Will Crypto Currency Replace the Dollar and End Fiat Money?

The idea of cryptocurrency replacing the dollar and ending fiat money is a topic of much debate. According to the article, cryptocurrency has been around for over a decade, with the first cryptocurrency, Bitcoin, launched in 2009.

Many experts believe that cryptocurrency has the potential to become a widely accepted form of payment, but it still has a long way to go. The article notes that cryptocurrency is still a relatively small market, with a total market capitalization of around $2 trillion, compared to the US dollar's value of over $20 trillion.

However, cryptocurrency has been gaining traction in recent years, with more and more people investing in and using it. The article cites the example of El Salvador, which became the first country to adopt Bitcoin as a form of payment in 2021.

De-dollarization is a significant reduction in the use of dollars in world trade and financial transactions, decreasing national, institutional, and corporate demand for the greenback.

The dollar's dominance in global capital markets is at risk due to adverse events that undermine its perceived safety and stability, such as increased polarization in the U.S. that jeopardizes the perceived stability of its governance.

A candidate reserve currency must be perceived as safe and stable, and provide a source of liquidity sufficient to meet growing global demand, as noted by Alexander Wise, who covers strategic research at J.P. Morgan.

If the dollar's status is eroded, it could diminish its dominance in global capital markets, where borrowers and lenders around the world transact in dollars.

De-dollarization risks appear exaggerated, despite changes in cross-border flows and the rise in alternative financial architecture for global payments.

The dollar's share of FX reserves has fallen over the past two decades, but FX reserves are still mostly held in DM currencies.

Diversification away from the dollar is a growing trend, but the factors that support dollar dominance remain well-entrenched and structural in nature.

The dollar's role in global finance is supported by deep and liquid capital markets, rule of law, and predictable legal systems.

In fact, the dollar's transactional dominance remains undisputed, especially when taking into account other factors including dollar-denominated bank deposits, FX volumes, and trade invoicing.

The dollar's influence in global trade and FX is still significant, despite the US being the second largest goods exporter in the world and its share of global trade having declined in recent years.

The decline in trade intensity reflects some convergence in cost differences across countries, maturation of existing trade liberalization initiatives, more intra-country trading on rising demand from domestic customers, and growing service intensity of economies.

In short, the dollar's dominance is unlikely to erode significantly anytime soon.

Here are some key statistics that illustrate the dollar's continued influence:

As you can see, while the dollar's share of FX reserves has declined over the past two decades, it's still a significant portion of the total.

As we look to the future, it's clear that cryptocurrency is gaining popularity worldwide. Cryptocurrency use will likely continue to grow, with more people and businesses adopting it as a means of exchange.

One possible scenario is that a society and economy could fully adopt cryptocurrency, replacing their fiat currency altogether. However, this is unlikely to happen in most areas.

A more likely scenario is a hybrid system, where both digital assets and fiat currency coexist. Governments could recognize and regulate both, allowing consumers and businesses to choose which one they prefer.

Blockchain technology is already being integrated into existing monetary systems, and it's likely to become a standard feature in the future. This could lead to more secure and transparent financial transactions.

Some governments may choose to ban cryptocurrency use entirely, while others will allow it to exist and be convertible to fiat currency. This could lead to a fragmented system, with different countries having different rules and regulations.

Bitcoin can't become a reserve currency due to its current instability, making it unreliable for the world to use. Economists point to its volatility as the biggest factor stopping it from integrating with the world's markets.

Bitcoin prices fluctuate wildly, going from extremely high to somewhat low, making it one of the more unstable currencies in the market. This volatility is a major concern for governments and institutions that need stable assets.

The limited nature of Bitcoin is another issue standing in its way. There is a hard limit of 21 million Bitcoins that can be mined, and we've already mined about 16 million of them.

A Central Bank Digital Currency (CBDC) is a digital representation of an existing national currency, like the Australian dollar.

It would have the same value as the physical currency and be legal tender, issued by the Reserve Bank, just like banknotes in our wallets.

Retail CBDCs would allow point-of-sale purchases, government payments, and transfers between individuals, but would not replace hard currency.

Central banks are considering many design features, but most think their retail CBDCs won't pay interest.

The wholesale version of CBDC would only be available to financial institutions, similar to the deposit accounts they currently hold with the central bank.

This digital currency would enable more sophisticated financial transactions, like "smart contracts", than existing forms of electronic money, such as credit cards.

It's worth noting that CBDCs would not replace traditional currency, but rather provide an optional digital alternative.

A global trend is emerging, and it's all about central banks and digital currencies. 94% of central banks are considering creating their own digital currencies, also known as CBDCs.

This interest in CBDCs is not just a passing fad, as a recent report by the Bank for International Settlements (BIS) surveyed 86 central banks and found that about one third are already running pilot projects.

Most central banks, however, are being cautious and don't expect to issue their own digital currency in the next few years.

Cryptocurrency has the potential to make cross-border payments faster and cheaper, especially in countries where many families rely on remittances from members working overseas.

It can also improve financial inclusion in countries where a large proportion of the population don't have bank accounts.

However, one concern is that a retail cryptocurrency might replace commercial bank accounts, which could facilitate illegal activity due to anonymity.

Consumers may not have financial recourse or protections if cryptocurrency replaces fiat currency in its current state.

The International Monetary Fund recommends against adopting cryptocurrency as a main national currency due to price volatility and risks to macro-financial stability.

Some countries are already using retail CBDCs, a type of digital currency issued by central banks. The Bahamas was the first to launch a CBDC, called the "sand dollar", in 2020.

The Eastern Caribbean Central Bank also launched a CBDC, called DCash, in 2021. Nigeria and Jamaica have their own CBDCs.

China is the most advanced major economy in work on a retail CBDC, with the digital yuan, or e-CNY, being widely trialled.

Central banks might adopt Central Bank Digital Currencies (CBDCs) to preserve the role of central bank money and ensure monetary policy remains effective.

CBDCs can make cross-border payments faster and cheaper, which is particularly helpful in countries where many families rely on remittances from members working overseas.

Countries with a large proportion of the population without bank accounts may see scope for improving financial inclusion through CBDCs.

However, a retail CBDC might replace commercial bank accounts, as customers might transfer funds to the perceived safety of a CBDC.

This could facilitate illegal activity because, like banknotes, CBDCs may be fully anonymous.

Smart contracts are a crucial application of cryptocurrency, allowing for instant payments and transfers of ownership to happen simultaneously. A smart contract is like a vending machine that dispenses cookies when you insert the right amount of money.

For smart contracts to work in important transactions, the payment needs to be made using a stable form of cryptocurrency whose value won't fluctuate between the time you decide to buy and when the transaction happens.

Stablecoins like Tether and USDC are often suggested for this purpose, but they're rarely used outside the crypto ecosystem. Even major companies like Meta/Facebook have abandoned their stablecoin projects.

Central bank digital currencies (CBDCs) could provide a trustworthy basis for smart contracts, as they can maintain parity with national currencies like the US dollar.

The Reserve Bank of Australia has been cautious about introducing a central bank digital currency (CBDC). They haven't seen a strong public policy case to move in this direction, especially given the country's efficient electronic payments system.

More than 99% of Australian adults have a bank account, so the financial inclusion motive doesn't apply here. Few Australian families rely on international remittances.

Australia's payments system has been improved over recent years, with no sign of stablecoins or other crypto making a meaningful challenge to the use of the Australian dollar for payments.

However, the Reserve Bank seems to be becoming more interested in CBDCs, with an assistant governor suggesting it could "spur innovation".