Cryptocurrency use could “bring the internet to a halt”, but blockchain is a different story, says Bank for International Settlements

The ‘trustless’ properties of cryptocurrencies “limits their potential” to replace good old-fashioned cash, but the blockchain technology they’re based on could have financial functions, according to a report from the Bank for International Settlements (BIS).

Based in Switzerland, BIS is owned by, and serves, 60 international central banks. In its inaugural Annual Economic Report, the bank dedicated a chapter to cryptocurrencies, evaluating “whether cryptocurrencies could play any role as money”.

In a statement on the findings, BIS says: “Cryptocurrencies’ model of generating trust limits their potential to replace conventional money.”

The statement adds: “The decentralised technology underpinning private digital tokens is no substitute for tried and trusted central banks.”

The conclusion hinges around cryptocurrencies’ model of generating trust, in that ‘miners’ and users rely on each other for the system to work.

While cryptocurrencies promise convenient payment in an environment of trust, “delivering on that promise hinges on a set of assumptions”, the report says, including the assumption that the computing power involved is controlled by honest miners and that users actually verify the history of transactions.

Crypto use could “bring the internet to a halt”

The report goes on to list several of the oft-cited “underlying economic problems” with cryptocurrencies – namely: scalability, stability and trust in the finality of payments.

Distributed ledgers are easily congested, the report notes, and “this limits cryptocurrencies’ usefulness for day-to-day transactions such as paying for a coffee”.

Equally, the speed at which new cryptocurrencies are coming to market contributes to instability, the report says, noting that if current cryptocurrencies were to process the same number of transactions per day as traditional financial institutions do, the associated communication volumes could “bring the internet to a halt”.

“Recalling the private banking experiences of the past, the outcome of such liberal issuance of new moneys is rarely stability.”

It concludes: “Overall, decentralised cryptocurrencies suffer from a range of shortcomings. The main inefficiencies arise from the extreme degree of decentralisation: creating the required trust in such a setting wastes huge amounts of computing power, decentralised storage of a transaction ledger is inefficient and the decentralised consensus is vulnerable.

“Some of these issues might be addressed by novel protocols and other advances. But others seem inherently linked to the fragility and limited scalability of such decentralised systems. Ultimately, this points to the lack of an adequate institutional arrangement at the national level as the fundamental shortcoming.”

The report notes regulatory challenges associated with the rise of cryptocurrencies – notably, upholding anti-money laundering and combating financing of terrorism rules. It also raises issues around the capacity for fraud, and limits to investor protection.

However, BIS suggests that blockchain, the distributed ledger technology underpinning cryptocurrencies, could have significant financial use cases.

It references the blockchain-based ‘building blocks’ system in use for payments for food aid, serving Syrian refugees in Jordan.

While, essentially, this is ‘cryptopayment’, the report stresses that it is “not a cryptocurrency”, and notes that it’s controlled, centrally, by the World Food Programme, in order to speed up transactions and reduce the costs involved.

The report says: “An initial experiment based on the permissionless Ethereum protocol resulted in slow and costly transactions.

“The system was subsequently redesigned to run on a permissioned version of the Ethereum protocol.

“With this change, a reduction of transaction costs of about 98% relative to bank-based alternatives was achieved.”

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