Privately-issued digital currencies are very unlikely to replace government-issued fiat currencies as a medium of exchange but could partially displace haven assets like gold, new research shows.
Cryptocurrencies could replace gold as an electronic store of value once key hurdles such as trust, volatility, regulatory acceptance and reputational risks are overcome, according to a research note from the Bank of Singapore.
Once these disadvantages have been addressed, digital currencies can also be used in investor portfolios as a potential safe-haven asset and for asset diversification, it said.
“First, investors need trustworthy institutions to be able to hold digital currencies securely. Second, liquidity needs to improve significantly to reduce volatility to manageable levels,” Mansoor Mohi-uddin, chief economist at Bank of Singapore, said.
Concentrated holdings and thin market volumes are driving volatility in cryptocurrencies, which is one of the greatest barriers to their adoption in real world transactions, Swiss private bank Lombard Odier said in a recent research note.
“Bitcoin is highly volatile as its rally over the past year from $4,000 to more than $40,000 and then back towards $30,000 shows,” Bank of Singapore's Mr Mohi-uddin said. “Bitcoin is also correlated with stocks and other risk assets rather than trading as a counter-cyclical safe-haven. In a financial crisis, cryptocurrencies are more likely to be dumped by investors during a market meltdown, as occurred at the start of the pandemic in March 2020.”
Yet increased participation by institutional investors such as asset managers with longer-term time horizons than retail buyers or hedge funds could help to increase liquidity, lower volatility and cause price action to be driven more by fundamentals than speculation, Bank of Singapore said.
The appeal of digital currencies among younger people is partly due to convenience. Bitcoin and other cryptocurrencies are also easy to store in digital wallets, whereas precious metals often need to be stored in secure, physical locations and can't be used easily for everyday transactions, it added.
The flip side to this, though, is they are easier for fraudsters to steal. There are also reputational risks as digital currencies have been widely used by criminals, money launderers and others looking to take advantage of their anonymity.
“Government agencies need to curtail criminal activity to reduce the reputational risks for holding digital money,” Mr Mohi-uddin added.
Another potential disadvantage is that although the supply of precious metals is relatively finite, the launch of new cryptocurrencies in the future could potentially devalue existing digital tokens, Bank of Singapore said.
The volatility of cryptocurrencies makes them an inefficient unit of exchange, Mr Mohi-uddin said. Their limited supply makes them unable to facilitate growing economic activity, and governments are not likely to tolerate direct challenges to monetary sovereignty, with several central banks already developing their own digital currencies using blockchain technology.
“Governments are very wary of any technology that could potentially displace national currencies. This would reduce the ability of policymakers to print money during economic crises,” Mr Mohi-uddin said.