Advances in cryptography, combined with the potential for transmission and storage of data, have made possible the appearance of the so-called distributed ledger technologies.
These are databases of which there are multiple identical copies distributed among the participants in the network, which are updated in a synchronized and consensual. The great attraction of DLTs is that they allow
securely manage and share data, and store all information without this being altered. The best known type of DLT is the blockchain, that organizes information by blocks and is often compared to a book that cannot be erased.
Blockchain technology is based on three fundamental ingredients:
1) Thanks to cryptography, each block of information is uniquely identified. unique way.
2) Network participants must approve and validate all information that enters the network.
3) The record is unalterable and immutable and therefore extremely difficult to hack or modify.
Blockchain technology facilitates the appearance of cryptocurrencies, since, by creating a shared record of all transactions and establishing a decentralized method of validation, facilitates the digital exchange of money between users directly (payment infrastructures traditional banks have a central intermediary, be it the central bank, a digital payment company, a mobile platform…).
The best known application of the blockchain in the financial world is the settlement of payments (in international transfers, cryptocurrencies can play a valuable role as a bridging currency), as as the first figure illustrates.
Blockchain, a rapidly evolving technology that may end facilitating the development of mass-use applications
One of the areas in which more work is being done is to improve the scalability of payment systems that have blockchain as one of its essential ingredients. The first initiatives that emerged were fully decentralized and public networks. In these cases, like all participants must validate transactions, it slows down considerably the number of transactions that can be processed (a clear example is Bitcoin, which processes 7 transactions per second compared to 65,000 Visa) and energy costs are very high.
One of the solutions being explored is the use of permissioned networks, in which an administrator controls the network and decides who can participate in her. Their advantage is that they are more scalable and allow validation of transactions much faster, although they are more vulnerable to alteration and hacking attempts.
Beyond the blockchain
It is important to clarify that technological advances in the sector finance go far beyond cryptocurrencies and DLTs and have enabled improve the agility and performance of existing payment systems.
A good example of this are the spectacular advances in payment with mobiles. As we have seen, blockchain technology has a lot of potential, although it would be possible to issue a digital currency without the need to resort to her. In fact, an authority with powers of centralization of processes as a central bank could come to consider it by developing a infrastructure based on payment systems that are already working today.
The main areas in which the use of cryptocurrencies can be beneficial are:
• International financial transactions. Although blockchain technology is not the only alternative that is being studied in this field, it is a clear candidate to improve the efficiency of international payments by the reduction of costs that it can entail and a greater speed of the transactions with respect to systems with a high operational centralization.
• Reduction of the underground economy. Although one of the main properties of cryptocurrencies is the anonymity of transactions, mechanisms could be designed to facilitate the identification of illegal activities. For example, that payments in certain areas or of a certain amount were not anonymous.
• They can promote financial inclusion in underdeveloped countries or emerging, where a significant part of the population is not unbanked (but could store crypto in a digital wallet linked to your mobile phone).
Not all cryptocurrencies are the same
According to the BIS definition,2 cryptocurrencies are distinguished because they are electronic and because they allow peer-to-peer exchange without a third party that exercises intermediation tasks. But there are many kinds of cryptocurrencies. The so-called «flower of money» helps us to classify the different currencies, and also cryptocurrencies, depending on their properties in the most relevant areas: the type of currency issuer (central bank or other), its accessibility (universal or restricted), its form (electronic or physical) and its transfer mechanism (peer-to-peer or centralized). For example, depending on the issuer, there are three large cryptocurrency classes:
1) Private cryptocurrencies: issued by an individual or private entity.
2) Central bank cryptocurrencies.
3) Hybrid solutions (synthetic cryptocurrencies): the central bank is the issuer, but a group of private entities would be in charge of the customer interaction and innovation (in advanced economies, the natural candidate would be commercial banks).
Cryptocurrencies of central banks and private cryptocurrencies: pros and cons
A priori, if a central bank ends up issuing a cryptocurrency, and has with a well-defined regulatory framework and there are no doubts about its safety, it is very likely that it will be accepted as a widely used form of payment.
Being backed by a public institution that cannot go bankrupt, the
mere fact that part of the savings and transactions are taken
carried out with the “crypto” version of the currency, it should not affect the value of
said coin. Private cryptocurrencies, on the other hand, find it more difficult
maintain a stable value, since this depends, among other factors, on the
degree of acceptance or use that they have and, how this can change in the form
suddenly, its value is usually more volatile.
In any case, proposals are appearing that try to circumvent this
disadvantage. The so-called stablecoins or stable coins aim to save
this stumbling block by fixing what would in effect constitute a fixed exchange rate
between the cryptocurrency and an asset of stable value (such as a
currency of an advanced country). Libra, the cryptocurrency proposed by Facebook,
is within this family of cryptocurrencies.
It is often argued in favor of the development of backed cryptocurrencies
by a central bank that could be a complement to the tools
traditional monetary policy. For example, setting a type
of interest on the digital currency would expand the range of instruments of
those held by the central bank.
However, the introduction of bank-issued cryptocurrencies
plants would also present risks since they could contribute, at least
in part, to a disintermediation of financial activity:
• If part of the bank deposits of households and companies were converted
in cryptocurrencies not managed by financial intermediaries,
the supply of funds available to grant credits would decrease.
This would tend to make credit more expensive in addition to granting greater prominence
central banks as structural providers of liquidity to the
system.
• The existence of these central bank cryptocurrencies would increase
the volatility of flows between bank deposits and cryptocurrencies in
times of uncertainty or doubts about the soundness of any entity
and this would cause a risk to financial stability.
• The degree of financial disintermediation critically depends on who
host digital cryptocurrency wallets. If the host is
the central bank, individuals could hold accounts directly with the
central bank, which would aggravate the risk of disintermediation and the
financial instability. It would also be possible for them to be housed
entities unrelated to commercial banks; this would not eliminate
financial intermediation but would pose significant challenges
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