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What to think of the cryptocurrency boom? I often get these questions: A crazy bubble ready to burst? A new asset class set to revolutionize the global financial industry?
Free markets are not an instrument of price stability nor a fair way of distributing wealth. However, they are the best way we have invented to transform the most promising scientific innovation into societal relevance. They often create enormous new wealth in the process.
Free markets are also extremely effective at reflecting the sum of all publicly available information and the expectations it embodies. The fact that these expectations can be suddenly changed when unexpected information is published or when trends are suddenly reversed (as sometimes happens with monetary policy) is not proof of their ineffectiveness, on the contrary.
As such, the stock markets can also be an invaluable feedback loop for policymakers, which is another strong argument for resisting calls to shut them down during major crises (you never hear such calls in boom times).
What are the stock markets telling us about cryptocurrencies?
Cryptocurrencies do not constitute a legal store of value, nor can they offer a legally secure transfer of value across borders. But they do reflect a very powerful and unmet need that our children will likely be perplexed that we couldn’t see more clearly: to transfer value instantly across borders for personal or institutional transactions in a completely secure and legally enforceable manner, and without fresh. And certainly without the frustration of having to anticipate or hedge exchange rate variations, always subject to the vagaries and manipulations of macro sovereign policy.
Namely, the need for a global digital currency.
The genius of the aging blockchain technology underlying cryptocurrencies was its decentralized nature. This has given rise to the emergence of a huge industry solving or hatching complex mathematical puzzles to verify blockchain transactions. This is done through the complex confirmation mechanism known as Proof of Work, which aims to prevent double-spending fraud.
Because its computers rival the energy consumption of the U.S. federal government, the crypto mining industry’s carbon footprint is estimated to be equal to that of Argentina. What is the future of cryptocurrencies?
In China, the central bank has already created its own national digital currency, while India or South Korea have banned cryptocurrencies. Elsewhere, central banks and securities regulators have been reluctant to take a stand, allowing cryptos to develop outside of any clear regulatory framework.
Herein lies the strength and weakness of private sector initiatives such as cryptocurrencies, when they seek to address the limitations of financial instruments backed by the sovereign powers of nations.
The powers of central banks are limited to the borders of nations that allow them to issue currency. The progress of supranational institutions towards a global digital currency and a shared prudential supervisory framework for clearing houses and market infrastructures has been slow after a first impetus after World War II. It mainly intervened in response to major financial crises caused almost systematically by excessive indebtedness in the banking sector.
Bitcoin, Ethereum et al provide a framework supported by technological innovation without being hampered by the limits of national borders. They show us a horizon of possibilities. The huge amount of capital they have attracted reflects the urgent need for a global digital currency and a much more efficient, secure and free payment system.
After a period of relative inaction and observation, during which the crypto industry grew to near systemic size, central banks are now certain to act. The introduction of their own digital currencies will likely seal the end of the private sector crypto experiment.
This would release pressure from securities regulators to approve the issuance of cryptocurrencies and related derivatives and Delta 1s, many of which have publicly stated to be devoid of any intrinsic value.
Central banks could act in several ways
Some have banned cryptos completely, no doubt hoping they will disappear. The People’s Bank of China issued its own. Considering the size and growth rate of its economy, and the nearly 20% of global financial assets that are already Chinese owned, the PBOC can confidently expect its digital currency to succeed nationally. But will he succeed overseas beyond the belt and the road?
Would an approach that would force other central banks to adopt its governance, operational framework and standards be scalable on a global scale?
A more gradual approach could involve a small group of like-minded central banks like the Fed, BoE, ECB, and BOJ. A cross-border clearing framework, shared standards and a single DLT administrator, backed by a shared regulatory agreement, would give legal status to a global digital currency.
This would eliminate the environmental costs associated with mining crypto and the risk of illegal use by money launderers. Blockchain technology could support such a framework. But again, adoption by other major central banks in China, Russia, India or Brazil would be far from assured.
Join the IMF
There is an already established global institution with most of the world’s governments as stakeholders. Its mandate could be extended to include the creation, issuance and administration of a global digital currency based on the Special Drawing Rights regime, under the regulatory umbrella and technological architecture managed by member central banks. .
It may seem far-fetched in our current era of Nation anger rising up against Nation, and Kingdom against Kingdom. But privately issued cryptocurrencies face a grim future if central banks step into the game with a credible global governance framework.
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