What are Cryptocurrencies?
Cryptocurrencies are digital tokens. They are a type of digital currency that allows people to make payments directly to each other through an online system. Cryptocurrencies have no legislated or intrinsic value; they are simply worth what people are willing to pay for them in the market. This is in contrast to national currencies, which get part of their value from being legislated as legal tender. There are a number of cryptocurrencies – the most well-known of these are Bitcoin and Ether.
Activity in cryptocurrency markets has increased significantly. The fascination with these currencies appears to have been more speculative (buying cryptocurrencies to make a profit) than related to their use as a new and unique system for making payments. Related to this, there has also been a high degree of volatility in the prices of many cryptocurrencies. For example, the price of Bitcoin increased from about US$30,000 in mid 2021 to almost US$70,000 toward the end of 2021 before falling to around US$35,000 in early 2022. Rival cryptocurrencies like Ether have experienced similar volatility. The extraordinary interest in cryptocurrencies has also seen a growing amount of computing power used to solve the complex codes that many of these systems use to help protect them from being corrupted. Despite the increased level of interest in cryptocurrencies, there is scepticism about whether they could ever replace more traditional payment methods or national currencies.
How Does a Cryptocurrency Transaction Work?
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Suppose Alice wants to transfer one unit of cryptocurrency to Bob. Alice starts the transaction by sending an electronic message with her instructions to the network, where all users can see the message. Alice's transaction is one of a number of transactions that have recently been sent. Since the system is not instantaneous, the transaction sits with a group of other recent transactions waiting to be compiled into a block (which is just a group of the most recent transactions). The information from the block is turned into a cryptographic code and miners compete to solve the code to add the new block of transactions to the blockchain.
Once a miner successfully solves the code, other users of the network check the solution and reach an agreement that it is valid. The new block of transactions is added to the end of the blockchain, and Alice's transaction is confirmed. (This confirmation is not instant as it takes time for six blocks of transactions to be processed so that users can be certain that their transaction has been successful.)
Is Cryptocurrency Money?
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A frequently asked question is whether cryptocurrency can be defined as ‘money’. The short answer is that cryptocurrency is not a form of money. To understand why, we can ask whether the characteristics of cryptocurrencies match the key characteristics of money:
- Widely accepted means of payment
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- Store of value
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- Unit of account
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A Central Bank Digital Currency (CBDC) can most easily be understood as a digital form of cash. It can be issued by the central bank, accessible to the general public, and used to settle transactions between firms and households. The unit of account would be the national currency, and it could be exchanged at parity (i.e. one for one) with other forms of money, such as physical currency or electronic deposits with well-regulated financial institutions.
What are the main differences between cryptocurrencies and CBDCs? In other words, what makes a CBDC money? A central bank has the ability to ensure that a digital currency it issues exhibits the three main features of money – that is, a CBDC could function as a widely accepted means of payment, store of value and unit of account.
Because it is issued by a central bank, a CBDC would have legal tender status, making it widely accepted as a means of payment. A CBDC would also be an equivalent store of value to other forms of money, since it could be exchanged for an equal value of physical cash or electronic deposits. Finally, the unit of account for CBDC issued by the Reserve Bank would be the Australian dollar. This means it could be used to measure the value of goods and service. These and other key features have been summarised in the table below.
| CHARACTERISTIC | CRYPTOCURRENCIES | CBDCs |
|---|---|---|
| Means of payment | Accepted by a small number of retailers | Universally accepted, legal tender |
| Store of value | Tend to be volatile, depends on market price | Stable, consistent with central bank price stability mandate |
| Unit of account | Own unit of account | Fiat currency (e.g. Australian dollars) |
| Governance | Typically decentralised, relies on consensus between large number of entities. | Centralised |
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Some of the technology behind cryptocurrencies raises a number of considerations for public policymakers. Given the anonymity provided by cryptocurrency systems, and their worldwide reach, there are questions about how to limit the use of digital currencies for criminal activities. In addition, the current fascination with cryptocurrencies has potentially added to the speculative nature of these markets, and has raised concerns around consumer protection. If cryptocurrencies were to be more widely adopted, they could also present some challenges for the role of the banking sector and raise additional financial stability concerns in a crisis. Furthermore, the vast amounts of electricity used in the mining of cryptocurrency raise concerns about the allocation of resources and environmental consequences of these payment systems.
In contrast, a CBDC could potentially support a number of public policy objectives, including safeguarding public trust in money and promoting efficiency, safety, resilience and innovation in the payment system. The Reserve Bank is continuing to closely examine the case for a CBDC and working with other central banks on this issue. The Reserve Bank is considering the relevant technical issues, as well as the broader policy implications.
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