Cryptocurrencies craze could spark ‘digital runs’ on central banks

13 Mar 2018358 Views

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If nations’ central banks jump on the bitcoin bandwagon, the devastating outcome could be ‘digital runs’ on the banks at speeds never before witnessed.

Whether cryptocurrencies such as bitcoin are a fad or here to stay, the launch of digital currencies by central banks around the world could threaten worldwide financial stability, the Bank for International Settlements (BIS) has warned in a new report.

The rise of decentralised ledgers is one thing, but many fear that the cart has been put before the horse when it comes to the rise of multiple cryptocurrencies, with bitcoin being the most recognisable one so far.

‘A central bank digital currency could allow for “digital runs” towards the central bank with unprecedented speed and scale’

Even though bitcoin has lost half of its value in recent months and $5.6bn was raised through initial coin offers (ICOs) last year, the craze for cryptocurrencies shows no signs of abating.

The reality is that cryptocurrencies aren’t regulated and their fluctuations are more reminiscent of Dutch tulip auctions and dot-com booms than sensible financial policy.

Uncharted waters

Last night (12 March), the world’s top central bank, the Bank for International Settlements in Basel, said that while digital currencies may have some merit in terms of new efficiencies, it warned against central banks around the world jumping on the bandwagon without thoroughly researching the implications.

Benoît Coeuré, chair of the Committee on Payments and Market Infrastructures, said central bank digital currencies (CBDCs) showed promise in wholesale payments.

“Central bank digital currencies could help make settling trades of securities and foreign exchange more efficient in the future. But more work and experimentation would be needed to explore these benefits.

“General-purpose central bank digital currencies could revolutionise the way money is provided and the role of central banks in the financial system, but these are uncharted waters, with potential risks. This report is a starting point for further discussion and research, and will help countries make choices given their own circumstances,” Coeuré said.

Jacqueline Loh, chair of the Markets Committee, said that while CBDCs could give central banks a new monetary policy tool that could enhance the transmission of policy rates to the real economy, existing tools can already achieve similar goals.

“Central banks should continue to monitor developments in digital innovations, as well as analyse the possible implications of central bank digital currencies for areas that are core to the central banking mandate. For example, a general-purpose central bank digital currency could impact bank deposits – a major source of funding for commercial banks – with implications for financial stability,” Loh warned.

What if there was a digital run on the central banks?

A key part of the report warned that there could be more, rather than fewer, financial stability risks posed by CBDCs.

It found that wholesale CBDCs might be useful for payments but more work is needed to assess their full potential.

While a CBDC might not alter the basic mechanics of monetary policy implementation, its transmission could be affected.

“Arguably, the most significant and plausible financial stability risk of a general-purpose CBDC is that it can facilitate a flight away from private financial institutions and markets towards the central bank.

“Faced with systemic financial stress, households and other agents in both advanced and emerging market economies tend to suddenly shift their deposits towards financial institutions perceived to be safer and/or into government securities. Of course, agents could always flee towards the central bank by holding more cash.

“But a CBDC could allow for ‘digital runs’ towards the central bank with unprecedented speed and scale. Even in the presence of deposit insurance, the stability of retail funding could weaken because a risk-free CBDC provides a very safe alternative.

“Depending on the context, the shift in deposits could be large in times of stress. A crucial element in such system-wide shifts is the stronger sensitivity of depositors to the actions of others.

“The more other depositors run from weaker banks, the greater the incentive to run oneself. If CBDC were available, the incentives to run could be sharper and more pervasive than today, as the CBDC would be the favoured destination, especially if deposits were not insured in the first place or deposit insurance was (made more) limited,” BIS warned.

Whatever happens, the cryptocurrency craze shows no signs of abating. This video below by broadcaster John Oliver sums it all up perfectly.

Editor John Kennedy is an award-winning technology journalist.