I enjoy reading Tyler Cowen and have learned a lot from his columns. So before I criticize his most recent effort, I want to thank him for all his fine contributions! Unfortunately, I think he drops the ball a little bit on his most recent effort. No worries--we all do sooner or later. What follows are some thoughts that came to my mind as I read his most recent article entitled "Cryptocurrencies Don't Belong in Central Banks." My (unedited/uncensored thoughts are recorded in blue...Tyler, take note: "uncensored"= risk-taking central banker!)
Should central banks embrace cryptocurrencies, or even pioneer their own? In a nutshell, no. Crypto assets are an unusual innovation, still in flux and often poorly understood. Trying to centralize them in a bureaucracy is exactly the wrong way to go.
"Crypo assets are an unusual innovation" -- this is a claim that makes little sense without first defining what is meant by the term. Most people have in mind some notion of a distributed (shared) append-only ledger of information updated and maintained by members of a community through some consensus algorithm that makes use of cryptography in securing information. I'm not sure how "unusual" this idea is where fintech is concerned (advances in information management systems have been happening for a long time). And, as I explain here, the concept of distributed ledgers updated via communal consensus is an ancient idea.
"Trying to centralize them in a bureaucracy" makes no sense at all if the very concept depends on a decentralized record-keeping arrangement. And in any case, a central bank that experiments with such a protocol is not "centralizing" all crypto assets--just its own crypto asset. What is inherently wrong with this? The fact that a central bank is a "bureaucracy?"
Yet China’s central bank claims it is working toward a blockchain-based digital currency. Singapore has already experimented in this direction. The phrase “Fedcoin” is sometimes bandied about, though I’ve seen no concrete sign of the U.S. Federal Reserve jumping on this bandwagon. In its recent quarterly review, the Bank of International Settlements asked central banks to consider whether cryptocurrencies might make sense for them.
The "Yet" beginning the paragraph does not belong there. It presumes we've accepted the premise laid out in the previous paragraph which, as I have suggested, makes little sense.
Central banks, however, are intrinsically conservative bureaucracies. They shun bad publicity, and they don’t like to be “out there” ahead of the curve. They don’t want their names connected with potential mishaps -- because they value their credibility and their political capital so highly. That’s appropriate, because central bank independence is typically fragile.
Almost everyone shuns bad publicity. No one wants their names connected with potential mishaps. It's not that central banks don't like to be "out there"--it's that they are usually prevented from being "out there" by government legislation. Of course, central bankers should be "conservative" in the sense of respecting the legislation that is designed to govern them.
Given that background, (which is wrong) should we foist a new and potentially risky responsibility on them? Central banks will feel some anxiety at having to manage a crypto project. (central bankers will always feel anxiety). To conserve their political capital, they will take fewer risks elsewhere, such as unorthodox monetary policy or larger balance sheets. (what justifies this bald speculation?) Yet the response to the 2008 financial crisis shows a certain amount of central bank risk-taking is needed. (those conservative central bankers again, I guess). I’m worried about central banks taking on unnecessary risky projects, thereby rendering them too cautious in other areas. (there's no need to worry about this in my opinion.)
An additional reason for skepticism stems from the nature of crypto assets. The word “cryptocurrency” is far more common than “crypto asset,” but it’s a misleading term. Bitcoin, for instance, is used only rarely in retail transactions, and for all its success it isn’t becoming more important as a medium of exchange. Bitcoin thus isn’t much of a currency in the literal sense of that term. There is a version of bitcoin, Bitcoin Cash, that changed the initial rules to be better suited as an exchange medium, but it isn’t nearly as popular. (I don't disagree, but I also don't understand the point of this paragraph.)
If you think of these assets as “cryptocurrencies,” central bank involvement will seem natural, because of course central banks do manage currencies. Instead, this new class of assets is better conceptualized as ledger systems, designed to create agreement about some states of the world without the final judgment of a centralized authority, which use a crypto asset to pay participants for maintaining the flow and accuracy of information. (Good, I agree with all this.) Arguably these innovations come closer to being substitutes for corporations and legal systems than for currencies. (Except that in monetary theory, we understand money as a ledger -- a record-keeping system. See, e.g., Kocherlakota, 1998).
Put in those terms, an active (rather than merely supervisory) role for central banks in crypto assets is suddenly far from obvious. Consider other financial innovations: Does anyone suggest that central banks should run their own versions of ETFs or high-frequency trading? Is there a need for central banks to start managing the development of accounting and governance systems?
Um, yes, yes, and yes. Central banks are already like bond ETFs (assets are bonds, liabilities are reserves and currency). High-frequency trading--like Fedwire, you mean? And I'm not sure why better accounting and governance systems should not be employed by central banks if it makes sense for other institutions?
Finally, bitcoin and other crypto assets are still in the midst of rapid evolution, with basic questions still unanswered. Should bitcoin “fork” to allow for greater speed in processing transactions? Is the future going to favor bitcoin, the Ethereum platform, or something else altogether? How many initial coin offerings make economic sense, as opposed to being bubbles? Should initial coin offerings be used to fund startups? How many crypto assets should survive in the long run? Can blockchains be used to record and settle the transfer of property titles? Are there any circumstances when it should be possible to revise transactions on a blockchain?
Yes, there are always questions concerning the outcome of fintech. This has been happening for hundreds of years. What is the point of stating this obvious fact and why should the prospect of evolving information technology discourage central banks from experimenting with it? What if such an attitude was adopted when email first appeared on the scene?
In general, I think the central banks in the world’s developed economies have done a pretty good job. But consider a simple question: Would any central bank have had the inspiration or taken the risk of initiating the bitcoin protocol in the first place?
Let's assume that the answer to this question is no. The only thing that follows from this is that we should not rely on central banks as our only source of fintech. But we already do not have such a reliance. So what is the point being made here? Let's experiment away, I say!
Well, maybe not. My own sense of the discussion concerning central banks and cryptocurrencies is that people are confounding two conceptually distinct issues.
The first issue is whether central banks should open the digital component of their balance to the general public (say, the way the U.S. Treasury does at https://www.treasurydirect.gov/). And why not? After all, central banks allow anyone in the world to hold the paper component of their liabilities. This idea is actually very old--it is related to the question of whether a central bank (or post offices) should permit people to open book-entry utility accounts. This remains a good question and there are many issues to sort out, including what impact such an innovation would have on banks. But it has nothing to do with "cryptocurrencies" except to the extent that cryptography is used to secure communications--something that is already widely employed.
The second issue is whether central banks should issue "digital cash." The digital reserve money associated with the scheme in the paragraph above is not cash-like in the sense that it is not a bearer instrument. People have to identify themselves when they open accounts at the U.S. Treasury. Presumably, they'd have to do the same thing if they opened up a digital money account at at post office or central bank. Digital cash is something more akin to paper money. As far as I can tell, the technology to create digital cash has been around for a long time. That is, there is nothing technological that prevents a central bank (or anyone) from issuing numbered accounts (think of the good ol' anonymous Swiss bank account, for example). Even PayPal could issue digital cash--if it was legally permitted to, which it isn't. So, the question here is whether a central bank should issue digital cash. The wallet-to-wallet debit/credit activity could be done in-house via a central book-keeper, or the activity could be delegated to some third parties (e.g., Bitcoin miners). I don't really see central banks getting into this business, but they will have to think about how private-sector digital cash may impinge on their ability to conduct monetary policy. (Note: the innovation with Bitcoin is not digital cash per se, rather the innovation has to do with P2P digital cash--debit/credit operations that do not rely on a central book-keeper.)
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