EU Statement: Bitcoin Will Remain A Part Of The Global Monetary System

Two EU analysts ask whether crypto currencies can become dangerous for central bank money. The answer is a cautious no – but the tone of voice has changed significantly. The EU accepts that Bitcoin has grown larger than it initially expected.

The report “Virtual currencies and the monetary policy of central banks: future challenges” published in early July is not the first EU report on crypto currencies. However, it is the first report of the federation of states to pay tribute to Bitcoin and other cryptocurrencies in their full glory.

The two authors of the Policy Department for Economic, Scientific and Quality of Life Policies, Dabrowski Janikows, acknowledge that bitcoin and other crypto currencies have so far been underestimated: “Virtual currencies (VCs) were considered a niche phenomenon – a kind of technological folklore – that could disappear every day.” However, this has changed recently. “Because Bitcoin has not disappeared, but has, on the contrary, continued its expansion and found followers all over the world.”

Now that Bitcoin has come this far, the two authors ask the question, which the EU has always put aside with a pitying smile: Can crypto currencies influence EU monetary policy? Can they even challenge the dominant role that state currencies currently play? And must the EU react preventively to prevent it from losing its monetary sovereignty?

When I started writing this blog five years ago, I honestly did not expect the EU to actually discuss such issues.
A mixed balance…

In order to find answers, the report first introduces the technological peculiarities of crypto currencies and tries to define them. He is relatively conservative and adheres to the usual views:

  • Virtual currencies are private, decentralized money,
  • which exists exclusively in digital form.
  • They enable direct, cross-border transfers,
  • which are stored in a public and decentralized account book (block chain) in chronological order.
  • The block chain is updated by Minern,
  • which generate new units of currency in a decentralized manner,
  • but must follow a cryptographic algorithm.
  • Transactions are not linked to the identity of individuals,
  • but assigned to pseudonymous addresses.

All this is largely correct, and one can certainly work with it. However, this definition is relatively conservative, perhaps even too conservative to reflect the current state of crypto currencies. It does not hold cryptocurrencies that do without minerals, private coins like Monero or offchain networks like Lightning.

Building on this definition, the report lists the advantages of crypto currencies: The low transaction costs, especially for cross-border payments, the high speed of transactions and the increased anonymity. The authors find the first two advantages rather doubtful when the crypto currency is in competition with payments within the SEPA area, which are already partly cheaper and faster than bitcoin payments (without Lightning).

In addition, these thin advantages are offset by numerous disadvantages for the user, such as the risk of losses due to theft or fraud and the high fluctuations in price. Crypto currencies also carry risks in society, for example when they help criminal enterprises and tax evasion. “Hypothetically, virtual currencies can also help entire jurisdictions circumvent financial sanctions and thus undermine the effectiveness of foreign policy.”

The analysts do not seem entirely enthusiastic.
… but a stable future

Despite all this, crypto currencies have become increasingly popular in recent years. The legislators of the different countries react differently to this. They try to classify, tax or even prohibit bitcoin. However, the authors strongly advise against this:

“One should not maintain the illusion that one can completely eliminate the use of VCs for private payments or as value storage by strictly regulating or prohibiting them.” According to the authors, there will always be motives for economic actors to use crypto currencies. It is also difficult to achieve full regulation, as innovation in the financial sector generally progresses faster than regulation. “Therefore, it is important to prepare for VCs to remain a stable component of the global money and financial architecture for the coming years.

So here we have it: EU analysts predict that Bitcoin has a stable future!

Network Effects and Imperfect Markets

As I said, the report shows more respect for crypto currencies than any previous report from an EU institution. On the central question – the challenge of state money – he tries to make the potential of bitcoin smaller than it might be in reality.

First, the two authors make a brief historical excursion into the many private funds that were issued in the 18th and 19th centuries but failed throughout when the central banks were commissioned to print banknotes. Why? According to the authors, there are two main reasons for this: The network effects and the problem of information asymmetry.

The network effect means that there are a number of benefits for everyone if a particular currency is widely accepted and used as money in many or all markets. Among other things, this reduces exchange costs and increases liquidity on the markets. Private currencies have never achieved such a network effect. This was only achieved by the large currencies issued by states, which also benefit from the support of the legislator and from the obligation to surrender taxes to it.

Moreover, the authors contradict the liberal economists who claim that a free market will choose the best product – in this case the best money – in competition. Because markets are not perfect in the wild. There is an asymmetry of information that does not bring the product to the top that best serves its purpose, but often enough that with which producers can best cheat consumers. This is also the reason why governments regulate financial services providers almost everywhere.

In other words, the market will prefer public money to private money because public money has greater network effects and is regulated.