Cryptocurrency prices differ across countries, and these price deviations fluctuate widely. Our paper provides evidence that distrust toward domestic authorities can explain the dynamics of local cryptocurrency prices relative to the U.S. dollar price. The price deviation rises after an outbreak of a financial crisis, political scandal, or socioeconomic event that undermines confidence in the domestic government or economy. With panel regressions, we show that Bitcoin price deviations increase by 1.8% when the institutional failure index rises by one standard deviation. These price responses are much stronger in countries with lower trust levels and during periods with tighter capital controls.
We are entering a new monetary era. Central banks around the world— spurred by the development of privately controlled digital currencies as well as competition from other central banks—have been studying, building, and, in some cases, issuing central bank digital currency (“CBDC”). Although digital fiat currency is one of the hottest topics in macroeconomics and central banking today, the discussion has largely overlooked the most straightforward and appealing strategy for implementing a U.S. dollar-based CBDC: expanding access to bank accounts that the Federal Reserve already offers to a small, favored set of clients. These accounts consist of entries in a digital ledger—like other digital currencies—and are extremely desirable, offering high interest, instant payments, and full government backing with no limit. But U.S. law restricts these accounts to an exclusive clientele consisting primarily of banks. Privileged access to these accounts creates a striking asymmetry at the core of our monetary framework: government-issued physical currency is available to all, but government-issued digital currency (in the form of central bank accounts) is not. This dichotomy is unwarranted. Congress should authorize the Federal Reserve to give everyone—individuals, businesses, and institutions—the option to maintain accounts at the central bank. We call these accounts FedAccounts. Unlike the CBDC approaches currently under discussion, which would use complicated and inefficient distributed ledger technology and be walled off from the existing system of money and payments, FedAccounts would be seamlessly interoperable with the mainstream payment system, relying on technologies that the Federal Reserve has used for decades.
Dirk Andreas Zetzsche, Linn Anker-Sørensen, Maria Lucia Passador, Andreas Wehrli
Financial law and regulation have, to date, assumed that regulated activities and functions are concentrated in a single legal entity responsible and accountable for operations and compliance. Even with regard to financial market infrastructure where the regulatory perspective acknowledges the need for interoperability of many entities as a system, each entity is subject to its own rules and regulations, and can thus meet its own compliance requirements independent of other system participants. The entity-focused regulatory paradigm is under pressure in the world of DLT-based payment arrangements where some ledgers, and thus the performance of the services as such, are distributed. DLT arrangements could provide an alternative to the traditional reliance on a mutually trusted central entity to transfer funds and enable the creation of new foundational infrastructures by distributing technical functions or linking existing systems. As such, we identify and outline concepts for use cases where DLT is potentially improving the efficiency of cross-border payments, namely a Best Execution DLT, a DLT application for a Network of Central Banks, a DLT as an AML/KYC utility, as well as DLT arrangements for an Identity Platform, a Small Payments Platform and, finally, an Interoperability Platform connecting multiple closed-loop and proprietary banking systems. Despite the wide-ranging interest in DLT-based payment systems, research so far has focused on technical concepts and lacked legal details. This article seeks to fill this gap by providing an initial analysis of the legal challenges related to DLT-based payment systems. From a legal perspective, the distribution of functions in DLTs comes with new risks created from the joint performance of services and functions as main characteristic of a distributed ledger, and the need for additional agreements, ongoing coordination across, and governance arrangements among the nodes. Further, in a cross-border context, multiple regulators and courts of various countries (asking for compliance with their own set of rules and regular reporting) will be involved. All of these must decide whether for compliance with any single rule they look at the DLT as a whole (herein called ‘the ledger perspective’) or each individual node (that is each institution participating in the DLT, herein called ‘the node perspective’). Moreover, financial and private law must provide for risk allocation, liability, responsibility and accountability for all legal obligations related to each function and activity. This article examines the extent to which the ledger perspective or the node perspective should prevail against the backdrop of a range of DLT use cases, resulting in policy recommendations for regulators. In this article, we propose the adoption of what we call an enabling approach for payment systems: ledger operators must specify in a Plan of Operations subject to regulatory approval to which rights and obligations the ledger perspective applies; in the absence of such a stipulation, rules apply based on the node perspective. However, for systemic risk controls, AML/CFT, data protection and governance, as well as DLT governance, we propose a reversed default rule in which the ledger perspective prevails in the absence of rules stipulating that the node perspective applies. Finally, in private law matters, we propose protecting consumers and SME clients through a standardised payment services contract structure, without mandating details.
Cryptocurrencies have become popular. Economic agents use cryptocurrency such as bitcoins to make payments and it pose a threat to fiat currency. Central banks have begun to respond to this threat. They realize that they need to join the race to offer a digital currency and dominate the digital currency landscape which can lead to the collapse of most private digital currencies that are not issued by a central bank or a monetary authority. In this paper, I show how the issuance of a central bank digital currency can lead to the collapse of private digital currencies such as bitcoin. I argue that central banks will leverage on their monetary powers, and the trust that citizens have in government-backed money. This may give central banks strong incentives to issue a central bank digital currency. The issuance of a central bank digital currency can erode trust in cryptocurrencies, and lead to lack of trust in cryptocurrency, thereby leading to the collapse of cryptocurrencies although not immediately.
Can technology protect investors from extreme losses? This paper investigates the short- and long-run hedging and safe haven properties of Bitcoin for the US dollar over the period 2010-2023, incorporating the COVID-19-related market turmoil. Our findings reveal that (i) Bitcoin acts as a strong hedge for all US dollar currency pairs examined, (ii) Bitcoin functions as a weak safe haven for the US dollar at short investment horizons, as indicated by a limited relationship during acute negative price movements, (iii) Bitcoin, instead of acting as a safe haven may, instead, increase aggregate risk at long horizons during periods of extreme losses. The analysis, performed using a series of horizon-dependent econometric tests, provides evidence of some US dollar risk-reduction benefits from Bitcoin but limited potential for enduring relief from long-run extreme negative US dollar rate movements.
We rationalize cryptocurrency adoption in a small open economy model. We show that digital dollarization, where stablecoins pegged to the USD are used for transactions, can improve social welfare. In contrast, the adoption of volatile cryptocurrencies, such as El Salvador’s 2021 decision to make Bitcoin legal tender, results in welfare losses. This outcome aligns with the observed low take-up of Bitcoin as legal tender. The welfare benefits of digital dollarization increase with the magnitude of macroeconomic shocks, providing motivation for the growing use of stablecoins in emerging markets as a safeguard against high inflation and macroeconomic instability .
Today, financial system and all its services are completely centralized. Banks, exchanges, insurance companies and other financial institutions have someone in charge that controls these services. This centralized financial system, or CeFi, has its own risks. What if we decentralized the financial system in the same way that Bitcoin decentralized money?
One of the benefits of decentralized finance (DeFi) – an alternative financial system built on blockchain – is composability, which means the system's building blocks (tokens) can freely interact with one another to form new services. One example is stablecoin, a token with fixed exchange rate, which is backed by token collaterals. While stablecoins can be used to facilitate payments and exchanges, in DeFi they can be used to earn returns (“yield farming†), potentially multiplicatively. We use transaction-level blockchain data to analyze a stablecoin's flows between protocols and provide suggestive evidence of DeFi yield-chasing behavior. We shed light on what DeFi total value locked might really measure and highlight the complexity in DeFi analysis and market surveillance.
Bank runs are a natural phenomenon for financial institutions that issue fixed value liabilities (e.g. money) that are backed by assets with uncertain value. I analyze Iron Finance, a decentralized finance (DeFi) protocol that issues stablecoin (a token with fixed nominal exchange rate: IRON) liabilities in exchange for a basket of other tokens (including a token issued by the protocol itself: TITAN). A combination of mathematical algorithms and incentive to arbitrage is used to maintain the exchange rate peg, but a shock to the protocol sent it into a downward spiral – much like a bank run. The incentives built into the protocol to defend the peg exacerbated its unravelling, raising the challenge of how DeFi protocols can address this vulnerability while remaining decentralized.
Depending on the chosen perspective, cryptocurrencies either constitute a unique opportunity to end national patronizing built on debt-based fiat money (currency) or a menace to a well-established financial order that ensures economic stability. A central issue in the heated debate surrounding cryptocurrencies is whether they have any intrinsic value at all. In this conceptual position paper, we briefly summarize existing standpoints and suggest three alternative propositions: (1) to avoid using the term “intrinsic value” for the valuation of cryptocurrencies, (2) to refer to the sum total of all properties that could potentially qualify them as money, and (3) to consider the amount of capital and energy that is needed to create them. These suggestions bear substantial implications for the economic classification of cryptocurrencies.
Uniswap is a decentralized exchange (DEX) and was first launched on November 2, 2018 on the Ethereum mainnet [1] and is part of an Ecosystem of products in Decentralized Finance (DeFi). It replaces a traditional order book type of trading common on centralized exchanges (CEX) with a deterministic model that swaps currencies (or tokens/assets) along a fixed price function determined by the amount of currencies supplied by the liquidity providers. Liquidity providers can be regarded as investors in the decentralized exchange and earn fixed commissions per trade. They lock up funds in liquidity pools for distinct pairs of currencies allowing market participants to swap them using the fixed price function. Liquidity providers take on market risk as a liquidity provider in exchange for earning commissions on each trade. Here we analyze the risk profile of a liquidity provider and the so called impermanent (unrealized) loss in particular. We provide an improved version of the commonly denoted impermanent loss function for Uniswap v2 on the semi-infinite domain. The differences between Uniswap v2 and v3 are also discussed.
Christian Catalini, Alonso de Gortari, Nihar B. Shah
Stablecoins have the potential to drastically increase competition and innovation in financial services by reducing our reliance on traditional intermediaries. But they also introduce new challenges, as regulators rely on intermediaries to ensure financial stability, market integrity, and consumer protection. Because they operate at the interface between traditional banking and cryptocurrencies, stablecoins also represent an ideal setting for understanding the key trade-offs cryptocurrencies involve, and insights from robust stablecoin design and regulation are highly relevant for related innovations in decentralized finance (DeFi), nonfungible tokens, and Web3 protocols. In this review, we describe the following: key stablecoin design choices, from reserve composition to stability mechanism; legal claim against the issuer; noninterference with macroeconomic stability; and interoperability with public sector payment rails and central bank digital currencies. Last, we cover the key benefits of stablecoins in the context of real-time, low-cost programmable payments, financial inclusion, and DeFi.