In its latest annual report, the Bank of International Settlements (BIS), which is owned by 60 central banks and exists to promote financial stability and to foster international cooperation, has dismissed the idea that Bitcoin and other cryptocurrencies could serve as a substitute for money.
The report flags a number of problems. First, whereas stability is an essential property of money, the value of cryptocurrencies is inherently volatile. Because such currencies are not backed by a central bank that adjusts supply in line with levels of demand, any fluctuation in demand translates into a change in value. The resulting instability is exacerbated by the frequency with which new, closely substitutable cryptocurrencies are set up.
Second, the BIS does not believe that cryptocurrencies are scalable. To process the number of transactions currently handled by mainstream retail payment systems, the size of the ledger of cryptocurrencies would have to swell, in a matter of months, beyond the storage capacity even of whole servers. According to the BIS, the communication volumes "could bring the internet to a halt".
Moreover, as the use of a cryptocurrency increases, the more cumbersome and congested its payment system becomes. Already, some transactions have remained suspended in queues for several hours. Such delays disqualify cryptocurrencies from use in day-to-day transactions. Ultimately, the increasing difficulty and energy-intensiveness of these processes translates into high transaction costs and "environmental disaster".
The BIS also warned that cryptocurrencies remain more vulnerable to fraud than mainstream currencies. In particular, cryptocurrencies can be manipulated by miners who control substantial computing power. Cryptocurrencies especially at the stage of initial coin offerings ("ICOs"), are frequently the target of outright fraud.
Coming from an institution owned by central banks, the scepticism of the BIS report may not be surprising. Nevertheless, the concerns flagged by the report appear well-grounded and are increasingly likely to come to the fore as the demand for Bitcoin and similar currencies grows. It is particularly notable that the BIS has highlighted the risk of fraud alongside systemic issues such as stability and scalability. That warning echoes earlier messages this year from Action Fraud and the United States' Securities and Exchange Commission ("SEC"). Plainly, investors should continue to exercise special caution when dealing with cryptocurrencies, and in particular when participating in ICOs.