An interesting perspective on crypto-currencies from an op-ed by Mr Agustín Carstens, General Manager of the BIS. He says that the short experience of cryptocurrencies shows that technology, however sophisticated, is a poor substitute for hard-earned trust in sound institutions. Perhaps not an unsurprising stance from the central bankers’ banker! As we highlighted yesterday, some central banks are now exploring alternatives via CBDC’s.
How to preserve trust in financial transactions is a tricky business in our digital age. With new cryptocurrencies proliferating, it’s as important to educate the public about good money as it is to build defences against fake news, online identity theft and Twitter bots. Conjuring up new cryptocurrencies is the latest chapter in a long story of attempts to invent new money, as fortune seekers have tried to make a quick buck. It has become the alchemy of the age of innovation, with the promise of magically transforming everyday substances (electricity, in this case) into gold (or at least euros).
Many cryptocurrencies are ultimately get-rich-quick schemes. They should not be conflated with the sovereign currencies and established payment systems that have stood the test of time. What makes currencies credible is trust in the issuing institution, and successful central banks have a proven record of earning this public trust. The short experience of cryptocurrencies shows that technology, however sophisticated, is a poor substitute for hard-earned trust in sound institutions. We will explain this concept further in a special section of our annual report on 17 June.
Recent episodes show how private cryptocurrencies struggle to earn public trust. Cases of fraud and misappropriation abound. Above all, the technology behind cryptocurrencies makes them inefficient and certainly less effective than the digital payment systems already in place. Let me highlight three aspects.
First, the highly volatile valuations of cryptocurrencies conflict with the stable monetary values that must underpin any system of transactions which sustains economic activity. Over the last two decades, consumer price inflation in advanced economies averaged 1.8%. In contrast, over the last three months, the five largest cryptocurrencies have on average lost 21% of their value against the US dollar.
Second, the many cases of fraud and theft show that cryptocurrencies are prone to a trust deficit. Given the size and unwieldiness of the distributed ledgers that act as a register of crypto-holdings, consumers and retail investors in fact access their “money” via third parties (crypto-wallet providers or crypto-exchanges.) Ironically, investors who opted for cryptocurrencies because they distrusted banks have thus wound up dealing with entirely unregulated intermediaries that have in many cases turned out to be fraudulent or have themselves fallen victim to hackers.
Third, there are fundamental conceptual problems with cryptocurrencies. Making each and every user download and verify the history of each and every transaction ever made is just not an efficient way to conduct transactions. This cumbersome operational setup means there are hard limits on how many, and how quickly, transactions are processed. Cryptocurrencies therefore cannot compete with mainstream payment systems, especially during peak times. This leads to congestion, transaction fees soar, and very long delays result.
In the end, one has to ask if cryptocurrencies are an improvement compared with current means of payment. Technological advances can mitigate some of the shortcomings of existing cryptocurrencies, but institution-free technology is unlikely ever to remedy the fundamental problem of recreating trust from a fragmented system of unregulated, self-interested actors. In particular, in a decentralised network of users, nobody has the incentive to stabilise the currency in times of crisis. This can make the whole system unstable at any given point in time.
Admittedly, there are also sobering examples of sovereign monies failing, mostly when public trust broke down – even in recent times. But on the whole, recent decades can be seen as a historically rare period of monetary stability, underpinned by independent central banks.
The technology behind cryptocurrencies could be used in other interesting ways, however. Central banks have long championed the use of new payment technologies – as long as they prove socially useful – in the interests of increased efficiency. One should also note that digital central bank money is not new: it has been quietly enabling some of the most significant innovations in financial plumbing for the last 20 years.
Currently, central banks around the world are working on systems for retail payments that will allow instant transfers, anytime and anywhere. They are also actively testing the distributed ledger technology underlying cryptocurrencies – not as a substitute for the current system, but to build on it. Even in this digital age, trust in the issuing institution matters and will continue to underpin currencies. Central banks, for their part, will have to continue earning that public trust by closely guarding their currency’s value.
