Global interest in cryptocurrencies such, as Bitcoin and Ethereum, has surged as coin prices soared and new coin offerings have expanded dramatically. Once the realm of technophiles and speculators, cryptocurrencies seem to have started down the path to “mainstream.” Pooled and derivative products, such as index funds and futures contracts, have emerged offering some relief from extreme daily price volatility, ranging from 3% to 8%. Similarly, initial coin offerings (ICOs) have extended the currency “use case,” emulating other more established forms of fund-raising. Despite the progress, core challenges leave behind a large moat between crypto and the core functions of fiat currencies. High volatility makes them poorly suited as a store of value, while access, scale, and, lack of legal tender-status inhibit their utility as either a medium of exchange or a unit of account. Moreover, broader concerns raised by cyber risks, price manipulation, and the carbon footprint generated by the high energy consumption of some block validation protocols all work to obscure the “mainstream” path.
Financial product development built on cryptocurrencies is a key to overcoming scale constraints and coaxing larger institutional interest in crypto-assets. However, here too significant barriers remain. Currently fund products are accessible only to qualified or accredited investors with sufficient capital to weather price and operational risks. Asset owners and institutional investors, including pension funds, sovereign wealth funds, and endowments, have opted out primarily because crypto-assets are not tangibly backed, have significant drawdown or downside exposure, lack sufficient custody arrangements, and, certainly not least, are exposed to regulatory uncertainty.
How then will governments and their central banks respond? Will they clear the mainstream path, set up roadblocks, or rather detour cryptocurrencies to a transparent, secure, and more scalable highway? The solutions and innovations adopted in response to this question hold the key to the future of cryptocurrencies. First, however, governments and central banks must earnestly confront disruption paralysis to overcome the inertia and reactiveness that have resulted in fractured or failed starts. This includes 1) defining a national digital currency strategy to inform the regulatory process and 2) clearly distinguishing monetary policy objectives from other strategic opportunities facilitated by a wider adoption of blockchain technology. The devil, of course, remains in the details with potentially disintermediating effects that could leave the fate – and the prices – of even the largest market cap cryptocurrencies hanging in the balance.
Certainly, proposals and programs abound. The Brookings Institution catalogs at least 29 separate government initiatives linked to crypto or central bank digital currencies (CBDC’s). These range from the implementation of digital payment systems to the introduction of digital or e-money to the issuance of sovereign cryptocurrencies, in some cases parsing the traditional functions of money – e.g. value vs. payment – to address specific national objectives. They are also distinguished as much by their frailty as by their diversity. In Estonia and Russia, for example, initiatives have circulated to create respectively the “estcoin” and the so-called “CryptoRuble.” In Estonia, which uses the Euro, the estcoin initiative was recently downplayed by a government spokesperson, while in Russia, Vladimir Putin himself dismissed the prospect of issuing the CryptoRuble. In Switzerland, a broad-based campaign to reform the Swiss monetary and banking system through the issuance of “sovereign money” – Vollgeld – brought the matter to a national referendum. The Swiss National Bank lobbied hard against the initiative, which ultimately managed to secure only 26% of the vote. In Venezuela, hardly a model for monetary stability or policy innovation, the “Petro,” a “cryptocurrency” backed by petroleum reserves, was created to function not as a national digital currency, but rather as a sovereign initial coin offering designed to provide the government with access to new capital. In recent weeks, the Petro has been linked to attempts to restructure the Venezuelan Bolivar, which has been racked by hyperinflation.
Where then to look for innovation? …the Marshall Islands? The RMI – population 75,000 – became independent of US administration in 1986, but continued to use the US Dollar as a national currency. In February 2018 RMI issued a currency law introducing a cryptocurrency – the SOV – as legal tender in the island nation. The SOV is a true cryptocurrency that is issued on distributed ledger technology (DLT), i.e. blockchain, using a unique, permissioned protocol that appears to overcome several of the discrete challenges of cryptocurrencies launched on public, permissionless networks. Users must undergo “know-your-customer” prescreening and be issued an identity token, which identifies them to counterparties. Thus, transactions are “private,” but not “secret.” Is the SOV the new baseline? Hardly. The RMI suffers from high unemployment, low digitalization, and is threatened by climate change. Certainly, questions will remain as the SOV scales even over a tiny population. Yet, perhaps it can serve to inform the continuing work of governments and central banks, most especially, as they leverage DLT to reassert the sovereign role of the state over “money.”
The disruption of blockchain does not, however, rest exclusively in the monetary sphere. More broadly, blockchain use cases extend deeply across industries, including financial services, with potentially transformative affect. When applied to custody services, for example, they offer the potential to significantly increase interoperability and standardization, while reducing the risk and increasing the speed of clearing and settlement processes. This places authorized, i.e. permissioned or private, implementations of DLT squarely at the cusp of the evolving global capital market infrastructure. It is here too that governments, through their sovereign investment vehicles – such as Singapore’s Temasek – have placed their bets.
To date many governments, central banks, and indeed sovereign wealth funds have eschewed a discrete role in markets for cryptocurrencies – whether as investor or even regulator. When and how they do will have very real consequences for the future development of crypto assets and their values. Caveat emptor…