Over the weekend CoinDesk published a thought-provoking opinion piece on the “long tail” of digital assets.
Galia Benartzi, founder of Bancor, argues that we are on the brink of an ecosystem of “user-generated currencies”, each with specific uses and characteristics.
“Communities of any flavor can now be empowered to agree on credit-issuing policies and governance structures, and enjoy internal marketplaces from which to buy and sell goods or services, without relying on access to national money.
…as technical barriers to entry are removed, we are on the precipice of millions of user-generated currencies, of all shapes and sizes.”
The author compares the potential with the impact that WordPress and YouTube had on user-generated content. The result was chaos and information overload, but also empowerment and freedom of expression.
The result of a proliferation of tokens (beyond the bewildering array we already have) is also likely to be chaos, information overload, empowerment and greater freedom.
It could also, however, imply less freedom.
For instance, through lack of fungibility. If I hold tokens issued by you that can only be used in your business or community, then I am tied in. With cash, I can use my notes and coins almost anywhere. (True, this is changing as we move towards a “cashless society”, but you get the idea.)
Also, digital transactions are more traceable. Activity around communities will be easier to monitor, and even anonymous tokens send an indirect message to those watching (nothing is more guaranteed to arouse suspicion than to deny access to information).
Finally, the resulting chaos could lead to loss of value through “leakage” – people not understanding the systems, misallocating resources and eventually dropping out. Several studies have shown that too much choice tends to paralyze consumers. When you’re talking about jam or detergent, the cost is not material (except to the manufacturers, I suppose). But when you’re talking about “money”, the cost – to the functioning of the economy – is greater.
The idea of a “long tail” of currencies is heartening and exciting. Personally, I love the stimulation of the “long tail” of music and books. But the proliferation of online information brought us blogs and fun videos, but also click-bait, fake news, trolling, piracy and identity theft. The end result of a blossoming diversity in means of exchange will also not be as empowering and uplifting as we had hoped.
The idea of bitcoin and central banks joining forces is not quite as farfetched as it seems. True, bitcoin is a decentralized global currency system, and regional central banks are, well, centralized and regional. So, on the surface they have nothing in common, except for the objective of a fast, efficient, low-cost method of payment and settlement. The main difference between bitcoin and the central banks is in how they think that should be governed and executed.
What do central banks want? They want an efficient way of settling interbank trades. They want a healthy banking system. And they want to influence the economy by controlling both the money supply and the interest rates.
What does bitcoin want? It wants to empower individual users to control the use of their own money, free from intervention, manipulation and censure, and totally open to market forces.
Could central banks use bitcoin’s technology to achieve their goals? In theory, yes. Would this end up being the irony of ironies? No, not really.
Central banks would not so much be interested in bitcoin as in its underlying technology of the blockchain. More efficient settlement, increased transparency, less economic vulnerability and a greater control over the money supply would have a significant impact on the Bank’s power and usefulness. It could be positive, or it could be negative. We could see a consolidation of central banks’ influence. Or, we could see them blockchained out of existence.
One of central banks’ main functions is to act as a clearing house for interbank trades. A vast amount of money is electronically transferred between banks at the end of each business day, to make sure that the net positions reflect that day’s financial activity. The central banks coordinate and settle this, using a variety of transfer platforms. It’s efficient. But it could be more so, especially if the need for a central clearing house was eliminated. What if the network of commercial banks and other financial institutions could settle directly on the blockchain? The central banks’ obligations could be reduced to that of regulation and monetary policy.
Another main function of central banks is that of issuing the currency. What if, instead of fiat currency, they issued a blockchain-based digital currency? (Which would, technically, also be fiat in that it is backed not by gold or similar, but by faith in the central bank.) That way we could all hold money directly issued by the central bank. Right now the only way to do that is with cash. If we could all effectively “open an account” with the central bank, there wouldn’t be much point in also having commercial bank deposits. Apart from the additional unnecessary costs, commercial banks are not as secure. They do not hold enough liquid assets to offset the client deposits, which leaves clients at the (remote, but still) risk of not being able to take their money out when they want to. With the central bank, that’s not a problem.
But with no retail deposits, commercial banks couldn’t lend as much as they do. Now, they take their retail deposits and lend them out to other individuals and business, thus making money more efficient and giving the economy a boost (not to mention making a profit in the process). This has the added effect of increasing the money supply, by effectively “re-using” money. It’s good for the economy (at least on the surface), but it’s difficult to control. The startling reality is that we don’t actually know what the money supply is at any given time. Central bank deposits at commercial banks can be used to back loans, but the scope is obviously more limited.
So, with commercial deposits replaced by central bank digital currency, lending would dry up (unless we can come up with a way to leverage central bank deposits). But some economists argue that it wouldn’t be a bad thing at all. Either way, the central bank would have a much tighter control on the money supply, and a much greater influence on the economic performance of the country. In theory, anyway – we all know that when it comes to economics, that is rarely the same as reality. The idea is a radical departure from the current economic system that we know. But, coming full circle, that is the point of bitcoin, the reason technologists have been searching for decades for a solution to the persistent problem of decentralized trust. Yet while bitcoin wants to be an alternative to central bank hegemony, the central banks themselves want to get in front of the inevitable change that this new technology will most likely force on the traditional system.
And all of this is not as farfetched as it sounds. Central banks are looking into these ideas, and the past few months have seen a slew of pronouncements from central banks all over the world. Just last week the Bank of England released a report that claims that a central bank-issued digital currency would permanently increase GDP by 3%. In March, Bank of England Deputy Governor Ben Broadbent gave a speech in which he outlined what such a system of central bank digital currency and blockchain settlements could look like. In January of this year the Bank announced that it was looking into the possibility of using the blockchain for the UK interbank settlement system. Last September the Bank of England’s top economist, Andrew Haldane, proposed the idea of issuing a state-backed cryptocurrency while simultaneously applying a negative interest rate on paper currency, or even banning paper currency outright.
Also in March of this year, researchers from the University College of London (not affiliated with the Bank of England) proposed the RSCoin framework for cryptocurrencies issued by central banks. This would allow the central banks to centralize the money supply, allow direct access to payments, and give an exact figure for the money supply at any given time. The cryptocurrencies would run on nodes validated by authorized “mintettes” (I think they’re being serious, I’m not sure).
Just last month it emerged at a conference of 90 central banks from around the world, hosted by the World Bank, the IMF and the Federal Reserve, that several of them have been investigating the blockchain for some time. Earlier this year the Dutch central bank revealed the development of an internal digital currency prototype called DNBCoin, for experimental purposes. And the following month the French central bank announced that it has been actively looking into bitcoin, digital currencies and distributed ledgers. Even Russia’s central bank has expressed an interest in the possibility of a central bank-issued digital currency.
A few weeks ago the Bank of Canada revealed that it has been experimenting with how to apply the blockchain to interbank payments. In May, the Deputy Governor of the Bank of Japan urged central bankers around the world to consider the implications of this technology. India’s central bank is investigating how to use the blockchain to reduce the dependence on cash and improve tax collection. China’s central bank is looking into issuing its own digital currency. The central bank of South Korea is researching distributed ledger applications. Barbados, Kazakhstan, the list goes on. And we can expect many more similar announcements in the coming months.
Cryptocurrencies are a reality, and with technological improvements and increased opportunity, they will become a more widely spread mechanism of financial transaction. Central banks can watch while their power to control the money supply is whittled away by the increased use of money outside their influence. Or, they could try to compete by incorporating cryptocurrencies into their national spheres. This obviously is not a simple proposition, and the ripple effects will need to be seriously considered. And no-one likes the idea of “experimenting” with something as fundamental as national and global economics. But change is inevitable, cryptocurrencies offer significant advantages, and the demands of the market are evolving. Calling for the disruption of the central banks is at this stage irresponsible, especially since we don’t yet have a viable alternative. However, if the central banks start to disrupt themselves, we could gradually move into a new economic order, with potential and promise that reach far beyond lower costs, faster transactions and enhanced transparency.