Welcome to Finance and Fury, The Furious Friday Edition

Monday ep this week went through BTC – Went through a monetary reset towards a crypto-fiat system –

Today – talk more The BIS and central banks versus BTC and the crypto markets – how are they planning to get there.

There are two side to crypo – especially Bitcoin – BTC is a divisive topic – garners strong passions in the population

  1. One side are the proponents – hail it as the future currency – is immune to the manipulation of politicians and central banks –
    1. Suggestions of Bitcoin being the basis for restoring world currencies to a new monetary standard or Bitcoin standard.
  2. On the other side – Bitcoin is seen as an electronic version of snake oil, tulipmania and Ponzi schemes
    1. While admitting to the underlying blockchain technology being useful and a great idea – not in the context of a currency
  3. If you remove BTC and just said crypto currency – I think both sides are right mostly
    1. Fiat system – is a bubble in its size – far surpasses tulipmania – isnt this a ponzi scheme?
    2. Why not adopt that same model but in derivative form of some digital credit – stable coins – crypto pegged to a fiat currency valuation
  4. So how will the takeover occur – through indirect methods – the back door into the crypto markets


To start with – look at the basis of all digital transactions – You need some form of 3rd party verification process –

  1. Not needed with physical currency – I go to the shops and exchange my $20 AUD for food, tell checks and takes cash
    1. An early theory of digital coins was to allow the same peer-to-peer transaction where the third party would be involved
  2. But with all digital transaction, there must be a 3rd party verifier – why coin theory evolved
    1. Everyday use of electronic money – this is the bank which holds the payer’s account
    2. In BTC – the distributed ledger built on blockchain technology does this – provides a trustworthy system in an environment where no particular party is trustworthy – verifies each party from the coin/tokes code
  3. The BIS has focused on the very functionality of cryptos – In their Annual Economic Report 2018, Chapter V is entitled ‘Cryptocurrencies: looking beyond the hype’
    1. While it says crypto in title – analysis and criticism is only focused on Bitcoin – but this does use blockchain technology
    2. They find that there may be times where blockchains provide the answer to a lack of trust, but the payment system is not one of them – Their arguments lie in two parts:
      1. Viable money systems have some essential characteristics; and
      2. Bitcoin fails to fulfil these requirements – pretty basic –

Overview of Chapter V

  1. BIS V begins with a historical review of money, noting that history is a graveyard of failed currencies – they derive the proposition that ‘money’ must meet the definitions of money:
    1. A unit of account, providing a common measure of value across goods and services that are not otherwise comparable;
    2. A medium of exchange – accepted token which can be exchanged for goods and services – under Fiat by decree – Gov only allowing AUD in our stores
    3. A store of value that enables a holder to transfer purchasing power over time.
  2. The BIS states that trust is central to the success of a currency – without trust in ‘the system’ a currency will soon cease to fulfil one or more of the essential characteristics of money – but which one? store of value, unit of account or medium of exchange?
    1. I would go one further and say it isn’t trust but confidence – trust is a part of this – but Trust and Confidence do appear almost similar in meaning – but there is a slight difference
      1. Trust refers to the firm belief that one has on another individual or thing – you trust your breaks will work even though you haven’t had a service in 10 years
      2. Confidence refers to the assurance that we have on someone or something – you have confidence your breaks will work as your car was serviced last month
      3. When confidence is lost it is almost impossible to get back
    2. Trust in bank deposits is generated through a variety of means – regulation, supervision and deposit insurance schemes,
    3. All come from the central authority of the state – trust money in your bank account is safe, but do you have the confidence in the bank not taking your money in a bail out?
    4. Trust covers medium of exchange and unit of account – you trust that it will be useful in the future – same with store the value – why? Central banks have promised a rate of loss of value – inflation loss of money in real terms
    5. What drives the ship (so to speak is confidence) – which comes an inward view of the financial system –
      1. Those at the tops – group of 30, central bank Governors, etc – their actions show confidence they have in the system – why they are looking at alternatives out now – and turning to an option readily adopted by a large chunk of the population voluntarily
      2. Well – because the type of currency is being accepted b the population – but the BIS is looking at banks being the controller of the currency – why? To create trust – ‘The tried, trusted and resilient way to provide confidence in money in modern times is the independent central bank.’
      3. Central banks are not some independent entity – resulted in inflation and a host of other collapses and economic bubbles that plague the economy since their inceptions –
  1. BIS has the following shortfalls with Bitcoin which prevents it from becoming a serious currency (don’t worry, theirs will solve these problems):
    1. Scalability – Scalability is certainly a serious issue for Bitcoin and other cryptocurrencies. Bitcoin can currently process somewhere around 7 transactions per second. By contrast, the Visa system processes around 24,000 per second!
      1. Research proposals to increases the Bitcoin rate, but none have yet been proven effective in real-world transactions
      2. There is another aspect of Bitcoin that causes scalability problems. The Bitcoin blockchain is big, currently about 170 Gb and growing at about 50 Gb each year, and it must be communicated to all the ‘miners’ in the Bitcoin system.
        1. If one coin tried to process national payments that the blockchain would soon swell beyond the storage capacity of most, if not all, computers. It would, says BIS V, bring the internet to a halt
      3. Bitcoin is the huge energy use. BIS V notes that Bitcoin uses the same electricity as a medium size country such as Switzerland. Other estimates put power usage on a par with Singapore or Ireland. The ‘proof of work’ protocol uses vast amounts of computing power and, therefore, vast amounts of electricity
        1. Power required for ATMs worldwide, the power used by banking computers and the SWIFT network, and the power required to provide security for normal financial institutions, then Bitcoin looks rather frugal.
        2. This is probably true, but it hardly seems fair to compare the power usage of payment systems that provide for a large proportion of the world’s population with that of Bitcoin which is insignificant as a payments provider.
    2. Value stability – obvious Achilles Heel. The first commercial sale which accepted Bitcoin was for two pizzas worth about $25. The purchaser paid 10,000 Bitcoins. In December 2017 the price was near US$20,000 and at the time of writing is just over $10k AUD or US$6,800- as we can see a ‘self-anchored’ currency such as Bitcoin is inherently unstable.
      1. Bitcoin adds blocks of transactions to the ledger on average once every ten minutes. A payee cannot be certain of payment at least until the particular payment is incorporated in the ledger. As BIS V notes, there have been times when payments have queued so that finality cannot be determined until much later
    3. The finality of payment – perhaps it is not as serious as imagined. After all, you don’t need too to be that old to remember when online payments took five days! Business seemed to survive in spite of it. Still, a modern payment system should achieve finality faster

Bitcoin community response

  1. Many cryptocurrency advocates ready and willing to answer the claims of BIS V – responses fall into one of two categories
    1. All cryptocurrency proponents have a deep distrust of central banks –
    2. “BIS V is hopelessly out of date” – There is active research going on, tests being done, new systems being built that will answer each and every criticism of BIS V – no arguing this point – researchers are indeed addressing the problems exposed by the BIS
  2. The most important current research is (probably) the Lightning Network and the Casper version of the ‘proof of stake’ protocol – aimed at increasing the throughput transactions- allows blockchain technology scale to be a serious payment system – Casper protocols are intended to reduce the power requirements of the existing Bitcoin network by replacing ‘proof of work’ with ‘proof of stake’.
    1. This work is done by MIT labs – where do they get their money – Donors include a few crypto companies and individuals (Jim Breyer, Jim Pallotta, Jeff Tarrant, Reid Hoffman and Fred Wilson) – all investment managers and venture capitalist billionaires in their late 50s 60s who are installed in the current financial system
  3. BIS V is correct in its criticism of Bitcoin price stability and of scaling issues.
    1. Look at BTC pricing – and one way of stability may by constant adjustments in the money supply- by an automatic algorithm – but that isn’t what BTC is – but likely what Central Bank version may look like
  4. Let’s say that every kink is out of the system and the future is of cryptocurrencies – How will central banks and governments work towards a future for their cryptocurrencies?
    1. Disintermediation of the payment system would undoubtedly have widespread financial consequences – cutting out the middle men of the economy – banks and Central Banks – so has to keep them involved – and use indirect regulations

Methods of legislation to be used

  1. Bitcoin and similar payment structures are outside any direct control of central banks and individual governments
  2. BIS V notes that cryptocurrencies ‘can only be regulated indirectly’ and discusses some of the possible approaches.
    1. Also note that ‘Since cryptocurrencies are global in nature, only globally coordinated regulation has a chance to be effective.’ – Thankfully global Govs are incompetent – but doesn’t mean they won’t try
  3. What are some methods they can use?
    1. The first key regulatory challenge is anti-money laundering (AML) and combating the financing of terrorism (CFT). The question is whether, and to what extent, the rise of cryptocurrencies has allowed some AML/CFT measures, such as know-your-customer standards, to be evaded.
      1. Shutdown of Silk Road, a major marketplace for illegal drugs, suggest that a non-negligible fraction of the demand for cryptocurrencies derives from illicit activity
      2. Regulation could focus on the point at which a cryptocurrency is exchanged into a sovereign currency
      3. Other existing laws and regulations relating to payment services focus on safety, efficiency and legality of use. These principles could also be applied to cryptocurrency infrastructure providers, such as “crypto wallets”
    2. ensuring consumer and investor protection – common problem is digital theft – access to distributed ledgers are complex – so most users access their cryptocurrency holdings via third parties such as “crypto wallet or exchanges”
      1. Irony is many people turned to cryptocurrencies out of distrust in banks and governments – but are relying on unregulated intermediaries – many examples like Mt Gox or Bitfinex – either being fraudulent or hacking attacks
    3. Major justification – concerns the stability of the financial system may be at risk without taking over cryptos
      1. Widespread use of cryptocurrencies and related self-executing financial products will likely give rise to new financial vulnerabilities and systemic risks – Systemic risk is the competition from crypto crashing banking system
      2. Cryptocurrencies with regulated financial entities could be addressed – The tax and capital treatment rules for regulated institutions wanting to deal in cryptocurrency-related assets could thus be adapted
      3. Regulate the exchanges – where most people trade crypto – you can regulate the crypto markets
  4. Policy responses, including regulation of private uses of the technology, the measures needed to prevent abuses of cryptocurrencies and the delicate questions raised by the issuance of digital currency by central banks

In the next Furious Friday ep – in a few week’s time – look at the future of cryptos – the types of stable coins – and how it might work

Thank you for listening, if you want to get in contact you can do so here: http://financeandfury.com.au/contact/


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