New Gold Standard? Protest Movement? Money? Nope.

Crypto assets are about new financial markets and institutions, not new money. That's why they are interesting.

Listening to Michael Casey and Noelle Acheson’s interesting conversation about the critiques of Bitcoin, I was forced to reflect (yet again) on whether Bitcoin is actually money or not. Personally, I don’t think it is and nor do a great many other well-informed commentators.

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But what is it? Some people (justifiably, in my opinion) always saw Bitcoin as more of a protest movement than as a viable alternative to the Bretton Woods world. Some other people saw it as a replacement for a rotten international monetary system. Within the Bitcoin community there are people who go even further and see cryptocurrency as a new dawn for society.

In the very early days of Bitcoin, I met a number of people who saw crypto-assets as the basis for an alternative economic system, a kind of trustless base layer for a universal "internet of value" that would sweep away the sclerotic institutions of global corporatism and unleash a new wave of capitalism. These people often talked about a new gold standard, although I'm not sure why, because society had long ago decided that a gold standard was not the best way to run modern economies.

(I don't see any evidence that this alternative system is emerging. On social media we see what Concoda calls " a non-stop stream of 'freedom porn'" yet in reality the crypto-asset markets are thin, opaque and manipulated.)

The Governor of the Bank of France said that there is no such thing as a cryptocurrency, only crypto-assets, when speaking at the Paris Fintech Forum recently. I understand what he means. Brett Scott, who is always thoughtful about such things, recently made a similar point to M. de Galhau. He said that just as a child trading an action figure for a football "does not undermine the Federal Reserve (which issues dollars that both are priced in)" so "swapping a dollar-priced Bitcoin collectible for dollar-priced goods does not fundamentally alter the structure of the monetary system".

I agree with these sceptical perspectives and I've been pretty consistent in my view that Bitcoin is not money but a new form of digital asset that might, in certain circumstances, exhibit money-like characteristics.

So if crypto-assets are not a protest movement, not a new gold standard and not a new money, then what are they?

Crypto Choices

One way to answer the question is consider why it is that people buy and sell crypto-assets. I have often wondered whether most people dabbling in the leading cryptocurrencies see it as a new dawn or digital collectibles. Now the question has been answered.

The Bank for International Settlements (BIS) Monetary and Economic Department have just published a working paper (no. 951) by Raphael Auer and David Tercero-Lucas called "Distrust or Speculation? The Socioeconomic Drivers of U.S. Cryptocurrency Investments", which is a fascinating analysis of the market drivers around crypto-asset purchases. What they find, using data from the U.S. Survey of Consumer Payment Choice, is that there no evidence at all that (despite the cacophony on Twitter and the ranting observed at cryptocurrency gatherings) cryptocurrency investors are motivated by distrust in fiat currencies or regulated finance. In fact they are no different to the general population with respect to security concerns over cash and commercial banking services.

In other words, people trade crypto-assets because (as David Gerard has consistently observed) "number go up" in a post-modern digitally-turbocharged version of the greater fool theory that all you need to profit from an investment is to find someone willing to buy the asset at an even higher price, no matter whether the asset is worthless or not.

Future Markets

The crypto-asset market is then, ultimately, just like any other market. This is an important and serious conclusion of the BIS work, which is that since the objectives of investors are the same as those for other asset classes, so should be the regulation. Crypto-assets are not sought as an alternative to fiat currencies or regulated finance, but instead are a "niche digital speculation object".

Quite. This is why I have always been much more interested in the world of digital assets, tokens and decentralised finance than the cryptocurrencies themselves. Tokens can be used in decentralised financial markets (“defi”) to execute trades through smart contracts which, for a variety of reasons, makes them much more interesting.

This matters because the current state of financial systems, together with the complex regulatory environment, means markets that are riddled with inefficiencies. Critics say that these inefficiencies were only exacerbated by the response to the financial crisis (Dodd Frank and so forth) and make a good case for a new, defi approach. This approach would mean real utility for crypto-assets and, in my opinion, give us a window into a future of markets in which bots engage in complex trades around instruments that are too complicated for human traders to understand.

That mention of the great financial crisis reminds us, of course, about what happened when we let human traders loose on instruments they didn't understand (mortgage-backed securities) and they blew up the financial system. So what's to stop defi bots trading crypto-assets from doing the same? Well, it may be that one of the great advantages of having bots doing the trading is that we can make bots follow rules, whereas we can't make their human equivalents behave ethically no matter what the sanctions.

Regulation Inside

It is fair to note, though, that these more efficient markets’ decentralised nature could well be their Achilles’ heel and a significant barrier to widespread institutional adoption. In the same way that defi offers new ways for market participants to take advantage of their yields and value propositions, hackers and saboteurs could also rely on that same flexibility to conduct attacks. For example, hackers can borrow from one protocol while swapping other tokens in a different protocol and follow this indirect chain of transactions and exploits consecutively. Instruments that are too complicated for the good guys can be very appealing to the bad guys.

Hence I was interested to read in the BIS report that one "promising option" is that supervisory and regulatory agencies could pursue is what they refer to as "embedded supervision". In other words, embedding the supervisory framework for the trading of digital assets in the smart contracts themselves. This is a useful confirmation of the applicability of "ambient accountability", a concept set out in a paper by Richard Brown (now CTO of R3), Salome Parulava (then with Consult Hyperion) and me in our 2016 paper for the Journal of Payments Strategy and Systems.

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Bank of America recently called central bank digital currencies "kryptonite for crypto”, echoing the point that crypto-assets are not cryptocurrencies) but when on to say that it is intrigued by defi, which it said has the potential to be more disruptive than Bitcoin. I am sure they are right. 

Just because crypto-assets aren't currencies does not mean that they are not useful. In this respect I agree with economist Tyler Cowen, who said in a recent podcast that "I don't think of crypto as a currency. I think of it as a new set of institutions". If these institutions can reduce the costs of financial intermediation (largely by reducing the costs of regulation, compliance and auditing) then they will make a very significant contribution to improving the lives of all.

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