Suppose that several private cryptocurrency banks emerge in the US. These banks

Question

Suppose that several private cryptocurrency banks emerge in the US. These banks exist completely outside outside of federal reserve system, such that they are not required to keep reserve deposits with the FED. Therefore, they can issue out loans in terms of their own cryptocurrency. (For example, bank C loans out cryptocurrency C).

i. If these private currencies were ruled to be legal tender and are covered by the FDIC (deposit insurance), what would happen to the money supply?

Ii. If the US government imposed the legal tender rule but did not impose FDIC (deposit insurance) coverage, what what happen to the stability?

Explanation / Answer

Question

(i)

The money supply consists of currency in circulation and checkable deposits with banks.

Currency in circulation is the legal tender as recognized by the government.

On the other hand, checkable deposits are underlined by the official currency.

If the private currencies were rules to be legal tender then deposits and loan (money creation and multiplication of deposits) made in terms of private currencies will also become legal and would be taken as part of money supply.

So, money supply would increase.

(ii)

FDIC(deposit insurance) is a mechanism that safeguard the money of depositors (upto a certain amount) in case of failure of bank. This mechanism provide stability to banking system as depositors feel safe with respect to their money in bank and thus bank runs do not occur leading to collapse of banking system.

However, if FDIC is not imposed on the private cryptocurrency banks then customer perception with regards to safety of their deposits with such bank would be low and thus these banks will prone to bank run in case of slight adversity in economic scenario. This will compromise the stability of entire banking system.

So, stability will get reduced.

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