BIS published a paper that discusses the economics of how Bitcoin achieves data immutability, and thus payment finality, via costly computations—that is, "proof-of-work." Additionally, it explores what the future might hold for cryptocurrencies modeled on this type of consensus algorithm. The analysis shows that liquidity of Bitcoin will fall substantially in the years to come in the absence of relevant technological advances.
This paper introduces the concept of “economic payment finality” in the blockchain. A payment can be considered final only once it is unprofitable for any potential adversary to undo it with a double-spending attack. The conclusions are, first, that Bitcoin counterfeiting via "double-spending" attacks is inherently profitable, making payment finality based on proof-of-work extremely expensive. Second, the transaction market cannot generate an adequate level of "mining" income via fees as users free-ride on the fees of other transactions in a block and in the subsequent blockchain. Instead, newly minted bitcoins, known as block rewards, have made up the bulk of mining income to date. Looking ahead, these two limitations imply that liquidity is set to fall dramatically, as these block rewards are phased out. Simple calculations suggest that once block rewards are zero, it could take months before a Bitcoin payment is final, unless new technologies are deployed to speed up payment finality. Second-layer solutions such as the Lightning Network might help, but the only fundamental remedy would be to depart from proof-of-work, which would probably require some form of social coordination or institutionalization.
The paper emphasizes that claiming that technology alone cannot do the trick is not to say that it is useless. It simply means that the focus could shift away from the issue of whether the technology can replace traditional sovereign money and financial institutions. One key question for future research is whether and how technology-supported distributed exchange can complement and improve on the existing monetary and financial infrastructure. For example, in mixed systems, normal market functioning could be guaranteed by decentralized economic consensus, yet should it fail there would be overarching coordination mechanisms that are also tied to the legal system. What would be the gains regarding efficiency, transparency, and resilience from such semi-decentralized exchange compared to current market designs? Answering these and related questions will require a more widely distributed understanding of the new technology and how it might be used in existing markets. However, for those already involved in distributed ledger technology, what is needed is an awareness of how institutions have sustained trust throughout mankind’s history, an issue that lies at heart of central banking and financial regulation. The authors also conclude that, in the long run, the value of cryptocurrencies might be to catalyze the thinking on how society can handle access to data and the right to edit it, a much-needed impulse at a time characterized by loss of privacy and the rise of technology-driven disinformation campaigns.
Keywords: International, Banking, Regtech, Fintech, Cryptocurrencies, Distributed Ledger Technology, Blockchain, Bitcoin, BIS
Previous ArticleCBB Consults on Revised Credit Risk Management Modules for Banks
HKMA is consulting on revisions to the Supervisory Policy Manual module CR-G-14 on margin and other risk mitigation standards for non-centrally cleared over-the-counter (OTC) derivatives transactions.
PRA provided further information on the application of regulatory capital and IFRS 9 requirements to payment holidays granted or extended to address the challenges arising from COVID-19 outbreak.
HKMA announced the publication of a report on fintech adoption and innovation in the banking industry in Hong Kong.
BIS published a working paper that examines the drivers of cyber risk, especially in context of the cloud services.
ECB launched consultation on a guide specifying how the Banking Supervision expects banks to consider climate-related and environmental risks in their governance and risk management frameworks and when formulating and implementing their business strategy.
ECB published an opinion (CON/2020/16) on amendments to the prudential framework in EU in response to the COVID-19 pandemic.
EBA published a report that examines the interlinkages between recovery and resolution planning under the Bank Recovery and Resolution Directive (BRRD).
SRB published the final Minimum Requirements for Own Funds and Eligible Liabilities (MREL) policy under the Banking Package.
US Agencies (FDIC, FED, and OCC) published a final rule that makes technical changes to the March 31, 2020 interim final rule that provides a five-year transition period for the impact of the current expected credit loss (CECL) methodology on regulatory capital.
ECB published results of the March 2020 survey on credit terms and conditions in euro-denominated securities financing and over-the-counter (OTC) derivatives markets.