CEPR/SUERF/CB&DC webinar with Darrell Duffie, Todd Keister, Harald Uhlig, Dirk Niepelt.
Digitisation rapidly changes money, banking and finance. Are these changes fundamental and radical—or part of a continuous process of technological progress and efficiency improvement? Do academics have to re-think money, banking and finance—or do conventional theories apply? And do finance professionals and regulators need to re-assess their frameworks and tools to keep up with the transformation?
Darrell Duffie (Stanford University and Fintech & Digital Currencies RPN Member), Todd Keister (Rutgers University and Fintech & Digital Currencies RPN Member) and Harald Uhlig (University of Chicago, CEPR and Fintech & Digital Currencies RPN Member), three experts on macro economics, monetary economics and finance, shared their views on these and related questions. The webinar, which has been moderated by Dirk Niepelt (University of Bern, SUERF, CEPR and Fintech & Digital Currencies RPN Leader), started with brief opening remarks by each of the experts, followed by a discussion and a Q&A session.
Conference jointly organized by CEPR’s MEF group and RPN FinTech & Digital Currencies at the Study Center Gerzensee. Organized by Refet Gürkaynak and Dirk Niepelt.
Conference website.
Finanz und Wirtschaft, November 24, 2018. PDF. Ökonomenstimme, November 26, 2018. HTML.
In the FT, Martin Arnold reports about plans to launch “Saga,” a reserves-backed krypto currency, maybe the closest substitute yet to central bank digital currency.
It is being launched by a Swiss foundation with an advisory board featuring Jacob Frenkel, … Myron Scholes, … and Dan Galai, co-creator of the Vix volatility index. The currency aims to avoid the wild price swings of many cryptocurrencies by tethering itself to reserves deposited in a basket of fiat currencies at commercial banks. Holders of Saga will be able to claim their money back by cashing in the cryptocurrency.
Saga also aims to avoid the anonymity of bitcoin that raises financial crime concerns with regulators and bankers. It will require owners to pass anti-money laundering checks and allow national authorities to check the identity of a Saga holder when required.
Deposits will be made in the IMF’s special drawing right basket of currencies, which is heavily weighted in US dollars.
Reserves for All come into sight.
Update (30 March): From the white paper:
Saga … deploys a reserve anchoring algorithm, serving to stabilise the currency in terms of leading state-issued currencies. As Saga gains trust, its reserve ratio will decrease in favour of an independent establishment of value.
???
NZZ, March 15, 2018. PDF. Ökonomenstimme, March 19, 2018. HTML
In another excellent post on Moneyness, J P Koning likens the monetary system to the plot in the movie Inception, featuring
a dream piled on a dream piled on a dream piled on a dream.
Koning explains that
[l]ike Inception, our monetary system is a layer upon a layer upon a layer. Anyone who withdraws cash at an ATM is ‘kicking’ back into the underlying central bank layer from the banking layer; depositing cash is like sedating oneself back into the overlying banking layer.
Monetary history a story of how these layers have evolved over time. The original bottom layer was comprised of gold and silver coins. On top this base, banks erected the banknote layer; bits of paper which could be redeemed with gold coin. The next layer to develop was the deposit layer; non-tangible book entries that could be transferred by order from one person to another.
The foundation layer has changed over time:
One of the defining themes of modern monetary history has been the death of the original foundation layer; precious metals. … as central banks chased private banks from the banknote layer … and then gradually severed the banknote layer from the gold layer. By 1971, … [b]anknotes issued by the central bank had become the foundation layer. The trend towards a cashless world is a repeat of this script, except instead of the gold layer being slowly removed it is the banknote layer.
Fintech improves the efficiency of the layer arrangement and its connections. It also adds new layers: For instance, some payments made via mobile phone effectively transfer claims on deposits. And it may circumvent layers:
In U.K., the Bank of England is considering allowing fintech companies to bypass the banking layer by offering them direct access to the bottom-most central banking layer.
In contrast, a krypto currency like bitcoin establishes a new foundation layer, on which new layers may be built:
Even now there is talk of a new layer being developed on top of the original bitcoin foundation, the Lightning network. The idea here is that the majority of payments will occur in the Lightning layer with final settlement occurring some time later in the slower Bitcoin layer.
I fully agree with this characterization. In addition to the theme emphasized by Koning—adding layers—I would also stress the theme of untying higher-level layers from lower ones: Central bank money typically is no longer backed by gold; deposits typically are not fully backed by notes; and mobile phone credits may no longer be backed by deposits. The process of untying layers relies on social conventions and trust, and it is fragile. Important questions concern the cost of such fragility, and its necessity. Fragility is not necessary when the social cost of liquidity provision at the foundation layer is negligible.
On Wired, Andy Greenberger discusses Monero, Dash, and Zcash, krypto currencies that provide more privacy than bitcoin and its derivatives.
Unlike commercial services like PayPal, Bitcoin allows anyone to spend money online without providing identifying details. But if someone’s Bitcoin address is linked with their real identity, any transaction from that address is entirely visible on the public blockchain … Hiding those transactions requires taking extra steps, like routing bitcoins through “tumblers” that mix up coins with those of strangers—and occasionally steal them—or using techniques like “coinjoin,” built into some bitcoin wallet programs, that mix payments to make them harder to trace. “If I pay my rent in Bitcoin, it wouldn’t be that hard for the landlord to figure out how much money I earned if I don’t take extra precautions” …
Monero … implements a few features that Bitcoin still can’t offer. It uses a technique called “stealth addresses” to generate addresses for receiving Monero that are essentially encrypted; the recipient can retrieve the funds, but no one can link that stealth address to the owner. It employs a technique called “ring signatures,” which means every Monero spent is grouped with as many as a hundred other transactions, so that the spender’s address is mixed in with a group of strangers, and every subsequent movement of that money makes it exponentially more difficult to trace back to the source. And it uses something called “ring confidential transactions,” which hides the amount of every transaction.
…
Monero isn’t the first cryptocurrency designed to offer a financial privacy panacea: Dash, formerly known as Darkcoin, integrates the “coinjoin” technique that allows bitcoin users to mix their transactions with a few other spenders in what Todd calls a weaker form of anonymity than Monero offers. More recently, Zcash debuted with the strongest anonymity promises yet—it uses cryptographic tricks designed to make tracing a transaction not only unlikely, but mathematically impossible. Zcash has yet to be integrated into dark web markets, though, and still requires wielding the command line to use.
SRF, October 8, 2016. Link to MP3.
The blockchain technology opens up new possibilities for financial market participants. It allows to get rid of middle men and thus, to save cost, speed up clearing and settlement (possibly lowering capital requirements), protect privacy, avoid operational risks and improve the bargaining position of customers.
Internet based technologies have rendered it cheap to collect information and to network. This lies at the foundation of business models in the “sharing economy.” It also lets fintech companies seize intermediation business from banks and degrade them to utilities, now that the financial crisis has severely damaged banks’ reputation. But both fintech and sharing-economy companies continue to manage information centrally.
The blockchain technology undermines the middle-men business model. It renders cheating in transactions much harder and thereby reduces the value of credibility lent by middle men. The fact that counter parties do not know and trust each other becomes less of an impediment to trade.
The blockchain may lend credibility to a plethora of transactions, including payments denominated in traditional fiat monies like the US dollar or virtual krypto currencies like Bitcoin. An advantage of krypto currencies over traditional currencies concerns the commitment power lent by “smart contracts.” Unlike the money supply of fiat monies that hinges on discretionary decisions by monetary policy makers, the supply of krypto currencies can in principle be insulated against human interference ex post and at the same time conditioned on arbitrary verifiable outcomes (if done properly). This opens the way for resolving commitment problems in monetary economics. (Currently, however, most krypto currencies do not exploit this opportunity; they allow ex post interference by a “monetary policy committee.”) A disadvantage of krypto currencies concerns their limited liquidity and thus, exchange rate variability relative to traditional currencies if only few transactions are conducted using the krypto currency.
Whether blockchain payments are denominated in traditional fiat monies or krypto currencies, they are always of relevance for central banks. Transactions denominated in a krypto currency affect the central bank in similar ways as US dollar transactions, say, affect the monetary authority in a dollarized economy: The central bank looses control over the money supply, and its power to intervene as lender of last resort may be diminished as well. The underlying causes for the crowding out of the legal tender also are familiar from dollarization episodes: Loss of trust in the central bank and the stability of the legal tender, or a desire of the transacting parties to hide their identity if the central bank can monitor payments in the domestic currency but not otherwise.
Blockchain facilitated transactions denominated in domestic currency have the potential to affect central bank operations much more directly. To leverage the efficiency of domestic currency denominated blockchain transactions between financial institutions it is in the interest of banks to have the central bank on board: The domestic currency denominated krypto currency should ideally be base money or a perfect substitute to it, directly exchangeable against central bank reserves. For when perfect substitutability is not guaranteed then the payment associated with the transaction eventually requires clearing through the traditional central bank managed clearing mechanism and as a consequence, the gain in speed and efficiency is relinquished. Of course, building an interface between the blockchain and the central bank’s clearing system could constitute a first step towards completely dismantling the latter and shifting all central bank managed clearing to the former.
Why would central banks want to join forces? If they don’t, they risk being cut out from transactions denominated in domestic currency and to end up monitoring only a fraction of the clearing between market participants. Central banks are under pressure to keep “their” currencies attractive. For the same reason (as well as for others), I propose “Reserves for All”—letting the general public and not only banks access central bank reserves (here, here, here, and here).