The proliferation of cryptocurrencies is beginning to alarm governments and central banks. There are sound reasons for concern that go beyond the protection of the public from scams and rip-offs.

While bitcoin is the best known, it is not the only cryptocurrency – at the last count there were around 6,000, with several thousand more that have disappeared without trace.

The 10 largest cryptos are claimed to be ‘worth’ just over $2,000billion, with bitcoin accounting for roughly half the total.

Many millions of people around the world have been tempted into ownership by the impressive increase in value of some cryptos since first they were issued

Buying in

But, where does all this brand-new supply of financial assets come from?

People just invent them, basically. These are private financial assets, not the liability of any established financial institution and their value derives solely from the willingness of new holders to acquire them for real money. And it is easy to acquire them, too easy.

Teenagers are routinely offered bitcoin accounts for small amounts over their smartphones and many millions of people around the world have been tempted into ownership by the impressive increase in value of some of cryptos since first they were issued. There is a built-in limit to the issuance of extra units of each crypto, although no limit to the creation of new ones – no regulatory approval is required.

Buyer beware

There have been numerous frauds, hacking episodes and hooky exchanges which have gone bust. But it is undeniable that anyone who bought some of the more prominent cryptos several years ago would today be looking at a considerable profit. They would have needed steady nerves though. The price of bitcoin in dollars has halved and doubled in short periods on several occasions along the way.

While these assets can be used to settle ordinary transactions online provided the seller will accept payment in crypto form, only a small number do so. Crypto will never be popular even as an online medium of exchange – settlement takes too long and there are significant transaction costs, aside from very limited acceptability.

The support for today’s price is essentially the belief that a new owner can readily be recruited when people sell and that not too many sellers emerge all at once. Should the belief in stable or rising prices ever weaken, there is nothing to prevent a collapse. No central bank or government has any obligation to support the market value of cryptocurrencies, which are not legal tender.

Regulation

Aside from the risks to the public, central banks and governments have in recent years come to see cryptocurrencies as posing additional problems. The proliferation of crypto and the rise in prices means that a new type of financial asset has arisen at significant scale, is unregulated and has the potential to disrupt mainstream finance if things were to go wrong. Any financial asset which adds to liquidity outside the control of monetary authorities is a potential headache even if consumer protection was not an issue.

Since there is no registration of ownership, criminals can use crypto as they use high-denomination banknotes, only in much larger amounts – ferrying millions around in the form of banknotes is rather old-fashioned and there is evidence that money laundering has been facilitated courtesy of bitcoin and other cryptos. Some central banks have already begun withdrawing large denomination notes because of money laundering concerns.

Alternatives

With support from the Bank for International Settlements, the central bankers’ umbrella body, the US Federal Reserve, the European Central Bank, the People’s Bank of China and various others have commenced work on what are called CBDCs (Central Bank Digital Currencies). Only commercial banks can hold deposits at institutions like the ECB and can use transfers there for settlement. If this privilege were extended to everyone else, cryptos would exist only as a speculative asset and any case based on their role as an alternative form of money would evaporate. Instead of holding your positive balances at AIB or the Bank of Ireland, you would hold them at the central bank and could make any digital payments you desired, since everyone else would have an account there too. The commercial banks would fund their lending with equity and debt rather than deposits in this all-out version of the central bank digital currency and the payments system would become, in effect, a public utility. There are intermediate options where the central banks would offer more limited access to digital accounts and where there would still be a role for private payments systems.

Whatever route is chosen, it appears that crypto will no longer be accorded sole possession of the unregulated digital frontier. The European Central Bank has commenced a detailed study of the issues involved and could come up with concrete proposals sometime next year.

If you fancy a modest punt and a little bit of excitement, stick to the horses.