BIS attacks crypto in report to G20 officials

The Bank for International Settlements attacked crypto assets in a report to the Group of Twenty today (July 11), while detailing continued progress on central bank digital currency (CBDC) in a second report.

Stark in its condemnation of crypto, the BIS concluded that “crypto’s inherent structural flaws make it unsuitable to play a significant role in the monetary system”. 

The structural flaws “derive from the underlying economics of incentives of validators rather than from technology”, the BIS said. 

Stablecoins, which act as the main medium of exchange within the crypto ecosystem, “piggyback on the credibility of the central bank’s unit of account and may pose risks to monetary sovereignty”. 

Stablecoins’ turnover is far higher than that of other crypto assets because decentralised finance (defi) players borrow and lend them against crypto collateral in a self-referential network. The ecosystem fails to finance activity in the real economy, the BIS said. Instead it “amplifies known risks”. 

In previous research, the BIS found that trading activity actually increased at three major exchanges following the terra/luna collapse in May 2022 and FTX’s bankruptcy in November. While “whales” – “large and sophisticated investors” with 1,000 coins or more – were selling their bitcoin, retail “krill” were buying. Downloads of crypto exchange apps were highest in emerging market economies in countries such as Brazil, Turkey and Thailand. 

The BIS also criticised the crypto ecosystem’s “false decentralisation claims”. It said the market is fragmented and “characterised by congestion and high fees”. 

While the transparent nature of defi technology makes detecting fraud easier, holding individuals to account is more difficult due to an inability to identify users. 

Using the blockchain to execute smart contracts also creates problems, the BIS said, when errors or illegal actions are validated and made immutable. “Currently, there are no clear rules as to how oracle providers are incentivised or vetted, or who is held accountable if a smart contract acts upon incorrect off-chain information.” Oracles link real-word data to the crypto network. 

Meanwhile, the large number of off-chain crypto transactions are one of contributors to data gaps that make oversight to protect investors difficult. Off-chain transactions are those that are validated off the blockchain, for example by using custodial services, agreeing to transfer assets between wallets peer-to-peer, or giving the private key of a wallet to another user to transfer ownership without moving funds. 

To address the lack of standards of blockchain transactions, the BIS Innovation Hub Eurosystem Centre, the Deutsche Bundesbank and the Netherlands Bank are working on Project Atlas, an open-source defi map. Preliminary data from Project Atlas shows bitcoin inflows to exchanges in 2022 were highest to North America, followed by Africa, both drawing more than $20 billion. 

CBDC in “novel territory”

In line with the Financial Stability Board’s G20 roadmap for enhancing cross-border payments, the BIS said its wholesale CBDC experiments show bringing multiple currencies and assets into a single system reduces costs and inefficiencies. 

Projects Jura, Dunbar and mBridge all used common distributed ledger platform (DLT), “as this was seen as easier and with more upside” than interlinking separate domestic platforms. All the projects assumed that central banks would allow access to their wCBDC by non-resident financial institutions. 

DLT subnetworks were built to respect jurisdictional boundaries and data location requirements. Dual notaries allowed central banks to control and monitor their currencies and payment versus payment (PvP) settlement. In PvP, both sides of a transaction get paid at the same time, which is viewed as a key way to enhance cross-border payments. 

The BIS acknowledges that a common ownership and governance model for multiple central banks “is novel territory”. However governance arrangements for a DLT platform could include “levels” of rules. A first level would include controls around access to the system that are applicable to all participants. In the second, jurisdiction-specific rules could limit access to CBDC, while a third level would cover currency-specific rules, such as foreign exchange controls.