While cryptocurrencies should not supplant traditional currencies due to scalability limitations, Central Bank Digital Currencies (CBDCs) could create a more stable financial system, according to the European Parliament’s Economic and Monetary Affairs Committee.

A paper authored by various members of the Kiel Institute for the World Economy concluded that the prospect of CBDCs could act as an alternative to the current fractional reserve banking system.

“Currently, cryptocurrencies such as Bitcoin could not supplant traditional currencies to any significant degree, as the available technology faces severe limitations regarding scalability,” read the document. “In particular, it would be prohibitively expensive to conduct even a moderate share of the transactions now handled via traditional currencies through cryptocurrencies.”

Rather than as a medium of exchange, crypto and related assets are so far primarily used as a vehicle for financial speculation,” the authors noted, adding that the associated large swings in value seem to attract speculators looking for outsized returns. “Recently, a number of actors have tried to circumvent existing regulations on traditional financial products by the means of virtual assets.”

The paper stated that the effects of CBDCs can be disruptive, adding that as long as cash - which provides valuable services such as anonymity of payments - is not abolished, a CBDC may not reduce the effective lower bound on interest rates very much.

“To avoid recurrent instability of the banking system, commercial banks would need to come up with more reliable funding sources than deposits,” the authors stated, referring to the potential switching of accounts away from traditional banks.

“As the fractional reserve character of the current banking system can be a major source of instability, such a disruptive change is not necessarily a bad development, but could finally pave the way for a more stable financial system,” the paper concluded.

The report came to a different conclusion than the Bank for International Settlements, which recently suggested cryptocurrencies are an “environmental disaster” and have the potential to “bring the internet to a halt”.

The ‘central bank of central banks’ explained in its Annual Economic Report that distributed ledger technologies (DLT) are not currently able to scale up sufficiently, so are not suitable as a replacement monetary system.

In the UK, the Bank of England is considering whether central banks could issue their own digital currencies, while the Treasury Select Committee launched an inquiry into the risks and opportunities around digital currencies and DLT.

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