In a 24-page examination published on June 17, 2018, the Bank for International Settlements (BIS) provided a reality check for cryptocurrency investors and distributed ledger technology fanatics. The BIS described the functions of money and gave evidence that cryptocurrencies typically fall short of their promises.
"Overall, the decentralised technology of cryptocurrencies, however sophisticated, is a poor substitute for the solid institutional backing of money," the BIS wrote. "That said, the underlying technology could have promise in other applications, such as the simplification of administrative processes in the settlement of financial transactions. Still, this remains to be tested."
Many in the blockchain and cryptocurrency communities should be familiar with the BIS' complaints. From "environmental disaster" to insufficient throughput (how many transactions per second a blockchain network can process), the technical limitations of cryptocurrencies are obvious.
One issue the BIS touched upon that doesn't receive much attention is data storage itself. If you think about it, replicating ledgers all over the world is awfully inefficient. At first, there might be some security benefits (and really, that's the essence of decentralization) but there are diminishing returns to this process.
The BIS also raised concerns about the "probabilistic" nature of blockchain-based settlement. In other words, because of the way blockchain protocols are designed, cryptocurrency transactions might be reversed long after they were first processed.
What does this mean? Well, if you can't trust that you've received payment for goods or services, why would you use a cryptocurrency as a medium of exchange?
Later, the BIS addressed the "unstable value" of cryptocurrencies themselves. Notwithstanding issues of consumer confidence, the BIS wrote, "The inherent instability is unlikely to be fully overcome by better protocols or financial engineering, as exemplified by the experience of the Dai cryptocurrency."
Note: Basically, the Maker DAO attempted to maintain a stable peg to the US dollar by controlling the supply of its cryptocurrency, the Dai coin … It didn't work.
The BIS also noted that there are thousands of cryptocurrencies, which are virtually substitutable, in existence. Why would a user prefer one over another? Why would a miner? Will they last? Ultimately, there's nothing especially unique about bitcoin (save for its brand recognition).
Still, the prolific rise of cryptocurrencies can't be ignored. The BIS advised that governments design international regulatory solutions and carefully distinguish which regulator(s) might be appropriate for alleged "utility tokens." The BIS offered a brief comment on central bank digital currencies but by all indications, CBDCs seem to be a pipe dream without benefits to speak of. Altogether, the BIS provided the textbook case for why cryptocurrencies won't become decentralized money.
But for now, the bulls still run wild.