Last week Timothy Lane, Deputy Governor of the Bank of Canada (BoC), spoke about the state of cryptocurrencies. Lane does not foresee any imminent risks to the BoC’s ability to fulfil its mandate. Nonetheless the bank is creating a contingency plan for a scenario where crypto-assets cause issues. This prudent approach in the face of low risk is because of the potential for rapid changes.

In his speech, Lane highlighted the rate of growth in crypto-assets. However, he clarified that the sector is not currently a threat to Central Banks because of the small size and limited interconnectedness with mainstream financial systems. However, that could change, hence the contingency plan.

One of the future risks is if cryptocurrencies were to undermine the BoC’s ability to provide a means of payment with stable purchasing power. Another is if it affected their ability to implement monetary policy. Additionally, current permissionless blockchain technologies lack finality and hence payments can be reversed. The BoC needs to be able to provide a means of settlement that has finality and security.

In Bitcoin’s case it takes ten minutes to process a transaction and an hour to be reasonably sure it won’t be reversed.

Current low risk

In July the Financial Stability Board (FSB) published a report about crypto-assets which concluded that they don’t pose a material risk to global financial stability at this time. However, the market needs to be monitored vigilantly.

Part of the low risk is the market size which is currently around $220 billion and trading volume in the region of $15 billion/year. By comparison, the global equity market is $100 trillion.

The limited connectivity with mainstream financial services is the other factor that mitigates risk. Connectivity between cryptocurrencies and the real economy comes down to their use as payments, ICOs, derivatives based on crypto, and crypto exchanges some of which act like banks.

Once leverage is used more heavily or financial institutions increase their exposure to crypto-assets, the risks increase.

Central Bank Digital Currency

Lane presented a Central Bank Digital Currency (CBDC) as the contingency plan should crypo-assets undermine the bank’s mandate. “As it turns out, the questions of “under what conditions” and “in what form” are closely intertwined,” said the deputy Governor.

Concerns include using a CBDC for illicit transactions and how it could impact commercial banks’ role as intermediaries. A CBDC is off the cards without addressing the risks. Though the bank continues to explore the area, including exchanging information with the Swedish central bank.

There was a passing reference in the speech to Project Jasper, the BoC project for settlement between financial intermediaries.