Five cryptocurrency questions central banks need to answer

Five cryptocurrency questions central banks need to answer



Five cryptocurrency questions central banks need to answer

In 2018, there is perhaps only one industry subject to more rapid change than cryptocurrencies and that is official sector approaches to cryptocurrencies.

Over the course of their brief history, cryptocurrencies, famously bitcoin, have enjoyed a wide range of central bank responses, from prohibition to indifference to acceptance. To this mix, conflicting views from the Bank for International Settlements (BIS), International Monetary Fund (IMF) and the Financial Stability Board can be added for good measure.

But with so much activity in the sector, the world needs one thing from central bankers now: clarity. Here then, are five questions that central banks must answer.

Crytpocurrency image

How can they convince people that cryptocurrencies are not ‘money’?

One area where the central banking community has reached a consensus is that privately issued virtual currencies based on decentralised accounting systems, such as bitcoin or ethereum, are not to replace traditional currencies. They are not money. The IMF could not be any clearer: “They are neither a good means of payment, nor a good unit of account, nor are they suitable as a store of value.”

And yet many in emerging as well as developed economies view bitcoin as miraculous alchemy, creating gold – or money – from nothing. For them, it does the trick. The challenge is clear: central banks need to clearly and convincingly explain the distinction between the underlying technology – such as blockchain – and cryptocurrencies per se. If they don’t, people will vote with their feet.

Regulate! But how?

The former governor of the Bank of Mexico, Agustín Carstens, is not a fan. Now boss at the central banks’ bank, the BIS, cryptocurrencies represent to him “a bubble, a Ponzi scheme and (due to the energy consumption required for the maintenance of their infrastructure) even an environmental disaster”. While other central bank leaders tend to more moderate vocabulary, they agree closer attention should be paid to the risks cryptocurrencies pose, at both the systemic level and that of the individual consumer.

So it is no surprise that central bankers across the globe openly acknowledge their regulatory and supervisory frameworks need to be ready for cryptocurrencies. This is, however, where the consensus ends.

A recent paper highlights the different ways regulators approach the ‘bitcoin question’. These range from the liberal US Commodity Futures Trading Commission, which merely classifies cryptocurrencies as commodities, to the draconian ban that the People’s Bank of China slapped on all cryptocurrency trading. However, this inconsistency, coupled with borderless markets (a consumer from China can still trade bitcoin on an exchange based in the US), means that in the long run the effectiveness of national regulation will be limited.

How then can they drive international co-operation in regulation?

Well, they have made a start. Bilateral projects between the European Central Bank and the Bank of Japan, and the Bank of Canada with the Monetary Authority of Singapore, stand out. As do the research initiatives led by the BIS, the views of the new boss notwithstanding. Yet, while these ongoing efforts indicate the growing awareness of the need to co-operate and co-ordinate internationally, it is not possible to talk about systematic attempts.

And there’s the crux. International efforts require significant investments, and – what is particularly important to appreciate – cryptocurrencies are some way down the priority list due to their (still) tiny share of the global financial system. Of course, by the time they have become a big enough share to move up the list, it may be too late.

How should central banks approach their own cryptocurrency-like projects?

Now, here is a twist. When they are not heaping opprobrium on cryptocurrencies, central bankers are trying their hands at “digital currencies”, as they call them. No, really. The central banks of Sweden and Switzerland – hardly hotbeds of radicalism and sedition – have actively considered the possibility. While the technical differences between these efforts and the likes of bitcoin are doubtlessly clear to those involved, they are likely to be lost on a wider public.

A recent report from the St Louis Federal Reserve attempts to draw a line. While central banks should actively consider the development of digital currency, it says, no reputable official sector institution would issue a decentralised digital currency, the users of which can remain anonymous. The removal of the decentralised aspect would inevitably take away a large part of what makes cryptocurrencies attractive. But, given the risks (especially in relation to illegal activities), going down this route is likely to create more problems than benefits for an official sector issuer. So caveat issuer.

What are the implications of a central bank digital currency for monetary policy and financial stability?

On the previous questions, we can, in truth, allow central bankers a little latitude. But not this one, for this is core central bank business. With regard to monetary policy, the implications seem not to be overly problematic. Central bankers would be able to maintain some control over monetary transmission and may even find it easier to implement certain policy measures (especially unorthodox ones such as ‘helicopter drops’) that would be applied directly to individual accounts held at a central bank.

However, the impact on financial stability is less straightforward. For example, as individuals would choose to hold central bank digital currencies, commercial lenders would be deprived of significant sources of funding. This would have an impact on liquidity. The implications could be even more serious during a crisis with cross-country flows as customers would choose to move their money into a safer digital currency. As a result, active use of central bank digital money is likely to require an even greater level of co-ordination and co-operation between jurisdictions than the regulation of privately issued cryptocurrencies.

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