THE BIG READ: IoB’s deep dive into important topics. Chris Middleton listens to Bank of England governor Mark Carney take down cryptocurrency in a display of traditional banking logic. Then Chris challenges Carney’s argument with a very different view. A detailed, provocative – and important – debate. (2,800 words.)
UPDATED 11 March, 2018.
Cryptocurrencies are “failing” as money, claimed governor of the Bank of England Mark Carney on 2 March, 2018.
In a speech entitled ‘The Future of Money’ to the Inaugural Scottish Economics Conference at Edinburgh University, Carney questioned whether cryptocurrencies can even be considered money.
Quoting the Adam Smith definition – that money is a store of value with which to transfer purchasing power, a medium of exchange for goods and services, and a unit of account with which to measure the value of a good, service, saving, or loan – Carney said:
“[This] hierarchy points to the reality that money is a social convention. We accept that a token has value whether made of metal, polymer, or code because we expect that others will also do so readily and easily.”
Measuring cryptocurrencies such as Bitcoin and Monero against this definition, Carney said: “The answer has to be judged against the functioning of the entire cryptocurrency ecosystem, which extends beyond the currencies themselves to the exchanges on which cryptocurrencies can be bought and sold, the miners who create new coins, verify transactions, and update the ledger, and the wallet providers who offer custodian 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.”
Store of value, medium of exchange
First, cryptocurrencies are proving poor short-term stores of value, claimed Carney, referring to their volatility over the past few years. “The average volatility of the top ten 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.”
The question ‘what are cryptocurrencies backed by?’ is a good one. Arguably, the answer at present is depreciating computer hardware: ageing metal, rather than precious metal, such as gold.
Carney went on to say that cryptocurrencies are an inefficient medium of exchange, too. “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.
“Currently, no major high street or online retailer accepts Bitcoin as payment in the UK, and only a handful of the top 500 US online retailers do.”
But that will change as crypto volatility is replaced by the network’s balancing effect as more and more people join. The UK typically lags two years behind US tech adoption trends.
Carney then claimed that cryptocurrencies are simply a new form of bubble: “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.”
The greater fool theory concerns an object’s price not being determined by its inherent value, but by the beliefs of a market’s participants. Hence, you can always find someone who is a greater fool than you in terms of how much he will pay for something, or how valuable he believes something will be.
“Far from being strengths, the fixed supply rules of cryptocurrencies such as Bitcoin are serious deficiencies,” he continued.
“Fundamentally, they would impart a deflationary bias on the economy if such currencies were to be widely adopted. 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.”
An interesting point: the network effect is already a massive deflationary factor in society, by commoditising everything it touches – the journey from vinyl to CD to iTunes to Spotify being the most obvious example, or the journey from salaried to gig employment. Bankers would argue that this is a reason not to make long-term investments in cryptocurrencies. They may be right.
Carney then called for cryptocurrencies to be regulated, in order to – he suggested – harness the technologies for wider public use. “In my view, holding cryptoasset exchanges to the same rigorous standards as those that trade securities would address a major underlap in the regulatory approach,” he explained.
This last point was perhaps the most interesting, and suggests that the Bank of England wants to absorb a technology that is designed to be an alternative to the inherent flaws of traditional banking, and which has – arguably – emerged from public usage.
Is banking dead?
Opening his speech, Carney said: “A few of you may view paper money – even the Bank of England itself – as archaic vestiges of an old centralised order of payments that will soon be swept aside by a digital, distributed future.”
Carney then countered that viewpoint by alleging a direct link between cryptocurrencies and criminality:
“Its advocates claim that a decentralised cryptocurrency, such as Bitcoin, is more trustworthy than centralised fiat money because its supply is fixed and therefore immune from the age-old temptations of debasement; its use is free from risky private banks; and those who hold it can remain anonymous and therefore free from the ravenous eyes of tax authorities, or worse still, law enforcement.”
This is ironic, as any distributed ledger system, such as blockchain or hashgraph, would theoretically expose anomalous criminal behaviour unless every computer in the network was behaving in exactly the same way.
And Carney’s comments would seem to imply that banks are inherently trustworthy. However, in 2012, banks including UBS and Barclays were fined a total of $22 billion for rigging the London Interbank Lending Rate (Libor). In 2014, US and UK regulators fined several banks, including HSBC, UBS, JP Morgan, and Citibank, $2.6 billion for conspiring to manipulate foreign exchange rates.
Since 2015, banks in the UK are thought to have paid out $30 billion (£22 billion) in compensation for mis-selling payment protection insurance (PPI) – a scandal that affected over 1.5 million people.
And since 2008, there have also been multimillion-dollar fines for, among other things, banks laundering Iranian money, and running illegal interest-hedging schemes. In the latter case, HSBC, Barclays, Lloyds, and RBS were among the banks involved in a scandal that affected thousands of small businesses.
In the past 10 years, it seems, few big-name banks have not been involved in illegal behaviour.
Nevertheless, Carney continued – and finally hit the bullseye: “Some also argue that cryptocurrencies could be more efficient than centralised fiat money because the underlying distributed ledger technology cuts out intermediaries like central banks and financial institutions and allows payments to be made directly between payer and payee.”
And this last point, surely, is the real reason that Carney took to the stage to claim that cryptocurrencies are failing.
So is he right?
Internet of Business says
The challenge for long-established institutions such as the Bank of England – and indeed, for the global banking sector – is that the concept of a decentralised, distributed, peer-to-peer ledger does indeed call into question the need for traditional banking.
The suggestion that some banks may go the same way as Maplin or Toys R Us in the UK isn’t something that any banker would take lightly.
But set aside the issue of whether cryptocurrencies and blockchain pose an existential threat to the banking sector, and the real questions at the heart of this debate instantly become more interesting.
The core challenge facing cryptocurrencies is simple, and yet was omitted by Carney in his commentary: their advocates often ignore the fact that these new digital currencies aren’t magic beans that grow in a virtual kingdom. They reside in computer hardware.
A good comparison is cloud computing – or ‘the cloud’. The idea that some have of cloud being an egalitarian fog of code that floats past national borders has always been absurd. But that was the point of a handful of ex-Oracle startup CEOs inventing the term in the Noughties.
‘The cloud’ is really about data centres built on land under national laws, and the West Coast marketing departments of hosted software companies knew this when they coined the term – quite deliberately to deceive – in the early years of this century.
As the CEO of one newly christened ‘cloud’ company (previously application service provider) whispered to me in San Francisco in 2007, “We had to give the consultants something to sell”, and what they were selling was rented space on racks in US industrial parks.
Say “my data’s in the cloud” and it sounds reassuring, futuristic, even like a humanist credo; say “my data’s in a warehouse in Utah” and suddenly it doesn’t sound like such a great idea, despite the opex and agility advantages.
The cloud was invented by marketers as a means to persuade people to stop hosting their data on premise and instead host it somewhere else – for money. It’s the ultimate cashflow system for anyone who rents out space on a chunk of hardware. (Of course, there are private and on-premise clouds, but you take the point.)
But so what?
This is relevant because cryptocurrencies also reside in computer hardware: fast, expensive computer hardware, such as the high-end GPUs made by companies such as NVIDIA, which mine for coins by cracking code. And that means cryptocurrencies cost money.
As previously reported by Internet of Business, this is the real reason why NVIDIA’s stock price and revenues have created their own mini bubble since 2014 – a bubble that tracks the movement of cryptocurrencies’ market capitalisation (see for yourself in the attached graphic on that report).
The key question then is easily stated: what is the cost per watt of mining? The big problem is that this is not a simple calculation to make and – at present – it’s the real reason why it is so hard to establish a fair value for any cryptocurrency. Hence the prevalence of ‘greater fools’ and bubble behaviours.
But whatever the answer to crypto’s true value may be, lies in working out the real-world financial, environmental, and human cost of not only powering up and running a GPU – or a mining rig full of them – but also of manufacturing the hardware and shipping it across the globe.
Put another way, cryptocurrencies aren’t separate from the laws of physics, as many gamblers seem to believe, but are in fact entirely dependant on them. Just like the cloud, they’re anchored in hardware – which is why you can now heat your house while mining for cryptocurrency.
But what has any of this got to do with banking? That’s simple.
In the traditional banking system, these types of technology and processing costs have long been absorbed by the banks – in theory, at least. But the financial crash of 2008-09 exposed that as a lie: the public bailed out the banks to the tune of an estimated $1.4 trillion (£1 trillion) – and that was just in the UK.
Years of austerity followed a bailout that was nearly one-third of the size of the entire British economy. And they will continue to follow.
As previously mentioned, since the 2008 crash, banks have also been fined nearly $100 billion for illegal behaviour, such as money laundering, fleecing the public, and conspiring to manipulate exchange rates. Clearly, the idea that banks were covering transaction processing costs was a long way from the truth.
The human and financial costs of the public’s support of the banking system – as opposed to a banking system that should serve and support the public – have been swiftly forgotten by the financial services sector.
So the big question then becomes rather different: has the traditional banking system been a good custodian of nations’ – and citizens’ – wealth? And is it somehow intrinsically superior to crypto, blockchain, and hashgraph? Carney would answer yes; but he would be wrong.
The global banking sector has been run not by sober, trustworthy individuals in recent years, but by high-stakes gamblers and thrill-seekers – many of them offshore. Not to mention by algorithms that value personal debt more highly than personal credit.
Just as a cancer is a normal cell that stops receiving chemical signals in a healthy body, so the banking system has stopped serving the society it grew within and has started devouring it. And little has changed. By contrast, blockchain’s advocates claim it is a system of cells that is always under control in the interests of the body’s constantly monitored health.
There are flaws in blockchain, to be sure – which we will explore in future analyses. The biggest of these is that it creates not just highly controlled environments, but also highly controlling ones. For example:
Picture a car or truck that the driver is afraid to get out of, because he will stop being paid. Or a factory floor that workers never want to leave because the flow of micro-payments will cease when they walk out of the building.
Of course, many thrill-seeking gamblers have now piled into the crypto market, too, as have the hackers and botnets creators who want to use someone else’s computers to absorb the cost and processing of mining.
But that’s no different, in spirit, to how many banks behaved in the run-up to the 2008 crash, and continue to behave to this day. We have all paid for their gambling habit, and for bankers’ realisation that the tedious predictability of compound interest is not as thrilling as living on the edge or betting people’s livelihoods on sub-prime debt.
That aside, are cryptocurrencies an efficient means of exchange? Carney says no – based on setting a handful of years of data against centuries of data from traditional banking; an oranges/apples argument if ever there was one. And on that point, he will be proved wrong again.
And the reason lies in the Internet of Things.
Over the next few years, a global IT infrastructure will be overlaid on, and woven into, the internet as we know it today. And it will include smart environments that recognise people, know their location, and will either pay them or be paid by them seamlessly.
Much of this infrastructure is already being built on blockchain – including in the manufacturing and supply chain – and on other technologies including sensors, RFID tags, smart edge applications, AI, machine learning, and location-based services. As a result, the IoT’s natural currency may prove to be crypto. In time, this system will become the Internet of Everything.
Put another way, our data is the new gold, and the only meaningful currency is our consent.
Some case studies about the types of company that will arise in this new environment can be found towards the end of this separate Internet of Business report.
One of the other criticisms levelled at cryptocurrencies by Carney is that the system is too slow to process them, meaning that traditional banking systems could have processed thousands of transactions in the same time that a distributed ledger could process a handful.
At present, this is true. Most banking transactions currently take milliseconds, while blockchain or crypto transactions can take minutes. Over time, this too may change, subject to Moore’s Law and basic physics.
So in the long term the serious question that demands an answer will no longer be “is a cryptocurrency money?”, but “what does a traditional banking system offer most human beings on the planet?”
The answer to that question is what will really determine whether cryptocurrencies become a social convention in the long run. As Carney says, one governing purchasing power, a medium of exchange, and a unit of account. Money.
Blockchain and cryptocurrencies are holding the banks to account in many ways. In response, therefore, the banks will have to do much better than close ranks, put the boot in, and try to bend the technology to their will.
This is not an ideological viewpoint, but a simple statement of fact: a repeat of 2008-09 would be intolerable for everyone who has already paid for the banks’ mistakes with their closed businesses, their wages, their jobs, their withdrawn benefits, their closed community centres, or their lives. Banks must start working for everyone, and not just for themselves.
But here’s the rub: in a competitive market, that’s impossible. And that, Mr Carney, is why these new technologies exist.
• In related news, Bill Gates said in a Reddit Q&A on 1 March that he believed the anonymity of cryptocurrencies was causing deaths by being linked to drugs, money laundering, and terrorism. Some participants in the session were critical of his remarks, suggesting that he had a poor understanding of the technology. He has previously spoken out in favour of cryptocurrencies.