The Bank of International Settlements (BIS) is now throwing their weight behind Central Bank Digital Currencies for household use (“Retail CBDCs”). For clarity, this doesn’t necessarily mean recording fiat currency as tokens on blockchains: regular account-based technology can also be used. But it means that households could store and spend fiat money digitally outside of a bank or other private sector company.
In March this year, Agustín Carstens, General Manager of the BIS said in a speech entitled “The Future of Money and Payments“:
Also, research and experimentation have so far failed to put forward a convincing case. In sum, central banks are not seeing today the value of venturing into uncharted territory.
Three months later in June, a Financial Times article entitled “Central bank plans to create digital currencies receive backing” reports him saying:
“Many central banks are working on it; we are working on it, supporting them,”
“And it might be that it is sooner than we think that there is a market and we need to be able to provide central bank digital currencies.”
This is a huge and important narrative shift.
Fiat currency, if well managed can be tremendously valuable for a nation state, both internally for its own domestic stability and growth, and competitively for the nation to improve compared with other nations.
However, if mismanaged, the consequences can be disastrous.
Some central banks are better than others at this game – as with many things, there is a bell curve of competence.
In the broader history of money, fiat currencies are still an experiment. They rely both on the sponsorship of nation states, and the faith and habits of users.
Today, state sponsored money is under pressure. Whether you like fiat currencies or not, the emergence of two threats has added urgency to the agenda to defend them.
Those two things are:
- Credible corporate sponsored international money.
- The persistence and “mindshare adoption” of cryptocurrencies.
Corporate sponsored money
JP Morgan’s Coin
It started with JP Morgan’s “coin”, announced this February. Outside of a few geeky blockchain/DLT circles, no one really cared too much about this. It wasn’t a new form of money, and it was monetarily the equivalent of a bank deposit, recorded on a different ledger system, for use by existing corporate clients of JP Morgan.
Wide adoption is not a concern: incumbent banks have, in general, demonstrated a consistent track record of creating miserable user experiences. It is unlikely that JP Morgan coin will have much economic effect.
Also the banks are under control: if the bank doesn’t behave, it is relatively easy to slap a penalty on the bank due to the extensive regulatory levers that can be pulled.
However, Facebook, a company with a track record of creating addictive experiences and has almost a quarter of the world’s population as users, then raised the stakes in June. It announced Libra, a corporate sponsored form of private money. It is primarily targeted at those who live in lousy regimes with poor banking systems and unstable or unpredictable national currencies.
Libra got people’s attention.
Libra is credible: Facebook has the technical capability to deliver, it has the customers (the right customers in the right countries), and the cash to buy political influence.
A current detractor to Facebook’s credibility is the current increasing backlash from rich countries about Facebook’s misuse of personal data. Facebook’s pre-emptive response is to decentralise control of this system to up to 100 corporates.
But is Libra a threat to state sponsored money? It is not designed to compete against major currencies – indeed, its nominal value is linked to the value of those major currencies.
But what about the target countries, where currencies are volatile and Facebook penetration is high and banking services and adoption is low? They are the targets.
Many of these countries already use external currencies for day-to-day transactions: they are already “dollarized”. That is, commercial transactions are denominated and settled in US dollars. Invoices are written and paid in US dollars. People pay in US dollars at the checkout in shops.
But today “dollarization” is under threat: a global trend is making it harder to use US dollars in foreign countries.
Typically, local banks will need to hold their digital US dollars with a bank in the USA. However, US banks are increasingly closing the US dollar accounts they had opened for for foreign banks. This is euphemistically called derisking, as the US banks reduce their risk of getting fined by their regulators by terminating relationships and banking facilities for foreign banks, especially those in poor countries.
This cuts off the ability to move US dollars in and out of the country through banking channels. See an Economist article “A crackdown on financial crime means global banks are derisking” and a World Bank report “The Decline in Access to Correspondent Banking Services in Emerging Markets” for more.
Room for a new one?
So, is there room for a new currency with a great user experience, that is more stable than some existing currencies, to be used by customers who already use Facebook?
You bet there is. This is dollarization replaced with Libraization.
This initially has the greatest potential in regimes with poor banking infrastructure and unstable currencies. This may reduce the influence of the US dollar in those countries, especially those that are already dollarized. It may also undermine the local central bank – but in dollarised countries, they aren’t that influential anyway, and they are used to the economy using foreign currencies.
But later, if and as adoption grows, the technology will get better and it its usefulness will increase. It will creep up the value curve. This reminds me of the process of disruptive innovation as described by Clayton Christensen in his book The Innovator’s Dilemma – I wrote a summary of this in relation to FinTech in “Disruptive Innovation in FinTech”.
Would people in rich countries use Libra? Personal anecdote. I live in Singapore, a rich and stable country. About six years ago I used to travel frequently to the Malaysian part of Borneo for weekend trips. I would book my car hire through WhatsApp (a much better medium to communicate than the telephone when language and accents can be a barrier, and where images can be sent), and I would book my homestay (hostel) through Facebook messenger. It worked well. The worst part of the experience, and probably most expensive for the merchant, was the payment. If Libra had existed, the whole business transaction would have been much smoother, and possibly cheaper for the merchant. Yes, even as an overbanked person living in a rich country, I would use Libra for this kind of thing.
Knowledge and mindshare of cryptocurrencies keeps growing.
The Libra announcement has added fuel to this – it has encouraged a whole new group of people to read up on “blockchain” and “bitcoin” (shameless self-promotion: I wrote an introductory book for business people and students about this: The Basics of Bitcoins and Blockchains so if you’re not too familiar with this topic, now is a great time to read up!).
Some proportion of people who do their research after hearing about Libra will be persuaded by the anti-fiat arguments put forth by cryptocurrency maximalists. Some of those will go and buy some bitcoin and other cryptocurrencies either out of interest or as a hedge or for those juicy returns that can’t be found in stock markets. This buying pressure, as they say in the industry, may make #NumberGoUp. It is ironic that even the most extreme cryptocurrency enthusiasts measure their net wealth denominated in fiat currencies.
Cryptocurrencies today are not a threat to state sponsored money. They are tiny. But cryptocurrencies are increasingly being discussed in the open. They are being carefully monitored by authorities and they are increasingly reported in the media.
Cryptocurrencies may not be better for society than fiat currencies (at least the well managed ones). But as more people learn about the nature of money, cryptocurrencies are gaining mindshare.
It is only a matter of time before the incumbent immune response kicks in – Retail CBDCs are one potential response.
I believe that the Libra conversation is positive both for the cryptocurrency industry and for the blockchain industry. It forces those clarifying regulatory conversations that have been needed, but haven’t been top of the agenda, to happen. It brings the future closer.
This clarity will allow the crypto and blockchain industry to take the next steps, whatever they may be.
It is telling that only about two weeks after Facebook’s announcement of Libra, Maxine Waters, Chair of the US House of Representatives Committee on Financial Services, wrote an open letter to Facebook’s senior management, “to request that Facebook and its partners immediately agree to a moratorium on any movement forward on Libra – its proposed cryptocurrency and Calibra – its proposed digital wallet.”.
They sound terrified. Things are about to get interesting.
PS If you enjoyed this post, you may also enjoy my book The Basics of Bitcoins and Blockchains. Just saying.