A report from the International Monetary Fund (IMF) in September 2022, co-authored by BIS Chief Carstens, identifies three shortcomings that preclude cryptocurrencies from serving as a “sound basis for the monetary system,” which shows how fiat money has won the battle against cryptocurrencies.
The fight between cryptocurrencies and fiat currencies, according to Bank for International Settlements (BIS) president Agustin Carstens, is over, with the latter winning. Fiat currency is money that is recognized as legal tender by a government order.
“That battle has been won … A technology doesn’t make for trusted money,” Carstens said in an interview with Bloomberg TV on Wednesday. “Only the legal, historical infrastructure behind central banks can give great credibility” to money, he added. Carstens is anticipating a “strong statement” from the G20 nations for stronger regulation on digital assets, pointing out that crypto as a financial activity can only exist “under certain conditions.”
Castens’ comments follow the collapse of cryptocurrencies during the previous year, with Bitcoin—the most valuable cryptocurrency worldwide—falling by almost 38%. Bitcoin’s price peaked in March 2022 at about $47,450, and as of Feb. 22, it was trading at $23,700.
The decline in cryptocurrency is attributed to a number of factors. One reason was that retaining cash became far more appealing than investing in hazardous and unpredictable assets like cryptocurrency when interest rates rose.
The LUNA coin fall in May made the downturn even worse. LUNA formerly held the seventh-largest cryptocurrency market cap in the world. Nevertheless, due to a flawed business plan and other problems, LUNA’s value dropped by 96% in a single day in May 2022.
When one of the biggest cryptocurrency exchanges at the time, FTX, filed for bankruptcy in November due to worries about the company’s balance sheet and subsequent withdrawals that led to a liquidity crisis, confidence in the market for cryptocurrencies further plummeted.
Flaws of Cryptocurrencies
Co-authored by Carstens, research from the International Monetary Fund (IMF) in September 2022 identifies three shortcomings that preclude cryptocurrencies from serving as a “sound basis for the monetary system.”
The first is the absence of a “sound nominal anchor” in cryptos. The price of cryptocurrencies fluctuates greatly. Stablecoins, a subset of cryptocurrency whose value is linked to a currency like the US dollar, “borrow credibility from real money issued by banks,” according to the author.
Second, fiat money is secured by a reliable organization, such as a central bank, which ensures the security of transactions and the stability of the currency. Such centralized, governmental-level guarantees are absent from cryptocurrencies.
Third, because cryptocurrencies are decentralized, they rely on rents and fees as incentives for anonymous validators to confirm transactions. Congestion is the outcome, and scaling is prevented.
“For example, when the Ethereum network (a blockchain widely used for DeFi applications) nears its transaction limit, fees rise exponentially. As a result, over the past two years, users have moved to other blockchains, resulting in growing fragmentation of the DeFi landscape,” the report notes. DeFi is short for decentralized finance.
National Risks
The U.S. Financial Stability Oversight Council (FSOC) warned that digital assets like cryptocurrencies could inadvertently threaten the nation’s financial stability in October of last year.
Despite the distributed nature of crypto asset systems, operational risks may still exist because of a concentration of critical services or because of flaws in the distributed ledger technology that underpins the assets, according to the agency.
“Crypto-asset activities could pose risks to the stability of the U.S. financial system and emphasizes the importance of appropriate regulation, including enforcement of existing laws. It is vital that government stakeholders collectively work to make progress on these recommendations,” the report warned.
The White House listed risks from cryptocurrencies in a blog post on January 27. These risks included potential financial losses, fraud, and the empowerment of America’s adversaries.
Last year the price of the Terra (LUNA) cryptocurrency plummeted by over 99 percent, sweeping out crypto owners’ riches. Around one stage, prominent crypto market Binance briefly banned Terra (LUNA) network withdrawals, preventing even those who needed to sell from doing so.
Following the ransomware attack on Colonial Pipeline in May 2021, national security adviser Jake Sullivan put cryptocurrencies on the administration’s radar in June of that same year. Colonial was compelled to pay the hackers’ ransom in the amount of 75 Bitcoins, which at the time was equal to $4.4 million.
In June 2021, former president Donald Trump also expressed his disapproval of Bitcoin, stating that it was vying with the dollar as the world’s reserve currency.
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