Worldwide regulation of cryptocurrencies that could kill off their kudos has moved a step closer with outright criticism from the Bank for International Settlements’ (BIS) general manager Agustín Carstens.
The BIS represents central banks from 60 countries that, between them, have 95% of the world’s GDP. All central banks are likely to take note.
Digital tokens masquerading as currencies
In a lecture “Money in the digital age: what role for central banks?”, Carstens today said: “The meteoric rise of cryptocurrencies should not make us forget the important role central banks play as stewards of public trust. Private digital tokens masquerading as currencies must not subvert this trust.”
He said central banks had a duty to make sure technological advances are not used to legitimise the profits from illegal activities, and to educate and protect investors and consumers. They must also ensure cryptocurrencies do not become entrenched and pose a risk to financial stability.
“Novel technology is not the same as better technology or better economics,” Carstens said. “That is clearly the case with Bitcoin: while perhaps intended as an alternative payment system with no government involvement, it has become a combination of a bubble, a Ponzi scheme and an environmental disaster.”
Examples of currency instability
Carstens was speaking at an event in Frankfurt organised by Sustainable Architecture for Finance in Europe (SAFE), the Center for Financial Studies and the Deutsche Bundesbank.
Carsten’s lecture was accompanied by a report into how the forerunners of central banks stabilised economies after the Thirty Year War in central Europe, 1618-1648.
Large price swings, high transaction costs and a lack of consumer and investor protection make cryptocurrencies unsafe and unsuited to fill money’s role as a shared means of payment, store of value and unit of account, he said. While he referred specifically to Bitcoin, he generalised about other cryptocurrencies, which include Ethereum, Ripple and Litecoin, for example.
Regulation of exchanges
Central banks and financial authorities should pay particular attention to the ties linking cryptocurrencies to real currencies, and ensure they do not become parasites on the institutional infrastructure of the wider financial system.
“To ensure level playing field for all participants in financial markets, access to legitimate banking and payment services should be limited to those exchanges and products that meet accepted high standards, Carstens said.
“This means ‘same risk, same regulation’. And no exceptions allowed,” he said.
Central banks vital to currency stability
In Carston’s lecture he argued: “Money is an indispensable social convention backed by an accountable institution within the State that enjoys public trust. Many things have served as money, but experience suggests that something widely accepted, reliably provided and stable in its command over goods and services works best.
“Experience has also shown that to be credible, money requires institutional backup, which is best provided by a central bank. While central banks’ actions and services will evolve with technological developments, the rise of cryptocurrencies only highlights the important role central banks have played, and continue to play, as stewards of public trust.
“Private digital tokens posing as currencies, such as bitcoin and other crypto-assets that have mushroomed of late, must not endanger this trust in the fundamental value and nature of money.”
Much of Carsten’s lecture discussed the nature of money and the digitisation process, With analysis summed up by the “money flower” diagram. It shows how currencies in various forms are related and available.
But Cartsten swiftly focussed on what he called the “leapfrogging” distributed ledger technology behind Bitcoin and other cryptocurrencies. While the technology had been examined by central banks it had yet proved itself to be valuable and safe, despite the rash of new cryptocurrencies.
“Trust is the fundamental tenet that underpins credible currencies, and this trust has to be earned and supported,” he said.
Mexico had dozens of banknotes
He referred to three periods: examples of when currencies had lacked trust. In addition to the Thirty year war, he included the United States Free Banking Era, from 1837 to 1863, when many banks sprang up that issued currency with no oversight of any kind by the federal government.
He also included his own country, Mexico. “Mexico had the first series of hyperinflations at the beginning of the 20th century. My country had a revolution from 1910 to 1921, in which no central government existed in an effective way, with many factions fighting and disputing different territories.
A winning faction would arrive in a territory, print its own money and make void previously issued cash. So different bills issued by different factions coexisted, leading to chaos and hyperinflation,” he said.
Several trunks of banknotes confiscated by the US Navy in 1914 were recently returned and in them were a dozen forms of currency Mexico’s central bank had never known existed.
“The unhappy experience with private forms of money raises deep questions about whether the proliferation of cryptocurrencies is desirable or sustainable,” Carstens said.
“Even if the supply of one type of cryptocurrency is limited, the mushrooming of so many of them means that the total supply of all forms of cryptocurrency is unlimited. Added to this is the practice of “forking”, where an offshoot of an existing cryptocurrency can be conjured up from thin air.
“Given the experience with currency debasement that has peppered history, the proliferation of such private monies should give everyone pause for thought.”
Taking the wrong fork
Carsten went onto ridicule the proliferation of currencies through so called “forks” where a spin-off, supposedly better version of a cryptocurrency is created.
“Last year alone, 19 Bitcoin forks came out, including Bitcoin Cash, Bitcoin Gold and Bitcoin Diamond. Forks can fork again, and many more could happen. After all, it just takes a bunch of smart programmers and a catchy name,” he said.
And he laid in to the idea that it was a currency at all. “The volatility of bitcoin renders it a poor means of payment and a crazy way to store value. Very few people use it for payments or as a unit of account.
“In fact, at a major cryptocurrency conference the registration fee could not be paid with bitcoins because it was too costly and slow: only conventional money was accepted.”
Criminal and black market interest
Carsten then turned his attention to the popularity of Bitcoin and other cryptocurrencies among criminals.
He said: “To the extent they are used, bitcoins and their cousins seem more attractive to those who want to make transactions in the black or illegal economy, rather than everyday transactions.
“In a way, this should not be surprising, since individuals who massively evade taxes or launder money are the ones who are willing to live with cryptocurrencies’ extreme price volatility.”
Blockchain not a proven technology
And he rubbished the technology: “Central bank experiments show that digital ledger-based systems are very expensive to run and slower and much less efficient to operate than conventional payment and settlement systems.
“The electricity used in the process of mining bitcoins is staggering, estimated to be equal to the amount Singapore uses every day in electricity, making them socially wasteful and environmentally bad.”
Carsten told his audience: “The current fascination with these cryptocurrencies seems to have more to do with a speculative mania than any use as a form of electronic payment, except for illegal activities. Accordingly, authorities are edging closer and closer to clamping down to contain the risks related to cryptocurrencies.”
He said regulation was inevitable and would be welcomed: “There is a strong case for policy intervention. As now noted by many securities markets and regulatory and supervisory agencies, these assets can raise concerns related to consumer and investor protection.
“Appropriate authorities have a duty to educate and protect investors and consumers, and need to be prepared to act.”
Banking regulation and Basel
And Carsten was critical of banks jumping on the cryptocurrency bandwagon. “It is alarming that some banks have advertised ‘bitcoin ATMs’ where you can buy and sell bitcoins. Authorities need to ensure commercial banks do not facilitate unscrupulous behaviours,” he said.
He said banking regulation – agreed internationally through Basel conventions – require a level playing field and he demanded that cryptocurrencies and digital currency exchanges be regulated to the same standards as the rest of the market.
He wanted to ensure that “the same high standards that money transfer and payment service providers have to meet are also met by Bitcoin-type exchanges. It also means ensuring that legitimate banking and payment services are only offered to those exchanges and products that meet these high standards.”
Volatility = instability
But Carsten said regulation was needed to protect markets from the instability such volatile assets could cause.
“Financial authorities may also have a case to intervene to ensure financial stability. To date, many judge that, given cryptocurrencies’ small size and limited interconnectedness, concerns about them do not rise to a systemic level.
“But if authorities do not act pre-emptively, cryptocurrencies could become more interconnected with the main financial system and become a threat to financial stability.”
Trust in currencies
Carsten returned to the issue of trust in currencies. “Most importantly, the meteoric rise of cryptocurrencies should not make us forget the important role central banks play as stewards of public trust. Private digital tokens masquerading as currencies must not subvert this trust. As history has shown, there simply is no substitute.”
He ended by saying: “Central banks must be prepared to intervene if needed. After all, cryptocurrencies piggyback on the institutional infrastructure that serves the wider financial system, gaining a semblance of legitimacy from their links to it.
“This clearly falls under central banks’ area of responsibility. The buck stops here. But the buck also starts here. Credible money will continue to arise from central bank decisions, taken in the light of day and in the public interest.”
“In particular, central banks and financial authorities should pay special attention to two aspects. First, to the ties linking cryptocurrencies to real currencies, to ensure that the relationship is not parasitic. And second, to the level playing field principle. This means “same risk, same regulation”. And no exceptions allowed.”
The UK’s Bank of England has been out of line on cryptocurrency regulation, taking a softer line. Governor Mark Carney told MPs back in December he was interested in how it works and not worried that it impacted on stability. However, he said then: “What I say on this topic today will be outdated six months from now because things are moving so rapidly.”