Cryptoassets built on blockchains are unlikely to replace traditional money given the inherent limitations of their structure, argues a new paper from researchers at the Bank for International Settlements (BIS).
In a research bulletin, the authors point out that, while advocates of crypto and decentralized finance aim to build a “radically different monetary system,” the blockchain technology underlying these efforts is inherently limited.
“A system sustained by rewarding a set of decentralized but self-interested validators through fees means that network effects cannot unfold. Instead, the system is prone to fragmentation and costly to use,” the paper said.
The high fees required to incentivize validators to contribute to an individual blockchain encourages the creation of new blockchains, fragmenting the crypto landscape, the paper said.
In contrast, traditional payment systems rely on strong network effects to attract users, “creating a virtuous circle” that ultimately “drives costs down, improves service quality and promotes financial inclusion.”
The inherent fragmentation of the blockchain-based crypto sector increases governance and security risks, the paper noted. Moreover, it prevents crypto from fulfilling “the social role of money,” it said.
“Ultimately, money is a coordination device that facilitates economic exchange. It can only do so if there are network effects: as more users use one type of money, it becomes more attractive for others to use it,” the paper said.
“Looking to the future, there is more promise in innovations that build on trust in sovereign currencies,” it concluded.