The rising activity in cryptocurrency markets has led to repeated speculation that virtual coin tokens managed by blockchain technology will gain wider use in commerce. Among the side effects: There is pressure building upon central banks to either develop cryptocurrencies themselves or use existing cryptocurrencies that seem to be expanding in number by the day.

A number of central banks have announced they are testing use cases for blockchain, also called distributed ledger technology (DLT), which underlies bitcoin (BTC) and most other cryptocurrencies. These use cases include the possible development of the banks’ own coins for either limited or widespread uses.

Central banks are still in the early stage of exploring how and whether to create their own cryptocurrencies or possibly purchase virtual coins. At this time, there are several scenarios developing for 2018 and beyond.

Current Activities

A number of central banks, including the U.S. Federal Reserve, have declared that they are exploring blockchain technologies. The Global Blockchain Benchmarking Study, which surveyed central banks and other public-sector organizations in 49 countries and was published by Garrick Hileman and Michel Rauchs of Cambridge University in September 2017, offers a more detailed glimpse of what central banks are doing.

According to the study, 63 percent of central banks have already been involved in proofs of concept, or are running trials, for use cases for DLT; 25 percent have planned advanced trials within a year and 21 percent plan to deploy blockchain applications within two years. Despite this optimistic picture, 42 percent of the central banks surveyed said they could not predict when such trials might begin.

The most popular use case: Of the central banks surveyed, 82 percent were exploring the development of their own cryptocurrencies. The second was to use blockchain for payments.

The central banks say blockchain could improve efficiency, lower costs and speed processing times. It could make networks more resilient for payments, and through public audit capabilities and an audit trail, could be a means to reduce financial fraud and boost regulatory compliance.

At the same time, the central banks in the survey cautioned that blockchain is an immature technology, and they are concerned about security, scalability, privacy and performance over time.

Incentives to Buy or Create Cryptocurrencies

Central banks are being pushed toward cryptocurrencies by internal and external pressures.

On the inside, there is the possibility of greater efficiency, transparency and resilience. A white paper, State-Sponsored Cryptocurrency, written by Deloitte principal Eric Piscini in 2015, laid out a scenario in which banks would issue legal tender crypto tokens backed by existing currencies on a one-to-one basis.

“What would happen if we combined the best attributes of the technology of cryptocurrencies with the features of an established fiat currency under the sponsorship of a central bank?” Piscini wrote.

Externally, if cryptocurrency market capitalization continues to grow, pressures may rise for central banks to purchase tokens to bolster their foreign reserves. The capitalization of the digital coin market skyrocketed from $250 billion in November 2017 to over $700 billion in January 2018, and currently is $500 billion.

Eugene Etsebeth, former central banker with the South African Reserve Bank, points to two benchmarks to watch. “A turning point for G7 central banks will be when the Bitcoin market capitalization exceeds the value of all Special Drawing Rights that have been created and allocated to members (approximately $291 billion),” Etsebeth wrote in a December 2017 essay published by Coindesk. “Another tipping point will be the realization that the values of G7 currencies are devaluing against cryptocurrencies. The SDR and G7 country currencies will be forced to alter their foreign reserve weightings and eventually include a basket of cryptocurrencies.”

Despite such optimism, the volatility of virtual coin values remains problematic. Until feasible use cases on a large scale are developed or at least clearly envisioned, central banks are likely to remain cautious about buying tokens.

Bank-Issued Cryptocurrencies

Meanwhile, central banks are actively evaluating blockchain to determine whether to produce their own coins. The efficiencies gained would have to be high enough to surmount the disruption that would occur.

J.P. Koning, founder of the Moneyness blog, argues that public demand for virtual coins — as currency — may be more sluggish than it seems. “It is not apparent where this demand will come from given that private bank accounts already provide the public with the same set of services that a central bank product would hypothetically offer,” Koning wrote in a December 2017 column for Coindesk.

With the uncertainties about the technology, consumer demand and regulation, central banks are not ready to buy or create crypto coins in bulk. More likely, they may move toward deploying coins of their own on a limited scale. Perhaps it would be a collaborative effort similar to the digital Utility Settlement Coin in development by Swiss bank UBS and a dozen major international financial institutions to facilitate interbank payments.

The Irony of Disruption 

The possibility for technology disruption by blockchain is both its greatest feature and most limiting factor. It is ironic that central banks are now viewed as a possible major potential player in cryptocurrency, given that crypto coins were originally created explicitly to avoid big banks.

Central banks would have to see a definite advantage in establishing blockchain on a large scale and issuing their own cryptocurrencies, and that has not happened yet. Meanwhile, there is pressure from the current flurry of crypto coin activity. Whether that pressure will build, or burst, in the next several years is not clear.

Alice Lipowicz
Alice Lipowicz is a highly regarded technology writer, specializing in new technologies, government policy, contracts and regulation. She was named one of the 70 Most Social (media) Federal Technology Pros on Twitter and one of the nine Top Women Global Influencers of Tech Innovation in Cities.