Can Bitcoin Threaten Market Stability?

Central banks could take over Bitcoin or one of its rivals should cryptocurrencies become a systemic risk to financial markets.



The Bitcoin bubble has sparked debate over whether cryptocurrencies pose a risk to banking or financial market stability. They haven’t yet, but if they do, central banks could take over Bitcoin or one of its rivals.

In their 2017 reports examining threats to the financial system, the U.S. Treasury Department’s Financial Stability Oversight Council and Office of Financial Research had little say about cryptocurrencies beyond flagging their vulnerability to cyberattacks and criminality. In a February 6 lecture at Goethe University Frankfurt, Agustín Carstens, general manager of the Bank for International Settlements, said there was a “strong case for policy intervention” to contain risks tied to cryptocurrencies and that “financial authorities may also have a case to intervene to ensure financial stability.”

Carstens opened the door to considering this virtual form of money “systemic,” or worthy of central banks’ greatest concern. In December the price of a Bitcoin spiked to $20,000 before plummeting more than 50 percent.

Would Bitcoin at $50,000 put the global systemic-risk watchdogs on high alert, and at what low price might the digital currency be deemed nonthreatening to financial stability? For the moment it is a thought exercise. Bitcoin at $50,000, roughly five times its mid-February price, would have a total market value of $850 billion. Proportional rises in Ethereum and other cryptocurrencies would take that total past $1 trillion. Compare that with, say, the $87.1 trillion total capitalization of cash equity markets at the end of 2017, as reported by the World Federation of Exchanges.

No one questions the capital markets’ place in the financial and economic ecosystem; market conditions are on policymakers’ radar, and crashes can beget crises. Cryptocurrencies may have attained asset class status: They trade through their market’s particular breed of exchanges and in futures contracts, thereby entering the jurisdiction of regulators like the Commodity Futures Trading Commission — but it’s a stretch to call them systemic.

Even when beginning to sound a financial-stability alarm, Carstens acknowledged some prematurity: “To date, many judge that, given cryptocurrencies’ small size and limited interconnectedness, concerns about them do not rise to a systemic level. But if authorities do not act pre-emptively, cryptocurrencies could become more interconnected with the main financial system and become a threat to financial stability.”

In a speech in London on February 8, European Central Bank executive board member Yves Mersch took a deeper dive into interconnectedness and potential contagion. Until recently, virtual currencies, or VCs, have “lacked perceptible connections to the financial system” as regulated institutions have largely kept their distance from these assets. “Yet there are signs that greed has weakened their resolve, and some have begun to form tentative linkages,” Mersch warned. “A number of derivative products pertaining to VCs have recently been launched.”

The increasing risks of contagion tied to digital currencies and their “contamination of the existing financial system” warrant an international response, according to Mersch. Indeed, cryptocurrency regulation is on the agenda of the G-20 meeting of finance ministers and central bank governors on March 18–19 in Buenos Aires.

Most economists are not ready to declare an emergency. In a December survey by the U.K.’s Centre for Macroeconomics, 73 percent did not see cryptocurrencies as a current or near-term systemic threat, though 61 percent said regulatory oversight should be increased. Cass Business School banking and finance professor Thorsten Beck compared the hype to that of “Dutch tulip bulbs, but as [cryptocurrencies] are not linked to the banking system, there does not seem any immediate stability threat.”

Mersch and Carstens devoted part of their talks to the nature and history of money and how cryptocurrencies fit in. Mersch concluded that they don’t meet the definition of money; Carstens essentially agreed and said that “laissez-faire is not a good approach in banking or in the issuance of money.”

In a February 12 panel discussion at the American Enterprise Institute in Washington, Alex Pollock, a distinguished senior fellow at the R Street Institute, likened Bitcoin to “private currencies” such as 19th-century U.S. bank notes, which gave way to government fiat. He said that if Bitcoin became a threat to the monetary order, “it’s a good bet” that government would take it over.

Andrew Lo, finance professor at Massachusetts Institute of Technology’s Sloan School of Management, says cryptocurrencies “don’t pose an immediate threat. . . . My guess is that once the technological issues have been worked out, one particular currency will emerge as the de facto leader, at which point one or more central banks will take over that technology and start issuing government-backed cryptocurrencies, all but eliminating the private cryptocurrencies.”