This paper investigates optimal currency choice, particularly the choice between paper and digital currencies, when currency is utilized solely as a medium of exchange. The Baumol-Tobin model of transactions demand for money is extended to derive conditions under which digital currency is preferred to paper currency, taking into consideration the network externality in the choice of currencies. The model is applied to explain potential variations in currency preferences across countries, especially between advanced and developing economies. Also discussed is how the introduction of negative interest rates, currency taxes, and central bank digital currency affect optimal currency choice.
Keywords: Digital currency; Money demand; Network externality; Negative interest rate; Currency tax
Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.