In a speech delivered today, Bank of England Governor, Mark Carney, stated that crypto-assets don’t currently pose a risk to the stability of financial markets, even as he declared that cryptocurrencies are “failing” as a form of money.
Speaking at the inaugural Scottish Economics Conference at Edinburgh University on the subject of the future of money, Carney’s speech was heavily focused on cryptocurrencies.
Addressing the question of how well cryptocurrencies fulfill the traditional role of money, Carney argued that the answer has to be judged against the functioning of the entire cryptocurrency ecosystem. This ecosystem includes exchanges that enable the buying and selling of cryptocurrencies, miners who create new coins and verify transactions and the wallet providers who effectively offer custody services.
“The long, charitable answer is that cryptocurrencies act as money, at best, only for some people and to a limited extent, and even then only in parallel with the traditional currencies of the users. The short answer is, they are failing,” he then commented.
To support this conclusion, Carney highlighted the fact that cryptocurrencies are currently a poor store of value because of the price volatility associated with them. The average volatility of the top 10 cryptocurrencies by market capitalisation was more than 25 times that of the US equities market in 2017.
“This extreme volatility reflects in part that cryptocurrencies have neither intrinsic value nor any external backing. Their worth rests on beliefs regarding their future supply and demand – ultimately, whether they will be successful as money. Thus far, however, rather than such a sober assessment of future prospects, the prices of many cryptocurrencies have exhibited the classic hallmarks of bubbles including new paradigm justifications, broadening retail enthusiasm and extrapolative price expectations reliant in part on finding the greater fool,” said Carney.
He also argued that, rather than being a strength, the fact that there is finite supply of some cryptocurrencies such as bitcoin, is actually a serious deficiency. This is because, claimed Carney, these cryptocurrencies would impart a deflationary bias on the economy if they were to be widely adopted.
He commented: “If ‘those who cannot remember the past are condemned to repeat it’, recreating a virtual global gold standard would be a criminal act of monetary amnesia.”
Carney went to on say that another reason why cryptocurrencies have thus far failed as forms of money is that they are an inefficient medium of exchange.
“The most fundamental reason to be sceptical about the longer term value of cryptocurrencies is that it is not clear the extent to which they will ever become effective media of exchange,” he said.
Carney made the point that no major high street or online retailer accepts bitcoin as payment in the UK and that the more heavily used cryptocurrencies face severe capacity constraints compared with other payment systems. For example, Visa can process up to 65,000 transactions per second globally against just seven per second for bitcoin.
Finally, Carney pointed out that cryptocurrencies are not currently being used at any meaningful scale as units of account.
“Given that they are poor stores of value and inefficient and unreliable media of exchange, it is not surprising that there is little evidence of cryptocurrencies being used as units of account. Retailers that quote in Bitcoin usually update at very high frequency so as to maintain stable prices in traditional currencies such as US dollars or sterling. The Bank is not aware of any business that accepts bitcoins in payments that also maintains its accounts in bitcoin,” he said.
Despite the fact that he rates the chances of crypto-assets (Carney said this term is preferred, given that they aren’t true currencies) replacing fiat money are slim at best, Carney noted that they are still of interest to policy makers.
Currently, the Bank of England’s Financial Policy Committee (FPC) is considering the risks posed to UK financial stability, which internationally the Financial Stability Board (FSB) will report to the G20 in Argentina later this month on the financial stability implications of crypto-assets.
However, today Carney said that, in his view, “crypto-assets do not appear to pose material risks to financial stability”.
He revealed that this lack of concern is largely driven by the fact that crypto-assets are so small relative to the financial system. Even at their recent peak in December last year, the combined global market capitaliastion of crypto-assets was less than 1% of global GDP.
In comparison, at the height of the dotcom mania, the valuations of technology stocks were closer to about a third of global GDP. And just prior to the global financial crisis, the notional value of credit derivative swaps was 100%.
In addition to the relative size of the crypto-asset market, the major UK financial institutions only have minimal exposures to this ecosystem, which is another reason Carney cited as evidence that it does not pose a risk to financial stability.
Despite this, the Governor noted that, “financial stability risks could rise if retail participation significantly increased or linkages with the formal financial sector grew without material improvements in market integrity, anti-money laundering standards and cyber defences”.
Carney added: “Authorities are rightly concerned that given their inefficiency and anonymity, one of the main reasons for their use is to shield illicit activities. This cannot be condoned. Anarchy may reign on the dark web, but in the UK, it’s just a song that your parents used to listen to.”
Discussing how financial authorities should respond to the rising popularity of crypto-assets, Carney argued against banning them outright and in favour of regulating elements of the crypto-asset ecosystem in order to combat illicit activities, promote market integrity, and help protect the safety and soundness of the financial system.
“The time has come to hold the crypto-asset ecosystem to the same standards as the rest of the financial system. Being part of the financial system brings enormous privileges, but with them great responsibilities. In this spirit, the EU and the US are requiring crypto exchanges to meet the same anti-money laundering and counter the financing of terrorism standards as other financial institutions,” he added.
Carney concluded: “Conduct and market regulators are considering how to classify crypto-assets in order to secure market integrity and determine the appropriate type and level of investor protections. In my view, holding crypto-asset exchanges to the same rigorous standards as those that trade securities would address a major underlap in the regulatory approach.”