Bitcoin Isn't the Answer to Central Bank Woes

But the idea of abolishing cash will remain alluring.

A future without cash.


Here's a utopian image (or perhaps dystopian, depending on the point of view) to ponder: Central banks have switched from issuing money in the form of cash to releasing digital currency and registering transactions on a distributed ledger along the lines of the Bitcoin blockchain. Because it doesn't require much of an up-front investment -- the clearance and transaction recording system is decentralized -- the central bank is now able to do something it has never done, namely accept deposits from private citizens, providing an ultimate safe haven for their savings and making private banks, with their fractional reserves and the danger of runs, largely unnecessary.

If this ever came to pass, it would spell the end of banks as we know them. We wouldn't need them to receive salaries or buy food in the supermarket; we'd use our central bank accounts and smartphones for that. Bankers would still be able to attract deposits by offering higher interest rates, and they'd still be able to obtain money to lend out on open markets, but their business would become riskier, and it would target clients with a higher tolerance for risk. Borrowing would also become more expensive. 

QuickTake Bitcoin and Blockchain

It can be nice to imagine the much-derided banking industry unmoored from our daily needs, left to scramble for business like other non-essential industries. Of course, our transaction histories would be much more visible to governments than they are today .

This imaginary world of effectively socialized money is being seriously discussed by researchers and central bankers alike. In a new paper, Max Raskin and David Yermack of New York University talk about it as a distinct possibility, albeit a radical one that "carries significant risks for the rest of the financial system." In March, Bank of England Deputy Governor Ben Broadbent discussed the idea of "central bank digital currency" in a speech that focused on the implications of shifting deposits to central banks, including the de-facto end to fractional reserve banking.

There's something intriguing about of the idea of co-opting Bitcoin technology for the use of two institutions Bitcoin was meant to obviate -- centralized regulators and "trusted intermediaries." But the notion also has a major problem and it's a technical one.

Raskin is a lawyer, Yermack is an economist, and Broadbent said in his speech, "goodness knows there are people who know more about computers than I do." Yet the matter of whether the blockchain, the Bitcoin method of validating transactions and creating the distributed ledger, can coexist with any measure of centralization is a matter for engineers.

A Bitcoin user broadcasts her intention to transfer money to another user throughout the network. To prevent double spending -- using the same money for two separate transfers or purchases -- the transaction is then validated by other users, "miners," who are rewarded for this activity with the ability to generate more Bitcoin. The system is a thing of beauty, except mining has turned into an expensive, energy-intensive competition between industrial "Bitcoin farms": Unregulated competition doesn't always lead to maximum efficiency. 

How would this system work if it were owned by a central bank with the exclusive right to generate new money? Of course, it wouldn't be the same system. In March, George Danezis and Sarah Meiklejohn of University College London, inspired by the Bank of England's research program on digital currencies, suggested something called RSCoin, which would allow a central bank to keep complete control of the monetary supply. In that system, the first of its kind developed for central banks, the only mine is state-owned. Instead, transactions are verified by what Danezis and Meiklejohn call "mintettes" -- entities that are empowered by the central bank so serve as "notaries." These mintettes collect transactions into blocks and then send them to the central bank to be packaged into even bigger blocks and entered in the ledger. The central bank is supposed to keep a tally of the mintettes' activity and reward them accordingly.

Formally, this is still a distributed system. Yet it's unclear whether, given the necessity of approving, keeping track of and rewarding the mintettes, the system is any less costly to the central bank than merely issuing money in electronic form only -- in the form we currently know from dealing with banks. Under a system like RSCoin, allowing citizens to keep accounts at the central bank could also get quite expensive: Transaction volumes would grow exponentially, and rewards to mintettes, as well as efforts to keep them honest, would carry a cost comparable with those of today's credit card companies. 

The main advantage of distributed systems such as Bitcoin is that the verification rewards don't come from the users who perform a transaction. New Bitcoins are made more or less out of thin air, by performing some complicated calculations. By removing that opportunity, centralized control introduces costs that may defeat the purpose of moving to the new technology.

Since, apart from RSCoin, there are no advanced digital currency proposals for central banks, there's little chance that any of these conservative institutions will adopt the blockchain anytime soon. The benefits are less than obvious, and the hassle of building and maintaining an entirely new system -- which emerged by itself around Bitcoin due to its truly decentralized nature -- is enormous.

That doesn't mean fashionable talk of "digital currencies" and "blockchains" cannot be used to test out the idea of abolishing cash. Most money is already digital, anyway, and moving it around is getting quicker and cheaper thanks to technological advances unrelated to the blockchain. 

Central banks don't really have the technology to usurp retail banking cheaply, but, in an era of negative rates and increasing pressure to crack down on money laundering, they're acutely interested in ways to get paper money out of people's hands, and disruptive innovation is always a good pretext to make the desired changes.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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    Leonid Bershidsky at

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