Blog: Central banks reveal ‘vast gulf’ between crypto vision and reality – The Australian Financial Review

These include programmability, composability (the ability to combine different components in a system) and tokenisation (the process of digitising a real-world asset including a deposit), which will allow official money to seamlessly move between apps.

For example, instead of retail users buying speculative coins or private stablecoins, tokenised deposits could be built on top of central bank digital currencies to “ground them on more secure foundations”. This would offer the benefits of “atomic settlement” (payments and assets moving at the same time) and allow central banks to be at the core of the validation process.

Central banks indicated tougher crypto regulation is in the pipeline.

“The crypto sector provides a glimpse of promising technological possibilities, but it cannot fulfil all the high-level goals of a digital monetary system,” the BIS said.

“It suffers from inherent shortcomings in stability, efficiency, accountability and integrity that can only be partially addressed by regulation.

“Fundamentally, crypto and stablecoins lead to a fragmented and fragile monetary system. Importantly, these flaws derive from the underlying economics of incentives, not from technological constraints.”

Case for tougher regulation

The implosion of the TerraUSD stablecoin has underscored the weakness of a system that is sustained by selling coins for speculation, and underscored the urgency of regulating the space, the BIS said.

Global regulators “need to rigorously tackle cases of regulatory arbitrage”, starting from the principle of “same activity, same risk, same rules”.

“They should ensure that crypto and DeFi activities comply with legal requirements for comparable traditional activities. Stablecoin issuers, for instance, resemble deposit-takers or money market funds. As such, legislation is needed to qualify these activities and ensure that they are subject to sound prudential regulation and disclosure.”

Central banks are concerned that centralised crypto exchanges hold a significant share of their custodial cryptocurrencies off-balance sheet, while hiding the identity of transacting parties. Those that fail to follow “know-your-customer” and other Financial Action Task Force requirements “should be fined or shut down”.

The BIS is highly sceptical of private sector stablecoins, saying the fact they must “import the credibility of central bank money is highly revealing of crypto’s structural shortcomings”.

Stablecoins are “less stable than their issuers claim” and crypto is problematic because it lacks a “nominal anchor”, which is a way central banks anchor the value of money in the real economy, so are trying to import this – imperfectly – through stablecoins.

The report targets the ability of public blockchains such as bitcoin and ethereum to scale, pointing to the “scalability trilemma” as described by ethereum co-founder Vitalik Buterin. This suggests “permissionless” blockchains can achieve only two of three properties: namely scalability, security or decentralisation.

Systems based on pseudo-anonymity and a public ledger “introduces severe risks to privacy and integrity,” BIS said.

“It is also incompatible with a system based on real names, which is required to ensure integrity and accountability.”

Meanwhile, it says decentralisation is “an illusion” and points to DeFi’s tendency towards centralisation with key decisions made by votes of developers and early investors and a reliance on smart contracts tied to real-world “oracles”.

The global nature of crypto and DeFi would require international authorities to exchange information and take joint enforcement actions.

Realise the benefits

The BIS painted a vision where many of the benefits of crypto would be realised, but with central banks remaining at the heart of the monetary system. Central bank digital currencies and retail fast payment systems can serve the public interest through greater convenience and lower costs, while maintaining the system’s integrity, it said.

Blockchain technology would play a “constructive role”, but BIS suggests these should be “permissioned” (private) systems, rather than public ones, such as ethereum.

Money is too important to leave to technology companies, the group of central banks says. “Central banks are uniquely positioned to provide the core of the future monetary system, as one of their fundamental roles is to issue central bank money.”

This could soon involve “superior technological representations of M0 (the monetary base)”, including wholesale and retail CBDCs, which will offer benefits of crypto, including immediate settlement to reduce counter-party risk.

“Crypto offers a glimpse of potentially useful features that could enhance the capabilities of the current monetary system. These stem from the capacity to combine transactions and to execute the automatic settlement of bundled transactions in a conditional manner, enabling greater functionality and speed.”

Programmable CBDCs could also support machine-to-machine payments in autonomous ecosystems operating on the internet of things.

The report suggests work being done by the Council of Financial Regulators, including the Reserve Bank and Treasury, to study a retail CBDC for Australia is of global importance.

BIS pointed to 28 pilots under way to issue retail CBDCs, including one by the People’s Bank of China, which now counts 261 million users.

RBA governor Phil Lowe, who will travel to Switzerland this week to meet other central bank governors, has discussed the importance of “tokens” in his recent speeches on payments.

Tokenisation of bank deposits would create a digital representation of deposits on a blockchain and settle them in a decentralised manner. BIS said this could facilitate new forms of exchange – including fractional (part) ownership of securities and real assets.

Meanwhile, CBDCs could be made available to a wider range of intermediaries than commercial banks. Depositors could hold tokens in digital wallets and make payments by transferring tokens across wallets using wholesale CBDCs as settlement currency.

The BIS said retail CBDCs could be designed to protect privacy and give users more control over data, pushing back on the power of the tech giants.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s