Recently, the UK’s central bank, the Bank of England (BoE), stated that Bitcoin, stablecoins and cryptocurrencies could lead to large outflows of deposits.
Indeed in a lengthy document entitled “New forms of digital money” the BoE in paragraph 5.5 writes:
“There is a strong case for considering the value of precautionary transitional arrangements that aim to ensure that new forms of digital money can emerge without threatening monetary and financial stability.
Section 4 concluded that the most significant risk arises from the potential for stablecoins in particular to undermine confidence in money and payments, and hence in the wider financial system. However, it further noted that, during a transitional phase, other risks may also emerge. The banking sector could prove unprepared to withstand large outflows of deposits, non-banks may not be willing or able to replace bank lending to some borrowers should that be required, and sterling money markets may be disrupted. And it concluded that, in the short to medium-term, it would be prudent to recognise these risks and make arrangements accordingly”.
It is referring to the so-called “fractional reserve”, i.e. the fact that commercial banks are allowed to issue loans even if they are not fully covered by the deposits held in their accounts.
By law, these loans can be issued, in effect creating new money, which will then be reabsorbed as the loans are paid off.
The law also sets limits on the creation of money in this way, i.e. a minimum percentage of deposits as a proportion of the total money lent out.
This means that a reduction in deposits generates a larger absolute reduction in the amount of money that can be lent out, so that if this reduction in deposits is significant, the current banking system may have to reduce the amount lent out by a large amount.
Underlying this dynamic would be a hypothetical outflow of pounds from bank accounts to other uses, such as crypto exchanges. These exchanges do not make fractional reserves, and do not lend by creating money, so a major outflow of pounds from banks to exchanges would greatly reduce the ability of lenders to lend.
The Bank of England’s solution “against” Bitcoin
The BoE‘s proposed solution would be to temporarily restrict the use of new forms of digital currencies, but it is unclear how this would be achieved, other than by placing limits on fiat currency uses on crypto exchanges, for example.
The central bank proposes:
- limits on the total amount of new forms of digital money that an individual could hold (which is impossible to control when using anonymous non-custodial wallets)
- limits on the amount of daily transactions in new forms of digital money (impossible to enforce on decentralized networks)
- restrictions on the types of users able to carry out transactions in new forms of digital money (impossible to enforce on decentralized networks)
- different rates of remuneration for new forms of digital money compared to commercial bank deposits (impossible to impose on non-custodial wallets).