Bitcoin's continued market and cultural presence prompt many to question how cryptocurrencies may affect the undertaking of established monetary policy. Some worry that distributed digital currencies may undermine the ability of central banks to manage national economic policy goals. On the other end of the spectrum, some suggest that central banks may be aided by issuing their national cryptocurrency. This backgrounder will explain why both outcomes are likely, at least in the near future.

Many people believe that cryptocurrencies like Bitcoin can co-exist within the current monetary system, whether individuals purchase units as an alternative kind of investment or for their targeted technological applications. But others fear that if cryptocurrencies are adopted on a wide enough scale, it could have a negative externality, or spillover effect, on the economy as a whole in the form of monetary instability. It should first be pointed out that cryptocurrencies currently constitute a minuscule fraction of the world's financial assets.

This may change in the future, which could affect the menu of options available to central bankers in certain economic situations, as we will soon discuss. But the world's monetary managers can, for the present, breathe a sigh of relief that the existence of cryptocurrency will hardly hinder their day-to-day operations.

An excellent example of the argument that Bitcoin will thwart monetary mechanisms was put forth by a U.S. Federal Reserve Bank vice chair, Randal Quarles, at a financial conference in 2017. Quarles explained, "While these digital currencies may not pose major concerns at their current levels of use, more serious financial stability issues may result if they achieve wide-scale usage." His comments specifically concern the Fed's range of remedies in the case of a crisis situation. He argues that the existence of an alternative asset like Bitcoin during economic adversity may frustrate efforts to stem price and credit risk because the exchange rate for the U.S. dollar may become unstable.

But this argument could be applied to any asset that may become an attractive alternative to the dollar in the event of a financial crisis. Yet no serious policymaker today would suggest limiting the exchange of, say, gold because of the scenario that Quarles outlined. The only difference between existing assets like gold and cryptocurrencies in an emergency event is that cryptocurrency may be easier for people of all economic backgrounds to hold. This property is arguably one of cryptocurrency's chief virtues in the case of countries that exhibit poor monetary management.

Consider the case of Venezuela, where monetary mismanagement has brought misery and insecurity to its people. Individuals who have the misfortune to live in a nation that irresponsibly manages its money supply have traditionally lacked accessible forms of protection or escape from periods of extreme inflation and all of the ills that come with it. In the past, Venezuelans would have had very few options to attempt to save some value. And those options would have been unevenly distributed, with wealthier individuals more able to protect their assets than those in the lower classes.

Today, many Venezuelans of all classes turn to Bitcoin and other cryptocurrencies to protect themselves against the ravages of extreme inflation and bad governance. The International Monetary Fund (IMF) reports that prices in Venezuela may skyrocket by an astounding 14,000 percent in 2018. Venezuela has already suffered major shortages in critical household goods. Public protest against government policies has grown to sometimes violent levels. In this kind of economic climate, cryptocurrencies can be a godsend to families that need a more stable store of value.

The Venezuelan government has unsurprisingly attempted to crack down on cryptocurrency activity within its borders, most recently seizing mining equipment that people try to take into the country. In a somewhat tragicomical move, the Venezuelan government has changed tactics to try to trick their citizens into purchasing a state-controlled and ostensibly oil-backed "Petrocoin," which is not a real cryptocurrency at all but a mostly worthless decoy. But this has yet to do much to stem the surge of actual cryptocurrency activity Venezuelans undertake to protect their financial assets. In this situation, it is good that Bitcoin has undermined the Venezuelan central bank's authority to wreak havoc on its citizens. Fortunately, many people live in something other than a monetarily backward country like Venezuela. But Venezuela was only sometimes this way.

The existence of cryptocurrencies as an alternative haven during times of financial crisis may prompt central banks to behave more responsibly than they otherwise would. Responsible central bankers should therefore welcome the flourishing of cryptocurrencies as a way to bind their institutions to the mast of prudent monetary policy. Not all central banks have been immediately antagonistic toward cryptocurrencies. There is a diversity of opinions even within the Fed, and the leaders of several central banks have commissioned research and formed exploratory committees to determine how their institutions can best leverage these much-discussed technologies.

These officials recognize that cryptocurrencies can serve a very similar function to cash; that is, as a semi-anonymous medium of exchange accessible not only to banks but to the population as a whole. The digital nature of cryptocurrencies is attractive because it may be cheaper and easier to manage than a cash system. Some central banks have gone as far as to consider launching their cryptocurrencies as a substitute or even replacement for their current money base.

The governor of the Bank of England has publicly expressed interest in a cryptocurrency backed by a central bank, with the caveat that such a possibility would be quite a ways off in the future. Sweden's Riksbank, meanwhile, is actively pursuing an "e-krona" cryptocurrency that could be launched within the next decade. While it is laudable that these officials keep an open mind concerning the promise of distributed digital currencies, they will likely find that these projects must meet their requirements for a central bank-created monetary base.

The monetary supply of a distributed cryptocurrency with a public ledger, such as Bitcoin, cannot be controlled by any party. Instead, it is "mined" at a predictable rate, as coded into that project's protocol, by the miners that run and maintain the network. A central bank used to tighten or loosen the money supply in response to changing economic conditions will be pretty frustrated to find that their official cryptocurrency is rigid to their policy needs. (Indeed, this monetary rigidity is the source of much theoretical economic debate within the cryptocurrency community. Some offer suggestions for digital currencies that change the supply rate in response to specific economic targets.)

Yet this is not really a cryptocurrency, merely a kind of e-currency. Central bankers interested in adopting cryptocurrency technology may instead issue a digital currency whose monetary issue is centralized in the hands of the bank. This may yield the benefits of lower costs and increased access. Still, it does not ensure the censorship resistance and increased privacy of cryptocurrencies. Furthermore, it would require central bankers to increase their security prowess significantly. Such an undertaking would prove irresistible to cybercriminals. One element of cryptocurrency technology that central banks are already experimenting with to some success is the distributed ledger technology at its heart. Rather than adopting wholesale cryptocurrencies as a new kind of official money, the Bank of Canada and the Monetary Authority of Singapore simulate real-time gross settlement systems using a blockchain-like structure.

While these projects are only in their early phases, they may yield useful tools for forward-looking central banks. Suppose Bitcoin and other leading cryptocurrencies achieve a significant enough value and stability. In that case, bankers may find it prudent to add it to their portfolio of assets. Central banks may also decide to buy and hold existing cryptocurrencies as a part of their reserves, just as they do for gold and other assets. Some have gone so far as to suggest that Bitcoin's properties as money improve the current system so that central banks may switch to a Bitcoin-based reserve system entirely, echoing the former global gold system.

Cryptocurrencies hold much promise to expand the range of monetary options available to all classes of people and secure a degree of security and liberty not offered by some of the world's government-backed currencies. They currently exist in a small and experimental corner of the world's financial markets. Therefore, they cannot restrain the central bank's monetary policy levers. But they provide a needed escape for individuals living in desperate economic situations. It is laudable that a few central banks are showing interest in using cryptocurrency technology to update their monetary administration. Still, it is unlikely that a central bank will adopt a state-backed distributed digital currency wholesale because it would entirely remove their ability to manage the national money supply. Central banks will likely experiment with distributed ledger technologies to aid in settlement services or even begin buying existing distributed cryptocurrencies as a part of their reserve portfolio.

Cryptocurrencies have prompted discussions on their potential impact on established monetary policy and central banks' abilities to manage national economic policy goals. While some worry that digital currencies may undermine central banks, others suggest that these banks could benefit from issuing their national cryptocurrencies. However, both outcomes are likely in the near future. Cryptocurrencies currently constitute a minuscule fraction of the world's financial assets, with Bitcoin's market capitalization being only 1.3% of global coins and banknotes and 0.11% of the world's broad money supply. This means that central banks' day-to-day operations are likely to be supported by cryptocurrency at present.

Some argue that the existence of cryptocurrencies like Bitcoin during times of economic adversity may frustrate efforts to stem price and credit risk because the exchange rate for national currencies may become unstable. However, cryptocurrencies can be a godsend for citizens of countries with poor monetary management, like Venezuela, where they can offer protection against extreme inflation and bad governance. The availability of cryptocurrencies as an alternative safe haven during financial crises may prompt central banks to behave more responsibly.

Some central banks have considered launching their cryptocurrencies as a substitute or replacement for their current money base, like the Bank of England and Sweden's Riksbank. However, they may find that some parties can only control the monetary supply of a distributed cryptocurrency with a public ledger, making it difficult to adjust the money supply in response to changing economic conditions. Instead, they may issue a digital currency with centralized monetary control, which does not offer the same benefits as an actual cryptocurrency. 

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