When Bitcoin’s unit value reached $10,000 for the first time in 2017, it catalyzed interest from policymakers in how such digital currencies might influence financial markets.
Eswar Prasad, the Nandlal P. Tolani Senior Professor of International Trade Policy at Cornell’s Dyson School of Applied Economics and Management and a senior fellow at the Brookings Institution, testified at a hearing titled “The Future of Money: Digital Currency” before the House of Representatives Financial Services Subcommittee on Monetary Policy and Trade in Washington, D.C., July 18.
The hearing focused on the risks and opportunities associated with digital currencies, defined by Prasad in his written testimony as any currency that is not tangible. Cryptocurrencies, by contrast, exist only in digital form and involve the use of encryption via blockchain technology. Nonofficial cryptocurrencies, including Bitcoin, operate outside of traditionally regulated banks and currency markets.
Prasad’s testimony, based in part on research conducted for the Brookings Institute, indicated that transactions using cryptocurrencies can be more efficient, faster and cheaper than those using tangible currency, but the currency itself can be less stable. Central banks such as the Federal Reserve could issue digital versions of their currencies using such technologies.
Subcommittee Chairman Rep. Andy Barr, R-Kentucky, opened the hearing by expressing concern about the impact of cryptocurrency on the existing financial system. “Are digital currencies simply a new way to hold and transfer money?” he asked. “Or will it have a far-reaching and transformative effect that will change our economy forever?”
Prasad said: “It is premature to speak of disruption of traditional concepts of central banking, but it is worth considering if the looming changes to money, financial markets, and payments systems will have significant repercussions for the operation of central banks and their ability to deliver on key objectives such as low inflation and financial stability.”
In times of crisis, Prasad said, trust in the financial system becomes important. While the private markets in which cryptocurrencies operate might be efficient, they are unable to employ the stabilization mechanisms used by central banks and the government.
Congressmen were concerned that cryptocurrencies could erode the U.S. dollar’s dominance in global finance. “The U.S. dollar still has strong supporting institutions and offers a safe haven for global financial markets,” Prasad said in response. “So even in the age of digital currencies, the U.S. dollar remains secure, for now.”
Prasad noted that many central banks are considering issuing digital versions of their currencies. Sweden, for example, is actively considering introduction of the e-krona, a digital complement to cash. “When we think about Sweden, the e-krona is a way of providing a backstop so that not all of the country’s digital currency is managed by the private sector,” Prasad said. He also expressed skepticism about the viability of nonofficial cryptocurrencies that are not backed by central bank money.
“The promise of Bitcoin hasn’t panned out,” he said. “It is not effective and expensive to make transactions with Bitcoin. Currencies with public backing have the potential to operate effectively in financial markets. For example, the currency Tether has a backing ratio of one to one with the U.S. dollar and is gaining more traction.”
Prasad concluded by speaking about the potential for digital currency to disrupt traditional financial markets. “Digital currency and blockchain in principle can make transactions faster and easier to verify, and bring down costs,” he said. “It could affect traditional bank operation and increase efficiency, though we aren’t there yet.”
Rachel Rhodes is a public affairs and media relations specialist in Cornell’s Washington, D.C., office.