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Cryptocurrency Are a Boost to the Financial System, Not a Threat

Source: iStock/gpointstudio
  • The total value of cryptocurrencies is too small to be a systemic risk.
  • One of the chief economic benefits provided by cryptocurrencies are ICOs.

Some of the world’s central bankers believe cryptocurrencies are a threat to the stability of the global economic system.

"What concerns me most," Yves Mersch, an executive board member of the European Central Bank, said in January, "is when financial market infrastructures such as stock exchanges enter this business. That poses a major threat to financial stability."

He was speaking barely a month after bitcoin futures trading opened on the Chicago-based CBOE exchange, suggesting that the global financial system had been made more vulnerable as a result.

However, his alarmism is to a large extent unfounded, even if the UK Parliament partially confirmed it by launching a cryptocurrency inquiry at the end of February. Not only are cryptocurrencies not a significant risk to national or global financial systems, but they've so far provided the world's economies with many benefits, according to experts we spoke to.

Firstly, uptake and trading of bitcoin still actually isn't widespread enough to create a serious threat of contagion.

This was a point made, among others, by the Centre for Macroeconomics, a research centre funded by the Economic and Social Research Council in the UK, which in a December survey of just under 50 leading economists concluded that "the total value of cryptocurrencies is too small to be a systemic risk to financial stability."

“Crypto Brothers and Sisters” ≠ Lehman Brothers

At the time of writing, the market capitalisation of the world's cryptocurrencies equals USD 365 billion. By contrast, the market capitalisation of all the world's shares was USD 87.1 trillion at then of 2017. Cryptocurrencies are therefore worth only some 0.4% of those shares, making it highly unlikely that the eradication of their value would have a serious effect on this economy.

Much the same was expressed to us by Richard Jackman, an emeritus professor at the London School of Economics.

"I think the bursting of a bitcoin bubble (if it is a bubble) will not crash the economic system," he says.

While acknowledging that such bursting might have severe effects on the 'crypto-professionals' who've invested large sums of money into bitcoin, he explains that it would “not spread out into the system as a whole. It would not be like the Lehman Brothers the crash of 2008 which involved ordinary high street banks and financial institutions." Before the crash Lehman was the fourth-largest investment bank in the United States.

This reminder of the 2007-8 global financial crisis is interesting, and not only because bitcoin was devised partly as response to such 'traditional' crises. Mati Greenspan, an analyst with eToro, a trading platform, believes that the cryptocurrency could in fact help reduce the likelihood of such calamities occurring in the future.

"Bitcoin was designed to provide a truly global form of money," he says. "One that cannot be manipulated or counterfeited and is not controlled by any government, bank, or institution. Therefore, in my view, it actually provides more stability than the current system offers."

This may be a controversial view. Still, cryptocurrencies have had a variety of positive macroeconomic effects, and not just in terms of creating openings for journalists.

Benefits of ICOs and mining

In an October 2017 research paper published by economists at the University of Manchester, it was found that one of the chief economic benefits provided by cryptocurrencies are ICOs.

According to the paper's authors, "cryptocurrencies have provided us with the new funding model, which can be used by non-profit organisations, start-ups and networks to rapidly develop the use of the decentralized cryptographic technology in numerous different industries."

In other words, ICOs have enabled a whole new breed of companies and organisations to obtain funding when they might otherwise have struggled. In 2017, they raised USD 5.6 billion for new startups, while this year they've already raised just under USD 2 billion.

Such figures show how cryptocurrencies are making a whole range of new ventures and businesses possible. Even in the much-maligned crypto-mining sector, where electricity consumption is a big issue, new mining centres can bring jobs to otherwise underemployed areas.

These benefits and effects aren't colossal, but given that the cryptocurrency industry is still very young they offer some indication of the boost it might provide to the global economy in a few years time.

There is, of course, a risk that cryptocurrencies remain volatile, rise in value, and get increasingly caught up in the global economy as big banks begin to trade in them more.

As Prof. Jackman says, "the use of bitcoin, or of cryptocurrencies generally, might expand enormously, so much so as to become a significant part of the economy's money stock."

This would present considerable risks of contagion in the event of a crypto-crash. However, Mati Greenspan is hopeful that the gradual move towards regulating the industry will make cryptocurrencies more stable in the long run.

"I believe that the correct approach is the one currently being taken by many financial regulators around the world, which is to foster innovation," he says, replying to the question of what would be a good way of dealing with the threat of financial instability. "Weed out the undesirable activity without harming a budding ecosystem."

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