The US dollar is ‘the only real currency in the USA’, ‘both dependable and reliable’, ‘the most dominant currency anywhere in the world’, and ‘it will always stay that way’. Those were US President Donald Trump’s words last July when he sent out his tweets querying the efficacy of Bitcoin and Facebook’s Libra to act as real currencies.
But his conviction is not shared by everyone. Indeed, we also don’t believe the hegemony of the US dollar will end soon, but competing currencies are coming from the cryptosphere and increased diversification away from the dollar is highly likely.
This has happened before. Sterling’s command of international money markets ended in 1945, in what was considered prior to that event unthinkable. Bank of England governor, Mark Carney, recently stated that like history repeating itself, a new digital currency could pose a serious challenge to the US dollar’s position as a global reserve currency.
Carney is by no means unique in his questioning of the status quo. Over the years, there have been calls by countries such as China and Russia to counter the dollar’s hegemony with other fiat currencies, but the head of a central bank raising the prospect of a digital currency taking over is nothing short of remarkable.
The dominance of the US dollar
Although the US dollar is not the only global currency accepted for trade throughout the world, according to the International Monetary Fund (IMF), as of Q1 2019, it makes up 61% of all known central bank foreign exchange reserves. In addition, 40% of the world’s debt is denominated in USD, and the greenback’s prominence is also evident in forex markets where 90% of all trades involves the US dollar.
Moreover, back in 2010, in the wake of the global financial crisis when concerns over international overdependence on the US dollar proliferated, it was reported that approximately 65% of all dollar bills were used outside the country – and not just as a store-of-value, but as hard currency in day-to-day transactions.
What we can see from these figures is that the US dollar fulfills a role as a widely accepted medium of exchange, unit of account, and store-of-value. But what of crypto? Is there a serious contender for the top spot, or is the rise of digital currency more likely to lead to another scenario?
In crypto we trust
During a recent US Senate hearing on crypto regulation, there seemed to be a general consensus among lawmakers that banning cryptocurrency is technically not feasible – neither necessarily desirable. Crypto is a global innovation, often open-source, it exists by virtue of its underlying algorithm, and unless the government shuts down the Internet, its circulation cannot be stopped.
Moreover, in a recent paper on the rise of digital money by the IMF, it is argued that the two most common forms of money – cash and bank deposits – will face tough competition from digital money and could even be surpassed. The reasons for this, the paper cites, include convenience, low transaction costs, speed, and the ease with which digital currencies can integrate into people’s increasingly digital lives.
As a medium of exchange, Bitcoin – by far the largest crypto asset by market cap – is nowhere near where it should be in order to rival the US dollar. However, a growing list of companies – including Microsoft, Expedia, and AT&T – do already accept it as a valid form of payment. Also, in an effort to escape inflation or bypass capital controls, Bitcoin has been the go-to currency for communities in Venezuela, Cuba, and even Greece, both as a day-to-day medium of exchange and a store-of-value.
Nevertheless, considering the fact that the standard deviation of Bitcoin prices is around 10 times higher than all G7 currency pairs, it is currently too volatile to rely on as a means of payment or practical unit of account.
Libra, which would be more akin to a stablecoin, would not display such volatility. Better yet, if backed by a diversified basket of assets it may offer substantial stability even compared to fiat currencies. What also puts Libra at an advantage is Facebook’s 2.4 billion strong user base to start with, as well as the backing of global corporations such as Visa, MasterCard, and PayPal.
However, as one former Bank of England economist points out, States are unlikely to let Libra become a freewheeling medium of exchange, especially if it jeopardizes anti-money laundering efforts.
Moreover, compared to Bitcoin, Libra cannot count on the same degree of political neutrality, and it is likely that its release will be met with resistance. In fact, a number of countries, including China, have already indicated their readiness to issue their own digital currency to protect their monetary policy and grab a share of this emerging market.
Diversity is key
With digitalization and continued advances in blockchain technology, the global financial space is undergoing rapid transformation. Whether or not a currency as dominant as the US dollar stands to be replaced may be too soon to answer. But as one article by the IMF points out, there are some unique and undeniable benefits that cryptocurrencies have to offer, and over time we may see a tempering in volatility and the implementation of better issuance rules – this would greatly facilitate further adoption.
As such, it’s more likely that, instead of replacement, we will see diversification take place across the financial spectrum with different currency types emerging as stores of value, reserve assets and preferred mediums of exchange.
As Carney already pointed out, such a dislodging would unlock a vast amount of dollars that governments currently hoard, and present emerging economies with an opportunity to lower their dependency on one single system.