On the Economics of Digital Currencies

Abstract

Can a monetary system in which privately issued cryptocurrencies circulate as media of exchange work? Is such a system stable? How should governments react to digital currencies? Can these currencies and government-issued money coexist? Are cryptocurrencies consistent with an e cient allocation? These are some of the important questions that the sudden rise of cryptocurrencies has brought to contemporary policy discussions. To answer these questions, we construct a model of competition among privately issued at currencies. We nd that a purely private arrangement fails to implement an e cient allocation, even though it can deliver price stability under certain technological conditions. Currency competition creates problems for monetary policy implementation under conventional methods. However, it is possible to design a policy rule that uniquely implements an e cient allocation by driving private currencies out of the market. We also show that unique implementation of an e cient allocation can be achieved without government intervention if productive capital is introduced.