What is the future of banking, central banking and financial intermediation in a world in which cryptocurrency is dominant? Let’s speculate a bit, with the proviso that no one can fully anticipate how these markets will evolve.

It is no wonder that the ruling class is concerned.

We can find hints in the speech by IMF head Christine Lagarde at a Bank of England conference in September 2017. She dropped some words that likely sent some chills down a few spines in the audience. She explained that cryptocurrency is not a passing fad but a genuine innovation in money. The only remaining barriers to widespread adoption are technical, fixable and likely to be overcome as the sector develops. This, she argued, has profound implications for the future of financial intermediation and central banks.

“In the future,” she explained, “we might keep minimal balances for payment services on electronic wallets. The remaining balances may be kept in mutual funds, or invested in peer-to-peer lending platforms with an edge in big data and artificial intelligence for automatic credit scoring … Some would argue that this puts a question mark on the fractional banking model we know today, if there are fewer bank deposits and money flows into the economy through new channels.”

She continued to press the point, as it relates directly to the Bank of England and the Federal Reserve.

“How would monetary policy be set in this context? Today’s central banks typically affect asset prices through primary dealers, or big banks, to which they provide liquidity at fixed prices — so-called open-market operations. But if these banks were to become less relevant in the new financial world, and demand for central bank balances were to diminish, could monetary policy transmission remain as effective?”

She put a question mark after that last sentence, but she might as well have made the statement: Monetary policy cannot be effective in this world. In fact, it is worse. It might not matter at all.

It’s an astonishing thing to consider. For more than a century, academics, regulators, captains of finance and high-level government officials have worked to find the perfect monetary policy to stabilize the macroeconomy, provide liquidity for growth without inflation and otherwise become masters of economic planning.

But this entire machinery is premised on two important conditions. First, the government must have the monopoly on money. It has held this for more than a century. Government prints the money, controls its supply, imposes legal tender and regulates against the enforcement of contracts denominated in unofficial currency. And second, most of this money has to be held in some way in the banking system. If you take away both of those, the cause of central banking has a serious problem pursuing any form of monetary planning at all.

That is indeed a very different world. And it is no wonder that the ruling class is concerned.

Today, banks like JPMorgan and Goldman Sachs are experimenting with blockchain technology and cryptoassets. And Lagarde’s own statement might be seen to portend the issuance of a new global cryptocurrency to replace the Special Drawing Right. The core problem of these large-scale attempts to reproduce the power of the distributed ledger is that it might be too little, too late. The model of a new world of banking and credit is already revealing itself.

Would Banks Exist?

How is conventional banking affected by cryptocurrency? Lagarde offers that it raises questions about fractional-reserve banking, the practice of keeping fewer deposits on hand than can be immediately paid out to customers at any one time. The practice has been well established for hundreds of years, and yet it can lead to unwarranted expansions of credit and fuel system-wide instability.

Consider the history of banking. What was the purpose of the bank? There have been traditionally three primary functions that banks have provided since the ancient world.

The first has been to provide safe storage for money itself. This is the warehousing function. It is essential and worth paying for. People need a safe place to store their money.

That money needed a warehouse has always been taken for granted.

The second is the loan function. The more credible the warehousing function becomes, the more the bank is in the position to leverage its specie holdings for its credit-granting functions. This is the origin of fractional-reserve banking. The bank cannot pay all depositors on demand. Instead, it relies on its financial soundness and a rate of return for depositors who entrust the bank with the responsibility of maintaining its balance sheet.

Print Friendly, PDF & Email