[Podcast] The impact of Digital Currency on Exchange Rates

21 Nov, 2022

[Podcast] The impact of Digital Currency on Exchange Rates

In the context of the industrial revolution 4.0, digital currency is growing in both market share and transaction value in the market. Several countries around the world officially recognize cryptocurrencies as legal tender. Besides, cryptocurrencies also have the potential to replace circulating currency, which is part of the monetary system from the balance sheets of central banks. With potential benefits in payment transactions, how will digital currencies affect the exchange rate and what is the appropriate policy in the management and application of the monetary policy of Vietnam in the upcoming time? Let's find out the following article.

Regulations on the use of Digital Currency in Vietnam

In Vietnam, the Government and the State Bank of Vietnam consider digital currency as a virtual asset (virtual currency) and do not consider digital currency as a currency or a means of payment, using digital currency in Vietnam as a means of payment is a violation of the law as prescribed in Clause 6, Clause 7, Article 1 of Decree 80/2016/ND-CP, amending and supplementing several articles of Decree 101/2012/ND-CP on non-cash payment. However, with the undeniable benefits that digital currency brings and more importantly, the needs of people, these currencies will likely be gradually recognized soon. Based on the Decision No. 1255/QD-TTg approving the project to complete the legal framework for the management and handling of virtual assets, cryptocurrencies, and virtual currencies, "construct and perfect the law on virtual assets, cryptocurrencies, and virtual currencies in order to ensure corresponding risks to control and minimize these risks, but not to affect creativity and innovative start-ups, ensuring flexibility to in line with the change in the continuous development of information technology and e-commerce”.

Some popular digital currencies in the world

*Bitcoin (BTC)

Bitcoin is a digital currency that operates based on blockchain technology. Bitcoin is mainly traded on online cryptocurrency exchanges. Unlike central banks that can arbitrarily adjust the supply of fiat currencies, the supply of Bitcoin is fixed and cannot be influenced by political decisions. Bitcoin is a form of digital currency that is not issued by a government or a financial institution but is created and operated based on a system of computers connected to the peer-to-peer internet. Many believe that digital currency can be used for international money laundering. For example, the world's central banks have been skeptical of Bitcoin because it cannot be monitored, predicted, or tracked. The digital currency has become a power in itself because it helps control the financial power of governments and banks. Digital currencies like Bitcoin have created a new market where, unlike the current financial system, no single entity has full control. Cyberspace is set to be the custodian of this disruptive market, and the near-zero transaction costs make digital currencies superior to traditional currencies in many ways.

Bitcoin trading is an uncharted area for global central banks. From the money supplier's point of view, international transactions decrease the money supply from one country and increase the money supply in another. This transaction is done without the use of central banks and global intermediaries. First, many digital currency users feel that decentralized exchanges are more suitable for the decentralized structure of most digital currencies; Many decentralized exchanges also require less personal information from members than other types of exchanges. Second, if users transfer assets directly to other users, it eliminates the need to transfer assets to exchange, thereby reducing the risk of theft from hacks and other fraud.

*Ethereum (ETH)

Ethereum (ETH) was introduced by founder Vitalik Buterin in late 2013 and the system was launched in 2015. Launched in July 2015, Ethereum is the largest and well established decentralized software platform. As of January 2021, Ethereum has a market capitalization of $138.3 billion, roughly 19% of the size of bitcoin (VNA, 2021). Also on the Blockchain platform, an Ethereum blockchain is similar to the Bitcoin blockchain. Blockchain technology is being used to create applications that go far beyond allowing just one digital currency. The main difference is that Ethereum blocks not only contain the block number, difficulty, etc., but also the most recent transaction and status list. For every transaction in the transaction list, a new state is created by applying the previous state.

Impact of digital currencies on exchange rates

With the development of the digital economy, the emergence of a new private digital currency has replaced some functions of the traditional currency. Digital currency based on blockchain technology, with high transaction efficiency, low transaction costs, and avoiding inflation to maintain asset value and privacy, has stimulated the popularity of stateless monetization. One of the reasons that affect the exchange rate is the price volatility of digital currencies, for example, an increase in the price of Bitcoin will lead to investors tending to invest in the real currency, through which the exchange rate will appreciate.

On the other hand, the supply of digital currency has the potential to impact the monetary system in which four indicators are used to quantify the impact of digital currencies on the change of the monetary system including cash ratio, digital currency level, a financial electronic level, and interest rate. Digital currency products have the potential to replace central bank currencies, thus affecting the money supply. Central bank currency is a component in all monetary aggregates. In each country, the monetary system has different characteristics in the mechanism of operating the exchange rate, especially the exchange rate. Digital currency can influence this mechanism. The monetary system is considered the heart of the market economy in every country, and the central bank is the primary authority to control the monetary system. If digital currencies are needed, central banks should be the issuers. This plays a catalytic role in innovation, promoting competition and efficiency in the monetary payment system. The ongoing digital revolution could lead to a complete departure from the traditional model of currency exchange. Digital currencies can separate the roles of currencies, creating more intense competition between specialized currencies, and affecting the value of other countries currencies. However, many documents report the effect of a very low decrease in currency in circulation due to the rise of cryptocurrencies.

In addition, digital currency offers the potential for easier and cheaper access to finance but raises the specter of reduced privacy and potentially unsafe financial transactions. However, just as digital technology has not created a paperless office, digital currency is unlikely to completely replace existing forms of money but can affect exchange rates. There is no denying that the portability of currency instruments and interoperability between platforms will play an important role in lowering barriers to trade and promoting competition. Therefore, many countries have also introduced monitoring systems for digital currencies as a guarantee for the national monetary system in general and the exchange rate in particular.

Digital currency monitoring system

(Source: Li et al., 2019)

Policies suggested for Vietnam

Based on collected data sources and through the Pearson correlation test, and multiple linear regression method, the author has made policy suggestions for financial market managers, especially the agencies responsible for monitoring the movements of digital currencies and exchange rates as follows:

First, defining the role of central banks and private intermediaries will ensure the maintenance of a two-tier financial system and more stable monetary policy implementation and financial stability..

Second, based on completing the legal corridor for the development of digital, agencies and sectors need to come up with mechanisms in transactions to prevent electronic crimes, money laundering, etc. To do this, it is necessary to have a connection between countries, and establish a process to control the issuance and circulation of electronic money to limit money laundering and counterfeiting, thereby creating a foundation for a more efficient national currency policy.

Third, developing a national payment system to ensure efficiency and limit risks for cross-border payment transactions related to digital currency, as well as strengthening international cooperation in digital currency management between countries. In addition, although it has not yet recognized digital currency as a legal transaction and investment in Vietnam, according to the world trend, Vietnam in the future will have access to digital money, until then, to support the innovation and needs of the burgeoning digital currency industry, it is necessary to develop systems for defining digital currencies and examine regulatory frameworks for their possible impact on with further technology adoption and diffusion.

To see the full study The Impact of Digital Currency on Exchange Rates, please access HERE. Author: Nguyen Hoang Nam – Learner at School of Law, University of Economics, Ho Chi Minh City, Specialist of ACB Securities Company Limited.

This is an article in the series of articles spreading research and applied knowledge from UEH with the message “Research Contribution For All”, UEH cordially invites readers to watch the next DIGITAL ECONOMY Knowledge Newsletter #67.

News, photos: Author, UEH Department of Marketing of Communication

Audio: Ngoc Qui