The world’s top bank weighs in on digital currencies

Established in 1930 by an intergovernmental agreement between many of the world’s most powerful nations of the time, the Bank for International Settlements (BIS) was originally created to facilitate reparations imposed on Germany after WWI. Headquartered in Basel, Switzerland, the organization is often referred to as the banker’s bank, its membership is comprised of 60 central banks, from countries that make up about 95% of world GDP.

Today the BIS released their own in-depth report on digital currencies, including bitcoin. Published by the internal Committee on Payments and Market Infrastructures (CPMI), the 24-page PDF report is simply named “Digital Currencies,” and the majority of its pages are focused on the implications and impact of blockchain-based currencies on our global financial system.

"Digital currencies and distributed ledgers are innovations that could have an impact on many areas, not only on payment systems and services […] This might lead to changes in the way that FMIs and other market participants operate."
— – Benoît Cœuré, Committee on Payments and Market Infrastructures Chairman

The content of the report demonstrates that bitcoin has now caught the attention of the world’s most senior banking institution, and the reaction to it could easily be called positive.

“This report describes a range of issues that affect digital currencies based on distributed ledgers […] These features may drive the development of the schemes and even lead to widespread acceptance if risks and other barriers are adequately addressed.”
— – BIS Report

In a refreshing and welcome break from the normal pattern of banks referring to them as “virtual currencies,” the BIS has elected to call bitcoin and other blockchain-based currency by the proper term “Digital Currencies” within the report, something that few, if any, other banks have done to date. Their reasoning for doing so is surprisingly reasonable.

“This report uses the term ‘digital currencies’, because, while recognising that the term is not perfect, the term is used widely and reflects the concept that these are assets that are represented in digital form. Previous CPMI reports used the term ‘virtual currencies’, reflecting their existence in a virtual rather than physical form; virtual currencies in particular are prevalent in certain online environments. Moreover, these schemes are frequently referred to as ‘cryptocurrencies’, reflecting the use of cryptography in their issuance, and in the validation of transactions.”
— – BIS Report

The role of regulation over digital currencies was a central theme of the report, including regulatory issues and approaches. Without mentioning any specific regulation, they weighed the banker and consumer risks while using digital currencies without any regulation yet.

Factors influencing the development of digital currencies were heavily explored in the report, including both the supply-side and demand-side factors, covering every issue bitcoin faces from scalability, altcoin fragmentation, volatility, pseudonymity, to security and more. The writer(s) of this well-researched report, who are not named at any point, seem to have a thorough understanding of the technology and economics behind cryptocurrencies, and likely have spent considerable time researching the bitcoin community too.

“Digital currencies are not a liability of an individual or institution, nor are they backed by an authority. Furthermore, they have zero intrinsic value and, as a result, they derive value only from the belief that they might be exchanged for other goods or services, or a certain amount of sovereign currency, at a later point in time.”
— – BIS Report

However, as bitcoin proponents have come to expect, the narrative of the report downplays the usefulness of the currency and embraces the unique properties of the blockchain. “The genuinely innovative element seems to be the distributed ledger,” it echoed, “especially in combination with digital currencies that are not tied to money denominated in any sovereign currency.”

“The main innovation lies in the possibility of making peer-to-peer payments in a decentralised network in the absence of trust between the parties or in any other third party. Digital currencies and distributed ledgers are closely tied together in most schemes today, but this close integration is not strictly necessary, at least from a theoretical point of view.”
— – BIS Report

The importance of network effects on digital currencies is confirmed and well addressed in the report, comparing their importance to those of retail payment systems and payment instruments. “A range of features and issues that are likely to influence the extent to which these network effects may be realised,” the report stated, chief among them was the advantage “that digital currency has a global reach by design.”

Several other appreciative-sounding comments were made, such as how “there may be gaps in traditional payment services that are or might be addressed by digital currency schemes” and

even perhaps a little jealousy in the department of cost savings: “Distributed ledgers may offer lower costs to end users compared with existing centralised arrangements for at least some types of transactions” the report admitted.

However, it would be inappropriate to call the BIS a ‘fan’ of bitcoin. In case anyone reading the report had any doubts that the BIS could see bitcoin as a de facto competitor to their business model, this report removes all doubt towards the end.

“The emergence of distributed ledger technology could present a hypothetical challenge to central banks, not through replacing a central bank with some other kind of central body but mainly because it reduces the functions of a central body and, in an extreme case, may obviate the need for a central body entirely for certain functions.”
— – BIS Report

If there was one single, overall conclusion, it was simply that “distributed ledger technology will continue to emerge and develop,” whether or not digital currencies catch on is still up in the air at the moment.

“For any of these implications to materialise, a substantial increase in the use of digital currencies and/or distributed ledgers would need to take place.”
— – BIS Report

The takeaway advice offered to central banks was familiar, yet ominous. Addressing business models as “Financial Market Infrastructures,” (FMIs), the BIS report clearly suggests for its member banks to assimilate digital currencies, not fight them. “Central banks could consider – as a potential policy response to these developments – investigating the potential uses of distributed ledgers in payment systems or other types of FMIs.”

Several central banks have already expressed similar views. The Bank of England was one of the first to show that they grasp the power of the blockchain.

“What I think is now reasonably clear is that the distributed payment technology embodied in Bitcoin has real potential.  On the face of it, it solves a deep problem in monetary economics:  how to establish trust – the essence of money – in a distributed network.  Bitcoin’s “blockchain” technology appears to offer an imaginative solution to that distributed trust problem.”
— – Andrew Haldane, Bank of England, Chief Economist

Singapore’s central bank said early on that they are watching intensely.

“Whether digital currencies will take off in a big way remains to be seen. But it is a phenomenon that many central banks are watching closely, including MAS.”
— – Ravi Menon, Managing Director of the Monetary Authority of Singapore

Germany’s central bank has shown that they understand the underlying implications of the blockchain pretty well.

“Blockchain technology is credited with having a particularly sobering impact on banks. By using the global computer network, this technology is enabling all transactions conducted in the world of finance to be documented in a presumably forgery-proof, near-real-time and, above all, decentralised manner, ie potentially without central securities depositories or banks.”
— – Dr Andreas Dombret, Deutsche Bundesbank, Member of the Executive Board

In South Africa, the central bank is aware that they need to be looking at more than just the currency aspect:

"Blockchain is still in its infancy and while regulators and markets are still trying to get to grips with the concept of Bitcoin, newer or more innovative technologies are already on our doorstep."
— – François Groepe, South African Reserve Bank Deputy Governor

Canada’s top banking authorities agree and are already talking about further uses for blockchain technology that they can be involved with, such as peer to peer lending.

“Global and domestic payment systems—the backbone of the financial system—could also look completely different….The Bank will help lay the groundwork for the next generation of Canada’s payment systems. Then there are disruptive technologies, such as the distributed ledger that’s at the heart of Bitcoin, or peer-to-peer lending facilities like the Lending Club.”
— – Carolyn Wilkins, Bank of Canada Senior Deputy Governor

If there is a single day in history that knowledge of bitcoin became propagated to all levels of the banking world, the emergence of today’s report would most likely mark it. So far the response to digital currencies has been more positive than negative, but if bitcoin were to ever grow the rest of the way into mainstream usage, we may find out if the BIS could change its tactics and central banks would be ready to pounce at that time.