NewsBusiness

BIS: Crypto's 'Structural Flaws' Make It Unsuitable as Basis for Monetary System

But central banks are very keen to develop and control their own cryptocurrencies.

4 min read
The Bank for International Settlements, Basel, Switzerland. Image: Shutterstock

A new report from the Bank for International Settlements (BIS) concludes that crypto's "structural flaws" make it "unsuitable as the basis for a monetary system."

The Annual Economic Report 2022 from the BIS, a global organization of 63 leading central banks, goes on to suggest that blockchain’s role in a future monetary system will likely take the form of central bank digital currencies (CBDCs), because “a system grounded in central bank money offers a sounder basis for innovation.”

The report points to Terra’s historic collapse last month and the current bear market as the catalyst for what analysts have labeled the start of a “crypto winter,” but says that focusing on price action alone “diverts attention away from the deeper structural flaws” in crypto that render it unfit for purpose as a monetary system. 

Fragmentation flaws

The report says the crypto space has two main flaws: the need for a “nominal anchor” and “fragmentation.”

The need for a “nominal anchor” refers to stablecoins, which peg their value to fiat currencies, like the U.S. Dollar (with varying degrees of success). The report says that the existence of stablecoins “indicates the pervasive need in the crypto sector to piggyback on the credibility provided by the unit of account issued by the central bank.”

The report argues that cryptocurrencies have done little to challenge the hegemony of central banks in providing a unit of account for the economy: “The fact that stablecoins must import the credibility of central bank money is highly revealing of crypto's structural shortcomings. That stablecoins are often less stable than their issuers claim shows that they are at best an imperfect substitute for sound sovereign currency.”

The report also points to the “fragmentation” of the sector, which is defined as the abundance of different cryptocurrencies competing for supremacy, as “perhaps crypto's greatest flaw as the basis for a monetary system.” 

In its analysis, the report expounds on this flaw as being most crippling to the public interest. It argues that fiat money has a “network effect,” meaning the more users flock to a fiat currency, the more users it then attracts.  

However, with crypto, the report claims that the more users flock to one blockchain system, the worse congestion gets and the higher the transaction fees, “opening the door to the entry of newer rivals who may cut corners on security in favor of higher capacity.”

It should be noted that here the report reads more like a targeted criticism of Ethereum in its current form than crypto in general. The world’s second favorite cryptocurrency has well-known scalability issues, like high fees and a low transaction throughput which have prompted a plethora of “Ethereum killers,” like Solana, Cardano, and Polkadot to offer their own alternatives. 

Ethereum’s developers have promised to address the network’s scalability in the network’s upcoming overhaul, dubbed “the Merge.” 

The answer: central bank crypto, of course!

Unsurprisingly, the report says that blockchain does have a place in a future monetary system: in the hands of central banks. It says that any future system “should meld new technological capabilities with a superior representation of central bank money at its core.”

BIS points to smart contract technology–self-executing financial contracts on the blockchain–as one of a number of advantages that will “enable transactions between financial intermediaries that go beyond the traditional medium of central bank reserves.” 

It also says that tokenization of deposits on blockchain’s distributed ledger system will enable new forms of exchange, “including fractional ownership of securities and real assets,” which could potentially open up a whole host of new financial services. 

Yesterday's report isn't the first time that the BIS has issued strident warnings about the risks of cryptocurrency and argued that digital currencies should be the exclusive preserve of central banks. In early 2021 it warned that Bitcoin could "break down altogether," with BIS general manager Agustin Carstens stating that, "If digital currencies are needed, central banks should be the ones to issue them."

Later that year, the BIS warned that decentralized finance (DeFi) creates financial vulnerabilities that "exceed those in traditional finance," singling out stablecoins as being "subject to classic runs."

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