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BIS economists suggest improving TradFi with CBDC to attract users away from crypto

The latest Bank of International Settlements bulletin looks at ways to mitigate the risks of crypto assets and suggests traditional finance could get its house in better order too.

Economists at the Bank of International Settlements (BIS) took a look at the risks inherent in the crypto ecosystem and came up with a seemingly novel solution. “Develop an alternative,” they advised in a bulletin released on Jan. 12. What they had in mind was central bank digital currency (CBDC). 

The authors of the bulletin, headed by BIS senior economist Matteo Aquilina, said they sought lessons from the crypto winter that descended in 2022. The recent failures in crypto asset markets underscore the need to address the risks presented by crypto before those markets become “systemic,” they said.

Both centralized and decentralized finance in the crypto world “share many of the vulnerabilities that are familiar from traditional finance (TradFi),” the authors said. However, risks resulting from high leverage, liquidity and maturity mismatches and substantial information asymmetries are greater in crypto.

Crypto is unlikely to go away on its own, despite the issues with it, the authors noted. They placed potential risk mitigation actions into the categories of banning specific activities with crypto, containing crypto in isolation from “the real economy” and regulating crypto “in a manner akin to TradFi.” They provide a separate appendix breaking down national and international crypto regulatory initiatives within that framework.

Related: Central Banks to set standards on banks’ crypto exposure: BIS

Each option has relative pros and cons, they noted. A ban, for example, “could conflict with founding principles of society,” among other things. The three approaches can be pursued simultaneously, however:

“Given their public policy mandates, central banks may want to do more. By encouraging sound innovation in TradFi, they could contribute to a more efficient monetary system.”

Improving the speed and cost efficiency of payments could be a major component of that strategy:

“The innovation that is present in certain areas of crypto could be harnessed to improve the way in which services are provided in TradFi.”

One of the best ways to do that would be through CBDCs, which offer a number of benefits, the authors claimed:

“They could help reduce the cost of payments, enhance financial inclusion, bolster the integrity of the system and promote user control over data and privacy.”

International and supranational organizations have provided platforms for an increasing amount of opposition to cryptocurrency. European Central Bank (ECB) executive board member Fabio Panetta recently advanced a similar argument for the development of CBDCs at the expense of cryptocurrencies. The same ECB blog had posted an article claiming cryptocurrency was on “the road to irrelevance” shortly before that. The International Monetary Fund has been criticized for its anti-crypto stance as well.

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