Crypto “Cannot Fulfil the Role of Money” due to Inherent Fragmentation, BIS Claims

Recently the Bank for International Settlements published a report on Blockchain scalability and the fragmentation of crypto, which concludes that it “can’t fulfil the role of money”.

BIS states that “limited scalability and a lack of interoperability not only prevent network effects from taking root, but a system of parallel blockchains also adds to governance and safety risks”. The network effect is the phenomenon by which the value or utility a user derives from goods depends on the number of users of compatible products. These effects are typically positive, resulting in a given user deriving more value from a product as more users join the same network.

So users are the main asset of any monetary system or network. And when it comes to blockchain, there is no one and only special coin, which everyone would like. Indeed, it is difficult to imagine that everyone will switch for example to ETH, taking into account that other coins have a very similar technology — just different marketing, plus word of mouth. Technical and financial problems that occur quite often in crypto markets and their instability also stops people from moving into this new system from ‘the old and reliable’ fiats. So unless crypto is at least stable for the majority to use, fiat money will be difficult to replace.

Among other flaws of crypto, BIS mentions low capability, high cost of transactions and fragmentation — nothing new. According to the publication, the mechanism of consensus induces the rise of fees and limitations of capability. That consequently leads to the rise of fragmentation, as people start using alternative blockchains. They aim for higher transaction limits, but these come at the cost of greater centralisation and weaker security. Bridges could solve the problem of fragmentation, but according to the report they are “jeopardising security by increasing the risk of an attack”.

Another interesting point mentioned is that “cryptocurrencies on different blockchains exhibit strong price co-movements, as they often share the same investor base, and growth is sustained by speculative buying of coins”.

To sum up, BIS comes to the following conclusion:

“Fragmentation means that crypto cannot fulfil the social role of money. Ultimately, money is a coordination device that facilitates economic exchange. It can only do so if there are network effects: as more users use one type of money, it becomes more attractive for others to use it. Looking to the future, there is more promise in innovations that build on trust in sovereign currencies”.

Meanwhile, most of the central banks (members of BIS) are working on CBDC’s. It means that BIS is interested in taking part in the development of the new monetary system (of course it is). Seems that BIS’s next step could be to offer itself as a coordinator which will unite CBDC’s (and maybe crypto) and get rid of all the above-mentioned flaws by taking control over the whole process.

By the way it’s not the first time we are writing about BTC role in monetary system. Read about Andreas Rahmatian, Professor of commercial law at the University of Glasgow, views here, and about IMF prospects of crypto here.