Digital Currency Runs

Abstract

Digital currency is designed to compete with central bank fiat money and the banking system but may create new financial stability risk. Central banks are considering issuing their own fiat public digital currency in response. This paper shows that privately issued digital currency, such as bitcoin, may be adopted in reaction to distortionary central bank inflation on fiat money. Banks that take private digital currency deposits can emerge to provide efficient liquidity risk sharing without the inflationary risk of fiat money. Rather than displacing banks, private and public digital currency threaten a new form of banking crises caused by disintermediation runs through withdrawals of digital currency. A central bank can act as lender of last resort to prevent the threat of such digital currency runs for banks with public but not private digital currency deposits. There is a trade-off for private digital currency that avoids the costs of central bank inflation but is subject to fragility through digital currency runs.

Keywords: Digital currency, fiat money, bank runs, lender of last resort