Cryptocurrencies Will Never Replace Money, Says Bank Of International Settlements

News | June 18, 2018 By:

The Bank for International Settlements (BIS) claims that cryptocurrencies are afflicted with inherent contradictions that make their widespread use as money impossible.

The BIS is an international financial institution owned by central banks which “fosters international monetary and financial cooperation and serves as a bank for central banks.” It carries out its work through its meetings, programs and through the Basel Process – hosting international groups pursuing global financial stability and facilitating their interaction.

In its annual economic report, the BIS said cryptocurrencies are not scalable and are more likely to suffer a breakdown in trust and efficiency the greater the number of people using them. For a monetary system to successfully facilitate transactions, the BIS said, it must be elastic to address demand and must be able to scale with the economy, a function central banks have successfully provided.

“Well run central banks succeed in stabilizing the domestic value of their sovereign currency by adjusting the supply of the means of payment in line with transaction demand,” the BIS said. “They do so at high frequency, in particular during times of market stress but also during normal times. This contrasts with a cryptocurrency, where generating some confidence in its value requires that supply be predetermined by a protocol. This prevents it from being supplied elastically. Therefore, any fluctuation in demand translates into changes in valuation. This means that cryptocurrencies’ valuations are extremely volatile.”

According to the report, in mainstream payment systems, once an individual payment makes its way through the national payment system and ultimately through the central bank books, it cannot be revoked. In contrast, permissionless cryptocurrencies cannot guarantee the finality of individual payments. One reason is that although users can verify that a specific transaction is included in a ledger, unbeknownst to them there can be rival versions of the ledger. This can result in transaction rollbacks, for example when two miners update the ledger almost simultaneously. Since only one of the two updates can ultimately survive, the finality of payments made in each ledger version is probabilistic.

“The lack of payment finality is exacerbated by the fact that cryptocurrencies can be manipulated by miners controlling substantial computing power, a real possibility given the concentration of mining for many cryptocurrencies,” the BIS said.

The BIS also said that underpinning of trust in each cryptocurrency is also fragile due to forking, a process whereby a subset of cryptocurrency holders coordinate on using a new version of the ledger and protocol, while others stick to the original one.

“Forking shows just how easily cryptocurrencies can split, leading to significant valuation losses,” the BIS said. “An even more worrying aspect underlying such episodes is that forking may only be symptomatic of a fundamental shortcoming: the fragility of the decentralized consensus involved in updating the ledger and, with it, of the underlying trust in the cryptocurrency. Theoretical analysis suggests that coordination on how the ledger is updated could break down at any time, resulting in a complete loss of value.”

The report noted that regulatory challenges also need to be addressed with respect to cryptocurrencies, such as anti-money laundering and terrorism financing.

“The question is whether, and to what extent, the rise of cryptocurrencies has allowed some AML/CFT measures, such as know-yourcustomer standards, to be evaded,” the BIS said. “Because cryptocurrencies are anonymous, it is hard to quantify the extent to which they are being used to avoid capital controls or taxes, or to engage in illegal transactions more generally.”

The BIS has issued a series of warnings this year after an explosive rise in cryptocurrency values attracted a wave of followers. In February of this year, Agustin Carstens, head of the BIS, warned that central banks must be prepared to act against cryptocurrencies to ensure they do not become entrenched and undermine trust in central banks.

“To date, many judge that, given cryptocurrencies’ small size and limited interconnectedness, concerns about them do not rise to a systemic level,” Carstens said at the time. “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.”