The Bank for International Settlements (BIS), which supports central banks in efforts to promote financial stability, claimed that permissionless cryptocurrencies are not suited to become the basis of a monetary system, a Bloomberg report showed on June 17. The BIS also acknowledged, however, that there are areas where cryptocurrencies can improve efficiency.
The BIS also acknowledged the possibility of the use of central bank issued digital currencies, which some central banks are already investigating.
The BIS gave an appraisal on cryptocurrencies and distributed ledger technology in its annual economic report.
According to the BIS, a monetary system must be elastic to address demand and must be able to scale with the economy. These are functions that central banks have successfully provided, the report says.
In contrast, the report continues, cryptocurrencies decentralized nature offers an insufficient substitute for traditional, institutional backing of money.
The BIS contends that the use of decentralized consensus can undermine trust in the system. The bank says that a breakdown in trust can cast doubt on the finality of payments, meaning the system could stop working. If this happens, the currency could lose value.
The bank also says that cryptocurrencies are subject to the issues of inefficiency and extensive power use. These currencies are unable to scale with rising transactions and cause congestion and fluctuation in value.
The bank also noted that the rate at which new cryptocurrencies come into being also contributes to instability.
The finality of payments is also an issue that the BIS investigated. The report argues that cryptocurrencies cannot guarantee the finality of individual payments since there can be competing versions of the ledger. Transactions get rolled back when two miners update the ledger at the same time. Only one of the two can survive, making payment finality an issue.
Miners who hold large amounts of computing power can also manipulate cryptocurrencies.
Forking of a cryptocurrency can also show how fragile decentralized consensus is in updating a distributed ledger.
New protocols solve some of the issues. Some, however, are inherently linked to the limited scalability and fragility of decentralized systems.
The report says that while cryptocurrencies fall short as money, the technology shows potential in other areas. Distributed ledger technology shows promise in several niche environments where decentralized access benefits show themselves to be superior to other traditional solutions.
Distributed ledger technology’s value will derive mainly from the streamlining of administrative processes used in complex financial transactions such as trade finance.
The report also says that regulation is an issue. Anti-Money Laundering and terrorism financing challenges need answers. The question of how much cryptocurrencies have allowed the evasion of these standards is up for debate. Some cryptocurrencies are anonymous, making it difficult to determine if they are used to avoid taxes or to engage in illegal activity.
Lastly, the BIS also reported that CBDC’s is another issue that needs investigation.
CBDCs function similarly to fiat currency, with central banks issuing a CBDC, then letting other banks, non-financial firms, and public consumers to use the CBDC without any further involvement from the central bank aside from determining who acts as a trusted node for the CBDC.