exchange rate policy. Central banks’ mandate, and its public nature, is stipulated by law, along with their privileges. In two-tier banking systems, the central bank is the monetary pillar of sovereignty.

6 For example, the Ways and Means overdraft facility of the Bank of England reserved for wartime, which was last used in April 2020, to support the liquidity of HM Treasury (OMFIF 2020). Although only temporarily, the

Treasury gained access to the central bank’s overdraft facility to prevent the sudden liquidity shortage from leading to market disturbances (Bank of

England, 2020). During the 2008 crisis, the available loan amount was close to GBP 20 billion, while the currently availably overdraft drawings are below

GBP 0.4 billion.

Monetary independence and social stability

During wartime, countries caused enormous damage to

each other by counterfeiting each other’s banknotes. The American Continental Congress, which sought independence from the British Empire, decided to print banknotes called Continentals in 1775, which were circulated along with British coins after ratification by each state. After the adoption of the Declaration of Independence, Congress made acceptance of the Continental compulsory, and Washington could incarcerate those who did not comply. At that time, the paper money circulated with a mere 5-per cent discount relative to the precious metal coins. However, the Brits started counterfeiting, printing and devaluing the Continental almost immediately to undermine the monetary leg of the independence process, and after 5 or 6 years, Continentals were worth onethousandth of their face value (Zarlenga, 2003). But by that time the Continental Army had already fought its decisive battle at Yorktown, with French help, and the newly independent United States returned to a monetary system based on bullion to restore the weakened economic confidence.

The French assignat and the Chinese fabi fell foul of international political intentions with less favourable con-

sequences. The printing of assignats started in the year of the French Revolution, and, in accordance with the National Assembly’s plans, they were backed by the land confiscated from the Church. Assignats managed to retain 80 per cent of their purchasing power in the first two years, however, in the absence of tax revenues, as the revolution spiralled out of control, its representatives entered into armed conflict with more and more European countries, and they started printing assignats. However, their output did not even come close to the 400 assignat forgers in London, who eventually flooded the continent with twice as many counterfeit assignats

than the official amount in circulation. With the autocracy of Napoleon, the Banque de France was established, which stabilised the franc with a gold standard. The Chinese fabi banknote was introduced in 1935 in the newly formed Republic of China. Nevertheless, in the wake of the full-scale occupation following Japan’s aggression in Manchuria, confidence in the fabi evaporated, and its excessive printing to finance the wartime budget led to hyperinflation and ultimately the banishment to Taiwan and the emergence of the People’s Republic of China (Ku, 2014).

Even the central banks established before the 1800s pursued

some form of monetary policy. Their primary mandate was to create high-quality outside money as an ultimate settlement asset to be used by society and safeguard its stability, and this was typically part of their founding charter. Secondly, when necessary, they ensured the currency’s convertibility to bullion, determining the exact exchange rate and keeping it stable. Thirdly, thanks to the size of their balance sheets, they adopted flexibly enough to economic conditions, managing seasonality and balance of payments fluctuations. Fourthly, it can be determined whether the monetary impetus provided to the economy or the financial system was of discretionary expansive or restrictive nature, mainly to fulfil the first two functions. Nonetheless, these institutions did not follow a conventional interest rate policy in today’s sense, as most of them had to operate with an interest rate specified in their charter (Bindseil, 2020).

Central banks had to tackle universal challenges even in the past centuries. Perhaps one of the most important challenges from within the given unit of sovereignty is related to the concept of central bank independence and non-democratic, technocratic operation. The idea of central bank independence also originates from the Middle Ages, and it expresses the ambivalence about the

state as the ‘sponsor/owner’. Although the founding documents stipulate that central banks are institutions serving the public interest, public policy and philosophical discussions continue to revolve around the extent of state influence over central banks.7 Transparency and accountability are not always ensured with central banks, and sometimes they do not represent the basic values of democratic forms of government. Yet the most daunting challenge has been when the currency issued by them has gradually lost its penetration and significance to a foreign currency.

2. Driving out the national currency – The process and historical examples of dollarisation

Traditionally, the greatest threat to monetary sovereignty is the

process of dollarisation. In modern monetary systems, stronger international currencies that enjoy more confidence and are widely used may drive out national currencies, which is referred to in the literature as dollarisation, based on the experiences with the dominant US dollar. During dollarisation, the role of the national currency is taken over by the currency of an economically more advanced country. As the local currency’s importance declines, the central bank’s room for manoeuvre also shrinks, and it may lose control over monetary aggregates and interest rates. Thereby, the country loses its monetary sovereignty, becoming unable to influence the economic actors’ decisions through its interest rate and exchange rate policy, and, perhaps most importantly, it loses its ability to create money.

7 John Law or Alexander Hamilton were in favour of the public interest, while

Ricardo usually argued against excessive state influence in the 19th century, but he was against money creation by private banks. For more on this, see the debate Currency School versus Banking School, for example between Laina and Goodhart.

Although dollarisation had occurred earlier, it became

widespread in the late 20th century. With respect to the main driving forces behind it, dollarisation can be deposit-driven or occur on a carry-trade basis (Geng, Scutaru and Wiegand, 2018). During deposit-driven dollarisation, households hold most of their deposits in a foreign currency due to a loss of confidence in the local currency. This form of currency substitution was widespread in countries with substantial inflation or economic instability (Vígh-Mikle, Zsámboki, 1999). In such a situation, the local currency cannot fulfil its asset function, therefore it is not suitable as a store of value, which prompts households to keep their savings in a foreign currency, and transactions are gradually revalued to that currency. In extremes cases, the local currency may lose its unit of account function, when its value is so volatile that the foreign currency becomes the preferred means of payment, with most of the transactions conducted with that currency. Dollarisation can also happen formally, if a country introduces the currency of another country, possibly after an informal dollarisation process. During carry-trade dollarisation, the household and corporate sectors are indebted in foreign currency, principally due to the lower interest rate on the foreign currency as compared to the domestic currency, and this creates an open foreign currency position and thus a financial stability risk (Geng, Scutaru and Wiegand, 2018). An important difference is that while deposit-driven dollarisation requires a major loss of confidence in the national currency, widespread foreign currency lending can occur in less dramatic economic situations, in the absence of the appropriate prudential measures. In both forms of dollarisation, the national monetary policy transmission mechanism is weakened as the role of the local currency diminishes.

For a long time, mainstream economics mainly emphasised the benefits of deposit-driven dollarisation for developing countries. In a hyperinflation environment, when the exchange rate of the currency continuously depreciates, large-scale or even

complete dollarisation reduces the importance of the depreciating domestic currency and thus may help mitigate inflation, which has a stabilising effect. In the long run, the greatest economic benefit can be the drop in transaction costs (Alesina-Barro, 2001) if the country’s trading partners also use the currency in question for clearing. Another advantage may be the drop in funding costs (Cohen, 2000), through the spillover effect of the lower borrowing rates in the more advanced country and the mitigation of risk premium.

In exchange for the advantages of dollarisation, nation states

must relinquish their monetary policy sovereignty. The lack of an independent monetary policy, i.e. the loss of the interest rate and exchange rate policy, considerably reduces a country’s ability to respond to economic shocks. The diminished role of the central bank increases the vulnerability of the financial sector (Mecagni et al., 2015), which may also have real economy consequences. A significant result of dollarisation is that it is very difficult to reverse the process, and for a long time economists regarded dedollarisation, or the restoration of monetary independence, to be almost impossible (Jameson, 2003). After considering the consequences and the possible effects, several countries decided to dollarise, but in many cases dollarisation can progress a great deal without, or in spite of, the state’s intention. There are also precedents for de-dollarisation. The main components of the successful strategies usually involve macroeconomic stabilisation and the promotion of amassing savings in the national currency while restoring confidence in it, along with prudential measures, which can reduce FX lending (Mecagni et al., 2015). Successful de-dollarisation occurred for example in Poland and Israel,8 by using the above methods.

8 Israel experienced dollarisation in the early 1980s, on account of high inflation and the loss of confidence in the local currency.

In the CEE region, Poland faced dollarisation challenges twice

in recent decades. In the 1980s, the market-oriented reforms of the planned economy entailed high inflation, which led to substantial dollarisation as financial constraints were eased (Sahay and Vegh, 1995). Poland was among the early reformers, and at the end of the 1980s both inflation and dollarisation exceeded the levels seen in other transition economies. Due to the high uncertainty, Polish households kept merely 20 per cent of their bank deposits in złoty, and most deposits were denominated in USD (Mecagni et al., 2015). However, Poland managed to restore confidence in the national currency by rapid macroeconomic consolidation and exchange rate stabilisation, so the volume of dollar deposits was pushed down considerably in a couple of years. The de-dollarisation strategy also included the issuance of złoty-denominated bonds with favourable interest terms, which improved the attraction of the currency as a savings instrument. Later, continued financial liberalisation and the significant interest rate differential relative to advanced countries’ currencies led to a rise in FX lending in Poland, just like in Hungary, which is an example of carry-trade dollarisation. Widespread FX lending across an entire national economy poses risks to all the parties concerned (Kolozsi, Banai and Vonnák, 2015). In Poland, there are still tens of thousands of pending court cases between debtors and the banks on franc-denominated loans.

In several countries, the state decided to engage in formal dollarisation after the process started to take hold among the population. For example in Ecuador, households started to keep their savings in USD at the end of the 1990s, in the face of strengthening inflation developments and the continuous depreciation of the Ecuadorian sucre (White, 2014). Ecuador’s president announced in 2000 that the USD would become the only legal tender to curb hyperinflation (Anderson, 2016). The decision was a sort of last resort, and IMF experts argued that the Ecuadorian economy was not ready for it, nevertheless

dollarisation did have a significant stabilising effect in the short run (Fischer, 2000).

However, despite dollarisation’s inflation-reducing effect in the short run, the lack of monetary policy independence has caused difficulties for Ecuador several times in the two decades since then. Still, most economists believe that the impact of dollarisation has been positive so far, and it is seen as the saviour of the Ecuadorian economy (WSJ, 2018), but the long-term effects are far from straightforward. In a country with huge oil exports, the independent movements in the dollar exchange rate have made it repeatedly difficult to for the economy to adjust (WSJ, 2015). While Ecuador’s dependence on external shocks is almost certain to persist, the reasons that necessitated dollarisation may not characterise the economy forever.

Figure 1: Examples for dollarization in Europe

In Liechtenstein, the Swiss franc has been the official currency since 1920, before that the Austro-Hungarian crown was used by the principality

Andorra and the Principality of Monaco may use the euro under a monetary agreement with the EU The San Marino lira, pegged to the Italian currency, was replaced in 2002 by the euro, which the state can use under a monetary agreement with the EU

Neither Montenegro nor Kosovo is a member of the Eurozone, after their independence they unilaterally introduced the euro as a currency still valid today

Following the declaration of independence, Albania had no independent currency until the introduction of the Albanian Lek in 1926. Introduced in the 19th century, the Cypriot pound has been stably convertible to one pound sterling for many decades

Source: Authors’ own editing based on the collection of Schuler (2005).

3. Big Tech ecosystems – Digital challengers to national currencies

National currencies are facing a new challenge in the 21st century, which can be best described as digital dollarisation. The increasingly globalised population of the developed world that has already experienced the IT revolution perceives national contours less and less, which is largely owing to corporations that are on a par with countries in terms of the number of their users and economic clout, and that are collectively referred to as Big Tech.9 These companies have a huge user base, technological solutions and their own ecosystem, which allows them to develop their own settlement asset. Potential consequences include the continued fragmentation of international payments, and if a global private currency gains monopoly, it may drive out existing national currencies, too (this is the so-called digital dollarisation). The rise of tech firms impacts almost all walks of modern life, reshaping the structure of the economy and a multitude of value chains. In the past two decades, as online payments emerged, the way how individuals and companies pay for products and services has changed considerably. Recently, with the widespread use of smartphones and mobile internet, an increasing number of electronic payment alternatives have become available not only in e-commerce but also in traditional payment situations (ECB, 2019). New payment technologies have often been developed by incumbents in the financial sector, but in many cases innovative firms with an IT background used them to carve out a piece for themselves from the financial segment (ECB, 2019). As the new payment methods are mainly popular among younger, more tech-savvy generations, electronic payments are expected to expand further. While electronic payments are on the rise, cash is on the decline all over the world. The revolution in electronic

9 Typical examples include Facebook, Amazon, Apple and Google.

payments transformed transactions the most in China, where people, who had used cash for almost every transaction before, reduced the share of cash payments to below 50 per cent in ten years.

100 90 80 70 60 50 40 30 20 10 0 Figure 2: The share of cash usage within all transactions

Per cent Per cent

India Brazil China USA Sweden 2010 2020 (estimation) 100 90 80 70 60 50 40 30 20 10 0

Source: Authors’ work based on McKinsey (2020).

As electronic payments and digital currencies become popular, digital dollarisation may pose a challenge to monetary policy sovereignty. Digital dollarisation refers to the process where a country’s currency is supplanted partly or completely by the currency of a digital platform (Brunnermeier et al., 2019). This phenomenon is in many respects similar to traditional dollarisation, but there are many differences in terms of their preconditions and consequences. Besides the forms of electronic payments that emerged earlier and use the traditional currencies of nation states as units of account, the appearance of bitcoin in 2009 ushered in an era of money not issued by central banks that can be used electronically, in direct peer-to-peer transactions (BIS, 2017). With the rise in cryptocurrencies, the believers in all things tech have increasingly started to maintain, albeit probably

wrongly, that bitcoin or other cryptocurrencies may be able to take over the role of traditional currencies and replace cash (Berentsen and Schär, 2018).

Based on the experiences so far with the cryptocurrencies currently in circulation, these forms of money pose only

a minor threat to national currencies. Although thousands of cryptocurrencies are traded nowadays, bitcoin accounts for more than two-thirds of their market value (Assenmacher, 2020). Bitcoin spread after the 2008 crisis, partly as a result of shaken trust in traditional financial actors, as it was able to create a payment solution without a central actor, independent of the traditional banking system (MNB, 2018). Nevertheless, despite its enormous market capitalisation, bitcoin has not become a true challenger to national currencies. On the one hand, the number of bitcoin transactions is low considering that bitcoin was originally devised as a means of payment, and on the other hand the number of transactions peaked in December 2017 (Assenmacher, 2020), and no significant rising trend has been detected since then. The main reason for the low efficiency of bitcoin as a means of payment is the substantial volatility of its price. The price of the best-known cryptocurrency has fluctuated between USD 1000 and almost USD 60,000 since 2017, and it was hardly able to function as a currency with such volatility, and it became a speculative tech investment vehicle.

However, cryptocurrencies with certain special features may be able to jeopardise monetary sovereignty. Years after bitcoin was born, a new subtype of cryptocurrencies, the so-called stablecoins were developed to create stable cryptocurrencies that can be better used as money. Stablecoins are digital currencies independent from national currencies that use some kind of stabilisation mechanism to minimise the fluctuations in their value relative to traditional currencies (ECB, 2020). The most basic type is the tokenised fund, in which the value of the coins is derived from

an underlying fund. For example Tether, the stablecoin with the largest market capitalisation, works on this principle. It is a cryptocurrency pegged to the USD exchange rate, and its price has fluctuated between USD 0.99 and 1.01 in the recent period. The fact that despite stablecoins’ smaller market capitalisation, their trading volume comes close to other cryptocurrencies, which proves that the former are better suited for replacing cash (ECB, 2020). At the same time, based on current trading data, they are mostly traded against other cryptocurrencies, which suggests that currently their main functions is to safely store the income from trading volatile cryptocurrencies without leaving the cryptouniverse (ECB, 2020). This use can be regarded as the partial adoption of the means of hoarding function, even if the volumes are currently low.

Although stablecoins are definitely more suited to fulfil the functions of money than other cryptocurrencies, decisionmakers only started to focus on them when Libra, the cryptocurrency developed by Facebook, was announced in 2019.

A digital currency that may be able to compete with national currencies could be modelled on Libra’s features from many respects. The envisaged cryptocurrency’s price will be pegged to a basket of national currencies (Libra Association, 2020). The Libra White Paper, originally published in 2019, drew a barrage of criticism from regulators, and intensified efforts to develop central bank digital currencies (Auer, Cornelli and Frost, 2020). In response to the strong reaction from regulators, the second version of the Libra White Paper was published, and one of the main changes is that the project is now referred to as a ‘payment system’, which enables the use of stablecoins representing national currencies along with the Libracoin (Libra Association, 2020).

The digital representation of the national currencies was no doubt added to the Libra project to alleviate fears about

monetary sovereignty. This is because the inclusion of stablecoins

tied to the value of national currencies in the project may mitigate the risk of Libra becoming a primary unit of account. However, due to the characteristics of the planned Libracoin, countries have every reason to regard it as a monetary policy challenge. With Facebook’s help, Libra can appear in a digital ecosystem with a huge user base, and reach wide swathes of society quickly. Although based on the second White Paper the current state of the project is definitely less of a threat to sovereignty than the original plans, it shows the potential peril caused to national currencies by a tech giant’s currency. Among tech firms, the companies that have established their own ecosystem deserve special attention. In 2020, six out of the seven corporations with the largest market capitalisation have their own digital ecosystem, which is their main source of revenue (McKinsey, 2020). The platforms of these tech giants expand in two directions. Horizontally, their user base grows as it includes more and more people, and vertically, they seek to increasingly meet consumers’ needs by offering more services, thereby deepening users’ integration in the network. For example Facebook can already use its internal ecosystem to act as a platform for conducting sales transactions and offering products, one only needs to think of Facebook Marketplace and other advertising platforms available on the social network. With the current huge user base and peer-to-peer nature of the social platform, it can be reasonably assumed that a massive number of transactions will be conducted in the ecosystem once the Libra project is implemented. Although officially Libra’s main mission is to provide financial services to those who currently have no access to them (Disparte, 2020, Central Banking), it can be inferred from the above that such a digital currency can rival national currencies. And from certain respects, Libra may only be the beginning, as companies with similar huge ecosystems can also develop their own currencies.

Another tech giant, Amazon, also poses a great challenge to

incumbent financial corporations. The company, which mainly focuses on e-commerce, has developed a wide range of financial services in the past decade: it engages in lending and insurance in cooperation with various financial and technology partners. Moreover, users have the option to hold a digital wallet and make cash payments that can be used in the Amazon ecosystem. Together with the existing huge user base, the platform’s developing financial services take it only one step away from designing its own digital currency.

With respect to the functions of money, when a currency similar to the above is backed by a basket of currencies, it may be able

to fulfil the store of value function. Furthermore, building on the widely used digital platform, it can easily perform the unit of account function as well. If transactions reach a critical mass, there will be no more question about suitability for the standard of value function or the independence and (unchecked) rise of the given digital currency.

There is another feature that may make digital platforms able to fulfil financial functions, namely the amount of processable

data available to them. An ecosystem based on interactions where users perform various activities may be the perfect setting for exploring consumer preferences when coupled with a payment function (Brunnermeier et al., 2019). By introducing its own currency, an ecosystem may even increase the number of transactions conducted on the platform, which generates further information for the company, and this allows it to meet users’ needs even more. When the growing amount of data goes hand in hand with the customer experience enhanced with its help, this can have a mutually reinforcing effect.

The so-called digital dollarisation, i.e. the widespread adoption in a country of a digital ecosystem’s currency independent from a sovereign, can start with the internationalisation of the given

means of payment. Over the course of history, currencies have been adopted internationally either by becoming international savings instruments, or by being able to fulfil an international means of payment function (Brunnermeier et al., 2019). The currency of a digital ecosystem can first spread due to its role in transactions, however, when coupled with the appropriate exchange rate stability, it may also be able to act as an international store of value.

While traditional dollarisation, or mainly its deposit-driven version, usually threatened those countries the most where the local currency was unable to appropriately fulfil the means of hoarding function, the new aspect in digital dollarisation is that it can appear even in countries whose currency has a sound savings instrument function.10 In advanced countries with a stable currency, digital currencies can spread through the expansion of the transactions on the platforms (Brunnermeier et al., 2019).

Digital dollarisation impacts monetary policy via various

channels. If a popular digital currency becomes dominant as a savings instrument, it considerably transforms the banking system’s balance sheet through the reduction of retail deposits. First, a decline in retail deposits could lift banks’ funding costs and thus also lending rates (Assenmacher, 2020), and second, the monetary authority would be unable to fully control the interest paid on deposits. A cross-border digital currency can entail financial stability risks. Confidence in the digital currency may be undermined, which could lead to waves of redemption similar

10 While the examples of traditional dollarisation usually included some difference in the level of development between the currency donor and the currency host, the Big Tech alternatives born in the technological revolution may even lead to digital dollarisation in advanced economies. One of the drivers of this process may be the advantage arising from financial diversification, or the IT developments based on the existing institutional system (e.g. Internet of Things). However, the example of the Kenyan M-Pesa mobile payment system suggests that a less developed country can start using a global digital currency by leapfrogging with the help of cheap smartphones.

to traditional bank runs (Assenmacher, 2020). The national central bank may increasingly lose control over monetary aggregates and have diminished influence over the interest rates experienced by economic actors, especially if a digital currency backed by a foreign currency or multiple foreign currencies becomes widely used.

The above changes may impact several channels of monetary policy transmission, just like in the case of traditional

dollarisation. A nation state can be deprived of three of its most important monetary capacities in this manner: its money creation and seigniorage income, independent exchange rate policy and independent interest rate policy. If all newly created marginal currency liquidity is dollarised into a tech currency by domestic economic actors, it may dramatically devalue the currency and exert an inflationary impact. In this context, quantitative easing (QE) measures, which can perhaps now be considered conventional, are unable to push down yields when they are denominated in the domestic currency. The effect of the interest rate channel on bank loans also diminishes, since most of banks’ marginal cost of financing will be in tech currencies rather than the domestic currency. The situation may escalate to a point where national central banks stop creating liquidity in the domestic currency, because it does more damage than the benefits or retained control provided by it.

Taking into account the above risks, the criticism levelled at central banks for a long time applies even more to global tech

giants’ money alternatives. The internal politically motivated objections to traditional central banks and the challenges faced them by are even more relevant when it comes to new global currencies. The former issue of central bank independence may arise in reverse in connection with global corporations: they may have excessive influence over certain digitally dollarised countries, as they have an impact on those countries’ interest rate environment and monetary aggregates. Moreover, transparency

and accountability, as related to democratic principles, are hardly applicable in connection with a currency issued by a company (group) floating above states, in an IT cloud. Ensuring nation states’ monetary sovereignty and independence becomes very difficult or even completely impossible. This phenomenon can be combated with nation states’ constitution11 or by developing a potential alternative.

4. Central bank digital currency – A potential response to the challenge

In modern monetary systems, the only live monetary link between the state and economic actors is through the banking system. Cash makes up an increasingly small share of the monetary aggregates in the economy, which nowadays are dominated by deposit money created by banks through lending. In accordance with its mandate stipulated by law, the central bank determines the interbank interest rate environment in a way that ensures that it sooner or later spills over to the central bank interest rates experienced by real economy actors via various channels. However, if commercial banks lag behind in the digitalization competition, they may even become circumventable (MNB, 2019). Consequently, if there is a change in hierarchy due to the gradual marginalisation of cash and the widespread use of Big Tech money substitutes appearing as alternatives to deposit money (hereinafter: tech currencies) (Figure 3and Figure 4), that

11 Nation states already stipulate the country’s official unit of account in their constitutions. This can be potentially complemented with an explicit ban, making, for example, the widespread use of Libra unconstitutional. The middle way can also be included in the constitution, where the unit of account and standard of value function of the national currency is clarified, just like its synthetic replication in global tech currencies: this allows the same amount of tech currency to be used as there is forint liquidity in the system, and the amount of the two can only grow together.

may threaten the monetary independence of the central bank and the state as a whole. Therefore strengthening the monetary link

between households, companies and the state may help avoid the external threat and assist the banking system in keeping its function of financial resources allocation.

Figure 3: The process of disintermediation in today’s monetary systems

Client A

Bank

(lending, money creation, payments, wealth mgmt etc.)

BigTech Platform (Payments, e-commerce, social networks, etc.)

Client B Client A

Bank

Cental Bank? Client B

Super-visory?

Source: Authors’ work based on Brunnermeier et al. (2019).

Disintermediation is merely the first step towards losing monetary sovereignty. As Figure 3 shows, the current bank-based financial system, where most financial services are ultimately conducted through banks, may gradually lose its bank-centred features. As Big Tech platforms start offering a wide range of increasingly popular services, the previously independent entities, such as commercial banks that grant loans as well as asset managers and central banks performing supervision, first merely fall lower in the hierarchy. Figure 4 shows how this process is demonstrated on balance sheets. When a critical mass flows into tech currencies, the structure of earlier monetary aggregates will reflect that, relegating the banking system into a sort of tech custodian function, while the central bank’s balance sheet gradually shrinks. Eventually, the red entities in Figure 2 may lose even their subordinate role and become completely marginalised

or even go out of business on account of their vertically integrated functions.

As monetary sovereignty faced new challenges with the spread of digital currencies, the possibility of introducing a central bank digital currency has become a priority for central banks.

Central bank digital currencies are official legal tender issued by the central bank in electronic form, universally accessible and suitable for conducting peer-to-peer transactions just like cash (BIS, 2017). The central bank can use a universally accessible central bank digital currency and its interest rate to influence the economy directly (Assenmacher, 2020). Figure 5 shows how today’s universally accessible money (cash and deposit money) can flow into a central bank digital currency, which may even become a safe-haven asset against a global stablecoin with a potential hegemony.

Figure 4: Tech currency emerging within today’s two-tier banking and monetary systems

Central Bank

Assets Liabilities

Banking system

Assets Liabilities

FX Reserves

CB Loans Cash

Liquidity Cash*

Liquidity

Loans, securities

Techcurrency

CB loans and other long-term funding

Retail and wholesale deposit money

Custodian tech-funding

Note: Cash is held mostly by real economy actors and to a smaller extent on the assets side of the banking system, that is why it was shown to be smaller on the banking system’s balance sheet than on the central bank’s liabilities side. Cash and deposit money together comprise the M1 monetary aggregate, the most important one available to the real economy right now. Source: Authors’ work.

The introduction of central bank digital currencies may

transform today’s two-tier banking systems, too. Although twotier banking systems and the efficient system of decentralised allocation of credit (market-based lending) are not directly at risk, central bank digital currencies may lead to a profound transformation in modern monetary systems. Nevertheless, the introduction of a central bank digital currency would entail more direct monetary policy implementation and several other favourable effects by reducing the existing frictions in the economy, for example by mitigating counterparty risk or transaction costs (Barrdear and Kumhof, 2016) and ensuring less procyclical bank operation. However, a separate study should be devoted to the magnitude of the transformation in the banking system and its financial stability implications, and these will be discussed later in the book.

By setting the interest rate on the central bank digital currency, central banks can implement direct monetary policy transmission. If the central bank digital currency is ‘priced’ attractively enough in the prevailing interest rate environment, that may be favourable to households and also determine the floor of the interest rate corridor on the money market for institutional investors. Moreover, the interest rates experienced by real economy actors are outlined much more clearly, and bank interest rates need to quickly adjust accordingly, first on the deposit side, then on the lending side. Furthermore, the conventional monetary policy that loses its efficiency due to the interest rate set by modern advanced central banks around 012 may get a new instrument: if necessary, a slightly negative interest can be introduced for its

12 This is the so-called ZLB or zero lower bound, a sort of liquidity trap. Since cash does not bear interest, it represents an implied interest rate floor at 0, and central bank’s more aggressive attempts at pushing rates below 0 may lead to cash hoarding. Some economists see the solution in central bank digital currencies, while others would introduce ‘helicopter money’, i.e. directly print money.

new asset, thereby stimulating economic interactions (BIS, 2018). This is further discussed in another study of this book.

Figure 5: Tech currency appears beside the introduction of CBDC

Central Bank

Assets Liabilities

FX Reserves

CB Loans Cash

Liquidity

CBDC

Banking system

Assets Liabilities

Cash*

Liquidity

Loans, securities

Techcurrency

CB Loans and other long-term funding

Retail and wholesale deposit money

Note: Cash is held mostly by real economy actors and to a smaller extent on the assets side of the banking system, that is why it was shown to be smaller on the banking system’s balance sheet than on the central bank’s liabilities side. Cash and deposit money together comprise the M1 monetary aggregate, the most important one available to the real economy right now. Source: Authors’ work.

Nonetheless, the main motivation for central banks to introduce a central bank digital currency may be the preservation of nation

states’ monetary sovereignty. If the legal tender is universally accessible in electronic form, that allows the national currency to remain the main unit of account even in a fully cashless society, even if new digital assets become widely used (Brunnermeier et al., 2019). This would leave the theoretical possibility of the ultimate capacity to reflect monetary sovereignty, namely the privilege to create money, in the hands of the state.

As nation states determine the national currency in their constitution (in Hungary it is the forint), its electronic conversion could be governed by an agreement between the sovereign monetary authority and the global money issuing

Big Tech firm. If the potential cooperation with future tech currencies is taken into account while designing a central bank digital currency, the constitution can be amended to lay down convertibility conditions for using a tech currency in the given country. To facilitate this, the platform would also accept the country’s digital currency used by the citizens of the country or within the country’s geographical borders. This would greatly reduce the chances of a digital dollarisation forced by the public, and the platforms may also find it positive that they are used more extensively due to convertibility (Brunnermeier et al., 2019).

Preventing the growing fragmentation of international and national settlement assets probably carries both economic and

geopolitical significance. The competition between large tech currencies (Facebook, Apple, Amazon, Google) on a market basis, in a Hayekian sense, does not necessarily promote the development of interoperability. This could lead to further fragmentation and a competitive disadvantage in the global economy, which calls into question the efficiency-improving effect of these platforms. And it may also lead to geopolitical conflicts, one only needs to think of today’s trade and currency war between China and the United States. Nation states’ central banks can become facilitators in this process by developing a central bank digital currency, thereby preserving their own independence and the economic advantages arising from technological progress foreseen today.

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