The Bank for International settlements has just published a scathing diatribe, but will it make any difference?by Paul Wallace / June 22, 2018 / Leave a comment
Central bankers don’t like cryptocurrencies. They are after all an intrusion on their own turf, offering an alternative money. So it is hardly surprising that the Bank for International Settlements, the central banks’ bank, takes a dim view of the innovation. New research in its annual report offers a particularly cogent attack on the viability of cryptocurrencies—digital forms of money based on encryption techniques.
The BIS goes back to basics, arguing that money is fundamentally about trust. That trust underpins how money fulfils its three central functions, as a store of value, unit of account and medium of exchange. It enables the use of what are essentially tokens in the form of banknotes and coin and facilitates payments from one account to another.
With conventional money that trust comes from the imprimatur of governments. Independent central banks commit to price stability, thus avoiding the erosion of money through inflation over time. And they play a vital role in payments systems (which they oversee) since the transactions between individuals and firms through their banks are settled ultimately in central bank money.
By contrast, cryptocurrencies are a decentralised way of creating trust. Instead of centralised validation cryptocurrencies share authority within their network. Instead of the centrally-held ledgers of banks and central banks there is one distributed (across users) ledger that records all transactions in an ever lengthening set of digital blocks called a blockchain. Bookkeepers called “miners” update the distributed ledger by adding another digital block, involving expensive computational effort for which they are paid a fee, and that is then verified by the network of users and miners.
The rollercoaster ride of bitcoin, currently trading at around a third of the heady price of close to $20,000 for each bitcoin reached at the end of last year, has made a mockery of cryptocurrencies as a store of value. Its extreme volatility also compromises any meaningful role as a unit of account. The BIS report highlights the weakness of cryptocurrencies as a medium of exchange.
The underlying problem is that the new model of decentralised trust is laborious and expensive. The updating of the ledger by miners requires so much computation that cryptocurrencies are potentially ruinous for the environment. As the BIS points out the electricity devoured by bitcoin mining alone is already comparable to that used in a mid-sized economy such as…