South Korea’s central bank has published a new working paper analyzing a dual-currency regime by pitting cryptocurrencies against traditional fiat currencies.
Penned by economists and academics from the Bank of Korea and Seoul’s Hongik University, the working paper, titled ‘Crowding out in a Dual Currency Regime? Digital versus Fiat Currency’, [PDF] was published earlier this week.
“[W]e examine the impact of a privately issued digital currency and fiat currency using the simplest framework, with which we may derive the most straightforward implications,” reads the introduction of the paper. “More specifically, we attempt to answer the question of whether digital currency will crowd out fiat currency.”
The authors claim their research employs the ‘simplest model of monetary economics’ to drive these straightforward implications with the minimum number of assumptions. The research considers dual currency regime, one which sees the coexistence of privately-issued digital currencies and fiat currencies issued by the government. Bitcoin is underlined is a notable example of a private digital currency.
Making note of a number of efforts with central banks exploring the possibility of issuing their own digital currencies, the researchers point to the example of the Bank of England which has publicly revealed its effort to do so. Such an attempt “could drastically change our monetary system” the authors write.
According to the researchers, the costs associated with both fiat and digital currencies will see both of them function together with each other’s drawbacks. High costs in using one could inturn spur demand for the other, and vice-versa, allowing both fiat and digital currencies to co-exist. They state:
“High costs of using fiat currency increase the demand for digital currency. Similarly, high costs of using digital currency relative to fiat currency raise the demand for fiat currency. In a world of imperfect currencies with uncertain costs associated with the use of a currency, it is unlikely that the relative costs of using digital currency will be low enough to drive out and accordingly crowd out fiat currency entirely. Our results rather suggest that the threshold of equating the demand for fiat currency with that for digital currency will allow the co-existence of both currencies.”
Fiat currencies have been historically known to decrease continuously, the authors confirm, due to inflation and the factor of new money pumped in to the supply by the central bank, also known as quantitative easing.
Bitcoin, in stark contrast, has a fixed supply which would imply a “deflationary bias”, the authors note.
“This could lead to a situation in which Bitcoin drives out fiat currency as a store of value,” the authors speculate, before quickly adding:
However, security or trust issues – the decentralization of digital currency and the absence of insurance provided by governmental authorities – may prevent digital currency from being used as a store of value. Instead, digital currency may be used as a medium of exchange dominantly.
The authors also point to future research possibilities, such as covering the topic of digital money appreciating due to ever-increasing demand and the possibility of a triple currency regime, one which would see private digital currencies like bitcoin, central bank digital currencies and fiat currencies operate together.
Bank of Korea image from Shutterstock.