Bank of England takes a closer look at bitcoin potential

In its quarterly economic review, the central bank argues that while digital currencies could, in theory, serve as money for anybody with an internet-enabled device, at present they serve the roles of money only to a limited extent and only for relatively few people.

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, says the BofE.

Further, the economics of the schemes - in terms of lower transaction fees and a finite supply of coins - poses significant challenges to their widespread adoption, the Bank contends.

"At a microeconomic level, a key attraction of some digital currency schemes at present is their low transaction fees. But the incentives embedded in the current design of digital currencies mean that these fees may eventually need to rise significantly, as usage grows," states the Bank. "At a macroeconomic level, most digital currencies, as currently designed, incorporate a predetermined path towards a fixed eventual supply - a feature which, in a purely hypothetical scenario in which the digital currency were used as the predominant form of money, would likely cause greater volatility in prices and real activity due to the inability of the money supply to vary in response to aggregate demand."

However, both digital currencies' status as money and the distributed ledger technology used by them have potential to develop over time, the BofE believes.

"Since the majority of financial assets such as shares or bonds already exist only as digital records, this opens up at least the possibility for distributed ledgers to transform the financial system more generally," the Bank states.

The Bank of England has posted two videos on YouTube explaining the economics of digital currencies and how they work.