Cryptocurrencies are causing the European Central Bank increasing concern. This exotic market segment operates outside the domain of central banks and, according to specialists, can undermine monetary and financial stability. This form of alternative liquidity is a highly undesirable development, according to Sylvester Eijffinger, emeritus professor of financial economics at Tilburg University and visiting professor at Harvard University’s economics department.
Many financial authorities see a potential systemic risk in it. While ECB President Christine Lagarde did not seem to see any competition in the “funny business” of crypto-currencies in January, concerns are steadily growing. The ECB, like the US Fed, wants to get rid of so-called stablecoins in the short term. This form of crypto-currency, the medium of exchange in many crypto-transactions, poses a systemic risk and must be subjected to strict regulation by banks as soon as possible, the ECB said last month in its half-yearly review of financial stability.
The AFM also calls crypto-currencies “difficult to fathom and vulnerable to deception, fraud and manipulation.” According to the supervisor, the value is mainly based on speculation and there is no underlying valuation. Professor Dr. Eijffinger (photo), who recently retired but is still giving guest lectures at Harvard University, is also very critical of cryptocurrencies in general and Bitcoin in particular. He understands the discomfort of central banks with this development.
Bitcoin is not money
“Bitcoin is not money”, emphasised Eijffinger, who prefers to speak of “alternative liquidity”. “Due to its volatile nature, it is not a reliable monetary unit. Nor is it a means of exchange in our general economy. This is partly because banks are not yet willing to trade or invest in it. Investors should also realise that it is not a security like shares and bonds. In addition, research shows that young people with limited or no financial literacy often speculate on them. That is a very undesirable development.”
Eijffinger said that he fully understands why the ECB wants to prevent crypto-currencies from gaining a foothold in the eurozone. The ECB is very concerned because such a development could seriously hamper the effectiveness of monetary policy, he said.
Cryptocurrency used to be a small market, but it is now starting to take on more serious proportions. From a financial and monetary stability perspective - with price stability defined at 2 per cent - the emergence of this alternative cyberliquidity is very worrying. The fact that this is taking place outside the realm of central banks is very uncomfortable. Apart from the enormous energy it takes to mine crypto-currencies, Eijffinger said he also believes that it is mainly the black economy that benefits from the existence of crypto-currencies such as Bitcoin, as DNB recently stated in its Vision on Supervision.
Banning crypto-currencies, as China wants to do, is an illusion according to Eijffinger. He compares a ban on crypto-currencies with a ban on the Dark Web, which is something that happens outside the field of vision of the authorities that deal with it. The solution the ECB is thinking of is a digital euro. Then there is a legal alternative for the young generation that evidently needs digital money’.
Strictly speaking, legal tender can only be issued by central banks, said Eijffinger. De facto, that makes crypto currency illegal. Although it cannot be banned, it can be combated. The carrot is the digital currency, and the stick is the detection of all kinds of crypto transactions.
The new digital money
“Right now, the central bank creates our monetary base, consisting of overnight bank reserves and cash. Issued cash is in fact a balance at the central bank. Digital money in the future could mean that individuals can hold a digital balance at a central bank. That would mean that we would be dealing with money creation that does not go through banks.”
“This system is not new. In the 1980s, private individuals could hold deposits with, for example, the Bank of England. We might go back to that system, but then digitally. Central banks will have extra work with that, but it will allow them to cope with the unfortunate and undesirable development called crypto currency.”
Blockchain technology
In contrast to crypto-currencies, Eijffinger is very positive about blockchain technology. He rejects the oft-heard claim that blockchain-based payments will undermine the intermediary function, and with it part of the earnings model, of banks in the future. It will make payments much faster, more efficient and more reliable. Blockchain is already being used experimentally by major Dutch banks such as ING and Rabobank. According to Eijffinger, there is no question of subversion. He said that he believes blockchain will increase the fintech character of banks and the reliability of the financial system as a whole.
“In addition,” he continued, “blockchain can offer an important solution to the problems that have arisen in the supply chains. A big part of the problems in that corner are guarantees of the reliability of buyers and suppliers. Blockchain can bring about a major innovation there. This underlying technology is therefore not only applicable within the banking sector but also in supply chain management. With blockchain you can build in proofs to guarantee payments.’
Blockchain investor stays away from cryptos
Eijffinger stated that an investor who finds blockchain technology interesting should not invest in crypto currencies at all. “People always talk about bitcoin and blockchain in the same breath, but I am truly convinced that you can use blockchain in the financial sector without being tied to crypto currencies. This technology can be applied separately to banking and other parts of the economy. The added value of financial parties implementing blockchain will grow. Therefore, my expectation is that the share price value of this industry will also rise in the long term.”
Not everyone shares the mistrust
The scepticism towards crypto-currencies is not embraced by everyone. Venture capital investor Maven 11 Capital, for example, closed its blockchain fund with $120 million in assets under management on 30 November. The fund is 80 per cent invested in cryptoassets such as Ethereum, a decentralised mining network for various crypto-currencies including its own Ether.
Fund manager Joost van der Plas of Mayen 11 Capital emphasised in an interview with Fondsnieuws that he invests in cryptoassets rather than digital currencies.” In popular speech, ether is still sometimes confused with a crypto currency that shoots up and down. We approach it as an application platform, a piece of technology where blockchain applications are built by over a million developers. So to invest in that technology you buy ether.”
One of the titles in the portfolio is the company Qredo, a blockchain protocol for storing digital assets. Qredo could become a potential nail in the coffin of custody banks. In the financial world, custody is a very big business. Qredo is a platform in which you can store digital assets. “At the moment, digital assets are often crypto currencies like bitcoin, but in the future they could be, for example, digital property deeds,” said van der Plas.
“In terms of macroeconomic conditions, all the stars are aligned for this domain,” said van der Plas. “It is almost the antithesis of the current financial system. We are in a special phase where our monetary system has little room for manoeuvre. Due to increasing inflation, investors are looking for assets that are less sensitive to inflation, such as gold and now crypto-currencies. Nowadays, everyone can see that you cannot ignore the blockchain technological development. The only question is how long it will take and where investors should put their money.”
Further reading
Read the bear case on blockchain made by a Bitcoin supporter.