The rise of bitcoin and other cryptocurrencies could relegate central banks to the sidelines unless they confront the challenges that digital currencies bring: decentralised financial dealings, anonymous transfers and the marginalisation of the middleman.
There is growing acknowledgment that the cryptocurrency revolution is going to disrupt banks and that banking models are going to change. Currently, cryptocurrencies fall outside the jurisdiction of central banks.
Cryptocurrencies are protocols that allow transactions to be validated without the involvement of third parties such as banks. In most countries, cryptocurrencies are not covered under the definition of money subject to the supervision of the central bank.
There is a clear shift in what will represent monetary value in future. The growth of the cryptocurrency universe without the involvement of any regulatory or supervisory authority gives rise to the question, what will the future role of central banks be in the cryptocurrency universe?
Traditionally, banking and payment transactions have relied on a central bank or middleman for making or enabling payments. However, the advent of blockchain technology means that a distributed network of computers can reach consensus on the validity of a transaction without an intermediary.
The fact that blockchain technology does not require a middleman to function poses a challenge for central banks.
Another major challenge is the relatively high level of anonymity in transactions involving cryptocurrencies. This makes it difficult for regulators to identify individuals who use them.
Far from sitting on the sidelines of the cryptocurrency revolution, central banks are looking closely at blockchain, which underpins bitcoin and other digital currencies, and its potential impact on them. They have an interest in blockchain because it represents a powerful tool for improving access to banking and financial services, is potentially disruptive to many financial institutions and raises existential questions for banks.
Hence, central banks around the world are creating “sandboxes” or “sandpits” for playing with blockchain technology and seeing what comes up. They are also exploring potential risk and how it can be mitigated, and encouraging collaboration between regulators and the technology, tax and banking sectors.
The role of central banks in a global economy increasingly adopting cryptocurrencies depends on whether regulators view such currencies as a form of money.
There is a school of thought that is supportive of central banks playing a role in the blockchain revolution. The main argument is that cryptocurrencies should be treated as a new form of money issued by a central bank, in the form of central bank-issued cryptocurrency. This would entail ensuring that cryptocurrency is included in the definition of money subject to supervision by central banks.
What’s more, some form of intermediation would still be required. With the growth of the cryptocurrency universe, there will be many public blockchains that will inevitably have to talk to each other. The intermediary role may be played by central banks.
Also, some arguments in support of central banks playing a role include the fact that the central bank could observe the transactions on an economy in real time, and would moderate what goes on the blockchain platforms.
At this point, though, the future role of central banks is still unclear, he says. The challenge for central banks arises from the very nature of cryptocurrencies. All that seems certain is that banking models are going to change.
- Francisco Khoza is head of banking and finance at law firm Bowmans