The Bank of England disses Bitcoin

“Hey, nice little digital currency you’ve got there guys. Real cute.”

Credit: Giphy

The Bank of England (est. 1694) has published its analysis of Bitcoin (est. 2009).

And it gives the upstart digital currency a nicely condescending slap down.

First, Bitcoin is tiny, according to the Bank’s maths.

“It is estimated that there is less than £60 million worth of bitcoins circulating within the UK economy, which represents less than 0.1% of sterling notes and coin and only 0.003% of broad money balances.

“It is estimated that as few as 20,000 people in the United Kingdom currently hold any bitcoins, and that as few as 300 transactions may be conducted by those people per day.”

The Bank graciously concedes that “In theory, digital currencies could serve as money for anybody with an internet-enabled computer or device.”

(In theory, you can do a lot of things.)

The Bank doesn’t think Bitcoin will ever reach ubiquity as a payment system, though.

It calls this scenario a“Bitcoinised” economy — “where everybody sought to conduct the totality of their day-to-day transactions entirely within the alternative currency and switch into sterling only when strictly necessary for interaction with the state (such as to pay taxes).”

With marvellous understatement, the Bank writes: “This would represent a significant change.”

Sadly, this is “extremely unlikely”. The best Bitcoin can hope for is limited adoption.

Even then:

“Should [digital currencies] achieve limited adoption as a payment system, they are unlikely to undermine the Bank’s ability to achieve monetary stability.”

The anarchist wing of Bitcoin is going to be furious.

The Bank’s position is maybe predictable.

As Mike Hearn, a Bitcoin developer told me in an email:

“It is perhaps no real surprise that a central bank would not be wildly enthusiastic about a system designed to avoid having central banks.”

It’s worth reading the two papers, ‘The economics of digital currencies’ and ‘Innovations in payment technologies and the emergence of digital currencies’ in full — it’s a serious and deep analysis of Bitcoin from people who know their money, and a refreshing break from Bitcoin boosterism.

Hearn calls them “a very nice and reasonable set of papers”.

And the reports are perhaps not quite as snarky as made out above. In fact, they see a lot of revolutionary potential in Bitcoin.

“A first attempt at an ‘internet of finance”

The papers pick out one of the most important features of Bitcoin: the distributed ledger. According to the Bank, this “marks a key innovation in payment technology.”

With digital money, there’s the double spend problem. This doesn’t happen in the physical world: if I give you a £2 coin, I can’t also give that £2 coin to someone else at the same time. As the Bank puts it, “you can’t spend the same money twice.”

Because digital records are, by their nature, easily copied, you need a way to prevent this.

Banks use ledgers. They maintain a master record of every customer’s money. The banks are the authority, and can intervene to prevent a transaction happening if they deem it invalid. “In order to use the system, people must trust that these centralised ledgers will be maintained in a reliable, timely and honest manner,” the Bank writes.

Not so in Bitcoin — it has a ledger, but one distributed across thousands of computers and accessible to all, called the block chain. The location and ownership of each bitcoin is known to every part of the Bitcoin network.

If I send you 1 bitcoin (BTC), that transaction is transmitted to the network, which checks whether I own that currency. Once the transaction is made, I can’t send that same 1 BTC to someone else.

It’s an elegant solution to the problem of online trust, and one the Bank admires:

“In a similar way, the potential impact of the distributed ledger may be much broader than on payment systems alone. The majority of financial assets — such as loans, bonds, stocks and derivatives — now exist only in electronic form, meaning that the financial system itself is already simply a set of digital records. These records are currently held in a tiered structure (that is, with records of individuals’ accounts stored centrally at their bank, and banks’ reserves accounts held centrally at the central bank), but it may be possible in the future — in theory, at least — for the existing infrastructure of the financial system to be gradually replaced by a variety of distributed systems (although this article makes no prediction in this regard).
Some developers have already implemented so-called ‘coloured coins’ which means using digital currencies as tokens for other assets by attaching additional information. This development could allow any type of financial asset, for example shares in a company, to be recorded on a distributed ledger. Distributed ledger technology could also be applied to physical assets where no centralised register exists, such as gold or silver.”

[I’ve broken this into two paragraphs for readability’s sake.]

It’s good that the Bank is thinking through the implications of the technology behind Bitcoin, rather than just what it looks like right now.

As they put it: “the distributed ledger technology may perhaps be better described as a first attempt at an ‘internet of finance’.

Not bad for an upstart.

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