Monetary policy in a world of cryptocurrencies

Pierpaolo Benigno 26 April 2019



Can cryptocurrencies jeopardise the primary function of central banking – controlling inflation and economic activity – or at any rate limit their operational tools? The short answer is yes, they can.

Currency competition is not a recent phenomenon. Hayek wondered why government should be given the exclusive right to issue and regulate money, observing that it “…has certainly not helped to give us a better money than we would otherwise have had, and a very much worse one…” (Hayek 1976: 32). Things have changed since his time, and central banks in advanced economies have succeeded in controlling the value of their currencies and taming inflation. 

Money is not an object, and indeed, it can be quite imaginary – cryptocurrencies are digital, not physically minted. It is even misleading, as Hayek observed, to think of ‘money’ as a noun: “…it would be more helpful for the explanation of monetary phenomena if ‘money’ were an adjective describing a property which different things could possess to varying degrees” (p. 56).1

To a certain or varying degree, cryptocurrencies have the same properties as traditional currencies, serving as medium of exchange, unit of account, and store of value. Chiefly, however, they function as a medium of exchange. Interestingly, monetary history offers other examples of uncoined money. As Luigi Einaudi (1936) noted, for centuries, ever since Charlemagne, an ‘imaginary’ money existed but served only as unit of account and never, unlike today’s cryptocurrencies, as medium of exchange. 

While digital and government currencies have some similar properties, government money also has special characteristics that today’s cryptocurrencies lack. Central banks also issue interest-bearing liabilities (reserves) and set policy in terms of this risk-free interest rate. Cryptocurrencies do not take the form of interest-bearing securities, and the growth in their supply is determined by an algorithm that allows new units to be minted. Government money is the liability of an agent, and the treasury can potentially back it by levying taxes. Digital currency is not the liability of any agent and has no fiscal backing. 

Recent monetary theory has shown that if central banks set the rate of interest, and are supported by fiscal backing, inflation can be targeted without causing any volatility in the price level aside from that due to fundamentals (Sims 1994, Woodford 2001). In these cases, government currency has a definite value. Unbacked cryptocurrencies, by contrast, can become worthless if everyone comes to believe they are. 

Despite the privilege that government money enjoys, it can enter dangerous territory in the presence of currency competition, as I discuss in a recent paper (Benigno 2019).2 To understand the challenges posed by digital currencies, consider the extreme case in which government and private money can both provide the same liquidity services. In such a world, the money that prevails as medium of exchange will be the ‘better’ one, i.e. the one with higher return and lower inflation. If the growth of cryptocurrencies is slow enough, and they keep appreciating in value, they could easily become the more convenient token for transactions. That is, government money could lose the function of medium of exchange while still, for the reasons set out above, retaining value. But the loss of some of the properties of money could be risky and lead government currency into further troubles. Agents could begin to ask why debt contracts should be denominated in this inferior currency, or even why they should have to pay taxes in it. Government could lose its privilege and its currency could go out of business. 

If anything, currency competition should improve the quality of government money. To avoid being supplanted by digital currency, central banks would need to achieve a sufficiently low inflation rate, lower than that of private money. Where the forces of competition are even stronger (say, in the presence of a significant number of private currencies), it is the strictness of entry barriers that determines the bounds on inflation. And in extreme but not unrealistic cases, these bounds can be very low, requiring almost negligible inflation if not outright deflation.

Currency competition can succeed in calming inflation and preventing the sort of manipulation of interest rates and prices to which governments have historically been prone – a result hailed by the proponents of currency liberalism. The demand for liquidity can be satiated and frictions and premiums in the transaction markets minimised. In fact, Hayek argued against the monopoly on money supply: “It has the defects of all monopolies: one must use their product even if it is unsatisfactory, and, above all, it prevents the discovery of better methods of satisfying a need for which a monopolist has no incentive” (Hayek 1976: 28). 

The recent financial crisis, however, has shown that the power of central bank money extends well beyond the property of medium of exchange. Central banks act as lenders of last resort to satisfy the liquidity needs of the economy, to make the financial system more resilient. What is more, the protracted situation of subdued inflation and zero interest rates has prompted the thesis that the inflation targets now being set by central banks are too low, and that a bit more inflation could be beneficial in avoiding liquidity traps as well as ‘greasing the wheels’ of the economy. 

These social objectives can be internalised only by a central issuer, such as government, and surely not by a plethora of ownerless private currencies, even if they operate in ideal competitive markets. The advent of digital currencies just as national borders are fading away in favour of a worldwide web for transactions definitely represents a serious challenge to current central banking. It should therefore not come as a surprise to learn that central banks are studying how to issue digital currencies of their own.


Benigno, P (2019), “Monetary policy in a world of cryptocurrencies”, CEPR Discussion Paper 13517.

Einaudi, L (1936), “Teoria della moneta immaginaria nel tempo da Carlomagno alla rivoluzione francese”, Rivista di Storia Economica 1: 1-35.

Hayek, F (1976), The denationalization of money, London: Institute of Economic Affairs. 

Nisticò, S (2019), “Criptovalute, sovranismo e sistemi monetari”, Sapienza University of Rome working paper.

Schilling, L and H Uhlig (2018), “Some simple bitcoin economics”, NBER working paper 24483. 

Sims, C (1994), “A simple model for study of the determination of the price level and the interaction of monetary and fiscal policy”, Economic Theory 4: 381-399.

Woodford, M (2001), “Fiscal requirements for price stability”, Journal of Money, Credit and Banking 33(1): 669-728.


[1] Nisticò (2019) discusses the extent to which the features of current cryptocurrencies are consistent with Hayek’s original proposal. 

[2] Among other recent works on cryptocurrency, see Schilling and Uhlig (2018).



Topics:  Financial regulation and banking Monetary policy

Tags:  cryptocurrencies, Central Banks, monetary policy, inflation, economic activity

Professor of Economics, LUISS Guido Carli; Research Fellow, EIEF and CEPR


CEPR Policy Research