Translation | Bank for International Settlements (BIS) Annual Report: Cryptocurrencies Cannot Sustain the Monetary System, Central Bank Digital Currencies (CBDCs) Can Take on Their Innovative Functions

The Bank for International Settlements (BIS) published its 2022 Annual Economic Report on the 27th, which consists of three main chapters in its 138-page report: "Old Challenges and New Impacts," "Exploring the Nature of Inflation," and "Future Monetary Systems." The third chapter extensively discusses BIS's observations on cryptocurrencies and the feasibility of integrating them into the monetary system. However, BIS's answer remains negative, especially in light of various extreme scenarios that occurred during the bear market, all of which serve as evidence for BIS's view that cryptocurrencies do not meet the qualifications.

Here are the key points:

Conclusions on "The Future of Money" by BIS

BIS stated that the monetary system is a crucial foundation of the economy, and central banks uphold the trust needed by the public. This trust requires high-level objectives to serve society, ensure safety and stability, and be accountable for behavior. Reliable, inexpensive transactions, efficient and inclusive finance, as well as user privacy and data control rights also need to be met.

However, recent events have shown that cryptocurrencies have structural flaws and cannot meet the requirements of the monetary system. Cryptocurrencies and DeFi are unable to serve the community, are congested, fragmented, and costly. The risks of fund loss and financial stability are imminent.

BIS believes that CBDC (Central Bank Digital Currency) and retail FPS (Fast Payment System) are the bright future of the monetary system.

Through central bank digital currencies, private companies can adopt new technologies, including programmability, composability, and tokenization, to create a dynamic monetary system. BIS stated that through collaboration between the public sector and private companies, the monetary system can become more adaptive, and cross-border payments will be more open, affordable, and seamless. With innovation, financial services will offer users more choices.

BIS believes that innovation must understand the actual needs of households and businesses in the economy, as well as the policy requirements of the monetary system. "Despite the many possibilities brought by decentralized technologies like DLT (Distributed Ledger Technology), central banks are still concerned with public interests."

BIS looks forward to new infrastructure and regulation, which will be developed through cooperation among central banks around the world and a wider range of stakeholders to build the future monetary system.

Key Comments on Cryptocurrencies by BIS

• High inflation, stagflation, the end of the post-World War II globalization era, and the turmoil in the cryptocurrency world remind us of important developments we cannot ignore in the monetary system.
• The prevalence of stablecoins in the crypto space indicates that cryptocurrencies generally need to rely on the trust provided by central bank currencies. Only central banks can offer the nominal anchor desired by cryptocurrencies, meaning pegging exchange rates. Although the crypto space initially rejected reliance on central bank currencies, they quickly realized the need for central bank currencies as units of account. Stablecoins are also widely used in most cryptocurrency transactions as a means of exchange.
• Cryptocurrency platforms are emerging rapidly, all claiming to provide financial transaction settlement. However, the congestion and high fees on these platforms are merely sacrificing security for new methods to increase transaction capacity.
• Regarding inclusive finance, BIS believes that the crypto space is moving in the opposite direction, benefiting only insiders and exploiting funds from new entrants in the speculative market.
• Cryptocurrencies are not without merit; they showcase some useful technical features that can benefit the current monetary system, such as composability, automated execution, enabling real-time settlements, and improving the efficiency of economic consensus.
• The premise of the crypto space is decentralization, not relying on central banks and trusted intermediaries. Cryptocurrencies aim to maintain self-operated systems through anonymous validators, free from the control of authorities and groups. However, their structural deficiencies prevent them from becoming the foundation of the monetary system; they lack a nominal anchor, and their limited scalability leads to fragmentation. They also often contradict the narrative of decentralization, as cryptocurrencies frequently rely on unregulated intermediaries, exposing financial risks.
• Most trading activities are centralized, as people tend to use centralized exchanges (CEX) rather than decentralized exchanges (DEX).

• Programmability, composability, and tokenization are not exclusive to cryptocurrencies; they can also be achieved based on CBDCs, fast payment systems, and relevant data structures.
• BIS is exploring privacy technologies such as zero-knowledge proofs in combination with CBDCs to protect user privacy.
• BIS believes that events related to Terra and its aftermath show significant structural limitations in cryptocurrencies and DeFi, failing to achieve the efficiency, stability, and integrity required by the monetary system.
• BIS emphasizes the necessity for stablecoins to incorporate the credit of central bank digital currencies, highlighting the structural flaws of cryptocurrencies. Stablecoins are not as stable as issuers claim; they are just imperfect substitutes for sovereign currencies.
• The fragmentation of the crypto space poses serious problems for its stability as a form of money.
• Cryptocurrencies, due to permissionless blockchains, lead to system fragmentation, congestion, and high fees.
• Speculation is the main driving force behind holding cryptocurrencies, but retail investors are not fully aware of the investment risks.
• Studies show a highly positive correlation between the price of Bitcoin and the significant increase in new investors. When the user base of cryptocurrency exchanges increases, the price of Bitcoin also significantly rises, with the majority of cryptocurrency app users being young people and males.

• It is currently challenging to estimate the actual scale of cryptocurrency exchanges because a large portion of custodial cryptocurrencies on centralized exchanges are off-balance sheet.
• Regulatory actions are urgently needed to address immediate risks in the cryptocurrency system and support public policy objectives.
• Cryptocurrency and DeFi activities must comply with regulatory requirements similar to traditional financial activities.
• Investors have the right to engage in high-risk assets like cryptocurrencies but must be provided with sufficient disclosure of information.
• As banks and non-bank financial intermediaries increase investments in the crypto space, central banks and regulatory authorities need to reduce financial stability risks. If the crypto space encounters shocks, there may be spill-over effects as traditional financial institutions enter the space. Currently, non-bank investors, family offices, and hedge funds are the most active institutional investors in cryptocurrencies.

Overall, BIS believes that cryptocurrencies offer insights for the monetary system in terms of the possibilities brought by technology, but they cannot achieve the high-level objectives of a digital monetary system. They can only address some issues through regulation concerning stability, efficiency, accountability, and integrity.