The EU’s Policy Department for Economic, Scientific and Quality of Life Policies released a report entitled “Virtual currencies and central banks monetary policy: challenges ahead.” Authored by Marek Dabrowski and Lukasz Janikowski, the report comes at the request of the European Parliament’s Committee on Economic and Monetary Affairs, and its findings are a focal point for the committee’s July 2018 Monetary Dialogues.
Referring to cryptocurrencies as virtual currencies (VCs), the report examines the functionality of cryptocurrency as a monetary instrument; its most popular iterations in bitcoin, ether and other popular currencies; and its ramifications for governments and their central banks.
In evaluating cryptocurrencies as a novel, potentially disruptive technology, the report ultimately concludes that “[policy] makers and regulators should not ignore VCs, nor should they attempt to ban them … VCs should be treated by regulators as any other financial instrument, proportionally to their market importance, complexity, and associated risks.”
Even so, the report is measured in its findings, and it does expose the limitations cryptocurrencies and their contingent blockchain technology currently pose. Directing its analysis to the question of crypto’s chances to supplant current central banking practices, the report succinctly concludes “the answer seems most likely ‘no.’”
A Fair and Balanced Analysis
In summary, the report reads as a more comprehensive and balanced analysis for cryptocurrency’s possible economic impact than the Bank of International Settlements own. The Swiss bank’s document, which roused the skepticism of leading industry voices, provided outdated research and findings that conveyed a shallow understanding of the industry outside of Bitcoin’s impact.
By contrast, the European Union’s report plays devil’s advocate for both cryptocurrency’s strengths and its weaknesses and examines the asset class from a variety of angles.
In its introductory analysis, the report consistently returns to the idea that cryptocurrencies are utilized as “a contemporary form of private money.” As private money, they “have no intrinsic value in the sense that they are not linked to any underlying commodity or sovereign currency,” the report claims, though it does admit that “in this respect, they do not differ from most contemporary sovereign currencies.”
The report continues to give a simple and cogent breakdown of cryptocurrency’s economic characteristics and technological features. It continues to provide brief descriptions of the market’s top three most popular assets (BTC, ETH and XRP) and the acceptance of cryptocurrency by popular merchants and services.
Subtitled “Potential economic advantages and disadvantages of VCs (risks and opportunities),” the report then launches into a subsection to weigh crypto’s pros and cons.
To summarize, the authors highlight a number of merit-worthy advantages. They cite the typical rallying cry of crypto-enthusiasts — that the assets allow for low-fee, transnational, fast and near-anonymous transactions. This is especially useful in developing or impoverished nations where citizens lack access to traditional financial instruments, the report states.
This last benefit, however, is marred by the learning curve cryptocurrencies present to new users. The authors also provide counter arguments for cryptocurrency’s promise to deliver fast, low-fee transactions, questioning the long-term sustainability of a blockchain network and the potential for higher fees once mining rewards become a thing of the past.
Among other disadvantages, the report also discusses scalability concerns, the ecological impact of mining and the shady online practices that anonymity can facilitate. Still, the “fear that VCs will facilitate money laundering, the financing of illegal activities, tax avoidance, the circumvention of capital controls … and fraudulent financial practices,” the report states, “may be legitimate in some instances but must not be generalised,” as by and large,“transactions in VCs result from the free business choices of economic agents.”
Delving further into crypto’s limitations, the report continues to point out the inherent risks of investing in a largely unregulated, speculative market, citing the 2018 market’s diminishing returns and the vulnerability of centralized exchanges.
The report finishes the section with a brief overview on the cryptocurrency regulatory policies of the United States, Switzerland and China.
In its second section, the report concludes, “For all of the above-mentioned reasons, one must be prepared that VCs will remain a stable component of the global monetary and financial architecture for several years to come.”
...one cannot exclude the possibility that a number of users and transactions will increase to the extent that VCs will become a fully-fledged substitute of sovereign currencies in the future. We assume that VCs have potential to serve as full-fledged private money regardless of their future share in the overall volume of transactions and financial assets.
As such, Dabrowski and Janikowski warn that “economists who attempt to dismiss the justifications for and importance of VCs, considering them as the inventions of ‘quacks and cranks’ (Skidelsky, 2018), a new incarnation of monetary utopia or mania (Shiller, 2018), fraud, or simply as a convenient instrument for money laundering, are mistaken.”
“VCs respond to real market demand,” they continue, and they believe that attempts to regulate or ban cryptocurrencies out of existence are misguided and inconsequential. Instead, policy makers should provide clear, cohesive regulations that treat cryptocurrency as a formal, taxable asset throughout the globe.
Given their global, trans-border character, it is recommended to harmonise such regulations across jurisdictions. Investment in VCs should be taxed similarly to investment in other financial assets.
All of this said, the authors still hold that cryptocurrencies pose little threat to the central bank status quo, and the report’s third and final section devotes its word count to a brief history of central banking practices and how cryptocurrencies are covering the same historical ground as other private monetary systems.
Ultimately, the report finds that, except in cases of extreme political, social or economic unrest, cryptocurrencies likely will never replace government-issued tender. It does admit that, in these extreme cases, they may stand in as substitute currencies for a faltering national currency in the throes of hyperinflation, as we have seen with bitcoin’s popularity against the bolivar in Venezuela in recent years.
“Despite their technological advances and global reach, VCs are far from being able to challenge the dominant position of sovereign currencies and the monetary policies of central banks, especially in major currency areas. However, in extreme cases, such as during periods of hyperinflation, financial crisis, political turmoil, or war, they can become a means of currency substitution in individual economies,” the report reads.
Even with this analysis, the report ends on an optimistically-balanced note, recognizing that the industry still has legs to run and the possibility of future innovation to take it further. Checking itself on its prior claims, it suggests that, with the right technological advancements, cryptocurrency’s potential should not be underestimated.
One cannot rule out that future progress in the area of information technologies can bring even more transparent, safe, and easier to use variants of VCs. This might increase the chances for VCs to effectively compete with sovereign currencies, including the major ones.