Central bankers' organisation argues blockchain is no substitute for the 'solid institutional backing of money'; Says the 'quest for decentralised trust has quickly become an environmental disaster'

The organisation that represents central banks from around the world has slammed the technology behind cryptocurrencies, saying that “however sophisticated”, it’s a “poor substitute for the solid institutional backing of money”.

The Bank for International Settlements (BIS) says that “looking beyond the hype,” it’s difficult to identify specific economic problems that cryptocurrencies solve.

Transactions are slow and costly, prone to congestion, and cannot scale with demand, it argues in a new report, Cryptocurrencies: Looking Beyond the Hype.

The decentralised consensus behind the technology is also fragile and consumes vast amounts of energy.

Scalability

BIS explains that the way cryptocurrencies achieve trust - through their supply being predetermined by a protocol and users verifying transactions - is inherently inefficient.

For example, the amount of electricity used to mine bitcoin alone was at the time the report was written equivalent to that used by a country the size of Switzerland.

“Put in the simplest terms, the quest for decentralised trust has quickly become an environmental disaster,” BIS says.

With cryptocurrency transactions requiring users to download and verify the history of all transactions ever made, each transaction increases the size of the ledger.

And as the ledger gets bigger, it takes longer for transactions to be verified.

“To process the number of digital retail transactions currently handled by selected national retail payment systems… the size of the ledger would swell well beyond the storage capacity of a typical smartphone in a matter of days, beyond that of a typical personal computer in a matter of weeks and beyond that of servers in a matter of months,” BIS says.  

It goes so far as to say that with large volumes of files being transferred, the internet could be brought to a “halt”.

Another scalability issue arises as, in order to limit the number of transactions added to the ledger at any given point in time, blockchain-based cryptocurrencies only allow new blocks to be added in intervals.

This can congest the system, which reduces the usefulness of cryptocurrencies in making day-to-day transactions, like buying coffee.

Volatility

BIS says that without a central issuer able to manipulate the value of a currency to keep it stable, cryptocurrencies’ values fluctuate entirely with demand.

“Further contributing to unstable valuations is the speed at which new cryptocurrencies - all tending to be very closely substitutable with one another - come into existence,” BIS says.

“Recalling the private banking experiences of the past, the outcome of such liberal issuance of new moneys is rarely stability.”

BIS also recognises the problem of “forking”. This occurs when a subset of cryptocurrency holders coordinate on using a new version of the ledger and protocol, while others stick to the original one.

This happened in 2013, when a flawed software updated led to one part of the bitcoin network mining on the legacy protocol and another part mining using an updated one.

“For several hours, two separate blockchains grew; once news of this fork spread, the price of bitcoin tumbled by almost a third.”

Other uses

BIS concedes that while cryptocurrencies don’t work as money, the underlying technology “can be efficient in niche settings where the benefits of decentralised access exceed the higher operating cost of maintaining multiple copies of the ledger”.

It identifies low-volume cross-border payment solution services as one of these “niche settings”, as all the intermediaries involved in the current system make it expensive.

BIS notes “cryptopayment systems” are one of a number of technologies that could improve the system, yet “it is not clear which will emerge as the most efficient one”.

SWIFT - the provider of the world’s main international payments network - is rolling out an upgrade to its system which speeds up cross-border payments and makes them more transparent.

Its head of Oceania earlier in the month told interest.co.nz this negates the need for an entirely new blockchain-based system.

Furthermore, the results of a trial it was involved with, using blockchain technology in the reconciliation part of cross-border payments, conclude the system upgrades banks would have to do to use the technology are too major.

BIS goes on to say: “Some decentralised cryptocurrency protocols such as Ethereum already allow for smart contracts that self-execute the payment flows for derivatives.

“At present, the efficacy of these products is limited by the low liquidity and intrinsic inefficiencies of permissionless cryptocurrencies.

“But the underlying technology can be adopted by registered exchanges in permissioned protocols that use sovereign money as backing, simplifying settlement execution…

“Crucially, however, none of the applications require the use or creation of a cryptocurrency.”

Regulatory challenges

Recognising the challenges of regulating cryptocurrencies, BIS says only a globally coordinated effort “has a chance to be effective”.

It says regulators could monitor whether and how banks deliver or receive cryptocurrencies as collateral.

It also suggests regulation could target institutions offering services specific to cryptocurrencies.

“For example, to ensure effective AML/CFT, regulation could focus on the point at which a cryptocurrency is exchanged into a sovereign currency.

“Other existing laws and regulations relating to payment services focus on safety, efficiency and legality of use. These principles could also be applied to cryptocurrency infrastructure providers, such as “crypto wallets”.”

Central bank issued currencies

BIS concludes there isn’t a strong case for central banks to issue digital currencies.

It warns issuing a “general purpose” central bank digital currency to consumers and firms would “profoundly affect three core central banking areas: payments, financial stability and monetary policy”.

Therefore, central banks in the likes of Canada, Europe, Japan and Singapore have experimented with issuing narrowly targeted CBDCs [central bank digital currencies], restricted to wholesale transactions.

“In most cases, the central banks have chosen a digital depository receipt (DDR) approach, whereby the central bank issues digital tokens on a distributed ledger backed by and redeemable for central bank reserves held in a segregated account. The tokens can then be used to make interbank transfers on a distributed ledger,” BIS explains.

While the same limitations outlined above apply, BIS says, “the design choices for the convertibility of central bank reserves in and out of the distributed ledger need to be implemented carefully, so as to sustain intraday liquidity while minimising settlement risks”.

BIS says that while the experiments conducted have largely replicated existing systems, the blockchain-based replicas aren’t “clearly superior” to the status quo.

This explains why central banks don’t feel any urgency to issue digital currencies.

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