BIS: Crypto’s ‘inherent’ flaws a threat to monetary system.
(Dinarian Note: Keep your friends close, keep your enemies closer... Know the enemies Agenda)
The market capitalization of the crypto ecosystem – notwithstanding a significant decline in 2022 – lies in the trillions of dollars, and there are thousands of crypto coins in circulation. The spread of crypto has been global in nature and driven by a wide range of investors.
In theory, the crypto universe builds on the premise of decentralization. Rather than relying on central bank money and trusted intermediaries, crypto envisages that the recordkeeping of transfers is provided by a multitude of anonymous validators. Decentralized finance, or “DeFi”, seeks to replicate conventional financial services in a decentralized way within the crypto universe, often underpinned by the medium of exchange role of stablecoins. DeFi incorporates innovations such as programmability and composability on blockchains.1 Such systems are “always on”, allowing for worldwide transactions 24 hours per day, seven days per week.
Recent events revealed a wide divergence between the crypto vision and reality. Although crypto operates under the banner of decentralization, in practice new centralized intermediaries have played a key role in channeling funds into the crypto universe and intermediating within it. The implosion of the FTX crypto exchange is only the most notable manifestation of the sector’s vulnerabilities. Rather than providing a more resilient financial architecture, crypto displayed the same well known vulnerabilities of traditional finance, but in amplified ways.
This report reviews the key elements of the crypto ecosystem and assesses its structural flaws. It then goes over the risks that it poses and discusses options for addressing them. It also identifies data gaps and discusses ways to alleviate them.
The report has three key takeaways. First, the crypto ecosystem is subject to a high degree of fragmentation and is characterized by congestion and high fees. This would have been the case even if it had stayed true to its original decentralized ethos. These structural flaws derive from the underlying economics of incentives of validators rather than from technology. And while crypto has offered some elements of genuine innovation, these can be replicated or embedded in the safer and more trusted traditional finance system (BIS (2023)). Second, despite an original ethos of decentralization, crypto and DeFi often feature substantial de facto centralization, which introduces various pain points. A prime example concerns stablecoins, which piggyback on the credibility of the central bank’s unit of account and may pose risks to monetary sovereignty. Third, while DeFi mostly replicates services offered by the traditional financial system, it does not finance any activity in the real economy but amplifies known risks.
As growth is driven mainly by the speculative influx of new users hoping for high returns, crypto and DeFi pose substantial risks to (especially retail) investors. In sum, crypto’s inherent structural flaws make it unsuitable to play a constructive role in the monetary system (BIS (2022)).