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Analysis

Integrate qualifying cryptocurrencies

Lessons from Germany's 19th century policy-makers

by Ousmène Mandeng in London

Mon 26 Feb 2018

Cryptocurrencies are an important monetary innovation and have reinvigorated debate about the meaning of money. They aim to disrupt and challenge monetary and financial arrangements, and calls for regulation have proliferated. However, few discussions on supervision have focused on the possibility of a sustained and significant expansion of cryptocurrencies as money.

Cryptocurrencies promise to deliver improved financial transaction efficiency, reduced transaction costs and an alternative to occasionally unsteady national currencies. However, they bear significant risks and have been derided as financial follies. Their total market capitalisation at the end of January 2018 was $520bn, though this figure was down from $830bn earlier that month.

The surge in cryptocurrencies raises fundamental concerns about financial instability. These currencies are inconsistent with the notion that there should be an upper limit on the amount of money in an economy to preserve macroeconomic stability. The total market capitalisation of all cryptocurrencies at the end of December 2017 was equal to around 15% of the currency held by the public issued by the US Federal Reserve, European Central Bank and Bank of Japan combined, compared with less than 1% in December 2016.

Announcements that the G20 will consider regulation for cryptocurrencies could engender an intrusive supervisory approach. Policy-makers' responses to date have been concerned mostly with illicit transactions, consumer protection, market manipulation and capital flight. At the same time, market watchers recognise that cryptocurrencies have brought important innovations and should not be unduly stifled.

The case for regulating cryptocurrencies as currency, if not necessarily as legal tender, is a controversial one. The rapid rise of cryptocurrencies and their (albeit limited) function as a medium of exchange seem to warrant this novel approach. The multitude of cryptocurrencies may require a new regulatory framework to address intercryptocurrency and national currency-cryptocurrencies relations.

Banknotes were the cryptocurrencies of the 19th century. They represented important innovations, reduced transaction costs, eased large-scale payments and were predominantly private currencies supplied by banks of issue. But some worried that the proliferation of banknotes would adversely impact monetary stability. In 1876 the Reichsbank, Germany's central bank until 1945, was established to regulate banknote issuance. The regulatory approach was based fundamentally on common quantitative ceilings, including quotas and reserve requirements, and qualification criteria for the private banks of issue and the Reichsbank.

Germany in the 19th century embraced monetary innovation. Policy-makers understood the benefits to the monetary system of coexisting private and official monies. The regulation reflected integration rather than exclusion while imposing common safeguards to preserve monetary stability. A similar system could be adopted for cryptocurrencies, in which they would have to satisfy certain qualification criteria to be considered under a common regulatory framework based on some adequate limit to currency issuance.

There is risk of excessive regulatory suppression of cryptocurrencies. While the potential pace of expansion justifies supervision to guide orderly entry, exit and issuance, cryptocurrencies should be allowed to develop. As happened in 19th century Germany, institutional and regulatory innovations are needed to deal sensibly with monetary innovations.

At the same time, history suggests that the tone of regulation set by some may not be representative of others' attitudes and expectations towards money. The risk of bias may be highly problematic and lead to the asymmetric distribution of cryptocurrencies' benefits.

Ousmène Mandeng is a Visiting Fellow in the Institute of Global Affairs at the London School of Economics and Political Science. This is an abridged summary of a research paper published by the LSE.

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