As the price of Bitcoin crossed the $20,000 level in December 2017, the worries over the role of crypto currencies in the financial system were renewed. There is the Bitcoin correlation to stock markets and also the impact of Bitcoin on banks. A lot of criticism of the Bitcoin system is coming from the central banks and understandably so. Till now the central banks regarded the crypto currencies as too insignificant to worry about. But with their combined value cross $200 billion, it is big enough for central banks to sit up and take notice. In 2018, central banks will have to opt for one of the 2 options; adapt to the Blockchain technology or try and crimp the popularity of Bitcoins. Here are 7 reasons why central banks may be antithetical towards Bitcoins and why banks fear Bitcoin.
Limited understanding of Blockchain technology
Crypto Currencies like Bitcoins are based on the Blockchain technology. Blockchain is a shared ledger technology wherein the applications are much beyond creating new currencies. The Blockchain technology is rather new and most central banks have neither the ability nor the wherewithal to understand the technology in depth. This is a technology where the creation of money is driven by complex algorithms underlying the currency. This is a system that most central banks are not comfortable with. Lack of understanding of the Blockchain technology could be the big barrier.
Bitcoins may weaken banks which central banks have strived to strengthen..
From the time the Federal Reserve was set up in the early part of the 20th century, the primary role of the central bank has been to ensure the strength and solvency of the banking system and protect it from systemic risks. Bitcoins create a new alternate currency channel and in the process may emerge as an alternative to the commercial banks that play a critical role in the payment system. Hence, this competition from crypto currencies could actually end up weakening the very banks that the central banks are supposed to strengthen.
The moral hazard of too many unregulated banks doing bank-like functions
In India, NBFCs have already emerged as significant players in the financial system and are already playing a key role in the financial services industry. The banking business is still fully regulated by the central banks and hence that is something the central bank has control over. The real problem comes when non-bank players start taking over these roles. We already have digital currencies like Paytm which are emerging as alternate payment systems and are not part of the bank payment system. Crypto-currencies may lead to more disintermediation and could be subject to less regulation, opening the gates for moral hazard.
May reduce the role of central banks as a money creator
One of the principal roles of the central banks is the creation of money or printing of money as it is popularly called. The creation of money is a highly lucrative task for the central bank as it pockets the spread between the intrinsic value of the currency and the face value of the currency. When it comes to crypto currencies, the currency creation entirely happen based on algorithms and the capacity to create currency can be limited. That is one of the advantages of non-fiat currencies as their value can be managed by limiting the creation of supply. This may largely reduce the role of the central bank in currency markets.
May devalue the local currency versus the Bitcoin benchmark
This risk follows from the previous point. Since crypto currencies like Bitcoins are non-fiat currencies, their supply can be limited. To that extent, Bitcoin has also emerged as an alternative to gold, which is also a non-fiat currency. The problem is something slightly larger. During the last one year, the price of Bitcoin has gone up from $2,000 to $20,000. This effectively represents a depreciation of the US dollar versus a non-fiat crypto currency. Currently, the value of the rupee is determined with reference to other hard currencies or a basket of currencies. The worry for the RBI is that Bitcoins may lead to implicit devaluation of the INR and lead to the currency market following the trend. That will have fairly deleterious economic consequences.
Inability to regulate payments systems limits the power of monetary policy
Today most of the payments happen through cheque or through digital currency. The advantage for the central bank is that most of these flows are still regulated directly or indirectly through the RBI. Thus the RBI has effective control of the payment system. Control over the payment system is very essential if central banks have to make monetary policy effective. The worry is that if crypto currencies pick up in a big way then the effectiveness of the RBI monetary policy will gradually reduce. That could impact monetary policy implementation.
Raises a question mark over capital flight
Finally, most central banks are worried about capital flight. This is more the case with emerging markets. Currently, the central banks and the government have effective control over capital flows as there are moved through the banking system. But, imagine a situation where investors can take money out of India via Bitcoins. The central bank and the government may lose effective control over the direction and intensity of capital flows.
For now, the central banks are highly sceptical about crypto currencies. For how long they can stall an idea like crypto currencies that have popular acceptance, is something to be seen!