Bar­bar­ians at the mone­tary gate

China Daily - - COMMENT -

One fac­tor could fur­ther desta­bi­lize an al­ready-ten­u­ous lever­age­and liq­uid­ity-based sys­tem: dig­i­tal cur­ren­cies. And pol­i­cy­mak­ers and reg­u­la­tors have far less con­trol on this fac­tor.

The con­cept of pri­vate crypto-cur­ren­cies was born of mis­trust of of­fi­cial money. In 2008, Satoshi Nakamoto — the mys­te­ri­ous creator of bit­coin, the first de­cen­tral­ized dig­i­tal cur­rency — de­scribed it as a “purely peer-to-peer ver­sion of elec­tronic cash”, which “would al­low on­line pay­ments to be sent di­rectly from one party to an­other with­out go­ing through a fi­nan­cial in­sti­tu­tion”.

A work­ing pa­per by the In­ter­na­tional Mone­tary Fund last year distin­guished dig­i­tal cur­rency (legal ten­der that could be dig­i­tized) from vir­tual cur­rency (non­le­gal ten­der). Bit­coin is a crypto-cur­rency, or a kind of vir­tual cur­rency that uses cryp­tog­ra­phy and dis­trib­uted ledgers (the blockchain) to keep trans­ac­tions both pub­lic and fully anony­mous.

How­ever you slice it, the fact is, nine years af­ter Nakamoto in­tro­duced bit­coin, the con­cept of pri­vate elec­tronic money is poised to trans­form the fi­nan­cial mar­ket land­scape.

This month, the value of bit­coin reached $4,483, with a mar­ket cap­i­tal­iza­tion of $74.5 bil­lion, more than five times larger than at the be­gin­ning of 2017. Whether this is a bub­ble, des­tined to burst, or a sign of a more rad­i­cal shift in the con­cept of money, the im­pli­ca­tions for cen­tral bank­ing and fi­nan­cial sta­bil­ity will be pro­found.

At first, cen­tral bankers and reg­u­la­tors were rather sup­port­ive of the in­no­va­tion rep­re­sented by bit­coin, and the blockchain that un­der­pins it. It is dif­fi­cult to ar­gue that peo­ple should not be al­lowed to use a pri­vately cre­ated as­set to set­tle trans­ac­tions with­out the in­volve­ment of the state.

But na­tional au­thor­i­ties were wary of po­ten­tial il­le­gal uses of such as­sets, re­flected in the bit­coin-en­abled, dark­web mar­ket­place called “Silk Road”, a clear­ing­house for, among other things, il­licit drugs. “Silk Road” was shut down in 2013, but more such mar­ket­places have sprung up. When the bit­coin ex­change Mt Gox failed in 2014, some cen­tral banks, such as the Peo­ple’s Bank of China, started dis­cour­ag­ing the use of bit­coin. By Novem­ber 2015, the Bank for In­ter­na­tional Set­tle­ments’ Com­mit­tee on Pay­ments and Mar­ket In­fras­truc­tures, made up of 10 ma­jor cen­tral banks, launched an in-depth ex­am­i­na­tion of dig­i­tal cur­ren­cies.

But the dan­ger of crypto-cur­ren­cies ex­tends be­yond fa­cil­i­ta­tion of il­le­gal ac­tiv­i­ties. Like con­ven­tional cur­ren­cies, crypto-cur­ren­cies have no in­trin­sic value. But, un­like of­fi­cial money, they also have no cor­re­spond­ing li­a­bil­ity, mean­ing that there is no in­sti­tu­tion like a cen­tral bank with a vested in­ter­est in sus­tain­ing their value.

In­stead, crypto-cur­ren­cies func­tion based on the will­ing­ness of peo­ple en­gaged in trans­ac­tions to treat them as “ne­go­tiable in­stru­ments”. With the value of the propo­si­tion de­pend­ing on at­tract­ing more and more users, cryp­tocur­ren­cies take on the qual­ity of a Ponzi scheme.

As the scale of crypto-cur­rency us­age expands, so do the po­ten­tial con­se­quences of a col­lapse. Al­ready, the mar­ket cap­i­tal­iza­tion of crypto-cur­ren­cies amounts to nearly one-tenth the value of the phys­i­cal stock of of­fi­cial gold, with the ca­pa­bil­ity to han­dle sig­nif­i­cantly larger pay­ment op­er­a­tions, ow­ing to low trans­ac­tion costs. That means crypto-cur­ren­cies are al­ready sys­temic in scale.

There is no telling how far this trend will go. Tech­ni­cally, the sup­ply of crypto-cur­ren­cies is in­fi­nite: bit­coin is capped at 21 mil­lion units, but this can be in­creased if a ma­jor­ity of “min­ers” (who add trans­ac­tion records to the pub­lic ledger) agree. De­mand is re­lated to the mis­trust of con­ven­tional stores of value. If peo­ple fear that ex­ces­sive tax­a­tion, reg­u­la­tion, or so­cial or fi­nan­cial in­sta­bil­ity places their as­sets at risk, they will in­creas­ingly turn to cryp­tocur­ren­cies.

Last year’s IMF re­port in­di­cated that crypto-cur­ren­cies have al­ready been used to cir­cum­vent ex­change and cap­i­tal controls in coun­tries such as Cyprus, Greece and Venezuela. For coun­tries sub­ject to po­lit­i­cal un­cer­tainty or so­cial un­rest, crypto-cur­ren­cies of­fer an at­trac­tive mech­a­nism of cap­i­tal flight, ex­ac­er­bat­ing the dif­fi­cul­ties of main­tain­ing do­mes­tic fi­nan­cial sta­bil­ity.

More­over, while the state has no role in man­ag­ing crypto-cur­ren­cies, it will be re­spon­si­ble for clean­ing up any mess left by a burst bub­ble. And, de­pend­ing on where and when a bub­ble bursts, the mess could be sub­stan­tial. In ad­vanced economies with re­serve cur­ren­cies, cen­tral banks may be able to mit­i­gate the dam­age. The same may not be true for emerg­ing economies.

An in­va­sive plant species does not pose an im­me­di­ate threat to the largest trees in the for­est. But it doesn’t take long for less-de­vel­oped sys­tems — the saplings on the for­est floor — to feel the ef­fects. Crypto-cur­ren­cies are not merely new in­va­sive species to watch with in­ter­est; cen­tral banks must act now to rein in the very real threats they pose. An­drew Sheng is a distin­guished fel­low at the Asia Global In­sti­tute at the Uni­ver­sity of Hong Kong and a mem­ber of the UNEP Ad­vi­sory Coun­cil on Sus­tain­able Fi­nance. Xiao Geng, president of the Hong Kong In­sti­tu­tion for In­ter­na­tional Fi­nance, is a pro­fes­sor at the Uni­ver­sity of Hong Kong. Pro­ject Syn­di­cate

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