Central Banks and Cryptocurrencies – Friend or Foe?

Posted on July 22, 2019

By Natalie Lord

Cryptocurrencies have rattled central banks around the world with their potential to change the financial landscape. The financial industry has those who express scepticism over the possible uptake of digital currencies, whilst others are more open to exploring the benefits it could offer. The volatility and the fact that the space is unregulated spooks many, but with its presence ever increasing, will cryptocurrencies ever move from being a foe to being a friend of central banks?

In its latest report, released in May, the European Central Bank (ECB) stated that it was not in favour of issuing a central bank digital currency, but that it is open to exploration due to the evolving digital economy.

The paper reiterated sentiments made by Mario Draghi, the head of the ECB, in September of last year when he said that that financial institutions in the EU were not as enthusiastic about cryptocurrencies as the public, and that the ECB didn’t see any concrete need to issue a digital version of the euro.

Further, he added that the central bank didn’t view cryptocurrencies as a threat to financial stability in the euro zone, stating that cryptocurrencies don’t perform the same functions as money, and that there were currently a very low number of merchants allowing the sale and purchase of goods using Bitcoin or other cryptocurrencies. As a consequence of this, he said that the central bank didn’t consider cryptocurrencies to have any tangible impact on the real economy or on monetary policy.

The central bank said in its report that: “The high price volatility of crypto-assets, the absence of central bank backing and the limited acceptance among merchants prevent crypto-assets from being currently used as substitutes for cash and deposits, as well as making it very difficult for crypto-assets to fulfil the characteristics of a monetary asset in the near future.”

But Jim Reid, Head of Global Fundamental Credit Strategy at Deutsche Bank, thinks differently. In an interview with CNBC in late June he pointed out the potential impending interest rate cut by the United States Central Bank, and said this was one of the reasons behind the recent surge in Bitcoin.

“If central banks are going to be this aggressive, then alternative currencies do start to become a bit more attractive,” he said.

Reid’s comment comes on the back of a recent speech by Fed Chairman Jerome Powell, who said last week that the central bank is considering a cut in interest rates due to current economic uncertainty and inflation risks. The US dollar fell to a three-month low against the euro on the news whilst Bitcoin moved to hit record highs for the year moving above the $12,000 mark.

Previously, Reid has criticised the continuing printing of money by banks, predicting that this could lead to the end of paper money.

Elsewhere, Bitcoin pioneer Nick Szabo, believes that central banks could start supporting cryptocurrencies by supplementing their gold reserves. At a presentation at the first Bitcoin summit in Israel, Szabo explained that he thinks more countries, in particular those troubled by conflict or financial mismanagement, will start using cryptocurrencies.

“There are going to be some situations where a central bank can’t trust a foreign central bank or government with their bonds, for example. One solution that’s been developed is to have the Swiss government hold it for you – that’s not a trust-minimized solution. The Swiss government itself is subject to political pressures, and so a more trust-minimized solution is cryptocurrency.”

He’s not alone in his thinking. In 2018, Christine Lagarde, Managing Director of the International Monetary Fund (IMF), expressed support for central banks issuing cryptocurrencies. She said that whilst it was not the case yet, it would soon become evident that central banks shouldn’t shy away from Bitcoin or the crypto industry.

There’s a lot of movement and considerable potential for change in the crypto environment as it gathers strength and support. Perhaps, in the not-too-distant future, we might find the central bank in bed with cryptocurrencies and firm friends after all.

 

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