Central bankers are hardly the radical type. Most of their job lies in placating the worries of countless investors and consumers, stabilizing markets and the broader economy—hardly a recipe for disruption. Yet from the marble hallways of the Fed to the elegant conference rooms of the ECB, you will find the inklings of a transformative new way of looking at the central bank’s role in handling money. Welcome, denizens of the 21st-century, to the age of govcoin. 

To understand why these government cryptocurrencies are so transformative, observe how banking currently works. Since the 17th-century, banks have fulfilled their roles as keepers of deposits and allocators of credit through essentially the same system, termed fractional reserve banking. In sum, since banks figure that most depositors will not withdraw their deposits at once, they can use said deposits to loan money to consumers and businesses. As a result, the former will buy products, and the latter will sell them, leading to more deposits. In this way, banks play a crucial role in storing and allocating credit and creating new money as deposits. 

When fractional reserve banking first developed in early modern Europe, it rapidly led to tremendous economic advances: more credit allocated for commerce, industry, and enterprise of all kinds, which powered Europe to unprecedented prosperity. But contemporaries soon noticed the system was not without its flaws. Consider, for instance, the consequences of a calamitous natural disaster or a financial crisis on the system: would people not rush to withdraw their deposits, spelling ruin for the banks? The answer to this question shaped modern central banking.

Already by the end of the 17th-century, England and Sweden had adopted central banks as “lenders of last resort”—emergency banks, for banks. By the 19th-century, the reasoning underpinning central banks was laid out by Walter Bagehot, a banker, and journalist, in his seminal Lombard Street. Published in 1873, at a time when currency was backed by gold, the book neatly details the logic behind central banks: instead of all banks needing to hold sizable gold reserves, an inevitable drawback to their profitability, one “central” bank would store gold while commercial banks would take deposits and issue loans. So even as commercial banks create more money than gold in their reserves, if people rush to withdraw their deposits in a time of crisis, the central bank could still bail out the commercial banks with its gold reserves. Though central banks today hardly store gold like Bagehot’s 19th-century Bank of England, the system persists with fiat paper currency taking over the role of precious metals. Commercial banks must hold a certain amount of paper currency, which is directly issued by the central bank, replacing gold. 

The idea of govcoin—government cryptocurrencies—promises to upend banking by effectively killing banks and replacing them altogether with the central bank. Since most money in circulation comes from loans and deposits, central banks have limited control over the money supply, constraining their efforts to jumpstart the economy in a downturn. Moreover, the most vulnerable citizens often have the least access to banks; 6% of Americans, amounting to around 14 million people, are unbanked, according to a report by the Federal Deposit Insurance Corporation (FDIC). The data are even gloomier in developing countries, with India alone having more than 190 million unbanked adults, which makes access to credit difficult—hampering commercial opportunities and welfare schemes. Indeed, during the coronavirus, the US government found out that many of its most vulnerable citizens could not cash in on their stimulus checks, as they lay outside the banking infrastructure that serves most US citizens. 

With govcoins, citizens could deposit money directly with the central bank. Any citizen would have access to credit, and the central bank could exercise more direct control over the economy. The latter sounds appealing to many who believe that the modern economy needs a radical change to face climate change; think of the Fed supporting decarbonization by doling-out credit to green entrepreneurs, or even a system of digitally exchangeable carbon credits directly pegged to the supply of govcoins. In addition, deposits would be backed by central bank reserves, removing the risk of bank runs plaguing fractional reserve banking. Others think it could stimulate entrepreneurship by expanding access to credit, reducing inequality in the process. Moreover, govcoins would reduce banking and transaction fees—a huge benefit to consumers. 

But even as decarbonization, a readier response in a crisis, and universal access to credit sound attractive, govcoins also harbor immense danger. They threaten to tie all commercial ventures to the central bank by killing banks, replacing private investors with government bureaucrats. Such a system would pose political dangers to liberty and endanger the vitality of free economies by sidelining private credit. As the famed economist Friedrich Hayek noticed in the 1940s—when statism’s rise appeared inexorable—the power of free markets lies in their decentralization. The army of bankers and venture-capitalists that fuel the engines of commerce possess far more information than a handful of bureaucrats. Indeed, transforming central bankers into government planners runs the risk of allocating credit on political, rather than economic, lines—a poor recipe for both freedom and economic growth. 

What to do, then: how can banking utilize the capacities of cryptocurrency to expand access to credit without entrenching economic power? The answer may lie in taking a more integrative view of the money economy. Several cryptocurrencies currently exist on the market, but many are poorly qualified as money; if Bitcoin, for example, experiences vast shifts in value daily and most retailers refuse to accept it for payment, it hardly functions as currency. Govcoin solves the problem by issuing crypto in the name of the state. But a swath of crypto alternatives pegged to “real” money—such as the dollar—are emerging, termed stablecoins. These currencies are still in their experimental phase, with regulation surrounding them scarce, though there are calls for new legislation. Such an approach best suits free societies: based on crypto, these new currencies could lower transaction costs much like Bitcoin promises to do and prevent the danger of political monopoly over the economy posed by govcoins. Moreover, if treated as banks—something America’s regulators are rightfully keen to do—they could help the private sector maintain its vital role in a future crypto-based money economy. 

Experimentation around govcoin is still in its infancy, yet the e-dollar, e-yuan, and e-euro are coming—accompanied by a tide of creative destruction. Such innovation is not only radical but in many ways welcome. Nevertheless, to stay open and transparent, market economies should monitor their deployment carefully lest they monopolize the all-important role of credit allocation. In particular, policymakers and entrepreneurs ought to favor the legal integration of stablecoins into the money economy to mitigate the potential dominance of govcoins while responding to the shortfalls of private cryptocurrencies, such as Bitcoin. Central bankers will have to walk a fine line between peril and promise. They should embrace the challenge.