Cryptocurrencies don’t belong in central banks

That is the topic of my latest Bloomberg column.  Here is one excerpt:

An additional reason for skepticism stems from the nature of crypto assets. The word “cryptocurrency” is far more common than “crypto asset,” but it’s a misleading term. Bitcoin, for instance, is used only rarely in retail transactions, and for all its success it isn’t becoming more important as a medium of exchange. Bitcoin thus isn’t much of a currency in the literal sense of that term. There is a version of bitcoin, Bitcoin Cash, that changed the initial rules to be better suited as an exchange medium, but it isn’t nearly as popular.

If you think of these assets as “cryptocurrencies,” central bank involvement will seem natural, because of course central banks do manage currencies. Instead, this new class of assets is better conceptualized as ledger systems, designed to create agreement about some states of the world without the final judgment of a centralized authority, which use a crypto asset to pay participants for maintaining the flow and accuracy of information. Arguably these innovations come closer to being substitutes for corporations and legal systems than for currencies.

Put in those terms, an active (rather than merely supervisory) role for central banks in crypto assets is suddenly far from obvious. Consider other financial innovations: Does anyone suggest that central banks should run their own versions of ETFs or high-frequency trading? Is there a need for central banks to start managing the development of accounting and governance systems?

Central banks are too conservative anyway, which of course is how they should be.  Don’t forget:

…consider a simple question: Would any central bank have had the inspiration or taken the risk of initiating the bitcoin protocol in the first place?


Should cryptocurrencies be kept by central banks? Should tulip bulbs be kept by central banks?

You couldn't pay taxes with tulips, and so far, you can't pay taxes with any cryptocurrency.

At the point you can pay taxes with a cryptocurrency, the people in control of the cryptocurrency will change their rules to mint currency at extremely high rates just to sell it to people wanting to pay less in taxes.

After all, Venezuela currency would not be worth more over time if it were a cryptocurrency.

Both cryptocurrencies and Venezuela currency values are listed primarily in US dollars or Euros, not in Bitcoin for Venezuela currency value, or Venezuela currency for Bitcoin value.

Parts of Swiss allow for taxes to be paid in Bitcoin.

Who are these people in control of "the cryptocurrency" you talk of? The hard cap of Bitcoin is perhaps the most immutable aspect of Bitcoin and is unlikely to ever change and even a debate of changing the cap into being more soft is unlikely to exists until block reward is much lower and block subsidy turning out not to be adequate to incentivize.

Gold doesn't belong in central banks either.

Maybe it's central banks that don't belong. :sadface

Finally something Cowen doesn't want to subject to unhinged experimentation and tinkering and what is it... central banks.

What fascinating self parody.

If it is simply a ledger system, you would know the identity of the person who passed one asset to another.

But, it isn't.

And, therein lies its value.

So, the question to ask is:

What kind of commerce will use this method of payment, and do you want to lose control of preventing some transactions (drug dealing, extortion, etc.) that come with an unidentifiable ledger chain.

I am sure North Korea, any country facing sanctions, the Taliban drug empire, and others would favor widespread adoption of such a ledger system.

But, what would you lose?

What would i gain? The age of hey this might be cool is over. It was a way for a lot of pernicious people to bilk a lot of money from taxpayers. Thankfully we are returning to the age of hard truths.

You're incorrect. The bitcoin ledger is completely public and transparent, and its record of transactions exists for eternity. If, at any point along a chain of transactions, one of the transactions can be tied to a real world identity, government prosecutors have a lead to pursue and from there it's a simple matter of following the chain.

Non-net neutrality seems to allow price discrimination not based no scarcity of a commodity. Where I am wrong there?

The resource is scarce by the demands of the technology, it is endogenous to the network. The memory buffers are finite, to keep the from jamming up the marginal price of the next increment of bandwidth has to go up.

For most of the Internet history, jams were common because the next increment of price was constant, everyone started watching video for free. It is like highways, when the incremental cost remains the same regardless of congestion,then building more highways never helps, drivers immediately jam them up. The cost of driving that extra two miles to get a 10% discount is not totally observable to the driver.


Since bitcoin was/is a bad idea, hopefully not?

I'm thinking of a Bitcoin like currency except new coins are somehow tied to total transactions. In other words, instead of a central bank setting monetary policy, the currency would set its own monetary policy by tracking to demand. The more economic activity demanded from the currency, the more the currency expands.

You could keep actual currency, a bank could transfer a million 'Bitdollars' to the Treasury and receive a million dollar bills.

Wouldn't this lead to either run-away inflation or a deflationary depression when this monetary policy reinforces and strengthens the recent trend?

Well I'm thinking of:


I'm wondering if the function could keep track of V, T in order to hold P level. If V picked up new coins would be released at a slower pace, likewise additional T would push towards the release of coins. Think of this as establishing an alternative economy of 'Bitdollars' which may exist along side the regular currency denominated economy. People could opt to enter or leave the Bitdollar economy and the currency would adjust as needed just as if a very small economy suddenly had a surge of immigration or migration its central bank may have to expand or contract its money supply as needed.

If the currency works well lots of people will use it. Otherwise no harm done, just use traditional currencies.

Yes, but this is stupid.

Why? If cryptocurrencies are really a decentralized ledger system then it seems you could build in a feedback system that expands or contracts the money supply based upon how often people use it and how much people use it. It could be built into the nature of the currency itself rather than having a central bank have to guess whether or not inflation is heating up or cooling down.

Note that the old gold standard kind of had that built into it. If the economy/population increased more people would seek out gold thereby increasing the money supply. In theory a decline in the economy would likewise push fewer new gold finds into the market.

Of course you can't schedule new gold discoveries to tie out exactly to the economy's needs. Bitcoin, however, is built upon an eventually fixed number of coins. Why should the coins not expand with the economy?

"The more economic activity demanded from the currency, the more the currency expands."

Not necessarily. This only applies (if economic activity == hashrate) to a cryptoasset whose protocol rules aren't optimizing for fixed block time, e.g, see Bitcoin cash having mined more coins/having less runway than Bitcoin.

Instead I wouldn't see economic demand as reasons for why the fixed cap on the total supply of a cryptoasset may wish to be increased, but instead would argue these reasons are more likely: (1) Low inflation to replenish the part of money supply that is lost and burned over time, (2) a "world currency" having political issues with a Geni coefficient more out of wack than we've ever seen before, (3) once block reward decreases adequately and if block subsidy isn't enough to incentivize miners and tx fees become too high (unless Bitcoin goes solely to be a settlement standard, see The Bitcoin Standard book for more) and may need a consistent extra coinbase reward/inflation.

Also why would new coins be tied total transactions? The prime usage case of Bitcoin is censorship resistant, unseziable, and so on, store of value. The prime metric/effective method for taking advantage of this has a velocity of 0.

1. V cannot be 0 or else the arguments for Bitcoin collapse. If you cannot transfer your Bitcoin to someone else (presumably in exchange for something of value), then your Bitcoin is as worthless as an attic full of Confederate dollars.

2. The prime usages you cite for Bitcoin do seem tied to the economy. The more people there are, the more value they would want to store in Bitcoin. The more trade, the more important the censorship restraint becomes. That would imply more Bitcoin.

You could argue that price shouldn't matter. A currency that deflates 10% each year or one that inflates 10% or another one that has perfect price stability are all exactly the same. But I'm unaware of anyone whose succeeded using a deflating currency. Even the gold standard presumes new gold discoveries, working mines harder, plunder, and other mechanisms would bring gold into an expanding economy. It might be an economy will adjust to price deflation on a fixed currency supply but then maybe not.

Anyway, what I'm thinking is that it would be interesting to make the monetary policy part of the cryptocurrencies protocol.

This actually happens with some token models in different ICO projects built atop Ethereum. Gnosis (a decentralized prediction market platform), for instance, has a two-tier token model: the top-level token, GNO, 'mints' another class of token called WIZ. WIZ tokens are minted according to the usage of Gnosis, so that whenever more prediction markets are being created and utilized, more WIZ tokens are created from GNO. And vice versa. WIZ tokens are used to pay for things like creating prediction markets, paying exchange fees, etc.

It's a tautology. Central banks should never get involved in designing watermarks for paper bills. By extension, they should never get involved in designing watermarks for digital money.
The rest of the question, in popular terms, is should the central banks get involved in auto pricing, AI? Yes, most definitely. Skip the concept of crypto, this is really about algebraic pricing, crypto is the same as abstract algebra. Then, since auto-pricing is coming to finance, it is based on algebraic methods, and it becomes the central tool for the central banks.

Blockchain congestion becomes the overriding issue in auto traded system. That becomes just another queuing problem over network, abstract algebra has the solution to that.

Crypto, also using abstract algebra, is a way of watermarking digital bills. One might say, two different technologies, different purpose, they opth use abstract algebra. Not quite so simple because the allocation of watermarks available to transactors becomes a congested, and managed flow.

A generic term that considers both ledger systems, watermarking, and auto pricing is Fintech. Fintech is about automated congestion management in finance. Should the central bank endorse Fintech? Absolutely, the central bank job is managed monetary congestion, it is right in the center of the revolution.

Despite China and Russia's best efforts to replace the dollar as the World Reserve Currency, the bitcoins thwarted their best laid plans and the revolution in information technology evolved a new currency and exchange medium. Wow!
Hackers are the new age bank robbers and buyers must beware that they do not lose their keys, but the bitcoin train keeps running on time and expanding its marketability.
I don't think the banks can afford to remain aloof. The Bitcoin market cap already exceeds that of Goldman Sachs & Morgan Stanley. It would place 15th on the NASDAQ & 58th on the NYSE.
My decision is to mine or not to mine...that is the question.

The USD would be placed #1 on any exchange. What's the point? You can't compare like that.

I've been involved with cryptocurrencies since 2011 and am something of an 'insider' in the space. Here's my take:

You're mostly right, Tyler, that governments and especially central banks shouldn't get involved in creating their own cryptocurrencies. The technology is still incredibly nascent and core infrastructure still needs to be built and coded which allows cryptocurrencies to scale up to civilization-usage levels of demand. We are, as you mention in your column, in the experimental phase of this new asset class.

There is one big caveat, however.

Central banks are the perfect backers for a class of token called stablecoins. A perennial problem facing crypto-asset projects is price volatility; how are you supposed to enter into any long term contract with a counterparty when the asset backing the contract might halve or double in value in a matter of days/weeks? It's absurd. Stablecoins, however, solve this problem by pegging their value to some stable, usually fiat currency, such as the USD. A dollar token, backed by the Fed and put on the Ethereum blockchain (and thus, usable by other smart contracts), would enable a huge new class of applications and use cases for public blockchains which are presently very difficult or impossible to achieve.

There's currently a project to implement what you're describing with a decentralized, algorithmic central bank.

It's called basecoin:

I'm familiar with basecoin. It has a few problems:

1. It's a huge pump for early stage investors (they're getting 75% of the base shares through the LLC, presumably at an attractive valuation).
2. Its technical roadmap is rather flaky.
3. It has the rube goldberg architectural problem of other 'decentralized' stablecoins that aren't tethered to a full reserve bank account. That is, the value of its coins aren't pegged to anything real and there's no collateral underlying them. Therefore, a run on the currency could become self-reinforcing and drive its value down to zero.

If and when the value of Bitcoin (and other "cryptocurrencies") crashes, it's possible that it will take the value of some "real" currencies with it. The loss of confidence could extend further than people expect.

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