Cryptocurrencies – what do they really offer?
Cryptocurrencies have high profile backers and detractors – JP Morgan CEO Jamie Dimon referred to them as a fraud and economist Joseph Stiglitz called for them to be outlawed.
On the other hand, Ben Bernanke, former Chairman of the US Federal Reserve, has talked about virtual currencies holding long-term promise, and the economics guru, the late Professor Milton Friedman pointedly referred to the benefits of a reliable e-cash.
Divisions on whether cryptos are the way forward or a disaster waiting to happen are as evident now as ever.
Money laundering fears
Detractors say cryptos serve little useful function other than to avoid governmental authorities and facilitate money laundering.
CipherTrace, a tech company that develops forensic tools and services for the blockchain, bitcoin, and cryptocurrency markets, recently published a report highlighting the rising amount of money laundered using cryptocurrencies in 2018.
According to the report, cryptocurrency theft and money laundering related to cryptocurrencies tripled in the first half of 2018 when compared to the previous year.
The counter argument is that bitcoin is popular in markets where their fiat currencies are unstable, such as Venezuela and Zimbabwe. Also, where governments attempt to restrict the outflow of domestic currencies, such as China, cryptocurrencies provide an attractive alternative.
Some would argue that bitcoin is fast becoming a mainstream asset class for some markets, including the US. In a recent interview with Business Insider, University of Cambridge Research Fellow, Garrick Hileman, suggests bitcoin is currently more an ‘asset’ than a currency.
He believes there are two factors that are preventing Bitcoin becoming a mainstream currency – high transaction fees and the volatility of crypto prices that typically fluctuate more than traditional currencies.
Hileman concedes though that bitcoin has the potential to become a more widely used currency, especially with the growth of its user base.
Are 2,000 cryptocurrencies sustainable?
Predicting the future of cryptos is not an easy business, least of all which of the 1,900-plus currencies will still be around a few years from now. The sheer number of cryptos does tend to scream ‘hype’.
No doubt in a few years many of these names will have disappeared. But how far will this go? Will there, at some point be only ONE cryptocurrency for the entire world?
Martin Armstrong of Armstrong Economics thinks this is unlikely. “I would probably bet on each government adopting a cryptocurrency per nation and prohibit the use of “foreign” cryptocurrency domestically. We also must respect that government wants to create some sort of cryptocurrency to ensure that everyone pays taxes.”
And what of the banking system. Does the rise of alternative currencies threaten to replace the banking system as we know it?
Writing for the Harvard Business Review, economists Antonio Fatás and Beatrice Weder di Mauro make the point that few market watchers seriously imagine that the new cryptocurrencies, for all the hype, will make national currencies redundant.
They argue that the US. dollar and other reserve currencies have historically performed well as a medium of exchange and as a store of value — the two principal functions of a currency. Bitcoin and its derivatives, on the other hand, do not perform as strongly on both accounts, therefore should not disrupt money as we know it.
However, the pair argue that this doesn’t mean new technologies won’t cause a great deal of disruption to the financial system.
“Traditional economists often ignore a crucial separation between money (the “what”) and the payment technology (the “how”). This confusion originates in the fact that for older forms of money — gold or bank notes — there is no distinction between the “what” and the “how”; you simply pay by handing dollar bills or gold coins to the seller.”
“Today, however, we pay out physical cash less and less often. Instead, when we transact, we usually transfer digital code in exchange for the good or service we’re buying. And it is through the technology that digitizes money that new entrants are challenging the financial system.”
Traditional banks face significant challenges. Firstly, changing legacy systems. Secondly, coordinating across the established payment networks is time consuming and costly and takes time. And, as Fatás and Weder di Mauro explain, in the case of international transactions, banks face the difficulty of managing liquidity pools in different currencies, as there is no ‘Central Bank of the World’.
It is conceivable that governments could look to combat the growing dominance of cryptos by making payment transfer a central bank function instead. If every individual had accounts at the central bank, and these were linked across countries, that would, in theory, create a centralized ledger for an entire economy, providing speedy and safe payments. Central banks are currently lukewarm on this idea insisting the risks to the financial system are high and the benefits uncertain.
Against this backdrop, a system based on a cryptocurrency (essentially a global currency) would appear a winning proposition. The problem is that using crypto currencies (assuming we always have multiple cryptos) means coping with another currency, an exchange rate, and uncertainty about value and the storage value of money.
Fatás and Weder di Mauro suggest that regulation itself may prove a huge disrupter in the banking space. Both the Open Banking initiative in the UK and the PSD2 directive of the EU require banks to provide access, through Application Programming Interfaces (APIs), to customers’ accounts. This enables parties other than the banks holding money to effect transfers.
Individuals can use their smartphone app to make payments without having to deal with separate money balances and possibly separate currencies. The app will access the relevant accounts through the APIs and transactions can be completed.
As Fatás and Weder di Mauro conclude: “The new regulations will enable a separation of the functions of money. Commercial banks may continue to hold money balances in traditional currencies and make loans to businesses with those balances, but transactions may be intermediated by a separate payment technology.”
Change the only constant
As with dotcoms in the late 90s and early noughties, forecasting the names of the business and technologies that will stand the test of time is hugely challenging. No doubt some cryptos will be consigned to the record books, while others are seen as trusted and innovative and subsequently survive and prosper.
The banking system will undoubtedly change, though in what way exactly, remains to be seen. What is true is that cryptos and blockchain have already been major disrupters – the question is where next from here?