The Bank for International Settlements (BIS) is not a great fan of crypto. The BIS is sometimes known as the central bankers‘ bank and as such you wouldn’t really expect them to be in love with crypto.
In the annual report, for which the 24-page summary was published yesterday, the BIS draws a number of conclusions about crypto and they are all negative. Actually we should revise that statement – the BIS makes a number of statement that seem to be about bitcoin as opposed to crypto per se. OK is it reasonable for it to concentrate on bitcoin as it is the oldest and best established of the nascent asset class, but many of the criticisms can be debunked when applied to crypto more widely or to bitcoin post software upgrades. It is not exactly an earth-shattering finding that bitcoin has a scaling problem, but the BIS seems to discount the possibility of that being fixed through technological means.
The BIS concludes that bitcoin if adopted on a nation scale or at any scale similar to cash and that needed for commercial operations, would break the internet because of the number of transactions required. “The associated communication volumes could bring the Internet to a halt as millions of users exchanged files on the order of magnitude of a terabyte.” Bitcoin does have a scaling problem but the report makes the mistake of assuming that at the endpoint of each transactions there needs to be a node, which is not he case. “To process the number of digital retail transactions currently handled by selected national retail payment systems, even under optimistic assumptions, the size of the ledger would swell well beyond the storage capacity of a typical smartphone in a matter of days, beyond that of a typical personal computer in a matter of weeks and beyond that of servers in a matter of months.” Updating the ledger is one thing – and involves a high l level of congestion on the bitcoin blockchain – but the suggestion here that each wallet needs to have a copy of the ledger is erroneous.
Further, the reports says that “technology is not substitute for trust”, although skips over the fact that the reason for the rise of crypto was precisely because of the lack of trusts in central banks and bankers more generally in the wake of the financial crisis. of 2007/8. “Trust can evaporate at any time because of the fragility of the decentralized consensus through which transactions are recorded.”
But side chain and off chain solutions such as Lightning could go a long way towards fixing those problems.
And then there is the mining issue: “Put in the simplest terms, the quest for decentralised trust has quickly become an environmental disaster.” But many crypto exists because they have more efficient (from an energy consumption perspective) mining mechanisms or don’t use mining at all. The BIS does not mention any of these in its report.
The report does may the valid observation that a failure of a network has the possibility of destroying value and in the BIS’s view this makes it flawed and unsuitable as a money form. However bitcoin has been up and running for nigh on 10 years and has never had any down time or been hacked. What would it take for bitcoin to implode at a technological level? It would require the internet to be turned off or otherwise incapacitated. If that did happen it would destroy value across the financial system, fiat included, given that most money exist in digital form. IN fact given the reliance of economies on internet technology the fallout would extend well beyond just financial companies.
The strongest point made in the report relates to volatility and how the current pricing makes all crypto unsuitable as a unit of account. The BIS locates this problem in the pre-determined supply of tokens set by the protocol which means there can be no adjustment in supply to meet different levels of activity. In our view this is a more fundamental criticism goes to the heart of crypto and the false premise that money supply can determine the health of an economy. Here’s the key excerpt:
“The second key issue with cryptocurrencies is their unstable value. This arises from the absence of a central issuer with a mandate to guarantee the currency’s stability. Well run central banks succeed in stabilising the domestic value of their sovereign currency by adjusting the supply of the means of payment in line with transaction demand. 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.”
However, supply mechanisms could be tweaked to allow for an element of flexibility without damaging cryptographic decentralized trust, providing the rules are known beforehand and their governance is transparent. In addition volatility issues are related to the lack of maturity of the asset class and will likely change as market depth increases, crypto becomes more widely held and institutions get more deeply involved.
Gary has been writing about cryptocurrencies since 2013 and currently works as the cryptocurrency analyst at interactive investor, the UK’s second-largest online investment platform. Gary contributes for Coin Intelligence News in a personal capacity and none of his commentary should be considered investment advice. Gary is the winner of the ADVFN International Financial Awards 2018 Cryptocurrency Writer of the Year. Contact Gary on twitter at: @gary_mcfarlane