Ted Cruz (R-TX) – a crypto-supportive Republican senator – believes a US Central Bank Digital Currency (CBDC) is likely to become a reality. The politician believes both the Federal Reserve and the White House currently want one, and that the Democratic party won’t vote against its issuance. In an interview published by What Bitcoin Did on Friday, Cruz discussed the current political climate surrounding crypto. In general, the senator believes Democrats are more opposed to the industry than Republicans, due…
There is undoubtedly a lot of noise in the cryptocurrency space, and not all of it constructive. Narratives projecting Bitcoin as a global panacea; the “decentralize everything” movement; or the infinitely faster, more scalable, and secure blockchain…the list goes on. Separating true from false is an incessant task, and one that this article intends to do for another of these claims: cryptocurrencies are ready to replace central banks (CB).
To begin, let us take a step back and understand what CBs are. Broadly speaking, CBs are responsible for monetary stability in a given jurisdiction. They create the rules and regulations under which national banks should function. Incidentally, there is a CB of CBS called The Bank of International Settlement (BIS), whose mission is to “serve central banks in their pursuit of monetary and financial stability, to foster international cooperation in those areas and to act as a bank of central banks.” Essentially, the BIS is to CBs what CBs are to private and regional banks (and other organizations).
How do the Central Banks Function?
One way to understand CBs is in terms of their functions:
- Monetary stability: establishment and regulation of monetary and exchange rate policy.
- Financial stability and regulation: prudential policy supervision and market oversight.
- Policy management: foreign exchange intervention and reserves holder, as well as lender of last resort.
- Financial infrastructure provision: fiat currency provision, banking and accounting services, inter-bank payment and settlement services, and registry provision.
Bearing this in mind, the question is if cryptocurrencies can perform these functions more effectively than CBs? At the moment, the answer is a resounding No! Let us see why:
- Monetary stability: liquidity is a prerequisite for stability, and cryptocurrencies are infamously illiquid. For reference, gold is measured as a $7 trillion market, and forex is 10x that of gold, whereas the entire cryptocurrency market sits at $250 billion.
- Financial stability and regulation: there is no regulatory oversight codded into cryptocurrency protocols.
- Policy management: no policy management fit for a national economy coded into cryptocurrency protocols.
- Financial infrastructure provision: new technology infrastructure, payment models, and protocol stack ushered with cryptocurrencies.
We can see simply that cryptocurrencies are not on par with CBs…yet. Currently, the vast majority of cryptocurrencies provide only a few of the functions of CBs, including an unpegged monetary policy (initially fixed, but later can be changed by miners), payment services, and money supply (block rewards). This is of little surprise given the near-nascence of Bitcoin. However, CB’s around the world are already considering the relevant implications of cryptocurrencies (for example, Central Bank Digital Currencies are being researched and developed in some countries like China).
Although cryptocurrencies are not poised against CBs currently, the question remains if they will successfully compete in the future. This is a difficult observation because there are numerous variables and assumptions to consider, including the effects of disintermediation and the decentralized finance movement on global economics, how currencies will be redefined, and not to mention whether one follows the Keynesian or Austrian school of economics. Furthermore, this analysis would include the more socio-politically oriented questions about self-sovereign identity, centralized governance, privacy, etc. and their effects on the economy.
Despite this, one thing is certain: if cryptocurrencies are to replace CBs, they will first have to successfully compete as alternative monetary systems ensuring price, financial, and payment stability.