Monday, January 3, 2022

Should central bankers be afraid of crypto?

As crypto continues to move into the public's consciousness, curious people who aren't familiar with it often ask me if central bankers at the Bank of Canada or the Federal Reserve should be worried that crypto may replace the dollar. 

In this short blog post I'll suggest that they should not be worried.

For central bankers like the Fed's Jay Powell or the Bank of Canada's Tiff Macklem, controlling national monetary policy is probably their most important task. By altering the money supply or shifting interest rates, Powell influences the value of U.S. dollar. These policy changes get transmitted across the entire country thanks to the ubiquity of the U.S. dollar as a unit for expressing prices. (For his part, Macklem relies on the Canadian dollar's dominance as a unit-of-account in Canada to exercise monetary policy). 

Monetary policy is important. First, it keeps the dollar's purchasing power stable. Since our wages and contracts are denominated in dollars, a degree of sameness and consistency is important. Second, monetary policy is an important tool for offsetting broader economic shocks, say the pandemic or the '08 financial crisis.

Given that crypto is often marketed as a dollar replacement, might Powell and Macklem be losing some sleep? After all, if crypto starts to replace the dollar as America or Canada's unit-of-account then neither central banker can carry out national monetary policy.

Luckily for Powell and Macklem, crypto is not a threat to the dollar.

Crypto is no longer a very useful term, since it encompasses so many different types of phenomena. There is bitcoin, programmable blockchains like Ethereum, stablecoins, non-fungible tokens (NFTs), decentralized finance (DeFi), and more.

Let's start with Bitcoin. In this category I've included other volcoins like Dogecoin, Shiba Inu, Bitcoin Cash, and Litecoin. I call them volcoins because they are incredibly volatile.

In the early days, many of us thought it possible that Bitcoin might develop into a legitimate threat to the dollar. But enough time has passed now that we know this isn't case. The dominant reason people have for owning volcoins is to get exposure to their exciting price moves. That is, volcoins are a gambling technology, not a monetary technology. Rather than competing for dominance with the relatively stable payments instruments issued by central banks, volcoins serve as substitutes for casinos, meme stocks, lotteries, poker, and OTM options. None of these bets will ever be a credible threat to Fed or Bank of Canada dollars.

Let's move onto stablecoins. Whereas volcoins are wildly unstable, stablecoins are the tamer version of crypto. The stability of stablecoins means that they could credibly replace banknotes issued by the Fed and Bank of Canada.

Even if stablecoins become widely used, they won't subvert Powell and Macklem's ability to conduct monetary policy. Because they are pegged to central bank money, stablecoins effectively do the opposite: they extend central bank monetary policy power into blockchain environments. Stablecoins are therefore allies of the Fed and Bank of Canada policy makers, not enemies, in the same way that regular banks such as TD Bank or Wells Fargo are allies because they extend the range of central bank monetary policy into the regular economy.

[Yes, stablecoins involve financial stability issues. But this post is about monetary policy, not financial stability.]

Nor is decentralized finance, or DeFi, a threat to monetary policy. DeFi is just another component of a nation's financial edifice, albeit more decentralized than the other bits. If a stock exchange like the NYSE or Toronto Stock Exchange is no threat to monetary policy, then neither does a decentralized exchange such as Uniswap pose a threat.

Finally, NFTs are a hyperfinancialized claims on underlying digital art. Art never has been a threat to monetary policy and never will be.

In sum, Jay Powell and Tiff Macklem may have reasons to worry about crypto, but concerns of monetary policy impotence should not be one of those worries. Crypto is not going to replace the dollar anytime soon.


  1. I have a question:

    If a stable coin pegged itself not to the existing unit of account but (for example) to the value of a basket of goods then (especially if the CB started to raise or miss its inflation target) could such a stable coin credibly be a candidate to replace the existing unit of account and undermine monetary policy ?

    1. Hi Rob.

      In answer to your question, I don't think so. While a stablecoin could certainly index itself to an exotic unit of account, the hurdles to adoption would be huge (much like Esperanto!). We speak in an economic language of prices that we have learnt when we are young. No one wants to switch over to a new language.

      I got into this in more detail here: