(Reuters) As the price of bitcoin spirals towards $10,000, central bankers are warning its success is just a bubble.
The price is now hovering at around $9,740 after climbing from $5,838 on 13 November. At the start of the year it was trading at just $1,000.
Bitcoin keeps bankers awake at night because cryptocurrencies threaten their control of the banking system and money supply, which could undermine policies used to manage inflation.
Bitcoin ‘could blow up’
Bankers are also worried they will be blamed if the market crashes, which is why several central banks are advocating regulations to impose control.
Others are even looking at whether to introduce their own digital currency and are testing payment platforms.
“The problem with bitcoin is that it could easily blow up and central banks could then be accused of not doing anything,” European Central Bank policymaker Ewald Nowotny told Reuters.
“So we’re trying to understand whether bank activity in relation to cryptocurrency trading needs to be better regulated.”
The global cryptocurrency market is worth $24bn, which is tiny compared with the trillion-dollar-plus balance sheets of the Bank of Japan, the US Federal Reserve or the European Central Bank.
These institutions issue yen, dollars and euros, both by creating physical cash or by crediting banks’ accounts, as is the case with their bond-buying programmes.
Cryptocurrencies, however, are not centralised. They do not pass through regulated banks and traditional payment systems.
Instead, they use blockchain, an online ledger of transactions maintained by a network of anonymous computers on the internet.
This has raised concerns about their vulnerability to hackers, as underlined by a score of incidents in recent months, and their use to finance crime.
‘Like the tulip bubble’
“Bitcoin is a sort of tulip,” said ECB vice-president Vitor Constancio in September, comparing it to the 17th century Dutch trading bubble. “It’s an instrument of speculation.”
China and South Korea recently banned fundraising through token launches, whereby a new cryptocurrency is sold to finance a product development.
Russia’s central bank has said it would block websites selling bitcoin and rivals such as etherium, ripple and litecoin, while the ECB told European Union lawmakers last year “they should not seek... to promote the use of virtual currencies” because these could “affect the central banks’ control over the supply of money” and inflation.
Commercial banks have so far been lukewarm to existing digital currencies.
But with electronic payments already supplanting cash, they’re alert to the danger that they would lose business if their clients decided to switch to them.
For this reason, Swiss banking giant UBS is leading a consortium of six banks trying to create its own digital cash equivalent of each of the major currencies backed by central banks.
This would allow financial markets to make payments and settle transactions more quickly.
Risk for regulators
This poses risks for central bankers, as the guardian of the banking and payment system.
“(We could) wake up one day and most of the big banks have been eviscerated and most of that activity has moved elsewhere,” St. Louis Fed President James Bullard told Reuters in a recent interview.
This could lead to a financial crisis if regulators lost sight of the activity, he said.
Some central banks such as Sweden’s Riksbank and the Bank of England are also looking at the merits of introducing their own digital currency.
Holders would have a direct claim on the central bank – just like with banknotes but without the inconvenience of storing large amounts of cash.