The winner of the Young Economist of the Year is William Lawson of St Olaves Grammar School for his submission on ‘cryptocurrency’ (‘Cryptocurrencies and the Bank of England’). William is the winner of the ‘cryptocurrency’ topic, with his submission discussing how cryptocurrency can affect the central bank.
His submission is available to read below.
Cryptocurrencies and the Bank of England:
By William Lawson
The goal of a Central Bank is to achieve macroeconomic stability and to regulate financial markets. The former is achieved through monetary policy – controlling interest rates and quantitative easing – and the latter through regulation of banks and financial market infrastructure. In Britain, this process is orchestrated by the Monetary Policy Committee and the Financial Policy Committee, alongside other BOE institutions like the Prudential Regulation Authority.
Cryptocurrencies, like Bitcoin, are decentralised virtual currencies which use blockchain technology to allow transactions to be verified and secured by users. These currencies therefore emphasise the role of individual cooperation, excluding central banks which exercise a great deal of power over traditional monetary systems. This poses a particular challenge to the Central Bank’s ability to regulate financial markets, as anonymity and decentralisation make it difficult to protect consumers or prevent illicit activity. This not only entails a financial threat to consumer safety, but also the social threat of rising crime. However, the complexity, volatility, and risk inherent in Crypto make it unlikely to become widely adopted, and therefore it is likely that the Bank of England will continue to control the UK monetary system.
Protecting Consumers in the Crypto Market:
In regulating the financial sector, the Bank of England seeks to protect consumers and promote stability; yet Cryptocurrencies are notoriously difficult to regulate. This is because they are decentralised, with control of the money supply and transactions not attributable to a particular body, and anonymous, with users protected by pseudonyms.
The first issue is one of protecting consumer interests. In Britain, the Bank of England regulates bank behaviours to minimise risk taking, whilst also guaranteeing deposits under £85,000 to protect consumer savings1. This task becomes far harder in the Crypto market, where anonymity and decentralisation make it impossible for regulatory bodies to safeguard people’s assets. Cryptocurrency wallet services are not subject to the same regulatory standards as mainstream banks, and yet if such firms do collapse there is no guarantee that investors won’t lose all their bitcoin. The socio-economic implication of this is that, without BOE protection, the volatile Crypto market is incredibly dangerous for consumers, with the Financial Conduct Authority saying, “If you invest in Crypto assets, you should be prepared to lose all your money”2. This is best seen in the potential collapse of crypto-wallet Coinbase, with corporate negligence potentially having a devastating effect for consumers3.
Secondly, but of perhaps more concern, is the need of the Central Bank and other regulatory bodies to minimise financial crime. Institutions like the Financial Conduct Authority, along with BOE institutions like the PRA, struggle to track and prevent crime carried out through anonymous Bitcoin transactions. According to a Europol study, “The use of cryptocurrency as part of criminal schemes is increasing,” as criminals become able to “obfuscate money flows”4. The issue is most acute in regard to weapons purchases, with numerous cases of radicalised individuals using Bitcoin to purchases guns, a transaction which could’ve been prevented had it been overseen by a centralised regulatory authority.
Uptake of Cryptocurrencies is not a major threat, however, to the ability of the Bank of England to regulate mainstream banks and other large financial institutions. Whilst some large banks do trade in Cryptocurrencies, only 4% of the global population own crypto and therefore the vast majority of a bank’s operations will be done using standard currencies. Moreover, large financial institutions based in the UK are registered with the BOE and therefore can be regulated and held accountable regardless of the extent to which they use crypto. Thus, the development of cryptocurrencies like Bitcoin is not a threat to the ability of the Bank of England to control mainstream financial institutions, or to prevent crises like the 2008 Global Financial Crisis.
The threat of Cryptocurrencies as a monetary system:
Money functions as a store of value, a unit of account, and a medium of exchange; as such it is the cornerstone of modern, specialised economies. It is commonly believed that Cryptocurrencies threaten to displace national currencies as the primary monetary system worldwide. If this were so, it would wholly nullify the ability of Central Banks to use monetary levers to achieve macroeconomic stability, as currency and money supply became decentralised. Yet it seems seriously unlikely that such a situation, in which Cryptocurrencies seriously threatened national currencies, could ever arise.
Cryptocurrencies fail to adequately fulfil the functions of money. Long transaction times (nearly an hour for Bitcoin transactions), combined with the need for third party verification of each transaction, mean that Crypto would provide an inefficient medium of exchange. At the same time, the volatility of Cryptocurrencies, with Bitcoin losing 50% of its value this year and Ethereum recently losing 20% of its value in 24 hours5, reduce its reliability as a store of value.
Furthermore, there is little widespread appetite for the complicated and somewhat inaccessible technology to be used as an alternative currency. Most of those that do own Crypto treat it as a speculative investment (indicative of its volatility) and few genuinely use it as a currency6. As a result, it seems incredibly unlikely that Cryptocurrencies could ever threaten the Pound Stirling as the main UK currency, and therefore the Bank of England will continue exercise sole control over the monetary system of the United Kingdom.
Overall, Cryptocurrencies pose some threats to the Bank of England’s objectives, particularly the regulation of the financial sector and the prevention of illicit financial transactions. However, the unlikelihood that Crypto ever becomes a widely adopted monetary system means that the Bank of England will likely continue to have substantial power to control the UK macroeconomy.
1 Bank of England (2018)
2 Financial Conduct Authority (2019)
3 Bambrough, B [Forbes] 2021
4 Europol (2021) Cryptocurrencies
5 The Independent (2022)
6 Glaser, F et al. (2019)
Böhme, R., Christin, N., Edelman, B. and Moore, T. (2015). Bitcoin: Economics, Technology, and Governance. The Journal of Economic Perspectives, [online] 29(2), pp.213–238. Available at: https://www.jstor.org/stable/24292130?readnow=1&refreqid=excelsior%3A314ffdb693a0e5f169d649e54f37ff2e&seq=18 [Accessed 10 Jul. 2022].
Bank of England (2018). What is the Prudential Regulation Authority (PRA)? [online] Bankofengland.co.uk. Available at: https://www.bankofengland.co.uk/knowledgebank/what-is-the-prudential-regulation-authority-pra.
KEY FINDINGS 2 EUROPOL SPOTLIGHT -CRYPTOCURRENCIES: TRACING THE EVOLUTION OF CRIMINAL FINANCES. (n.d.). [online] Available at: https://www.europol.europa.eu/cms/sites/default/files/documents/Europol%20Spotlight%20-%20Cryptocurrencies%20-%20Tracing%20the%20evolution%20of%20criminal%20finances.pdf.
Bambrough, B. (n.d.). Serious Coinbase ‘Sell’ Warning Triggers Sudden Price Crash As Bitcoin And Ethereum Dive. [online] Forbes. Available at: https://www.forbes.com/sites/billybambrough/2022/06/27/serious-coinbase-sell-warning-triggers-sudden-price-crash-as-bitcoin-andethereum-dive/.
Meiklejohn, S., Pomarole, M., Jordan, G., Levchenko, K., Mccoy, D., Voelker, G.M. and Savage, S. (n.d.). A Fistful of Bitcoins: Characterizing Payments Among Men with No Names. [online] doi:10.1145/2504730.2504747.
Glaser, F., Zimmermann, K., Haferkorn, M., Weber, M.C. and Siering, M. (2014). Bitcoin – Asset or Currency? Revealing Users’ Hidden Intentions. [online] Ssrn.com. Available at: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2425247.
The Independent. (2022). Ethereum price drops dramatically amid cryptocurrency collapse. [online] Available at: https://www.independent.co.uk/tech/ethereum-cryptocurrency-bitcoin-market-crash-b2077226.html [Accessed 10 Jul. 2022].
Financial Conduct Authority (2019). Cryptoassets. [online] FCA. Available at: https://www.fca.org.uk/consumers/cryptoassets.