Crypto’s Rising. So
Are the Stakes for Governments Everywhere
Competition in the global market for cash is heating up.
By Editorial Board
March 15, 2021, 7:00 AM GMT
Nice, but can you buy a pizza with it?
For centuries, money issued by governments has served as the
lifeblood of the global economy — the currencies in which people hold savings,
make payments and keep accounts, and in which nations measure their wealth and
geopolitical power. But in our digital age, it’s facing a bizarre, postmodern
sort of competition. Cryptocurrencies — created to supplant the traditional,
sovereign kind — have become a widespread obsession, inspiring their own
counterculture and attracting hundreds of billions of dollars in speculative
investment that may or may not have anything to do with their viability.
How, if at all, should issuers of the world’s official
currencies respond? In a word: carefully. As financial regulators, they need to
strike a balance between encouraging innovation and preventing harm. Most
important, as competitors in the global market for cash, they need to improve
their products.
Money comes in various forms, none ideal. Notes and coin allow for easy
face-to-face transactions and serve as a mostly stable store of purchasing
power, but they’re costly to hold in significant amounts and no use for
transactions at a distance. Bank
deposits, along with the credit and debit cards connected to them, are more
convenient but also flawed. They often entail hefty fees, and since (unlike
fiat money) they aren’t a direct liability of the government, they involve an
element of risk — relying on institutions that don’t always succeed in
maintaining the public’s trust. The 2008 financial crisis took a lasting toll
on confidence in the banking system — one reason holdings of physical currency
have since increased.
Enter Bitcoin, the first cryptocurrency. In a 2008 white
paper, the pseudonymous Satoshi Nakamoto described a system of electronic
cash that would operate outside established channels and dispense with the need
to trust any central authority or institution. A computer protocol would
create new digital tokens. And a voluntary
network of processing nodes would maintain a dispersed public ledger known as a blockchain, employing high-powered
cryptography to ensure accuracy, security and anonymity. Instead of
handling paper bills or transmitting deposits, people would make payments using private alphanumeric keys
establishing ownership of their Bitcoin.
More than a decade later, Bitcoin and other cryptocurrencies
have succeeded beyond their creators’ wildest hopes — after a fashion. But they
aren’t actually functioning as money. They’re poor stores of value, because their prices fluctuate wildly.
They’re also easy to lose: An estimated
20% of all Bitcoins are stuck in wallets to which people have lost the keys.
They’re not great for payments: Most places won’t accept Bitcoin, and transactions are often slow and expensive,
occasionally taking days or costing more than $25 each when the network is
congested. They’re extremely wasteful:
The computations required to maintain the Bitcoin blockchain alone consume as
much electricity as a mid-sized country, making a significant contribution
to climate change.
These seemingly fatal defects, though, haven’t prevented
cryptocurrencies from becoming a cultural and financial phenomenon. They’ve
taken on the trappings of a religious or revolutionary movement,
promising a future in which decentralized networks displace not only money, but
also companies, governments and society as we know it. This fervor overlaps
with the hyper-speculative world of day traders, where crypto has become a
favorite obsession — with help from the likes of Elon Musk, who put $1.5
billion of Tesla Inc.’s cash into Bitcoin. The total market value of Bitcoin, a
virtual asset with almost no practical
use except for illicit commerce, recently reached $1 trillion. Even
Dogecoin, created entirely as a joke, briefly topped $10 billion.
These remarkable gains are wearing down the resistance of
the financial and political establishment that cryptocurrencies were intended
to obliterate. Celebrity hedge-fund managers such as Paul Tudor Jones and
Stanley Druckenmiller have piled in. Big Wall Street banks are recommending
Bitcoin for investors and offering safekeeping
services. Bitcoin-focused trusts and derivatives — and possibly soon
a U.S. exchange-traded fund — offer exposure with no need to hold the actual
stuff. Mastercard is planning to process payments denominated in
cryptocurrencies. The mayor of Miami has proposed accepting property tax
payments in Bitcoin. A big step toward the mainstream came when Coinbase — the
leading crypto exchange, which earned more than $300 million amid the frenetic
trading of 2020 — filed for an IPO that could value it at close to $100
billion.
In other words, instead of revolutionizing the world of
finance, cryptocurrencies are stimulating its more casino-like aspects. They’ve become the ultimate speculative asset
class, a pure product of the collective imagination, with no apparent
connection to the real economy. Yet as more people and institutions get
involved — holding balances in cryptocurrency, borrowing in order to speculate
in cryptocurrency — the consequences could indeed be real. Regulators are
obliged to pay attention, because the volatility of cryptocurrency might begin
to threaten financial stability.
Some guidelines for public policy:
Don’t stifle innovation. Cryptocurrencies and the underlying
blockchain technology haven’t fulfilled their original purpose, but they could
yet have interesting and important applications. The blockchain’s capacity to create
unique and immutable digital records, for example, has enabled a burgeoning
market for one-of-a-kind collectibles — such as art, music and sports
highlights. Its decentralized governance has made way for new kinds of social
media, such as Minds and LBRY. Facebook’s proposed Libra system — now known as
Diem — is one of many that might spur reform of slow, cumbersome cross-border
payments. Authorities should be patient — giving entrepreneurs room to test
concepts before subjecting them to the full weight of regulation — lest they
quash ideas that could ultimately prove beneficial.
Tread carefully in markets. It’s not the job of regulators
to stop people making risky investments, but they do need to ensure people know
what they’re getting into and don’t harm others. The Securities and Exchange
Commission is right to get involved when digital tokens adopt the properties of
securities — as in many initial coin offerings. It would also make sense for
the U.S. to join Europe and Canada in approving Bitcoin exchange-traded funds;
this allows for adequate risk disclosure and custody procedures, and makes
speculation safer and less costly for the unsophisticated investor. As more and
bigger players get into the game, supervisors such as the Fed will have to ensure
that exposures don’t become large enough to threaten financial stability, and
that institutions have ample capital to absorb any losses.
Work on a better alternative. Give cryptocurrencies credit
for one thing above all. They’ve highlighted an enormous shortcoming of
ordinary money: There’s no true digital version of cash — one that represents a
direct claim on the government, can easily be transferred and is universally
available. It’s thus encouraging (for all except those heavily invested in the
existing digital tokens) to see central banks getting ready to compete. The Fed
and others are seriously considering the creation of their own digital
currencies.
To be sure, such radical innovation involves risk. A
full-fledged central bank digital currency would upset the business model of
traditional banks. If people were able to hold government-issued money directly
— the equivalent of opening an account at the central bank — they might dump
the deposits that remain the banking system’s primary source of funding. To
avert a collapse, central banks would have to ease the transition — by setting
limits on direct holdings, by using banks as intermediaries or by providing
banks with alternative financing.
Then there’s the issue of privacy. A digital currency could
allow governments to keep track of people’s spending — a possibility of
particular concern in China, which is already testing its own digital currency.
To alleviate worries about surveillance, central banks will have to provide a
degree of anonymity, while maintaining the access needed to track down
criminals and combat money laundering.
That said, a central bank digital currency could have vast
benefits. It could facilitate commerce, allowing consumers to make instant
electronic payments while avoiding billions of dollars in transaction fees. It
could make financial services accessible to millions of “unbanked,” helping
them build wealth instead of succumbing to financial predators. It could
improve tax collection and make economic indicators more timely and precise. It
could provide policy makers with new and powerful tools to fight recessions and
control inflation. Imagine, for example, the effect of issuing funds that had
to be spent within six months.
In the end, the legacy of the cryptocurrency craze might be
a better form of money. If so, all the commotion — not to mention all the
losses between now and then — will have been worth it.
(Corrects spelling of Diem in tenth paragraph.)
To contact the senior editor responsible for Bloomberg
Opinion’s editorials: David Shipley at davidshipley@bloomberg.net .
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