When the euro was introduced just over twenty years ago, there were tales of people around Europe refusing to exchange their national currency notes for the single currency, on the basis that the euro ‘will never catch on’. When the hacking group Darkside ransomed the dataset controlling the Colonial pipeline last week, the ransom was paid in a cryptocurrency.
These two, different tales from opposite ends of the ‘money’ spectrum tell us much about how finance, and money in particular is evolving. At one end, we see the development of a new, traditional money (euro) and the centralised financial and capital markets (to an unsatisfyingly incomplete degree), that go with it. At the other end of the spectrum is decentralised crypto finance, that exists on a largely anonymous, unregulated way beyond the ‘old’ global financial system.
These two worlds are soon set to collide. Regulators, witnessing the speedy rise of cryptocurrencies, the lurid ways in which they are traded (e.g. dogecoin) and the threat they present to the incumbent financial system, will I suspect soon take a heavier hand in overseeing the architecture around crypto currencies like bitcoin which currently can’t be regulated, though the infrastructure or architecture that trades it can be overseen.
For context, these two approaches criss-cross many other related debates – the rise of sophisticated organised crime, the future of the dollar as the world’s reserve currency and the need to build emerging market financial systems that can curb corruption.
A potentially decisive development is the acceleration in the rollout of central bank digital currencies (CBDC). Central banks are set to issue digital versions of their currencies to accompany outstanding reserves and bank deposits. Theoretically, central banks will give each of us a retail account, and households can exchange money directly with them (as opposed to going through the banking and economic systems). The logistical and communication aspects of this project will be fiendishly complex to the extent that ‘it will never catch on’ echoes through my head.
It is however, catching on. Nearly twenty million Chinese are hooked up to an experimental digital yuan run by the People’s Bank, whose intention is that the 2022 Winter Olympics in China will serve as a showcase event for the digital yuan. Small, advanced economies – notably Switzerland and Singapore (not forgetting the Bahamas’ Sand dollar) are to the forefront in planning digital currencies as is the Bank of England, which egged on by the strategic urgency created by Brexit, may be the first large central bank to roll out a digital currency (the Fed and ECB also have blueprints).
It strikes me that the ingredients necessary for this sort of manoeuvre are a well banked and financially literate population, one that is well penetrated technologically, and a central bank with a very good policy and regulatory brains trust. (I attach a link below to a good overview from the BIS)
Digital central bank currencies can achieve a range of aims – from making the transmission of money a cheaper and faster process (though I am not at all sure that this is good for payment companies and banks), a potentially more secure banking system, and the possibility to rebuild decrepit banking systems (stablecoins – that are linked to an underlying asset/currency – can play a role here). Two other factors are prominent.
One is the ability of central banks to better tailor monetary policy. As it stands, quantitative easing is delivered through financial markets. With a digital central bank currency where households have retail ‘accounts’ at the central bank, it can drop money directly into household accounts, with even a bias towards certain types of households. For example, if the central bank decides that families with two children tend to have a particularly strong impact on the economy then it can funnel relatively more money to them.
The other aspect of the CBDC that deserves greater attention is the enhanced power that it will give central banks. In opening up accounts with the public and businesses there is the risk that central banks assume a Leviathan level of control over financial systems, and to a very large extent subsume them. In China where the government aggressively policies social media content, it may seem automatic that an institution like the central bank can have immense power over people finances, and to an extent act like a fiscal authority as well.
So, if central bank independence and their outsized role in the political economy will be called into question, the counterveiling argument, for the larger central banks at least, is the geopolitical value in rolling out digital central bank currencies. Indeed, China’s announcement that it was advancing its digital currency project has prompted the Fed and the ECB to flag their own programs.
This trend raises many questions, the most prominent of which is the long term role of the dollar. What is perhaps more pertinent is to think how the architecture of central bank digital currencies will evolve – to what extent will central banks have power over household finances and economic behaviour, and to what extent will digital currencies change banking systems (I half suspect that the Chinese authorities’ attempts to rein in Alibaba is conditioned on its plans for the digital yuan).
Two of the important structural issues are outstanding. One relates to emerging countries, whose currencies and relatedly central banks are not as liquid as the ‘old’ monies – will they try to launch their own digital currencies or will we see competing waves of dollarization, euroifciation and yuanificiation across countries like Argentina, Serbia and Malaysia? What is promising here is that countries like Colombia and Uruguay are already active in terms of either mobile payments systems or digital currencies, and in Africa Kenya’s MPESA is a notable digital success story.
The second issue relates to the way in which ‘centralised’ digital currencies will interact with decentralised finance (cryptocurrencies and stablecoins). There is a vision of how these systems can join harmoniously together (see Giles’ excellent DigitalEconomist post on this below). The concern is that by definition the evolution of the crypto world is happening at such a rate, and in such a disorganised way that it presents a threat to the established financial order, and that the two systems grow in parallel, competing ways. It is an exciting and potentially very messy clash, though ultimately CBDC’s might just catch on.
Have a great week ahead,
Mike
The Levelling 