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Digital currency rose to its prominence in , marked by the birth of Bitcoin. The following seven years saw the burgeoning of a 10 billion dollar worth Bitcoin global network, which leads to more discussions from central banks around how to keep up with the trend both systematically and technologically.
Debates on the legitimacy of digital currency never end, with speculation around possibilities of its replacement of fiat money, an ensuing prospective governance mechanism and its function akin to that of central banks. Digital currency was designed to encrypt transaction and wane off trust of central agencies, in the spirit of the Cypherpunk movement to fend off governmental interference into public privacy. Early inventions like E-Cash or B-Money were not sufficient to make ends meet.
The technological shackle was not broken until the emergence of Bitcoin. It is true that transactions in Bitcoin are traceable, yet asymmetric encrypted technology guarantees privacy and anonymity. More importantly, Bitcoin is capable of conducting decentralized distributed bookkeeping network thanks to block-chain technology.
Each node in the network can save and verify all block chains containing transaction history. Any fabrication attempts will be known and spread across the entire network. Thus, a traditional currency system that depends on the involvement of a third party bank and central bank as the settlement body can be replaced. However, currency system revolving around the central bank is not designed only for trading and transaction, but is also held responsible for monetary policies such as credit expansion, price stability and flexible money supply — all duties that Bitcoin was deemed as insufficient to fulfill.
It is factual that decentralization is a major innovation of Bitcoin. While on the other hand, Bitcoin is vulnerable to external clashes as a result of lacking central adjustment system. Incidents like hacker attack, coding mistakes, fall down of major traders, changes in regulation and transaction size will affect the value of Bitcoin. Arbitrage margin gives rise to financial speculation that further complicates the situation.
In this sense, Bitcoin does not function as a measurement of value, which is a key attribute of currency. Furthermore, Bitcoin was designed to have a limit of 21 million. But the volume restraint also destines Bitcoin to be a failing system should it drive a deflation. One of the primary mandates of central bank is to rein in inflation, while facilitating currency circulation and investment expansion. In contrast, deflation was discarded by economists as it puts curbs on currency flow that consequently leads to a growth halt.
Bitcoin came under all the doubts and objection as a result of its fixed total size. Admittedly, Bitcoin is far from a perfect design, but we have to look into the possibility of its wider adoption in the future. Criticism against Bitcoin price volatility boils down to its ability to achieve a decentralized orderly governance. In other words, it is hard to have faith in Bitcoin for an effective credit management without national credit endorsement and central bank at the centre of monetary policy adjustment.
In fact, studies including commons governance, open source theory and internet socialism have proven that a social group without a powerful management body at its core will not necessarily degenerate into chaos. A seemingly loose organisation can still be effectively governed through healthy interactions among its members. The group composed of programmer, miner, vendor and user may not have the central authoritativeness akin to central banks, yet they are still nimbly making changes to Bitcoin in response to the macro environment, as evidenced by its development in the past nine years.
Whether it is to fix bugs or parameters, the online community managing Bitcoin ecosystem can reach consensus before making a group decision. For instance, rapid expansion of Bitcoin transaction led to a failure of timely recording all transaction histories. The managing community agreed on improving the block chain technology powering transaction process based on the consensus they reached.
In other words, an online community operating the Bitcoin system works the same way as how central banks managing market liquidity often seen in an economic boom. Though it might be a long process, any hasty decision-making brings huge risks in light of the sophistication and uncertainties of monetary environment. Time-saving may not be a priority in this case. Concerns about deflation were also cited to undermine the credibility of Bitcoin.
We should all contemplate on this question: Price drop will in fact drive people to spend more and consequently facilitate, instead of hurting liquidity. In fact, inflation or deflation is simply a reflection of the time preference of currency.
What it affects is not liquidity, but the ROC level of different asset owners. One should hold asset during inflation and hold cash to ride over deflation. In real life, asset holder refers to upper-middle class, while cash holders are primarily found among blue-collar workers who live paycheck-by-paycheck. Wage increase is hard to keep up with CPI when assets are inflationary, and thus put workers in a stringent vicious cycle.
Running this line of thinking, swinging between inflation and deflation is more of an issue with distribution, not an issue of production. The birth of Bitcoin was highly attributable to the financial crisis in , which was a bitter fruit eaten by the policymakers who supported a long-term inflation policy that resulted in the burst of subprime loan bubbles.
In this sense, the deflationary design of Bitcoin is less of a fundamental flaw, but more of an endeavor to revamp the currency system. The deflation-led Bitcoin does not necessarily mean there is no chance for a credit boom.
Block chain technologies such as smart contract and side chain can enable a credit expansion. Looking from this perspective, Bitcoin can be significantly improved should there be an unleash of new technologies.
Granted, it is highly recognized in countries plagued by terrible inflation, while for other regions, fiat money endorsed by state credit is irreplaceable. The central bank will remain its dominant position of monetary policymaker. With all premises being unchanged, how is digital currency innovation expected to contribute to the incumbent currency system? The financial crisis is an epitome of such dilemma. Despite strengthened post-crisis regulations, the central bank did not solve the root of the problem by fundamentally overhauling the entire system.
In fact, the solution has already surfaced as early as s. As a result, savings in the commercial banks were all deposited to central banks, which, subsequently, only functions as a normal bank, as assets and liabilities have all been transformed to deposits and bonds on the balance sheet.
At the same time, commercial banks are eligible to expand their roles by issuing long-term debt or more profitable short-term ABS, while facing potential risks derived from low liquidity on the balance sheet. Whereas the distributed bookkeeping technology related to Bitcoin is maturing, it is expected to become the future solution. A few central banks have consolidated businesses with non-banking financial institutions — something unthinkable before the invention of Bitcoin.
The distributed bookkeeping technology significantly cut the cost of settlement, as the central bank no longer needs a large and centralized data base for verification. A digital currency open network would be enough to streamline the supervision role of central bank, and the cost for restructuring will be remarkably lowered.
Uncertainty is the forever risk. It has been testified by the development of Bitcoin that governance over code is achieved through repairing and improving. An open source mode is probably the most effective governance that can be achieved at this moment. This is the only way to install the capability of detecting system bugs as early as possible and explore further into the block chain technology. Central bank could learn a lesson or two from the mechanism under which Bitcoin was governed.
Robert Solow is also a supporter for higher punitive interest rates for lower risks. While in reality, central bank often works as the last resort, has no choice but to give unrestricted loans, and definitely not at a punitive rate when the system is hit by a crisis. Bailout recipients are usually too big to fail, and their asset portfolio is to complicated to assess the value of the guarantee. As of now, banks have too many risky assets piled up on their balance sheets.
Distributed bookkeeping technology is a perfect solution in improving the transparency of asset composition for valuation. The Free Banking System proposed by Hayek called for abolishing central bank and currency issuance by commercial banks.
He believes free market competition will pursue the currency with the most stable value as the common currency for mass circulation, so the market can be immune to the negative impact exerted by a dovish central bank.
Information asymmetry did not cancel out the risks of a run and there is still a possible outbreak of liquidity crisis. Not necessarily so if we take into consideration its open source attribution and income distribution. Bitcoin can be deemed as a type of common resource to some extent. It is far too early for us to make an outright conclusion on digital currencies represented by Bitcoin, which is a technology with subversive power.
It is encouraged to put more thoughts on their future development, impact on the flat money and lessons central banks can learn from this invention. Bitcoin and central banks: Price volatility and deflation Bitcoin now faces two major critics: Bitcoin as a replacement? The Cambrian explosion of blockchains.
Today, there is a real curiosity, but above all, a need for education on the subject of Bitcoin and Ethereum protocols, as well as blockchain technology. As crowdfunding grows, the rewards increase — but so do the risks.
Crowdfunding is now recognized as a reliable funding avenue for both start-ups and established firms. But the growth of the sector raises questions. Crisis as usual or the end of old capitalism? The nature of the crisis debated. Is it simply a classical cyclical crisis or a structural one signaling the failure of a model? Thank your for your subscribe.