Dong He, deputy director of the monetary and capital markets department of the IMF, and Yan Liu, Assistant General Counsel at the legal department of the IMF, talk about central bank digital currencies (CBDCs): the current level of interest among central banks in issuing them, what concerns they need to address when designing them, and how commercial banks might be affected, depending on the design of the CBDC. We discuss how privacy could be built into such a currency while also fulfilling anti-money laundering and counter terrorist financial regulations and how a CBDC could affect the IMF’s ability to achieve its goal of financial inclusion. Plus, we also cover how crypto assets being widely adopted could influence economies, as well as Facebook’s Libra.
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Episode links:
IMF: https://www.imf.org/
Dong He: https://www.linkedin.com/
Yan Liu: https://blogs.imf.org/
Speech by IMF managing director Christine Lagarde on the case for new digital currency: https://www.imf.org/
He’s speech on monetary policy in the digital age: https://www.imf.org/external/
Article on how crypto assets could reduce the demand for central bank money: https://www.imf.org/external/
The IMF on Libra: https://www.imf.org/~/
Unconfirmed episode with Michael Casey on why it would be good if Libra rivaled the US dollar: https://
Also check out this Unchained episode from the Oslo Freedom Forum, which dived deeply into the issues around privacy vs. keeping out bad actors: https://
And this Unchained episode with Alex Gladstein of the Human Rights Foundation, which covered similar issues: https://
Transcript:
Laura Shin:
Hi, everyone. Welcome to Unchained, your no hype resource for all things crypto. I’m your host, Laura Shin. In case you haven’t heard, I have another crypto podcast called Unconfirmed. It’s shorter, newsier and comes out Fridays. If you haven’t taken a listen, go check it out. Also, I publish a newsletter on the top stories in crypto every week. To sign up go to Unchainedpodcast.com and you can enter your email address right on the homepage.
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Laura Shin:
My guests for today are Dong He, Deputy Director of the Monetary and Capital Market’s Department of the IMF, and Yan Liu, Assistant General Counsel at the Legal Department of the IMF. Welcome, Dong and Yan.
Dong He:
Thank you, Laura.
Yan Liu:
Hi, Laura. Thank you.
Laura Shin:
Let’s start with a basic question. What does the IMF do?
Dong He:
Okay. So, that’s an easy one I think. The IMF, International Monetary Fund, is basically a multinational organization. We are a member-based organization. We have 189 members consisting of governments of the countries. We promote international financial money and monetary stability. So that’s basically the function of the IMF. We were founded in 1944, so we’re going to celebrate the 75th anniversary this year actually as part of the Bretton Woods system.
Laura Shin:
And there’s one thing I want to add which is before the show Dong and Yan explained to me that the views expressed during this interview are their own and do not necessarily represent the views of the IMF. So, if part of the mission of the IMF is to ensure the stability of the international monetary system how has the advent of blockchain technology and cryptocurrencies affected the IMF’s activities thus far?
Dong He:
Well, this is an exciting time. We’re seeing a lot of changes in the technological space. I wouldn’t say that has changed our work so far but we’re interested in understanding what these technologies are, the implications for the financial systems in our member countries and eventually how that’s going to affect the international monetary landscape. So, I think this is just the beginning and we are still in the learning mode. So, we’re very interested in the issues that are going to shape the financial systems across the globe.
Yan Liu:
I just wanted to add since many of our member countries are very interested in this issue and we are obligated in a sense to really understand the implications so that we can provide policy advice and technical assistance to our member countries in this area.
Laura Shin:
Yeah. And I actually wanted to ask a little bit more about that, Yan, because the main ways in which the IMF works with the member countries I believe is through the central banks, and so before we get even more into blockchain technologies and digital currencies, can you just explain what the main ways are in which central banks can influence the economies of their countries?
Yan Liu:
I think, well there are many roles of central banks but in terms of our mandate we look beyond just what central banks do. We also look a country’s overall economic policies and also their financial sector policies to make sure that overall the global international system or global financial stability will be maintained. So, we are engaging with central banks and other entities within a country through our normal surveillance activities which is usually takes the forms of an annual health checkup. We call it Article Four Consultations. Also, we have other instruments like a financial sector assessment programs. We also provide financing to a country through the adjustment program, we also engage with central banks and other agencies in the country, and finally we provide, as I mentioned before, technical assistance to help central banks strengthen their institutional frameworks and also guide them in terms of the international best practices and also on the policy matters.
Dong He:
So, Laura, I guess your question is also about how central banks affect their own economies, right.
Laura Shin:
Yeah.
Dong He:
That’s the question you had. I see. So, basically central banks, the institutions, the government institution of a particular economy that issues the currency of that country. So, when we talk about the Federal Reserves, the dollar cash notes we carry around issued by the Federal Reserve as the central bank of the United States. So that’s the very basic function of the central bank. Of course, the central bank runs the monetary policy and monetary policy affects the stability of the US dollar as a unit of account. All economic activities here in the US are denominated in dollars and that dollar unit of account is really defined by the Federal Reserve as the central bank. Does that answer your question?
Laura Shin:
Yeah. And I also wanted to talk about some of the mechanisms that they use, like for instance commercial banks as far as I understand, at least in the US, are pretty central to the way the Federal Reserve manages the money supply here and I wanted to know if that was the case for all central banks in those countries, commercial banks also play a key role.
Dong He:
Yes, indeed. So, the central bank in all countries are basically the bank of the commercial banks. So, we have modern banking systems will have this two-tier structure, right. The commercial banks provide the deposits which are redeemable at par with the central bank liability one-to-one and the central bank is at the pinnacle of this pyramid you could say, so the central bank is the bank of the commercial banks and there are various ways for the central bank to influence either the price or the quantities of money in the particular economy. So, that’s basically how the system is set up.
Laura Shin:
So, and again, the topic for today is central bank digital currencies but I feel like it’s kind of useful to talk about some existing types of money. So, let’s talk about cash for a little bit. What role does cash play in a central bank’s ability to manage its economy?
Dong He:
So, cash is one component of what we call base money of a particular economy. So, the base money is the liability of the central bank. It has two components. One is cash, the other one is the reserves kept by commercial banks. As I said earlier, commercial banks also issue liabilities in the form of deposits. You and I keep our deposits with commercial banks and these deposits are part of the broader monetary system. So, these are also money but these are commercial bank money. It’s not central bank money.
So central bank money is composed of two components. One is cash, the other one is commercial bank reserves, and the commercial bank money is in the form of deposits that the public keeps with them, and these are redeemable one-to-one. This commercial bank money is at par with central bank liability. That’s the unit of account basically. One dollar is one dollar. So, you can convert your one dollar deposit in a commercial bank to a one dollar cash provided by the Federal Reserve.
Laura Shin:
So, cash is becoming less used kind of broadly and this is kind of maybe a function of everything becoming more digital. So, what is the role for cash or some kind of cash like form of money in the digital age?
Dong He:
Right. That’s a very good question. So, globally we have seen very fast digitalization, digitization payments in some economies but it’s not necessarily at the same pace. In some economies people still use a lot of cash like in Japan but in Sweden cash use has really declined very fast and they’re looking forward I think in the digital age the demand for cash is likely to decline. Now, cash has certain advantages. Let me give you an example where you buy a cup of coffee in Starbucks let’s say, you can pay with cash. You just pass a five-dollar bill to the cashier and that transaction is very efficient in the sense that it’s settled. It’s cleared and settled instantaneously and also there’s a feature that the cashier doesn’t have to know who you are. He or she doesn’t have to know the buyer is Laura Shin and you don’t have to know who the cashier is, but the other way to pay for coffee is to swipe your credit card.
Now, that is a very different payment instrument because for that transaction to be settled finally in the sense that for your bank balance to be debited and for the Starbuck account to be credited it has to be backed by a whole infrastructure. So, there are banks involved and it takes some time for that transaction to be settled. So, there are various ways to make payments. So, there are different features attached to each payment instrument.
Now, cash also has its disadvantage. If we are in different places like you are in the let’s say traveling in Peru, I’m here in the United States, it’s very hard for us to give cash to each other, so you have to make payments remotely and then cash is not very convenient. Then the bank transfers, credit cards would be much more convenient. So, these different instruments have different features that you could say strength and weaknesses, depends on the use of what sort of transactions we are conducting.
Laura Shin:
So, let’s talk about central bank digital currency. I’ve been seeing the IMF has been talking about this and really seeing some reports and articles but let’s define that. What do you really mean when you’re talking about central bank digital currency?
Dong He:
So, central bank digital currency is basically a digital version of central bank liability which is widely accessible. As I explained earlier, the only widely accessible part of the central bank money at the moment is cash and the other part is commercial bank reserves kept by commercial banks. So, when we think about creating a central bank digital currency, you and I will be able to hold that central bank money digitally for example, in our iPhone. So, it’s more like digital cash. It’s really like digital cash. At the moment when we’re thinking about cash that’s the only way that the public can hold central bank money. So, if we have a central bank digital currency then we can also hold central bank money digital form in addition to or instead of holding cash. So, that’s one way to think about this.
Laura Shin:
And is that created using blockchain technology or can it be created with any other type of technology?
Dong He:
It doesn’t have to be blockchain technology. I think this idea itself is technology neutral. So, you can have a more centralized way of doing this, for example a central bank itself is the issuer. So, in contrast to bitcoin for example, when new coins are mined or minted it’s a decentralized process on the blockchain. Central bank digital currency doesn’t have to be on the decentralized blockchain. It can be issued. Actually, it’s probably at this stage it makes more sense for the central bank to centrally control the issuance of the central bank digital currency.
Laura Shin:
And at this point why is the IMF interested in central bank digital currencies and what level of interest are you seeing from your member countries?
Dong He:
That’s a very good question because as I said, the central banks are in charge of maintaining price stability in modern economies, so they are interested and of course the IMF is also interested in ensuring price stability. So, if in the digital age if a private digital currencies have developed, if there’s less demand for central bank digital currency, for central bank currency for example, if cash is no longer used for economic transactions then either the public will have no interface or no interactions with the central bank. The central bank will also have more difficulty in influencing monetary conditions in the economy in the sense that particularly in the case that if there are alternative private currencies that are developed in the different unit of account. So that would make the central bank’s job of maintaining price stability in the countries much more difficult. So, we think that it’s important for the central bank to be engaged, to stay in the game in the digital age and that would help the central bank achieve their mandate of maintaining price stability within the digital age.
Yan Liu:
And to answer your second question, several central bank in both advanced and emerging markets and developing countries are considering the pros and cons of issuing the CBDC. For instance, Australia, Brazil, China, Denmark, Philippines, just to give you a few examples, and they are really looking very carefully at whether it makes sense to issue CBDC. So, I think this is really a topic that really raised a lot of awareness and also interest among the membership.
Laura Shin:
So, earlier we talked about how the central bank is kind of the top of the pyramid. It’s sort of this lender of last resort and then they work with the commercial banks to influence the economy to increase or decrease the monetary supply. So, when you introduce a central bank digital currency how does that process change?
Dong He:
You mean how does the money supply process change?
Laura Shin:
Yeah.
Dong He:
I see. It doesn’t alter that mechanism fundamentally. It’s just another form of central bank liabilities. So, we are doing research…yes.
Laura Shin:
Well, I thought that there was some thinking that it could potentially sort of reduce the role for commercial banks and people could kind of just have accounts directly with the central bank. So, in that sense…
Dong He:
I see your question. Yes. That’s a very good question. I think that depends on the design of the central bank digital currency and basically we can talk about two, conceptually speaking we can talk about two types of central bank digital currency. One is a value based or token based. It’s a bit like an object, like a token. Cash is such a type in the sense that what matters is the value or authenticity of the dollar bill or the object is held. Another one is called account based or claim-based money like our bank account, our deposits. So, if you design the central bank digital currency more like cash, it’s like digital cash, then that doesn’t affect the demand for deposits as much. On the other hand, if you designed a central bank digital currency more like a substitute for commercial bank deposits that would probably affect how we value commercial bank deposits.
So, some of us might move our deposits to the central bank. You feel that is much safer to keep deposits directly with the central bank, but of course there are different considerations. One is that where do you pay interest on this deposit. So, if there’s no interest then you wouldn’t want to give up the interest you earned on a commercial bank deposit. The other thing is that if there’s deposit insurance then you wouldn’t worry about the credit risks or you wouldn’t worry about losing that deposit with the commercial bank. So, you don’t necessarily forgo the interest you earned and move the deposit at the central bank. So, these are the options or design features we have to bear in mind when we design the central bank digital currency. So, it’s not a uniform impact talking about.
Laura Shin:
And we talked about how there are different designs, et cetera, for the ways these central bank digital currencies might be issued and I was wondering are central banks already structured in a way where they can issue central bank digital currencies? Like do existing central bank laws allow for that or are there other considerations that need to happen before such currencies could be issued?
Yan Liu:
Yeah. I think it really depends on whether it is within the central bank’s mandate to issue the digital currency and also whether they are allowed to do so under their existing central banking law. So, maybe I’ll just take one step back to explain what is a mandate and why it is so important. For a central bank its mandate is the reason why it exists and basically a central bank is established for certain purposes and also to discharge certain responsibilities and its purpose and responsibly are usually explicitly set forth in the central banking law, and in some countries as a matter of fact this could be enshrined in their constitutional law.
So, central banks are really in a way are limited in what they can do based on the specified responsibilities and mandates, and different central banks have different central banking laws but there are a few general principles which I’ll explain. For instance, they can issue currency. They can really set up accounts but under the existing central banking law generally speaking the currency where they manage the currency they really need banknotes and cash. So, the digital currency was not considered at the time when the existing central banking law was designed. So, in many countries we haven’t really looked at all the countries central banking law but I think the generally speaking the central banks do need to amend or modify their central bank laws in order to provide a very clear and certain legal basis for issuing the digital currency.
Laura Shin:
I also read a speech that Christine Lagarde. I guess I don’t know if she’s still currently the managing director at the IMF but she’s at least the outgoing if not former managing director of the IMF, and she talked about how central bank digital currency could help bring about greater financial inclusion. Can you describe how that works?
Dong He:
Right. So, for example at the moment we do have more than a billion people in the world who are unbanked in the sense that they don’t have a bank account. So, if you were to have a deposit held with a commercial bank to use that for payments, you need to be banked. You need to have an account with a bank but the cash is an instrument that does not require a bank account. So, a lot of the unbanked people in the world they hold cash but it’s very expensive. It’s also difficult to store. You can easily lose it. It’s also very expensive for countries. They have to spend a lot of money maintaining the hygiene of the cash notes in order to replace them for once in a while, to distribute them, to secure the storage. So, it’s a very expensive means of holding the currency.
Now, digital cash will make it much easier for these people to have access to a means of payments. In Africa and a lot of unbanked people they can keep their cash in a mobile account and it does not necessarily require a bank account. You can get the digital cash through the mobile phone companies, through post offices. So, that would help these people make economic transactions. Now, in the future if these services, payment services can be linked with other types of services through the mobile apps then they can be incentivized to save, to invest and that would enhance economic efficiency tremendously. I think that’s one way to think about it.
Yan Liu:
I think at the same time we should also bear in mind that this type of virtual kind digital currencies could raise some financial integrity concerns, so it’s quite important to really strike a proper balance between reaping the benefits to support financial inclusion and the need to safeguard the financial integrity to make sure that they would not be abused by the criminals. I think that’s really a very important consideration for policy makers when they’re designing the CBDC.
Dong He:
One way to think about it I that these days when central banks issue cash, the denominations are not necessarily huge. You cannot have a US dollar that’s denominated more than 500 dollars let’s say. The largest denomination is 100 dollars. So, one consideration when the central banks design the denominations of cash notes is that they don’t want to create too much convenience for illicit use of cash notes. So, when you move to the digital world, when you have digital cash, you have to think what is the amount of anonymity that should be allowed in the use of the digital tokens or digital cash. So, you need to strike a balance but there are also ways, technological ways to track the usage of digital cash to ensure that financial integrity is not compromised. So, that’s another way.
Yan Liu:
I think, yeah. When I refer to financial integrity I really mean the money laundering and terrorist financing risks, how to really manage these risks in order to really safeguard the financial system while at the same time really allowing more access to the financial services by millions of people.
Laura Shin:
And how do you do that without it being like a totally surveilled system? Like how do you manage privacy against those concerns?
Yan Liu:
Yeah. I think that is a very good question. I think that’s what Dong was saying that there are no panacea right now, but I think it’s important to really strike this balance and using the technology, as Dong was saying, that you probably can impose some strict limit on the size of the transaction and you can also use the technology to facilitate effective identity authentication and also tracking of the payments and transfer. This technology can really help either central bank or all sorts of entities to ensure that the AML/CFT measures are compliant because that’s really the requirements that each institution at central bank needs to comply with, but I do think that this discussion, I think it can be helpful but they really need some further evaluation to really make sure they’re effective to address these concerns.
Laura Shin:
We’re going to keep discussing this in a moment because actually Christine Lagarde actually wrote or gave a speech were she outlined a scenario like this. So, I’ll talk about that in a moment but first a quick word from the sponsors who make this show possible.
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Laura Shin:
Back to my conversation with Yan Liu and Dong He of the IMF. So, the speech that I referenced earlier in which Christine Lagarde sort of outlined a scenario in which the concerns of privacy versus anti-money laundering and terrorist financing could be balanced was she said that central banks could design digital currency in a way where user’s identities would be authenticated through customer due diligence procedures. So, I’m not sure…and then transactions recorded. So, I’m not sure exactly what that looks like so maybe you can describe that in a second but let me keep going, and then she said however, identities would not be disclosed to third parties or governments unless required by law.
So, she had this example where let’s say that somehow credit score companies or other companies figure out that if you’re the kind of person who purchases frozen pizza and beer then you maybe are a higher risk borrower or something like that. So, she would say so if you do go to the grocery and purchase a frozen pizza and beer then the supermarket, the bank and marketers wouldn’t have a way of knowing who you were or wouldn’t maybe know what you bought but at the same time anti-money laundering and terrorist financial controls could run in the background and then if there was any suspicion about you or your transaction then there would be this veil of anonymity that could be lifted.
So, can you just describe how that works? I understand the words that she was using but just like on a detailed level, like what are all the different actors that need to be set up in place, so what are the processes to make this possible?
Yan Liu:
Okay. So, basically the financial action task force, which is an international standard setter, they set the anti-laundering and terrorist financing standard for all countries. I think one key requirement is called customer due diligence which basically require for example the one you’re talking about, the commercial banks and other entities that are involved in the transaction with either cash or with credit card, they will basically set up a very robust monitoring system to see some suspicious transaction.
In your example, if somebody engaged in a transaction you see for instance a drug proceeds and if they have a proper system set in place they can trace the proceeds used in this transaction. They have an obligation not only to monitor that transaction but also report that suspicious transaction to a relevant authority, and that authority will take certain action to maybe do further analysis and they will take further actions to trace the proceeds and to the extent the proceeds are really identified as coming from a suspicious source and they could suspend the transaction. They can also take other action. For instance, in impose certain sanctions on the entities by commercial banks.
So, this whole sort of the process, basically saying commercial banks were the other entities, they need to ask questions. They need to really ask the person who gives you the cash where the cash comes from and if that’s from a legitimate source or it’s from illegitimate source and then based on that answer provided by the commercial bank, the authorities can take certain actions. So that’s sort of the normal customer due diligence requirement. When we talk about cash, it’s very difficult to really trace as Dong mentioned because of the anonymity.
I think when you use the mobile money and you use for instance the central bank digital currency to the extent you use certain technology like distributed ledger, you’re able to record the whole transaction and you’re sort of getting a better understanding of where the money is coming from that really can help you in terms of investigating, monitoring and also reporting the cases. Having said that, I do think that, as I mentioned before, this technology still needs to be evaluated because obviously we need to know the beneficial owner of the money, meaning the ultimate owner of the money that get into the transaction and distributed ledger may not necessarily help you really identify the ultimate owner of particular funds or particular credit or money. So that’s something we still have to look at but I do think the technology offers some promises in terms of facilitating the monitoring investigation and reporting by the commercial banks and other entities involved in the transaction.
Dong He:
So, this is more just to supplement what Yan had said. I think in the way technology is going to give us more options to think about these issues or to strike a better balance because as cash is completely anonymous then that creates a lot of difficulty for law enforcement. On the other hand, in a digital world you don’t want to be totally transparent either. Privacy is something that we value.
So, what Christine Lagarde mentioned is that you don’t want to have necessarily customer profiling because if people can tell that you’re buying certain products, you’re a type of person, that the prices they offer you, the type of products they offer you would be somehow dependent on that type of profile. That’s not necessarily ideal. So, but digital age you don’t necessarily want to have everything that’s visible, that’s transparent. So, we still value privacy. So, technology actually offers the potential for us to customize different degrees of privacy. You don’t necessarily have to have a centralized database that has everything. You can review your entitlements for certain things.
For example, if you walk into a wine store you just need to prove that you are over 18 years old or 21 years old and the store still doesn’t have to know your name every time when you make a payment. So, these are all the technologies that are going to be possible in the digital world. So, it’s only as a matter of public policy we need to strike a balance at which circumstances we want to know who is behind the transaction, more than your other types of situations. So, I think technology is really very exciting because it allows us to have this kind of flexibility.
Yan Liu:
I just wanted to add that after the current AML/CFT standard this flexibility is already provided there because we apply a risk-based approach. So basically, you need to really design the AML/CFT measures based on the level of risks. So, in Dong’s example, if you go to a store, you just pay 50 dollars to buy wine, the level of risk is not that high compared to you use 500,000 dollars to buy a piece of real estate. So, the standard already allows the countries to tailor their AML/CFT measures like the customer due diligence requirements to the level of risk.
So, in some situations you should ask the risk and some scenarios you don’t really need to ask questions. So, I think combined with the technology and combined with the risk- based approach, I think we should be able to design a very balanced approach that address the issue of privacy and also financial integrity concerns.
Laura Shin:
And just so I understand from what you were describing earlier, essentially there will be transactions that are more similar to cash that happen digitally, meaning that I could meet somebody and for whatever reason this person and I, maybe I send them money or they send me money and that would be very similar to if we met in person and I handed them a 20-dollar bill or they handed me one, but then when you were saying that there would also be customer due diligence maybe like a transaction or two away from that transaction, I might be interacting with someone where they would know who I am, like a bank or some other kind of institution, and then so if for whatever reason there was ever suspicion about what I was doing then you could maybe kind of reconstruct who else I was transacting with for any transactions where it wasn’t with an institution that knows who I am. Is that kind of what you were describing earlier?
Yan Liu:
Yes. Very close. I think basically as you’re saying that if you transact with somebody, for instance if you transfer 50,000 dollars to your relative in another country I think that the bank depending on their limits under their policy they may ask you to fill out a form. So they will ask you what is the purpose of the transfer and maybe they even ask you where did you get the money, and so you submit this form to the bank and the bank based off their internal control system, they will verify your responses and to the extent they’re satisfied with the accuracy or the sufficiency of your information, they will make the transfer, but to the extent they are not, they may either ask you for more information or they will not really make the transfer. So, that’s really sort of the normal procedure for customer due diligence.
Laura Shin:
And let’s also now then talk a little bit about the other area of money that has been burgeoning I guess is the word, which is crypto assets, and Dong, you wrote a really fascinating article on how crypto assets could one day reduce the demand for central bank money, and the way you started the article you kind of described some of the general benefits of crypto assets over central bank money. Can you describe what you think those advantages are?
Dong He:
So, as I mentioned earlier there are different types of payment instruments like cash versus bank deposit and depending on the characteristics of this particular payment instrument the information requirement is very different. So, potentially cryptocurrencies can make it very efficient for payments to take place in different locations. For example, we have had a lot of pain points in cross-border payments. You know that it’s very expensive. It’s slow. It’s not transparent. Once you send remittances you don’t know where they are. It’s very difficult to trace. So, some of the payment services based on cryptocurrencies can make this process very efficient. I mean it takes seconds or minutes for remittances or cross-border payments to happen.
Now, at the moment of course we know that cryptocurrencies are extremely volatile. So, this is a way I really think the advantage of central bank money has in the sense that modern central bank monetary policy is based on the economic signs. So, central bankers for example the monetary policy committee members they make monetary policy by looking at how the economy functions. They look at various shocks that are hitting the economy like trade wars, maybe even earthquakes. So, they see how the economy might be hit by these shocks and they respond by changing monetary policy stance like lower interest rate or if inflationary pressures are going up they can tighten monetary policy. So, you have a forward-looking manager policy making that allows central banks to maintain the stability of the unit of account, of the currency, and that’s where the cryptocurrencies have not been able to do.
They have the value of these cryptocurrencies fluctuates very widely and they do not provide the stability that a currency really needs for economic transactions to happen very efficiently, and so that’s really important because even for modern economies to function properly we need to have price stability, but on the other hand as a means of a payment, cryptocurrencies have some of the features that are very easy. They are very connected with the digital lives, particularly of young people. You can on social platforms or apps on your phones, you can use these currencies very easily. So that’s why I said earlier at the beginning that the central banks they need to stay in the game. They also need to make their currencies very easy to use for in the digital age. The central bank digital currency is one way to make that happen.
Laura Shin:
And another part of the article that I found really interesting was you said that if people adopted crypto assets that could prompt a shift from credit money to commodity money. What does that mean exactly?
Dong He:
So, modern monetary system was banking system and the money is created by credit relationships. So, central bank money is…for example, cash is a liability of the central bank or commercial bank deposit is a liability of the commercial bank. These are based on claims or credit relationships whereas commodity money is not liability of anybody. Gold for example is a commodity money. It no longer really serves any monetary function but traditionally in the old age in the gold standard, gold was used as a currency but it was not a liability of anybody. Now, if you think about what cryptocurrencies like bitcoin. Bitcoin is not a liability of anybody so that’s a type of commodity money if it serves some monetary function. So, you could envision in the future there will be multiple private cryptocurrencies or commodity monies being created and they could be denominated in different units of accounts.
So that’s not necessarily a desirable situation because money is really a very important utility that the government should provide to ensure that the economies function very well. We need to have price stability. So, if you have a lot of currencies competing and also in payment economics. We have so-called economies have scale so you may end up with a couple of private cryptocurrencies dominating the payment landscape and they behave as a monopoly. So, that’s not necessarily a very ideal situation. So, we need to have a central bank that’s the monopoly issuer of the legal tender or the fiat currency that can maintain price stability which is really for the benefit of the whole of the economy.
Laura Shin:
And one other piece of this I wanted to ask about was you mentioned that if crypto assets become more widely adopted and the scenario that you just outlined that could cause central bank money to no longer be the main unit of account and then you said that, that could make central bank monetary policy irrelevant and a good analogy is dollarization in developing economies. So, can you describe what happens there when a developing economy does undergo dollarization and how you think that would play out if crypto assets became more dominant?
Dong He:
So, you see in a country that’s highly polarized it’s not only that citizens hold a lot of their deposits in dollars, they also denominate their transactions in dollars. So instead of paying wages in local currency or the prices are quoted in local currency, you have a big chunk of the economy like 30 percent that the prices are actually denominated in US dollars and so even if it’s not in the United States you would still buy pizza for two dollars instead of let’s say a hundred local currency units. Then of course then it’s very hard for the central bank of that particular country to influence the inflation level or to ensure price stability of that country because a lot of economic activities are outside of scope of the influence. They are now denominated in foreign currency. So, you can imagine that if a lot of the economic activities are instead of denominated in the fiat currency they are denominate in cryptocurrencies, makes it very hard for the public authority like the central bank to ensure price stability of that economy. So, that’s really what I meant earlier.
Laura Shin:
And so, do you think that that’s what governments should try to do, to try to kind of…I don’t know if prevent is the word but stall the adoption of crypto assets? I’m sure most of my audience probably would love to see more adoption. So, I’m just curious, is this something where for the IMF and the different central banks that for them it would be definitely something that they should try to prevent.
Dong He:
So, it really depends on the specific country circumstances. I think across the IMF membership we have seen country authorities are reacting differently, right, some countries have banned the use or development of cryptocurrencies. Others have legal systems or laws that allow them to be developed but you want to have other regulations to ensure for example financial integrity is not compromised, you know, they should pay taxes. That’s some of the basic requirements that would ensure let’s say a level playing field. I mean I think the basic premise here is really that a currency, a fiat currency that’s properly managed, that has monetary policy that’s based on economic signs, that is really for the best of, for the good of the majority of the population. That’s something desirable as I mentioned earlier.
Economies cannot be left alone without monetary policy because we know that in the market economy if you don’t have a public authority like the central bank who manages either the price or the quantities of money, then the economies tend to fluctuate a lot. You have financial stability problems. You have business cycle fluctuations that are very large. So that’s not necessarily improving. So, the basic premise is really public policy has a role to play to ensure price stability so the economy doesn’t fluctuate so wildly or financial stability is ensured. So, that’s why we need a central bank.
Laura Shin:
And what about for that goal of financial inclusions because I know a lot of people in the crypto space one of their missions with the work that they do is to promote financial inclusion and they are quite well aware that there’s a large segment of the world’s population that they don’t make good candidates for customers, like they’re basically not the types of people that banks can make money from, and so I know that for instance some of the charitable efforts are around giving people direct access to cryptocurrencies that they can then convert into their local currency. So, in that way do you see cryptocurrencies helping to achieve some of the IMF’s goals around financial inclusion or any of the other ones?
Dong He:
In a way. I mean the reason why we’re thinking that central bank digital currency can help financial inclusion is precisely to play that role. If we have a digital version of cash that’s easily obtainable and not necessarily through a bank because these people are not banked, then that could help foster financial inclusion.
Yan Liu:
But that’s what we’re saying and absolutely thinking. You can help with the financial inclusion, which is very important mandate for the fund, but at the same time we do caution the countries that when we really design the central bank digital currency we need to also be careful with respect to a couple of issues that don’t mention for example they have to have legal basis, clear and certain legal basis. They need to have the proper measures put in place to ensure the financial integrity concerns or risks would be litigated. So, I think they kind of go hand in hand.
Laura Shin:
And I also wanted to ask about Libra in this regard. This is Facebook’s proposed digital currency. Are you seeing that that’s spurring any interest among the central banks to issue their own central bank digital currency? Like they see that as competition and it’s making them realize they need to step up their game.
Dong He:
So, our acting managing director, David Lipton, has recently written an article in the Financial Times and our colleagues have also published a new paper. It’s entitle the Rise of Digital Money. So, these issue are all being analyzed here in the fund. I think given really the scale of the proposed cryptocurrency Libra by Facebook and the Libra sort of consortium, this is a whole different ballgame because it’s a very large enterprise. You know, Facebook has more than a billion users.
Laura Shin:
Two billion.
Dong He:
Yeah. Well, more than two billion. So, this is of systemic importance in the sense that it’s going to affect how the global payment system works, so we need to ensure that it’s properly regulated, the financial risks are properly managed. For example, whether these are redeemable at real time, in real time to the currencies that back the Libra unit. So, some of these issues, the details are not yet disclosed but as a matter of principle regulations should really be in place to ensure the safety and soundness of this enterprise, but overall I think this this certainly has prompted a lot of interest for the official sector to understand what’s going on but also to respond in terms of the payment system, how do we ensure that the global payment system will still be able to meet the demand for the digital age.
Laura Shin:
And but do you think that Libra could pose a threat to some of these fiat currencies?
Dong He:
Well, for weaker currencies, for example for economies that still suffer high inflation, I think that danger is more apparent whereas for a more mature economies where monetary policy has a lot of credibility or the price stability is achieved, I don’t see necessarily a large challenge or a threat from Libra. I think the challenge there is more a financial stability issue in the sense that whether they are…supposedly it’s a very large money market fund and whether that would distort how the financial industry works, those are the issues that one needs to be concerned about, also issues with financial integrity, with privacy protection, you know, those issues are very much on the agenda. I don’t necessarily see a threat in terms of a new currency that has more credibility, certainly not for countries that have price stability already achieved.
Laura Shin:
And just to go back to that goal of financial inclusion, do you think that Libra could help in that regard?
Dong He:
Well, I’ve already answered the question. I think in some respect when you have a cryptocurrency that can be easily obtained it can make payments easier for those non-banked citizens. On the other hand, it really depends on the design of the currency. If the currency if very volatile, its value fluctuates, it doesn’t provide a stable store of value and the demand for that particular cryptocurrency would not necessarily high. So, we’ll have to see how the proposed cryptocurrency works. So, yeah. I don’t think you can make a blanket statement whether it helps or discourages financial inclusion.
Laura Shin:
Yeah. Plus, we’re not sure if it will launch. So, all right. Well, this has been such a great discussion. I really enjoyed talking with you both. Where can people learn more about you and the IMF?
Dong He:
Oh, the IMF website has a huge amount of material for people who are interested in how the IMF works, what it is about. The work I do, I am a monetary economist so I work a lot on central banking issues, on financial stability issues, so I have written papers and those are posted in various places, and so for those who are interested they can always find my papers.
Yan Liu:
Yes. Similarly, I think for the work that I’m doing. So, I’m basically oversee the legal department’s work on AML/CFT and also FinTac. I think as Dong said, you can go to www.imf.org. There you can really find a lot of reports and articles, financial issues.
Laura Shin:
All right. Great. Well, thank you both for coming on Unchained.
Dong He:
Thank you.
Yan Liu:
Thank you.
Laura Shin:
Thanks, so much for joining us today. To learn more about Dong and Yan and the IMF check out the show notes inside your podcast player. If you’re not yet subscribed to my other podcast, Unconfirmed, which is shorter and a bit newsier, be sure to check that out. Also, find out what I think are the top crypto stories each week by signing up for my newsletter at unchainedpodcast.com. Unchained is produced by me, Laura Shin, with help from Fractal Recording, Anthony Yoon, Daniel Nuss and Rich Stroffolino. Thanks for listening.
