“Cryptocurrency systems can’t scale or be trusted” – central banking organisation

“Cryptocurrency systems can’t scale or be trusted” – central banking organisation

UPDATED The more popular cryptocurrencies become, the less trustworthy and efficient they are, according to a key central banking organisation.

Cryptocurrencies are “not scalable and are more likely to suffer a breakdown in trust” as they grow, according to the annual report from the Bank of International Settlements (BIS), the umbrella organisation for the world’s central banks.

The BIS is warning the world’s central banks to think hard about the potential risks before issuing cryptocurrencies of their own.

Effective regulation of digital coins needs to be global, it added, targeting both regulated financial institutions as well as companies offering crypto-related services.

Are cryptocurrencies real money?

As previously reported by Internet of Business (passim), the core challenges facing all cryptocurrencies in the quest to create a distributed, peer-to-peer banking and finance system are:

  • What is any cryptocurrency backed by, other than fast-depreciating computer hardware? (aka ‘where is the gold?’)
  • And what is the cost per watt of mining? (aka what are the energy costs and the environmental impact of manufacturing and running vast networks of mining rigs, even a small one of which can heat a room).

Without being able to answer both of these questions, it is impossible to calculate the real-world value of any virtual currency, which – thanks to the laws of physics – will always have an impact on the physical world.

To these critical points, the BIS has added its concerns over trust and scalability. For any form of money to work across large networks it requires trust in the stability of its value and in the ability of the network to scale efficiently, said the BIS.

“Trust can evaporate at any time because of the fragility of the decentralised consensus through which transactions are recorded,” said the organisation’s report. “Not only does this call into question the finality of individual payments, it also means that a cryptocurrency can simply stop functioning, resulting in a complete loss of value.”

Distributed ledgers and networks are also prone to “congestion” the bigger they become, added the BIS, noting the high transaction fees of bitcoin, and the limited number of transactions per second that traditional public blockchains can handle.

The BIS’ head of research, Hyun Song Shin, reiterated a point made by Bank of England governor Mark Carney in February, saying that many people who hold cryptocurrencies are doing so for purely speculative purposes. (Read our in-depth report for a full discussion of all of the key issues involved with cryptocurrencies, trust, and money.)

Agustin Carstens, general manager of the BIS, previously described bitcoin as “a combination of a bubble, a Ponzi scheme and an environmental disaster”.

Risk and risk management

Earlier this year, banks’ rising use of AI, cloud technologies, and blockchain was criticised for challenging traditional notions of risk and risk management, in a research paper from industry lobby group UK Finance and financial services strategy company, Parker Fitzgerald.

The paper warned that financial regulators already force banks to hold more capital if they are exposed to greater risk. The increased use of cloud-based data storage, and experimental applications of AI and blockchain, could constitute higher risk, it said.

According to the report, regulators are unsure how these disruptive technologies may impact risk assessment and management within the industry, and this may oblige banks to hold more capital.

Internet of Business says

While the BIS’ concerns are detailed and doubtless genuine, they should also be seen in the light of a traditional banking system that is facing an existential threat from peer-to-peer technologies and blockchain. This emerging mix of systems that may create an environment in which seamless payments can be linked with GPS location, smart buildings, connected vehicles, and more.

Organisations are also experimenting with a mix of blockchain, cryptocurrencies, and carbon credits to help support environmental programmes, as we recently reported, and again here.

The BIS’ concerns should also be set alongside the public’s deep mistrust of the traditional banking sector, not only in the wake of the 2008-09 financial crash, credit crunch, trilion-dollar bailouts, and lasting austerity, but also of endemic corruption and speculative behaviour within the financial services sector itself. A classic pot/kettle argument, in fact.

For example, billions of dollars’ worth of fraud and market rigging in recent years have involved many of banking’s biggest names in scandals such as Libor, Euribor, and others.

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.

These are just a handful of the many scandals involving banks in recent years. In the past 10 years, it seems, few big-name banks have not been involved in illegal behaviour to some degree, while most put the public’s own finances at risk in the run-up to 2008. So the search for alternative systems that take back control is, perhaps, inevitable.

So, trust is a relative concept in the modern banking world. That said, all financial systems attract fraud and illegal behaviour, and it is foolish to believe that cryptocurrencies and blockchain-enabled systems will eradicate the problem. Indeed, the rising complexity of data-processing systems – coupled with AI and autonomous agents – may simply make it much harder to trace, let alone audit and regulate.

Fraud may become invisible, automated, or so complex as to be impossible to unravel.

Evidence that the apparently secure systems of record beneath cryptocurrencies are anything but was provided this week: South Korean crypto exchange, Bithumb, was hacked, following another heist last week at Coinrail. Hackers reportedly looted about 35 billion won ($32 million).

However, while the BIS is issuing its words of caution, other parts of the banking system are moving much faster into the worlds of blockchain and cryptocurrencies than the organisation itself appears to realise.

For example, in May, Japan’s biggest bank Mitsubishi UFJ Financial Group (MUFG) announced the design and deployment of a payment platform based on blockchain technology, in partnership with US cloud provider Akamai.

Once fully developed, the bank claims the platform will be both the fastest and most scalable of its kind, with the capacity to process one million transactions per second and offer near real-time confirmations.

Meanwhile, Biuro Informacji Kredytowej (BIK), the largest credit bureau in Central and Eastern Europe, has partnered with distributed ledger specialist Billon to deploy a blockchain system for storing and securing access to over 140 million credit records, relating to 1.2 million businesses and 24 million citizens in Poland.

BIK is owned by the largest banks in the country, including PKO Bank Polski, mBank, ING, BGZ BNP Paribas, Santander, and Citi.

Also in May, crypto investment bank and asset management company Clipper Coin Capital (CCC) launched in Hong Kong.

As for questions of speed and scalability, these are being addressed at system level by a range of new projects, schemes, and technologies, as explored in multiple Internet of Business reports since Carney’s speech in February.

Alongside the several reports linked to above in this article – which all discuss these issues – they include: