Digital currencies could boost economic growth in developing countries where more than 50% of adults don't have a bank account, BofA says

• Digital currencies could boost economic growth in developing countries, though adoption won't be without risks, Bank of America said.
• The firm said digital currencies could reduce transaction costs and allow more economic activities in emerging market economies.
• However, BofA warns that the rise of digital currencies could lead to inflation and dollarization.

Digital currencies could boost economic growth in developing countries, though adoption won't be without risks, according to Bank of America.

In a research report published last week, BofA's head of emerging market cross-asset strategy and economics for EMEA explained that both central bank digital currencies (CBDCs) and private digital currencies hold "a lot of potential" for increasing financial inclusion, a major issue in emerging market countries.

"Digital currencies have the potential to address many practical constraints on financial services in poor countries," David Hauner said. "More than 50% of adults in developing countries do not have a bank account. Digital currencies could substantially reduce transaction costs and allow more economic activities. This would be a major boost to economic growth."

Hauner found that already, emerging market countries where fewer people have bank accounts tend to be more active in bitcoin trading, showing that one of the uses of cryptocurrencies tends to be a substitute for bank accounts. Relative to GDP, the biggest countries in terms of bitcoin trading volumes are all emerging markets: Kenya, Nigeria, Columbia, South Africa, Russia, and Peru.

Digital currencies could also reduce cross-border payment costs, he said. The use of central bank digital currencies could formalize the economy, raise tax revenue, and reduce corruption and other illegal activities that often depend on the use of cash payments, Hauner added.

However, BofA warns that the rise of digital currencies could undermine a country's physical currency through dollarization and inflation. Hauner cautions that digital currencies are more likely to increase than decrease inflation.

"Easier access to alternative digital currencies is also likely to increase the volatility of domestic money supply and the exchange rate. Easier access to alternatives also raises the risks of rapid shifts of liquidity out of (or into) the currency and the banks which can magnify macro volatility in already less stable countries. Higher macro volatility would then reduce the effectiveness of policies and undermine the long-term rate of growth," he added.

Despite the risks, many countries may soon adopt a digital currency. Central banks representing a fifth of the world's population are likely to issue a general purpose CBDC in the next three years, Hauner said, citing the latest Bank of International Settlements survey.

Last week, El Salvador voted to establish bitcoin as legal tender alongside the US dollar, the country's national currency.

Hauner also said that concerns about currency substitution, disintermediation, monetary policy effectiveness, and inflation are lower for a central bank digital currency than a private digital currency.

"A CBDC is a direct claim on the central bank rather than a private financial liability. Thus, a CBDC would have the same credibility (or lack thereof) attached as traditional money," said Hauner.