ENTREPRENEURSHIP & POLICY WORKING PAPER SERIES The Macro-Economics of Crypto-Currencies: Balancing Entrepreneurialism and Monetary Policy Eli Noam In 2016, the Nasdaq Educational Foundation awarded the Columbia University School of International and Public Affairs (SIPA) a multi-year grant to support initiatives at the intersection of digital entrepreneurship and public policy. Over the past three years, SIPA has undertaken new research, introduced new pedagogy, launched student venture competitions, and convened policy forums that have engaged scholars across Columbia University as well as entrepreneurs and leaders from both the public and private sectors. New research has covered three broad areas: Cities & Innovation; Digital Innovation & Entrepreneurial Solutions; and Emerging Global Digital Policy. Specific topics have included global education technology; cryptocurrencies and the new technologies of money; the urban innovation environment, with a focus on New York City; government measures to support the digital economy in Brazil, Shenzhen, China, and India; and entrepreneurship focused on addressing misinformation. With special thanks to the Nasdaq Educational Foundation for its support of SIPA’s Entrepreneurship and Policy Initiative. Table of Contents Abstract . 1 1. Introduction . 2. 2. A History of Governmental and Private Moneys . 2 A. United States . 3 . B. Other Examples of Private Moneys . .4 . 3. The Emergence of Electronic Moneys . 5 A. Electronic Moneys . 5 B. Distributed Ledger Technology . 6. C. Blockchain Technology . 6 D. Cryptocurrencies. 8 E. An Illustration of a Bitcoin Transaction . 9 4. Advantages and Drawbacks of Crypto-Currencies . 10 A. Advantages . 10 B. Problems . 11 C. The Potential for Improvements . 15 5. The Impact of Cryptocurrencies on Macro-Economic Policy . 16 A. Impact on Inflation . 16 B. Impact on Stability . 20 C. Impact on Reserve Requirements . 21 D. Impact on Interest Rates . 22 6. Market Structure of the Cryptocurrency Industry . 22 A. Market Power . 22 B. Can Big Tech Companies and Financial Institutions Legitimize Cryptocurrencies? . 23 C. Implications for Entrepreneurs and Companies . 23 7. Monetary Stabilization by Cryptocurrencies? . 25 A. Stablecoins . 25 I. Private Coins Pegged to an Official Currency . 25 II. Crypto-Collateralized Coins . 26 III. Non-Collateralized Coins . 26 IV. Government Coins . 26 8. New Digital Tools for Macro-Economic Policy: Implications for Central Banks . 26 A. Regulatory Tools for Central Banks. 27 B. Developing Digital Tools . 28 C. Central Bank Cryptocurrency?. 28 D. Direct Customer Accounts at the Central Bank . 30 E. A Mixed System of Public and Private Moneys . 30 9. Conclusion and Outlook . 31 SIPA’s Entrepreneurship & Policy Initiative Working Paper Series The Macro-Economics of Crypto-Currencies: Balancing Entrepreneurialism and Monetary PolicyI by Eli NoamII Abstract Cryptocurrencies provide an important dimension of innovation to the evolution of the exchange medium we call money. There are now over 2,000 such curren- cies, and their potential and volume is growing. How- ever, they will, collectively and in volume, create real problems for the monetary system of a country. Cen- tral banks, which are institutions tasked with providing monetary stability, are more essential than ever. Yet they will see their problems rise while the power of their traditional tools to control money supply and interest rates—such as reserve requirements and the discount rates—is declining. But the new digital technologies— such as distributed ledgers—and new approaches pro- vide regulatory bodies also with new and potentially powerful tools. The task for central banks and policy makers is not to resist private digital currencies as trou- blesome irritants, but to create approaches to use, reg- ulate, and incent them in shaping the macro-economic path of their economy. In the process, central banks will also issue their own digital currencies, and a small number of those will become global super-currencies. I. This paper was supported by a grant by Nasdaq, the world’s first electronic stock exchange, to the Columbia School of Public Affairs (SIPA) for the study of entrepreneurialism. I thank Nasdaq and Dean Merit Janow. I am also grateful to Jason Buckweitz and Corey Spencer for their highly supportive roles, and to Sophia Waldenmaier, Philipp Strack, and Lisa Mischke for research assistance. Leon Perlman provided important help by sharing his knowledge and experience. II. Director, Columbia Institute for Tele-Information; Professor of Finance and Economics; Garrett Professor of Public Policy and Business Responsibility, Columbia Business School. _______________________ The Macro-Economics of Crypto-Currencies: Balancing Entrepreneurialism and Monetary Policy | 1 1. Introduction analyze the computer science dimension7,8,9,10,11,12,13,14 and business school professors interested in strategic New types of means of monetary exchange are implications.15,16,17,18,19 There have also been studies emerging—digitally based coin systems issued by by several major central banks on the implications startup private ‘fintech’ companies. and role of crypto-currencies in the banking sys- As these digital moneys have become more complex in tem.20,21,22,23,24,25,26,27,28,29,30,31 But what has been lacking their coding, they have become known as crypto-cur- are studies of the macro-economic implications of cryp- rencies. This paper will discuss their implication for to-currencies. Exceptions are simulation studies and monetary stability of an economy, and for the tradi- models for the UK32 and Canada33 that specifically tional tools used by governments and central banks to deal only with crypto-currencies issued by their central seek such stability. banks. They do not cover the macroeconomic impacts It concludes that competitive private cryptocurrencies of private crypto-currencies. This paper will try to inherently create monetary instability; that central analyze what such a system can do to the macroeco- banks are therefore more essential than ever; but that nomic tools of central banks. the effectiveness of the traditional tools of the central Despite the hype surrounding the new currencies, we banks is diminished. must keep a perspective. This is still a really tiny part of However, new tools for macro-economic stabilization the economy. As a payment mechanism it is clunky to and creation of growth are also available, and their operate in volume. And if it stays tiny, then why care? development and absorption must be a priority. But suppose it grows, gains in convenience and appli- Bitcoin has been all over the news since about 2011.1,2,3 cations, and becomes a major part of economic Major news organizations started reporting about it in transactions? Then what? This is not purely futuristic 2012.4,5 In less than a decade, Bitcoin has gone from imagination. Already in 2017, the market capitalization obscure curiosity to household name.6 The buzz has of crypto-currencies amounted to nearly one fifth to not abated nor has the push to expand its use, and, tenth the value of the physical stock of official gold.34,35,36 more generally, that of the overarching software approach of distributed ledger technology, with its cur- 2. A History of Governmental and rent major direction of blockchain. There are literally hundreds of electronic currencies now beyond Bitcoin Private Moneys and its alternates, such as Ripple, Ethereum, Litecoin, Money has been controlled for such a long time by Monero, or TRON. They are labeled, collectively, as governments that it seems to be the natural order of alt-coins, ICOs, distributed ledger currencies, block- things. But that is not so. There has always been private chain currencies, crypto currencies, digital currencies, money. This is partly because it is not clear what money or tokens. The Pollyannas, often tech entrepreneurs, is, exactly, and who creates it. Money is an interme- see blockchain and new money as a potential solution diate means of value that is acceptable to both sides to just about anything. The Cassandras, often from the of a transaction, and to numerous other participants banking industry and its staid Old Money ways, fret in an economy. People believe that when accumulating about enabling drug dealers, extortionists, terrorists, money, they will be able to buy goods and services in the tax cheats, and business frauds. future because other people will accept it as a means of payment. Money thus has three major dimensions: It is There is an over-coverage of these law enforcement aspects of crypto-currencies in the press, together with • Medium of exchange and payment a fascination with dimly understood virtual financial • Store of value assets whose value seemed to be going up for a long • Unit of account time, which was deemed to be a sign of its importance. Instead of people bartering two sheep and 20 eggs for a But there is an under-coverage by academic analy- cow, they exchanged money. Initially, this intermediate sis of this emerging form of money-like instruments. means had some inherent worth, such as gold or silver, The main exceptions are software technologists who 2 | SIPA’s Entrepreneurship & Policy Initiative Working Paper Series _______________________________________________________ that was rare and useful enough that it had indepen- vately issued bank note issuers. Their moneys differed dent value. In time (China, 7th century) paper notes in riskiness depending on their business conditions and emerged as claims against such commodities, and this liquidity. They would be discounted by users and other facilitated transactions. Eventually, the paper notes banks in order for them to accept them, at a discount were divorced from precious metals. This is known rate depending on these risk factors. as “fiat” money. It is a currency that a government There were some rules, e.g. the banks were required declared to be legal tender (acceptable in payment of to post collateral such as state government bonds to tax and contractual liabilities), but that is not backed back their banknotes.38 This was a way for state gov- by a physical commodity.