Digitalisation is accelerating, spreading both opportunity and disruption. The number and value of cryptoassets, such as bitcoin, have exploded. Billions of dollars are pouring into new ventures that hope to remake the banking and investment world with the help of blockchain-based decentralised finance.
Coherent regulation could channel this for the good of society, yet there is no consensus among central bank governors, finance ministers or regulators on how to proceed. They remain divided on a central question: are cryptoassets merely the beneficiaries of speculative excess, like the tulip mania of the 1630s, or are they 1998-style dot-coms, containing the seeds of a major technological and economic transformation even if surrounded by speculative excess, naïveté and sometimes fraud?
Senior financial officials fall into four categories on this key question. The dismissive, or most sceptical, regard cryptoassets as a speculative fad destined to blow up and vanish without any policy intervention. The staying power of bitcoin, Ether and altcoins has caused this group to dwindle. More numerous are the active opponents, who worry about the ramifications of cryptoassets on financial stability, consumer protection, financial crime and climate change. These officials want to limit the sector’s growth and keep it from affecting the core banking system and economy.
Pragmatists view the growth of cryptoassets and interlinkages with the traditional financial sector as inevitable. They want to devise laws, regulations and supervisory approaches that will promote financial stability and investor protection. The supporters, the final category, see cryptoassets as a technological breakthrough with real societal value. Their focus is on finding ways to foster innovation while establishing the kind of protections that the pragmatists desire.
Sceptics generally contend that bitcoin shouldn’t be viewed like a commodity – a digital form of gold, as it’s often described – because there are no legitimate end users of the kind that exist for physical commodities. However, there are at least four kinds of users.
Libertarians and techno-anarchists have an ideological preference for a non-governmental currency over fiat money, like the dollar or euro. Partly overlapping with this group are those people who distrust their government’s economic management and view cryptocurrency as a hedge, like gold, against the risks of hyperinflation or asset seizure.
There are also cryptocurrency users who place a high value on anonymity. Some are criminals but many are not, including people who live in authoritarian countries and want to keep their transactions private. Finally, technical users view digital currency as an important part of blockchain-based innovations. The number of people who fall into these camps is hard to gauge, but they are significant and growing.
What about the dot-com camp? These policy-makers see some areas where cryptoassets could transform the economy and create innovations in ways comparable to the impact of the internet. First, distributed ledger technology can help provide cheaper and faster payments services or track the ownership of securities. In many cases, provision of these services will be facilitated by digital payments, whether in cryptoassets like bitcoin, stablecoins pegged to fiat money or a central bank digital currency. Second, smart contracts and programmable money enable transactions to be carried out automatically when pre-agreed conditions are met.
Some champions of cryptoassets also believe they could serve as partial replacements for central bank money and are better suited to controlling inflation. Finally, cryptoassets could fuel a new system of DeFi, in which automated exchanges and software foster cheaper and faster transactions between borrowers, lenders, buyers and sellers than traditional financial institutions with their human-centric processes.
It’s too early to tell whether cryptoassets will live up to the promises of the enthusiasts or the nightmares of the skeptics. Yet there is another way to regard these digital assets, something that falls in between the tulip bulb of speculative excess and the dot-com of technological transformation. That is to regard them as financial assets.
Cryptoassets may not carry an ownership stake in an entity or have a claim on cash flows, like stocks and bonds, but they trade in liquid global markets, have regulated derivates, can be leveraged and can earn interest. Bitcoin, for example, compares favourably to mid-cap US equities in terms of market liquidity and volatility. For example, the 10-day 99% value at risk for bitcoin falls well within the range of the 20 smallest firms in the S&P 500.
The big advantage of treating cryptoassets as financial assets is that it would allow policy-makers to draw upon well-established regulatory approaches as they draft laws and rules to govern this sector. That could break today’s policy gridlock and foster the kind of coherent regulation which could encourage socially useful innovation while discouraging harm.
Douglas Elliott is Partner at Oliver Wyman and a Leader of the Future of Money Initiative at the Oliver Wyman Forum.