Should central banks embrace cryptocurrencies, or even pioneer their own? In a nutshell, no. Crypto assets are an unusual innovation, still in flux and often poorly understood. Trying to centralize them in a bureaucracy is exactly the wrong way to go.
Yet China’s central bank claims it is working toward a blockchain-based digital currency. Singapore has already experimented in this direction. The phrase “Fedcoin” is sometimes bandied about, though I’ve seen no concrete sign of the U.S. Federal Reserve jumping on this bandwagon. In its recent quarterly review, the Bank of International Settlements asked central banks to consider whether cryptocurrencies might make sense for them.
Central banks, however, are intrinsically conservative bureaucracies. They shun bad publicity, and they don’t like to be “out there” ahead of the curve. They don’t want their names connected with potential mishaps — because they value their credibility and their political capital so highly. That’s appropriate, because central bank independence is typically fragile.
Given that background, should we foist a new and potentially risky responsibility on them? Central banks will feel some anxiety at having to manage a crypto project. To conserve their political capital, they will take fewer risks elsewhere, such as unorthodox monetary policy or larger balance sheets. Yet the response to the 2008 financial crisis shows a certain amount of central bank risk-taking is needed. I’m worried about central banks taking on unnecessary risky projects, thereby rendering them too cautious in other areas.
An additional reason for skepticism stems from the nature of crypto assets. The word “cryptocurrency” is far more common than “crypto asset,” but it’s a misleading term. Bitcoin, for instance, is used only rarely in retail transactions, and for all its success it isn’t becoming more important as a medium of exchange. Bitcoin thus isn’t much of a currency in the literal sense of that term. There is a version of bitcoin, Bitcoin Cash, that changed the initial rules to be better suited as an exchange medium, but it isn’t nearly as popular.
If you think of these assets as “cryptocurrencies,” central bank involvement will seem natural, because of course central banks do manage currencies. Instead, this new class of assets is better conceptualized as ledger systems, designed to create agreement about some states of the world without the final judgment of a centralized authority, which use a crypto asset to pay participants for maintaining the flow and accuracy of information. Arguably these innovations come closer to being substitutes for corporations and legal systems than for currencies.
Put in those terms, an active (rather than merely supervisory) role for central banks in crypto assets is suddenly far from obvious. Consider other financial innovations: Does anyone suggest that central banks should run their own versions of ETFs or high-frequency trading? Is there a need for central banks to start managing the development of accounting and governance systems?
Finally, bitcoin and other crypto assets are still in the midst of rapid evolution, with basic questions still unanswered. Should bitcoin “fork” to allow for greater speed in processing transactions? Is the future going to favor bitcoin, the Ethereum platform, or something else altogether? How many initial coin offerings make economic sense, as opposed to being bubbles? Should initial coin offerings be used to fund startups? How many crypto assets should survive in the long run? Can blockchains be used to record and settle the transfer of property titles? Are there any circumstances when it should be possible to revise transactions on a blockchain?
Because crypto assets are not large enough to pose systemic risks for economies, it’s best to let markets try to figure out the answers to these and other questions. What’s needed now is further experimentation, not bureaucratization. If central banks move into this world, the danger is that they will try to settle issues on the basis of their conservative judgments. The Fed would command the bulk of market attention; it would be hard for alternative crypto systems to be seen as anything but competitors and potential sources of risk or disruption. (In this regard, a Singaporean project is less likely to dominate the market and thus it would be less of a problem.) Innovation is likely to slow down.
In general, I think the central banks in the world’s developed economies have done a pretty good job. But consider a simple question: Would any central bank have had the inspiration or taken the risk of initiating the bitcoin protocol in the first place?
So why should central banks be given a commandeering position in steering these evolving innovations?
Frontpage December 23, 2019