Xavier Rolet: How central banks could end the crypto experiment

What to make of the cryptocurrency boom? I often get these questions: Insane bubble ready to pop? New asset class on its way to revolutionise the global Finance Industry?

Free markets are not an instrument of price stability nor an equitable means to distribute wealth. However, they are the best way we’ve invented to scale up the most promising scientific innovation to societal relevance. They often create huge new wealth in the process.

Free markets are also extremely efficient at reflecting the sum of all publicly available information, and the expectations it underpins. The fact that these expectations may be subject to brutal change when unexpected information is released or trends reverse abruptly (as sometimes happens with monetary policy) is no proof of their inefficiency, quite the opposite in fact.

As such, equity markets can also be an invaluable information feedback loop for policymakers which is another strong argument to resist calls to shut them down during major crises (you never hear such calls in boom times).

What are equity markets telling us about cryptocurrencies?

Cryptocurrencies are not a legal store of value, nor can they offer a legally safe transfer of value across borders. But they do reflect a very powerful and unmet need that our children will probably be puzzled we couldn’t see more clearly: to transfer value instantly across borders for personal or institutional transactions in a totally secure and legally enforceable fashion, and at no cost. And certainly without the frustration of having to anticipate or hedge variations in Foreign Exchange, always subject to the vagaries and manipulations of sovereign macro policy.

Namely, the need for a global digital currency.

The genius of the ageing blockchain technology underpinning cryptocurrencies was its decentralised nature. This has given rise to the emergence of a huge industry solving or “hashing” complex mathematical puzzles to verify blockchain transactions. This happens via the complex confirmation mechanism known as “proof of work”, which is intended to avoid fraud through double spending.

Because its computers rival the US Federal Government’s energy consumption, the carbon footprint of the “crypto-mining” industry is estimated to equal Argentina’s.
What is the future for cryptocurrencies?

In China, the central bank has already created its own national digital currency, whereas India or South Korea have banned cryptocurrencies. Elsewhere, central banks and securities regulators have been reluctant to take a position, letting cryptos grow outside any clear regulatory framework.

Herein lies the power and weakness of private sector initiatives like cryptocurrencies, when they seek to address the limitations of financial instruments backed by the regalian powers of nations.

Central banks’ powers are limited to the confines of the nations that empower them to issue currency. Progress by supranational institutions towards a global digital currency and a shared prudential supervision framework for clearing houses and market infrastructure has been slow after an initial impulse post WWII. It mostly came in reaction to major financial crises almost routinely caused by excessive leverage in the banking industry.

Bitcoin, Ethereum et al offer a framework backed by technological innovation unhindered by the limits of national boundaries. They show us a horizon of possibilities. The huge amount of capital they have attracted reflects the urgent need for a far more efficient, secure and cost-free global digital currency and payment system.

After a period of relative inaction and observation, during which the crypto industry grew to near-systemic size, central banks are now certain to take action. The introduction of their own digital currencies will likely seal the end of the private sector “crypto experiment”.

Pressure would thus come off securities regulators to approve the issuance of cryptocurrencies and related Delta 1 and derivatives instruments, which many have publicly declared are devoid of any intrinsic value.

Central banks could act in a several ways

Some have banned cryptos altogether, no doubt hoping they will go away. The People’s Bank of China issued its own. Given the size, growth rate of its economy and the nearly 20% of global financial assets that are already Chinese-owned, the PBOC can confidently expect its digital currency to succeed domestically. But will it succeed overseas beyond the belt and road?

Would an approach that requires other central banks to adopt its governance, operational framework and standards be globally scale-able?

A more incremental approach could involve a small group of like-minded central banks like the Fed, the BoE, the ECB and the BOJ. A cross-border clearing framework, shared standards and a single DLT Administrator, backed by a shared regulatory agreement, would provide legal standing to a global digital currency.

It would eliminate the environmental costs associated with crypto mining and the risks of unlawful usage by money launderers. Blockchain technology could support such a framework. But again, adoption by other major central banks in China, Russia, India or Brazil would be far from assured.

Enter the IMF

There is an already established Global Institution counting most of the world’s governments as stakeholders. Its mandate could be extended to include the creation, issuance and administration of a global digital currency based on the Special Drawing Rights regime, under the regulatory aegis and technological architecture run by the central banks of members.

This may seem far-fetched in our present angry era of “Nation rising against Nation, and Kingdom against Kingdom”. But privately issued cryptocurrencies face a bleak future if central banks get into the game with a credible global governance framework.

Xavier Rolet, KBE, is the chief executive of CQS and former CEO of the London Stock Exchange

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