In Japan, discussions and pilot experiments toward the implementation of a Central Bank Digital Currency (Digital Yen) have been gradually advancing. Recently, perhaps due to awareness of developments in leading countries (particularly China), these initiatives are accelerating further. Our company has also been regularly monitoring trends in digital currencies, crypto assets, and the blockchain technology that supports them. If the Bank of Japan were to issue a Digital Yen in the future, what impacts could arise? I would like to write a column on this theme.

    Why Cryptocurrency Believers Continue to Make Mistakes.
　Before considering the future of the Digital Yen, we would like to reorganize our understanding of crypto assets, which are currently at a turning point. Our position is that crypto assets, as so-called virtual currencies, will not displace legal tender except in a very limited number of emerging countries or exceptional cases. First, let us organize and explain the reasons for this in three points.

    Cryptocurrency Believers' Mistake #1: Decentralized System Fundamentalist Ideology
　The first mistake cryptocurrency believers make is being trapped in "decentralized system fundamentalism" - the belief that "decentralized systems are absolutely superior to centralized systems." Indeed, centralized social systems that sometimes behave authoritatively can have undemocratic elements. The fundamental ideology supporting the IT and technology industry is certainly decentralized thinking. Blockchain's decentralized technology is a typical example.

　However, this does not mean that all social systems, including currency, would be better if they were decentralized - this is probably wrong. For example, suppose the Japanese yen were a centralized pre-modern system, and to solve this, each prefecture issued "prefectural currencies." If this happened, we would have to determine exchange rates for 47 prefectural currencies every time we crossed prefectural borders. Naturally, Tokyo's currency would be strong, while regional prefectural currencies would be weak. Would this really maximize social welfare?

　Moreover, prefectural currencies would still be "centralized" in the strict sense. If decentralization is better, we should decentralize further and create municipal currencies. This would result in issuing currencies for tens of thousands of municipalities nationwide, leading to even greater confusion. Ultimately, things would be consolidated into "appropriate units." These units would inevitably settle at the national level, where currency issuance and circulation management can be responsibly handled. History has proven this.

　There is an even more fundamental misconception in the idea that virtual currencies are superior because they are decentralized systems. To begin with, most virtual currencies, including Bitcoin, have an "ultra-monopolistic structure" where developers and early miners hold a majority (in some cases over 80%) of the total supply. Ultimately, what lies behind the proliferation of virtual currencies is a struggle for dominance among "new centralized authorities" by people who want to monopolistically enjoy seigniorage. We cannot find any ideal of a "democratic decentralized system" in this, at least not from our perspective.

    Cryptocurrency Believers' Mistake #2: The Illusion that "Monetary Credit is an Illusion"
The second mistake of cryptocurrency believers is the assumption that "monetary credit is an illusion." Indeed, the cost of manufacturing a 10,000-yen banknote is only a few dozen yen. The difference between face value and manufacturing cost becomes "seigniorage," which is a benefit to national finances. "Believing that a piece of paper has value is just an illusion" is one reason cryptocurrency believers attack legal tender. However, this is also wrong.

Certainly, current monetary manufacturing costs are lower than monetary value, and there are no backing physical assets since departing from the gold standard. However, monetary credit is not guaranteed by these factors. The very fact that currency continues to function as currency builds up monetary credit. Yen settlements conducted daily within Japan probably number in the tens of billions. If even once in these transactions "yen could not be used," the currency would lose credibility. Or if there were extremely severe price fluctuations where "something that cost 100 yen yesterday costs 200 yen today (inflation)," it would also lose credibility. Of course, "being given counterfeit money" would also cause loss of credibility.

Enduring the trials of tens of billions of daily transactions, stabilizing prices, and repelling counterfeit challenges - the accumulation of such factors forms monetary credit. Ultimately, only the state can provide such credibility.

    Cryptocurrency Believers' Mistake #3: The Illusion that "Money Supply Control is Also Possible with Algorithms"

　The third mistake of cryptocurrency believers is believing that "money supply can also be managed by algorithms and the exchange ratio with goods (prices) can be controlled." While we have written about this in previous columns, this time we will attempt to explain from a different perspective.

For digital currencies managed by blockchain, using "banknote serial numbers" as an example might be easier to understand. Banknotes have serial numbers, but it would be impossible to manage which numbered banknote is held by whom with paper currency. However, blockchain makes this possible. Which numbered banknote is in whose wallet can be determined by assigning serial numbers to both banknotes and wallets (accounts) and cross-referencing them. Of course, this technology could assign numbers to one-yen coins and manage them similarly. This would enable managing the movement (settlement) of yen throughout Japan using only electronic data and electronic wallet (account) data, without actually issuing banknotes or coins. This could be said to be the remarkable aspect of blockchain technology.

    Digital Yen Currency Would Dramatically Transform Transactions, but Privacy Issues Require Attention
If all currency were numbered, it would have significant effects not only on settlement convenience but also on crime prevention (including tax evasion). However, if mishandled, this could also lead to serious privacy violations. If Digital Yen currency is truly to be issued, this point would require careful examination. Additionally, since blockchain has drawbacks in immediacy and processing speed, it may not be suitable for real-time stock trading. Therefore, rather than managing everything through Bank of Japan accounts, we expect role-sharing with commercial bank deposit currencies and securities accounts. (However, this may change depending on technological developments, etc.)

    Money Supply is Ultimately Determined by Monetary Policy
　However, even if this were possible, how much Digital Yen to issue (up to which serial number to issue yen) would not be automatically determined by blockchain technology. It can only be decided through monetary policy. Virtual currencies claiming stability through dollar pegs as their strength have emerged, but several have already collapsed. Others will probably be eliminated with certainty in the long term. Arbitrageurs like George Soros, who challenged the British pound, would not leave such distortions uncorrected over the long term.

    Crypto Assets Will Expand as New Alternative Investment Criteria
　For these reasons, our company predicts that a future where crypto assets become virtual currencies and displace legal tender will not come. However, we do not deny at all that crypto assets are a new asset class for asset management and will have a significant impact on the investment world. Probably, the crypto asset market as an asset class will continue to expand and stagnate repeatedly while growing significantly in the long term. Asset classes like crypto assets, which have no underlying assets and are traded solely based on traders' arbitrage motives, have a high possibility of becoming new investment options unlike any before.

    The Significance of Crypto Asset Market Development
　Finally, I would like to predict what impacts might arise when crypto assets become established as new alternative investment instruments. In my view, one possibility is that in asset markets with underlying cash flow backing, such as stock and bond markets, the emergence of crypto assets could lead to more correct price formation (linked to underlying asset prices). In previous markets, whenever excess liquidity occurred, surplus funds would flow particularly into stock markets, creating bubbles. However, if this "excess money" moves to crypto asset markets seeking hotter arbitrage trading, stock markets might retain only funds linked to appropriate prices. In other words, crypto assets taking on bubbles might make bubbles less likely to occur in stock markets. This would be like a pressure release effect. The global investment market clearly experienced excess liquidity due to COVID and other factors. However, by having the crypto asset market absorb bubbles, there might be a hypothesis that startup markets and traditional stock markets were able to "somewhat" avoid excessive overvaluation as a result.

　On the other hand, if surplus funds (which we dare call easy money here) that previously flowed into startup and venture investments whenever excess liquidity occurred are now being absorbed by crypto asset markets, this might be stealing some resources for innovation. In the recent venture investment world, we felt there were many investors who preferred to profit quickly from crypto assets rather than startups that take time to exit. If this hypothesis is correct, crypto assets might have somewhat negative elements for overall innovation. However, there is no doubt they will continue to exist as alternative assets.