Why is it not likely for crypto to kill the central banks? There is no doubt that the central banks play a significant role in the world to make sure that the economy is robust and runs smoothly.
For this they make some solid planning and it is their well-defined policymaking that ensures that the country or its citizens do not face any financial crisis.
Still, there may be times when such situations cannot be avoided – the financial crisis of 2008, for example.
One of the most significant responses to that financial crisis was the rise in popularity and acceptance of Bitcoin.
Well, the question that may arise now is whether or not Bitcoin and other crypto coins can kill the central banks?
At some point it may seem possible given the beneficial features of Bitcoin and crypto such as:
- The decentralized nature of it
- The useful peer-to-peer technology
- The safety aspect and
- Its ability to make quick transfers.
However, cryptocurrencies come with their own set of drawbacks.
Some of its most significant drawbacks include their finite supply and its lack of legal status in nearly all economies.
It is these drawbacks that pull it back from dismantling and replacing the current centralized banking system where the central banks are responsible for making decisions that influence the economic affluence of the whole country with a decentralized system.
Well, here is an article that will tell you all about the possibilities, or the lack thereof, of crypto causing an end to central banks.
Contents
Why is It Not Likely for Crypto to Kill the Central Banks?
In the modern financial infrastructure, the central banks play a lot of other significant roles other than policymaking for the economy. These are:
- Maintaining the employment needs
- Stabilizing value of the currency and in turn the prices of goods
- Helping to keep the financial system favorable to the people from all walks of life so that it runs smoothly and lots more.
However, financial experts and market critics suggest that the central banks do create a negative effect on the consumers as well as the economy.
This is because they think that it is the central banks that are responsible for incapacitating recessions.
Still, in order to make sure that their importance in the economy is further enhanced, of late, the central banks are borrowing fundamentals of crypto technology and design.
This is done with priority to explore the use and success of the CBDCs or the Central Bank Digital Currencies in the economy.
Ideally, if that happens, a digital currency issued and governed by the central banks will be more likely to remove intermediaries while making a transaction such as a retail bank as well just like cryptocurrencies.
Moreover, since it will also use cryptography like the cryptocurrencies, it will also be impossible to hack or replicate the Central Bank Digital Currencies and may even turn out to be a much cheaper alternative to produce as compared to the metal coins.
Now, coming back to your question whether or not crypto can kill the central banks, you will need to look into things very closely and from all possible perspectives to have a better understanding.
If you consider the case of Bitcoin in particular among all other types of crypto coins, as a suitable substitute of central banks, you will need to know both the economics as well as the technology behind it.
As you may know already, the inventor of Bitcoin is Satoshi Nakamoto. In the whitepaper he (assuming that Satoshi Nakamoto is a person and not a group as it is alleged) defined Bitcoin as a cryptocurrency which is typically the ‘peer-to-peer version of electronic cash.’
It allows people to make online payments or transfer funds directly from one person to another digitally without the need of an intermediary such as a bank or any other financial institution.
Based on these specific aspects of Bitcoin, and also in the case of other types of crypto coins, it can be assumed that it will be able to solve some of the most significant issues.
This is with reference to the context of the current and traditional financial infrastructure system which is typically dominated by the central banks.
First of all, the innovative blockchain technology underlying crypto eliminates the chances of double spending and committing human errors.
This is because each crypto coin is unique and is secured cryptographically.
This means that there is no chance of duplicating it or even hacking the system to replicate an entry.
In simple words, this means that it is impossible to counterfeit a crypto coin or spend it twice.
Secondly, the crypto blockchain network is quite a trustworthy system even though it is basically decentralized in nature.
This means that in this case the algorithmic construct of the crypto network system is basically trust.
Every transaction that is made on any crypto blockchain network, including Bitcoin, is required to be approved by the majority of the nodes participating in the network and spread out all over the world.
This is called the Proof of Work or PoW consensus mechanism.
It is only when a transaction attains a consensus it is included in the ledger and is immutable once it is linked with a hash with the previous block in the chain.
Even if there is a single node that disagrees with a specific transaction it will not be included in the distributed ledger of the crypto.
Thirdly, the crypto network being decentralized in nature does not need any centralized infrastructure for its operation and to streamline the course of producing and distributing the currency.
Any person having a full node at home that is functional can generate crypto coins, a process called crypto mining.
There are no intermediaries required for P2P fund transfer between two wallet addresses on the crypto blockchain network.
Therefore, the system eliminates the need and cost of using a central authority or for the service of a bank in between while distributing the crypto coins.
All these economic sovereignty promised by Bitcoin and other crypto coins may seem to be very promising and alluring to anyone but when you look at the catches underlying them you may tend to think otherwise.
There are several things to consider but some of the most significant catches that need a mention here are as under.
The first important thing to consider about Bitcoin and other types of crypto coins is its status and acceptance as a medium of exchange.
Ideally, there has been a very few use cases of Bitcoin and other coins that have been recorded legitimately since these came into the market for the general public to use.
The most significant reason for the slow or low acceptance of crypto coins, especially Bitcoin, is its notoriety gained over the years as a favored means for the bad actors to make criminal transactions.
In addition to that, crypto is also considered nothing more than a tool for speculation.
The next most important factor to consider is that the status of Bitcoin, as well as other crypto coins along with it, as a means that can be used to make legal transfers is not clearly known.
Yes, it has become a legal tender in El Salvador but that is the only country that has allowed using crypto to make transactions as of now.
It is therefore considered more as an ‘exception to the rule’ than the rule itself.
On the other hand, some of the other major countries of this world such as China and the United States have thought of going the opposite way and cracking down on the infrastructure and users of Bitcoin.
In fact, China has gone a bit too far and has banned all types of crypto transactions and mining in the country since September 2021.
And finally, crypto coins come with a finite supply and are also very volatile by nature.
For example, Bitcoin has a hard cap of 21 million coins in total, out of which about 80% have been mined already.
Also, the mining reward of Bitcoin is halved after every 210,000 blocks are mined, which takes approximately four years’ time.
The first Bitcoin halving incident happened in 2012, the second in 2016, and the third in 2020.
This means the next Bitcoin halving will happen in 2024.
At this rate, considering all the other factors remain the same, it will not be before 2140 that all of the 21 million coins will be mined.
This scarcity created by Bitcoin makes it a valuable and an attractive asset to invest in and speculate on.
However, it is this cap on the amount of coins in existence that also causes some serious effects and limits its use.
Moreover, the scarcity factor also has a serious effect on the price of the coin that swings dramatically between the two extremes.
This makes Bitcoin even more difficult and an unreliable currency to use for making daily transactions.
Therefore, this significant problem of Bitcoin, which is also applicable to other crypto coins, makes it a less likely one that can kill the central banks, at least at this very moment.
In fact, the central banks are not deterred by the prospects of the use of Bitcoin and other coins simply due to the issues that it has as of now.
They know that it will take a long time from here for crypto to overcome these challenges and prove it as a reliable medium of exchange and kill the central banking system on the whole.
It Plays a Vital Role
If you want to know whether or not Bitcoin can kill the central banks it is necessary to know about their role in the first place.
In any given economy, the role of the central banks is very important.
As said earlier, the central banks of the countries make all the policies for the financial system of it to control the economy.
In fact, the financial policy of one country needs to be designed according to different factors that underline the global financial system.
The directives of different central banks vary from one country to another and are specifically designed keeping in mind the current state of the economy of that country.
For example, the banking policies and directives in the United States are designed by the Federal Reserve.
Their primary objective and responsibility is to create policies that will control inflation within the country as well as ensure that complete employment is maintained.
On the other hand, if you look at the banking and monetary policies designed by The Bank of England you will see that it emphasizes primarily on the solvency and stability aspects of the financial mechanism in the United Kingdom.
While creating directives and policies for the financial system of a country, the central banks typically use a lot of different tactics.
It is these tactics that are basically known as monetary policy. These policies are created so that it can achieve its mandates.
However, the main intention and responsibility of the central banks is to control the supply and circulation of money in the market as well as the interest rates.
For example, as and when required, the central banks have the power to either increase or decrease the amount of money circulating in an economy.
Without going into the details of the effects of increasing or decreasing the supply of money, be informed that when there is more money in an economy, the consumers will have more purchasing power.
This will, in turn, result in further economic growth.
On the other hand, in an opposite situation where the supply of money is decreased by the central banks will equal to less amount of money available in the economy.
This will translate into lower spending power of the consumers resulting in slower economic growth.
Sometimes, low supply of money may also cause a recession to start in the economy.
Therefore, you can see that the role of the central banks is very crucial and it is not restricted to maintaining the supply of money as and when required.
Their list of responsibilities also entails supervising and controlling exports, imports, and overseas investment with their well-defined policies.
Typically, in such cases, the primary job of the central banks is to regulate the interest rates to maintain a proper balance of funds in the economy.
Too much exports and investments may increase the amount of money flow in the economy and too many imports will mean an excessive outflow of money.
In both these cases, too much of anything will bring adverse effects onto the economy such as inflation and deflation, which, however, is beyond the scope of this article.
The central banks here play a significant role in determining the interest rates.
For example, if the rate of interest is high, it will deter the investors, especially the foreign entities, in real estate.
On the contrary, a low interest rate will promote such investments.
The central banks also play a very important role in the distribution of money in the economic system.
For this, the central banks use a network of banks that are scattered all over the nation.
Therefore, in this particular aspect, the central banks act as the pivot of the financial infrastructure of the economy.
This infrastructure is made up of financial institutions and banks and all of these are controlled by the central bank and its policymaking.
This eventually brings in economic booms and busts.
There are a lot of benefits of giving the responsibility of maintaining the functionality of the economy to the central banks.
Perhaps one of the biggest advantages of it is that they help immensely in building trust among the people of the country in the system.
Any currency that is issued and backed by a central authority raises immense trust among the people.
It also has the ability to be exchanged all over the world at a standard value.
This will prevent every party from issuing their own coin while making a monetary transaction.
This will therefore stop competition among different coins and prevent chaos from ensuing in the country.
This is not an imaginative situation. In fact, such an incident happened in the US economy long before the Federal Reserve came into its existence.
At that time, money was issued by different non-banking entities such as municipal corporations, merchants and others.
They literally proliferated through the US financial system.
Needless to say, the exchange rates of all these different coins were different and most of them were not backed by any valuable physical asset such as gold to justify their value.
And, several of them were frauds. The banks panicked and fled from the scene resulting in a situation that shook the entire US economy.
To cope with this panic situation, the National Currency Act of 1863 and the National Bank Act of 1864 were issued right away after the Civil War.
This helped in building the foundation for a centralized and federal monetary system.
The centralized monetary machinery then started issuing uniform national banknotes.
These notes were redeemable at their face value all over the country in the commercial centers.
Added to this, monetary and financial stability was brought to the US economy when the Federal Reserve was created in 1913.
Therefore, with all these benefits offered by the central banks it is quite hard to imagine that it will be replaced by crypto that itself is in its nascent stage. However, it also comes with a lot of disadvantages as well.
It is the Primary Authority to Make Decisions
Especially during recessions, it is the central banks of a country that have the full power to make decisions that will revive and restore the functionality of the falling financial system and save the economy from crumbling.
However, this also comes with a significant problem.
Vesting too much trust in a central authority to make the decisions can result in debilitating recessions further if they design and follow improper monetary policies and measures.
One good example of it is The Great Depression faced by the United States, perhaps the biggest economic recession faced by the country in history.
It all happened due to the mismanaged and wrong economic policies created by the central banks and a sequence of wrong decisions taken by the local Federal Reserve banks.
Some other examples of the US economy failing due to the slackening of hold on the economy and authority of the Federal Reserve as well as creating and following a policy of low interest rates are the Financial Crisis and the Great Recession of 2008.
The role of the central banks in an economy today however is made more complicated by the convolutions of the modern monetary infrastructure.
One of the most significant developments due to this issue is the advent and increase in popularity of the digital tokens that the money is taking its form now.
There is a notable increase experienced in the velocity of circulation of these tokens through the economy all over the world.
This has also changed the meaning of money which has made it more difficult and abstract to understand, especially for any average person.
Once again, the example of the Great Recession of 2008 can be given for such complexity.
This has caused a significant rise in derivative trading. In this process the housing loans were repackaged simply to make it look more attractive to the insolvent borrowers.
This also attracted the banks to make huge profits from such trades and they started selling the products to one and all, and even to those unsuspecting buyers who typically resold them to other buyers in some other places in the world.
However, milking the benefits of this situation, the whole financial system started to make huge profits.
All of these derivative trades were reinforced by the money held at the Federal Reserve.
Typically, the nature of the economy of the world is interconnected.
The decisions made by the central banks therefore should be ideal, well-planned, and most beneficial for the economy of the country.
This is important because any policymaking decision, right or wrong, made by any particular central bank will be transmitted to others across different countries.
As you have seen that the infectivity of the Great Recession was not limited to the United States only.
It did not take a long time to stretch from the United States and contaminate other economies of the world leading to a collapse in the stock markets all over the world.
All these potential culpability of the central banks in creating an impetuous crisis resulted in the creation of Bitcoin later on paved the path for several other crypto coins to come to the market.
And, looking at the growth and the potential of these coins, it can be said that it is quite likely that the central banks will also start to create their own digital currencies and introduce them into the market.
For your information, there are several countries that have already started exploring the possibilities and potential of CBDCs and are at various stages of their experimentations as of now. Few countries have even started their pilot programs.
According to a report of the Atlantic Council that racks CBDCs there are as many as:
- 5 fully launched CBDCs such as in The Bahamas, Nigeria and Eastern Caribbean Currency Union and more
- 14 pilot projects in Sweden, China, Ukraine, Jamaica and more and
- 15 under the development stage such as in the United States, India, Eurozone and more.
There are also as many as 33 more in the research process while 6 are inactive, according to the report.
However, these Central Bank Digital Currencies or CBDCs will have more value and trust than any other ordinary crypto coin being issued, supported and controlled by the central banks themselves.
This will make the possibility of crypto killing the central banks even bleaker.
Therefore, all these indicate that the central banks are going nowhere.
Moreover, the crypto also has to look into and do away with the different disadvantages of it in order to be even close to the importance and value of the central banks in any given economy.
Disadvantages
A vast majority of countries all over the globe still rely heavily on the central banks to run and manage their financial system and the central banks have been doing it successfully for so many years now.
There are lots of advantages of using the central banks to run an economy.
One of the most significant ones is that this type of centralized financial management system has only one single authority on whom the entire responsibility is given.
Though it is good in a way that there is only one authority that is accountable, it is the excessive power given to that particular authority that raises a few concerns.
Therefore, the people of the world are looking for a suitable alternative – and that happens to be cryptocurrencies.
However, there are some significant disadvantages of Bitcoin and other crypto coins that do not allow it to replace the authoritative central banks altogether.
These disadvantages are over and above those that are mentioned earlier.
First, Bitcoin and other crypto coins have a very small adoption rate.
This is a significant downside because a currency needs to have a universal acceptance in order to become the primary currency of any economy.
For example, the US dollar is typically recognized and accepted in all countries subject to exchange rates, but Bitcoin or other crypto do not enjoy that privilege as of now.
Secondly, another big issue is with the transactions made with crypto that are recorded on a dedicated blockchain network and are immutable.
This means that the transactions once made and entered on the distributed ledger cannot be canceled or reversed.
This means that if you erroneously, or otherwise, sent Bitcoin to a wrong address you will not be able to recover it. It will be lost forever.
Since there is no third party intermediary involved in the transaction, there will be no one to amend the situations or cancel the irreversible transaction.
Thirdly, crypto, especially Bitcoin which is the most favored and trusted crypto coin of all, has a very slow transfer speed.
Though there are a few specific types of new crypto coins that come with a very high transfer speed, Bitcoin still lags far behind even today in spite of the developments made in the technology.
As of now it takes about 10 minutes to confirm a Bitcoin transaction which is no doubt quite slow as compared to other available options.
Therefore, Bitcoin can be considered to be a good store of value such as gold or simply as a medium of exchange but certainly not a legitimate currency.
Finally, crypto coins, and Bitcoin in particular, have very limited use cases.
Though there are some major companies such as Microsoft, Whole Foods, PayPal, and Newegg that accept Bitcoin as payment, and other brands are contemplating on it, this is just the tip of the iceberg.
Ideally, crypto should be more accessible to the consumers and accepted by more merchants all over the world to become a legal tender.
However, this is less likely to happen fast because the financial institutions and the central banks prevent it from happening by trying to implement specific policies created with that particular objective.
Therefore, it can be said that Bitcoin in particular is believed to have the potential to disrupt the central banking system and the governments are also fearful about it.
However, in spite of its huge potential, killing the central banks is expecting a bit too much from crypto and Bitcoin which are still in their early days.
Conclusion
The central banks are surely at the driver’s seat of the modern financial infrastructure of the world in the existing economic system.
However, the cryptocurrencies have also proved to be a worthy substitute but it still has lots to do to kill the central banks.
I have special interest in crypto and intend to help common people to gain knowledge about the digital asset as well as its potential. Follow Me at Linkedin.
