Fed Research Finds Private Digital Currencies Can Be 'Attractive Cash Alternative' for Firms

Under certain conditions, issuing a digital currency can be an attractive alternative to cash for companies, according to the U.S. Federal Reserve Bank of Richmond in Virginia.

In an economic brief published Thursday, the Richmond Fed said the decision to develop and launch a platform digital currency comes down to several key factors.

According to the brief, the expense of creating a digital currency is notable, and an issuing company must also ensure its system is secure from cyberattacks. There are also risks for users, such as bankruptcy of the issuer.

When inflation is low and stable, the costs of issuance mean it is optimal for a company to use existing payment systems.

On the other hand, "when inflation is high enough that consumers prefer to minimize cash holdings, the cost of establishing and securing a new digital currency system is low, and the platform's market share is sufficiently large, then it is optimal for the platform to issue its own currency," the brief states.

The brief is based on a working paper by two of its authors, Jonathan Chiu, senior research advisor at the Bank of Canada, and Russell Wong, senior economist, research division, at the Richmond Fed.

As an example from the paper cited in the brief, for Amazon to turn a profit from issuing and accepting only its own digital currency, interest rates would need to be above 11%, or the retail giant would need a much larger market share. The authors' model also suggests that high regulatory costs in the U.S. would dissuade platforms from such an issuance.

For companies, the authors say that a key benefit is seigniorage revenue – the profit from selling the digital currency.

"Historically, this revenue has been reserved for sovereign nations, which have long held a monopoly on money creation," the brief says. It also cites loyalty benefits, data harvesting and lower settlement risk as reasons for companies to issue their own tokens.

Still, the authors say traditional payment methods are generally more secure, and the costs are likely to be lower than developing a digital currency. Rather than seigniorage, firms can still charge fees on payments made through the platform, they say.

Examining whether regulators should be worried about private digital currencies, the authors point out that company decisions are based on profit, not benefits for society, and their digital currencies could circulate outside the platform to compete with sovereign currencies.

"This can also reduce the seigniorage the central bank earns from issuing cash," according to the brief. "If widely adopted, platform digital currency can also subject the financial system to cybersecurity risks and bank runs."

The working paper further looked at whether financial regulations like deposit insurance and reserve requirements can "optimize" firms' decisions on issuing a digital currency. The conclusion was, such rules are "not very helpful."

"Raising reserve requirements for platforms issuing their own currency can reduce welfare for both consumers and platforms as it may discourage the provision of beneficial features like interest-bearing currency or low fees," the authors write. More research is needed into other policy tools to help guide such decision making, they suggest.