Really breaking banks

I can’t stress enough just how big a deal the UK’s transition to Open Banking is. The writer Wendy Grossman posted an excellent piece about this in her “net.wars” series recently. She said, without exaggeration in my opinion, that the “financial revolution” coming here in mid-January has had surprisingly little publicity perhaps because “it’s not a new technology, not even a cryptocurrency. Instead, this revolution is regulatory: banks will be required to open up access to their accounts to third parties”. As Wendy notes in her piece, Wired had a great article about this (written by Rowland Manthorpe) in October. Having talked to some of the key players and examined some of the key concepts, he draws an important conclusion, which is that open banking is not “just a technical fix, or even a solution specific to banking, but a new way of dealing with the twenty-first century’s most sought-after resource, personal data“.

He is spot on. Identity is, as some people maintain, the new money. Banks are about to be transformed from places that store digital monies (which they really don’t anyway, since the proportion of household wealth held in the form of demand deposits has already fallen to minuscule levels) into places that store digital identities. Now, this is hardly a new idea and it isn’t only techno-crackpots like me who keep going on about it. Back in 2014, the Financial Times was reporting that “Britain’s high street banks believe their future role will be as repositories of more than just money: they want to be the safe place where customers store their digital identities”. This makes complete sense as a strategy and as a European Banking Association (EBA) white paper of the time put it, “banks are well positioned” to be a crucial, supporting, positive part of their customers online lives. Banks know this to be the case, they just haven’t done much about it. I still can’t use my Barclays identity to open an account at RBS, much less to log in to Direct Line or Bet365.

Since that FT piece, some people (uncharitable persons, of whom I am not one) have suggested that banks will pratt about and muck it all up and hand digital identity on a plate to Apple, Facebook, Google, Amazon and Microsoft (the GAFAMs). Well, we’re going to start finding out in January, because I can’t help but feel that the major beneficiaries of the regulators pressure to open up the banks will not be nimble fintech startups but the internet giants who already have the customer relationships. Rowland speculates that open banking may expose some institutions to change and to competition that they simply cannot respond to. He even goes as far as to suggest that banks may well fail because of it. This is the sort of thing that they must have been mulling over down at Open Banking Limited, the entity set up to implement open banking in the UK, where the Implementation Trustee, Imran Gulamhuseinwala, “doesn’t seem to have much sympathy for failing banks”.

Now, having met Imran at dinner (with the Russian Ambassador, as it happens) I can confirm that he is one smart cookie (and a very nice guy too). He’s got a point about the competition that open banking should unleash, but when RBS goes under because all of its customers have shifted to Facebook and the bank becomes a low-margin heavily-regulated pipe that is not operationally-efficient enough to compete only on price and service levels, I suspect others may have a different perspective. Either way, I agree with Erik Tak, Head of the ING Payment Centre, who said at Trustech in Cannes this year (below) that the people who will benefit most from this opening up of retail banking will not be fintechs but those GAFAMs mentioned earlier.

Tak at Trustech

Wendy’s words are well chosen. Open Banking is a revolution, and all we can say for sure is that there is going to be change. But as to who the winners and losers are… well, the UK is about to become an interesting, exciting and unpredictable laboratory experiment in banking regulation. In a year or two, we may at least have a signpost to the future of retail banking in place.

Art and science in Bristol

Well, that was fun. I had the great honour of being invited on to a panel at the Festival of Economics, part of the Bristol Festival of Ideas. I’d never been to the festival before, but I really enjoyed it. It’s a very impressive event, and I’m not just saying that because my publisher, Diane Coyle, founded it. What I found especially impressive, apart from the sheer size of the audiences at the sessions I attended, was that the festival seemed to achieve its goal of bringing serious discussion of important topics to the general public. In our session we have a great audience and they gave us a wide variety of topics to deal with in the Q&A. All in all, an excellent event.

Green Room

I was talking about the future of money with Professor Steve KeenDaniela GaborTatiana Cutts and stand-in chair Romesh Vaitilingam who did a great job moving things along. I’m pleased to say that the session was lively and well-attended.

One of the topics that came up, naturally, was whether Bitcoin was a form of cash or not. Remember that US IRS Ruling about Bitcoins being a commodity, so that traders would have to track the buying and selling price of each individual Bitcoin in order to assess their tax liability? No? Here’s a reminder: “the real lesson from the IRS Bitcoin ruling is that for a currency—or any payment system—to work, its units must be completely fungible”. Now, fungible (from the Latin “to enjoy”) is a great word. One of my favourite words, in fact. In this context (ie, money) it means that all of the tokens are the same and can be substituted one for another. You owe me a pound. It doesn’t matter _which_ pound coin that you give me. Any will do. Any pound coin can substitute for any other pound coin because they are all the same: no-one can distinguish one pound coin from another. This isn’t true of Bitcoins. They are all different, and because they are all different, their history can be tracked through the blockchain. As the MIT Technology Review pointed out, while Bitcoin has a media reputation for providing privacy, analysis of the blockchain suggests it could be surprisingly easy for a law enforcement agency to identify many users of the currency. Actually, recent analysis of the blockchain provides much other interesting information, including the fact that around a quarter to a fifth of the bitcoins already mined are lost for good.

The idea of money that isn’t fungible but that can be tracked, traced and monitored reminded me of Nitipak Samsen’s winning entry in the Consult Hyperion 2011 Future of Money Design Award, an example that I include in my book. I used it to make the general point that if you want to look into the future you need to listen to artists as well as technologist. Anyway, I mentioned the Award on stage and a couple of people came up afterwards to ask more about this particular entry and the competition in general, so if you are one of them and you’d like to learn more, check it out here.

Have you ever wondered where the money in your pocket had come from? Who was the previous owner? Who was the owner before that? Might it be a famous celebrity?…

[From Money Trailer – Future of Money]

It is interesting to me to see these different perspectives (Nitipak’s artistic imagination about the bastard child of Facebook and Bitcoin, and the more technical ideas about fungibility) coming together and, to my mind, again illustrates just why the FOM Design Award became such a popular session at Consult Hyperion’s Tomorrow’s Transactions Forum. We (technologists) need artists to help us to imagine alternative futures.

So. TL:DR…

Bitcoin isn’t cash, because cash is fungible. If we want something to be cash, we need to make it fungible. But do we want cash? I’m always ready to listen to informed views, but right now my general feeling is that the costs outweigh the benefits.

Noted author talks fraud at Royal Institution

What a piece of luck! I was giving a talk at the CallCredit Fraud Summit at the Royal institution in London and I chose to talk about just how broken our identity infrastructure is. Hardly an original theme, but one that is worth amplifying. As Chris Green (CCO at Call Credit) noted in his introduction to the event, identity fraud is heading towards £200 billion per annum and identity theft is an epidemic.

Pretty bad. Worse still, it looks to me as if no one knows what to do about this, particularly the Government. Given that the Social Market Foundation (SMF) had just issued their report “A Verifiable Success — The future of identity in the UK” (August 2017) which noted that identity verification processes in the UK have not kept up with either technological or social change and says that “the case for change is founded on the dramatic increase in identity fraud, the inconvenience of identity verification and the correlation with social (and therefore financial) exclusion”, I thought I’d talk about how to actually do something about identity in the mass market.

RI

I illustrated the point about just how unsuited our ramshackle infrastructure is with the example of spies, referring to last year’s Financial Times interview with Alex Younger (“C”,  the head of MI6 which is James Bond’s department of the British intelligence services) who explained just how hard it is to be a spy these days. In the old days, it was easy. Just grab a fake passport out of the draw and off you go. But, as the chief spy pointed out, today social media means that it is far more difficult to create a plausible alter ego. Sure, it’s easy to create a fake social media account. It’s easy, but not very useful to a spy. To be plausible, a fake identity needs a reputation. Reputation, unlike identity, is hard to fake. It has a time component. It takes years to build up a reputation that will stand up to scrutiny! If you wanted to pretend to be someone now, you would have to have started building the fake LinkedIn profile a decade ago. The point is that it’s hard for James Bond to pretend to be me, but seemingly easy for me to pretend to be a James Bond on internet dating sites. This is a fun and interesting way to think about some of the issues around identity and I think the audience liked it!

So what was the piece of luck I referred to at the beginning? Well, I turned up at the event, along with the bestselling author (and former politician) Lord Jeffrey Archer. As we had some time spare, I thought I would be helpful and give Jeffrey a few tips on writing books, having just published one myself.

RI

 

 I think Jeffrey really appreciated my hints and suggestions but unfortunately had to leave for an urgent meeting so I wasn’t able to go into too much detail with him. Before my talk I went off to grab a cup of coffee and picked up the day’s Times to read. It had the very perfect story for me featured prominently. Hence I was able to whip out a copy of the day’s Times and wave it around to great effect at the appropriate point in my presentation!

RI

The point that I was making, of course, is that identity is not just broken but optimally broken, in that it helps the bad guys but not the good guys. We need someone to stop forward with a vision for a better identity future! Where is this person! I heard the Minister for Digital Stuff (this may not be his exact title) talking on BBC radio a few weeks ago in a report on the government’s introduction of mandatory age verification for adult sites. When asked how members of the public could gain access to adult services, the Minister said that people could use credit cards (which is a terrible idea, see for example Ashley Madison) or show their passport to adult sites (which is an even worse idea). I confidently predict that the widespread adoption of either of these solutions will push identity theft even higher.

So why is identity not fixed yet?

As I tried to persuade the audience, if we are going to make any progress we need to have a very different mental model of what identity is. Not some Victorian notion of identity as an index card in a filing cabinet but as the cornerstone of digital relationships and therefore reputation in an online world. We need to develop the strategy based on digital identity, the bridge between the real and virtual worlds. I explain this using the three domain model, as shown on the slide below, and hopefully demonstrated just how powerful this view of identity is.

3DID Basic Colour

 

We need to move our transactions into the authorisation domain as soon as possible. Let’s go back to example in the newspaper to see why. Imagine I go to the dating site and create an account. As part of this process, the dating site asks me to log in via my bank account. At this point it bounces me to my bank where I carry out the appropriate two factor authentication to establish my identity to the bank’s satisfaction. The bank then returns an appropriate cryptographic token to the Internet dating site, which tells them that I am over 18, resident in the UK and that I have funds available for them to bill against. In this example my real identity is safely locked up back in the bank vault but it has been bound to a virtual identity which I can use for online interactions. So my Internet dating persona contains no Personally Identifiable Information (PII), but if I use that persona to get up to no good then the dating sites can provide the token to the police, the police can see that the token comes from Barclays and Barclays will tell them that it belongs to Dave Birch. This seems to me a very appropriate distribution of responsibilities. When the Internet dating site gets hacked, as they inevitably do, all the criminals will obtain is a meaningless token: they have no idea who it belongs to and Barclays won’t tell them.

One of the key attractions of this architecture, and I’m sure that I am not the only person who thinks this, is that it gives an expectation of redress in the event of inevitable failure. Things always go wrong. What’s important is what the structures, mechanisms and processes for dealing with those failures is. If some fraudsters take over my bank account and use my identity to create a fake profile on a dating site, then I’d expect the bank to have mechanisms in place to revoke the tokens and inform both the dating site and me that such revocations have taken place without disclosing any PII.

This is important because PII is in essence a kind of toxic waste that no companies really want to deal with unless they absolutely have to. Under the new provisions of the General Data Protection Regulation (GDPR), the potential fines for disclosing personal information without the consent of the data subject are astronomical. Hence the complete cycle needs to be thought through because it will be crazy to have an infrastructure that protects my personal data when the system is operating normally but gives it up when the system fails, or when we attempt recovery from failure.

Digital identity gives us a vision of how to do this in our new online world. It is how we keep our real identity safe and sound while we explore the online world in safety using our virtual identities. A huge thank you to Call Credit for asking me along to share this vision with their audience.

Life imitates art, even in payments

A few years ago, I took part in an entertaining event at the British Computer Society (BCS) during which my alter ego, Mr. Don Rogers from the Isle of Man Economic College, set out a new payment system. During this talk (you can see the video here), Mr. Rogers proposed the “Crime Pays System” or CPS. Under this system, digital payments would be either “light” or “dark”. The default transaction type would be light and free to the end users. All transaction histories would be uploaded to a public space (we were, of course, thinking about the Bitcoin blockchain here) which would allow anybody anywhere to view the transaction details. This “Light Exchange” is designed to promote an environment of social accountability. The alternative transaction type would be dark. With this option advanced cryptographic techniques would make the payment completely invisible, leaving no trace of the exchange, thus anonymising all transactions. A small levy in the region of 10% to 20% would be paid per transaction. The “Dark Exchange” would therefore offer privacy for your finances at a reasonable price. The revenue generated from the use of this system would be taken by the government to substitute for the loss of taxes in the dark economy.

Pretty whacky, way-out, left-field thinking, yes? Well, I must in all honesty admit that it was not my idea. Like all such concepts way ahead of their time, it has its origins in art, not technology. The idea came from my good friend and wonderful artist, Austin Houldsworth. As you may know, for many years Consult Hyperion ran the Future of Money Design Award as part of the annual Tomorrow’s Transactions Forum. Austin organised this award and he also designed the cover for my book Before Babylon, Beyond Bitcoin. In fact, here he is showing me the machine that he built for the cover photo of the book.

Welcome to the Machine

 

Well, it’s taken a few years, but Austin’s idea is a few steps closer to reality, since Coin Telegraph reported that just such a payment system is being proposed for Russia. And our guess of a 10-20 percent holding tax was remarkably accurate, since what is being proposed in Russia is apparently a 13% tax.

The CryptoRubles can be exchanged for regular Rubles at any time, though if the holder is unable to explain where the CryptoRubles came from, a 13 percent tax will be levied. The same tax will be applied to any earned difference between the price of the purchase of the token and the price of the sale.

From BREAKING: Russia Issuing ‘CryptoRuble’

That’s pretty amazing if you ask me, but it does illustrate a general point about futurology, which is that sometimes the technologist’s roadmap can be a less accurate guidebook than artists’ imaginations.

Whether we achieve a mostly cashless society sooner or later should be left to technological advancement.

From Should We Move to a Mostly Cashless Society? – WSJ

No, it shouldn’t. This is a matter of great importance and with significant implications for society. The strategy should be set by society, not by technologists. And we need to make some big decisions about it fairly soon, otherwise we will allow technology (that is, technology companies) to create an environment that we may not be comfortable with. What might that environment be? Well, it won’t be like 1984 (for one thing, we didn’t need the government to come around an install screens to watch us all the time, we bought them ourselves from Apple and Samsung and Google). I don’t think it will be like Star Trek either, partly because of the physics and partly because of the money-free utopianism. I think it will be more like the future set out a few decades ago by the “cypherpunk” writers who predate the internet and social media but saw which way the wind was blowing. I’m not the only one who thinks that “we are, roughly, living in the world the cyberpunks envisioned”.

There’s a nostalgia around that word cypherpunk for me, because it’s now many years back I saw these visions and was captivated by them. A quarter of a century ago, my Consult Hyperion colleague Peter Buck and I wrote an article for the “Computer Law and Security Report” (Volume 8, Issue 2, March–April 1992, Pages 74-76), asking whether William Gibson’s work was science fiction or informed prediction (clearly, we thought it was the latter). The article (called “What is Cyberspace” [Ref] [PDF]), which tried to explain the idea of cyberspace to a lay audience (this was before Netscape, the year zero of the modern age, so most lawyers had never been online), turned out to be rather popular. I like to think that one of the reasons was the conviction that we were exploring the actual future, not a hypothetical future. I can’t remember where the idea of the paper came from, but I do remember that we chose extracts from Gibson’s brilliant writing to illustrate the concepts rather than trying to paraphrase, and I still get a thrill from reading them now.

That’s king hell ice, Case, black as the grave and slick as glass. Fry your brains as soon as look at you

[From “What is Cyberspace?”]

I loved the idea of the “black ice” then and I love it now. In the Gibson world, Intrusion Countermeasures Electronics (ICE) refers to security software that protects data form unauthorised access, and black ice is ICE so deadly that it can kill a hacker. Wonderful. It came back to me a couple of years ago when I turned on BBC radio at random while driving home, only to discover that someone was reading one of my all-time favourite books, Gibson’s “Burning Chrome”, and the mention of the black ice gave me that chill all over again.

Writing this blog post I can still remember the shock of reading Gibson’s 1984 masterpiece “Neuromancer” for the first time. (Gibson later called this work an optimistic view of the near future because it assumes only limited nuclear exchanges between countries – let’s hope he’s right.) Why was it such a shock? Well, since leaving university I’d found myself specialising in secure data communications. I worked on one of the first secure LANs for the UK government, on secure satellite communications for banking, on secure military networks for NATO, that sort of thing. I understood computer networks, but I didn’t grok them. I didn’t feel what it meant, where it was taking us.

Reading Gibson back then was like lifting a veil from parts of my own brain. I took an artist to give me vision and vocabulary. And what a vocabulary it was. My very favourite William Gibson quote, right after “the future is already here, it’s just unevenly distributed” is about money. It comes from his novel “Count Zero” and it’s about the cashless society. I re-use it shamelessly in presentation after presentation.

He had his cash money, but you couldn’t pay for food with that. It wasn’t actually illegal to have the stuff, it was just that nobody ever did anything legitimate with it.

 Use of Cash in Sweden

As I’ve written before, we are heading toward a cashless society, cashless in this Count Zero sense, where cash will still be around and it will still be legal tender (although I don’t think people understand what a limited concept that is), but it will disappear from polite society and from the daily lives of most people. This vision of a cashless society, not a society where there is not no cash but a society where cash is irrelevant, may have seemed outlandish twenty five years ago, but it’s a pretty accurate description of Sweden now (where only a tiny fraction of retail payments are cash)  and China soon. The future is less unevenly distributed than it was even a decade ago.

[An edited version of this piece was posted to Medium, 16th October 2017].

An island of artificial intelligence

As I’ve written many times (e.g., here), it is difficult to overestimate the impact of artificial intelligence (AI) on the financial services industry. As Wired magazine said, “it is no surprise that AI tops the list of potentially disruptive technologies”. With Forrester further forecasting that a quarter of financial sector jobs will be “impacted” by AI before 2020, there’s an urgent need for the island begin to think about the next generation of financial services and begin to formulate a realistic strategy not only to copy with the changes but to exploit them. It is because the need is so urgent that I was delighted to be asked to give a keynote at the Cognitive Finance AI Retreat in September (Which began with a beach barbecue, something I recommend to conference producers everywhere.)

Beach BBQ

A beach barbecue is always a good idea at a conference.

The event was put together by my good friends at Cognitive Finance working with Digital Jersey (where I am advisor to the board) and they did a great job of bringing together a spectrum of both subject matter experts and informed commentators to cover a wide variety of issues and provide a great platform for learning.

On the first day of the event, political economist Will Hutton emphasised that financial services will be at the “cutting edge” of the big data revolution, pointing out that not only does the sector hold highly personal, highly valuable data about individuals, but that it has more complex oversight requirements than most other sectors.

Clara Durodie, CEO of Cognitive Finance Group kicked off the event by talking about the potential for AI to help to manage the colossal flows of data that characterise the financial sector today and I think she was right to highlight that the use of the technologies presents tremendous opportunities here.

In his superb “Radical Technologies, Adam Greenfield wrote of the advance of automation that many of us (me included, by the way) cling to the hope that “there are some creative tasks that computers will simply never be able to peform”. I have no evidence that financial services regulation will be one of those tasks, so in my talk I suggested AI will be the most important “regtech” of all and made a few suggestions as to how regulators can plan to use the technology to create a better (that is faster, cheaper and more transparent) financial services sector. The strategic core of my suggestion was that jurisdictional competition to create a more cost-effective financial services market might be a competition that Jersey could do well in.

AI as Regtech

Regulation, however, was only one the topics discussed in a fascinating couple of days of talks, discussions and case studies. The surprise for me was that there was a lot of discussion about ethics, and how to incorporate ethics into the decision-making processes of AI systems so that they can be accountable. I hadn’t spent too much time thinking about this before, but I was certainly left with the impression that this might be one of the more difficult problems to address and talking with very well-informed presenters. Listening to experts such as Dr. Michael AikenheadKay Firth-ButterfieldDr. Sabine Dembrowski, Andrew Davies and many other leading names in finance and AI left me energised with the  possibilities and intrigued by the problems.

AI is an event horizon for the financial services industry. With our current knowledge, we simply cannot see (or perhaps even imagine) the other side of the introduction of true AI into our business. But we can see that our traditional “laws” of cost-benefit analysis, compliance and competition will not hold in that new financial services space, which is why it is important to start thinking about what the new “laws” might be and how the financial services can take advantage of them.

The smart money

Writing in the Bank of England’s “Bank Underground” blog, Simon Scorer from the Digital Currencies Division makes a number of very interesting points about the requirement for some form of Central Bank Digital Currency (CBDC). He remarks on the transition from dumb money to smart money, and the consequent potential for the implementation of digital fiat to become a platform for innovation (something I strongly agree with), saying that:

Other possible areas of innovation relate to the potential programmability of payments; for instance, it might be possible to automate some tax payments (e.g. when buying a coffee, the net amount could be paid directly to the coffee shop, with a 20% VAT payment routed directly to HMRC), or parents may be able to set limits on their children’s spending or restrict them to trusted stores or websites.

From Beyond blockchain: what are the technology requirements for a Central Bank Digital Currency? – Bank Underground

If digital fiat were to be managed via some form of shared ledger, then Simon’s insight here suggests that it is not the shared ledger but the shared ledger applications (what some people still, annoyingly, insist on calling “smart contracts”) that will become the nexus for radical innovation. They bring intelligence to money, and some people think this is more revolutionary than it first appears. One such person is Eric Lonergan. Eric is someone I always take seriously. He’s a hedge fund manager, economist and writer. He wrote a great book about money, called Money, and he is a source of clear thinking on many issues around this central topic of shared interest. Here’s what he had to say about Bitcoin recently.

The most significant innovation in Bitcoin is not blockchain, nor the fact that it is a non-state-backed electronic currency. It is truly ground-breaking because it is the first ‘intelligent’ money. An ‘intelligent money’ is one which self-regulates.

From Intelligent money & valuing Bitcoin – Philosophy of Money

Quite, but this form of intelligence is only one kind and the Bitcoin self-regulation is only one kind of self-regulation. There are some truly surprising possibilities once you add general-purpose programmability. I have bored people to tears repeatedly with my standard four hour lecture about why the incorrectly labelled “smart contracts” will be the source of real innovation in the world of cryptocurrency and, indeed, why one of the first uses of those smart contracts (ICOs and tokens) will be much more important to the world of financial services than, say, Bitcoin. But that kind of self-regulation may not be the only thing that intelligent money does. Eric goes on to say that:

‘Intelligence’ could also embed social goals – for example the currency could self-regulate the activities for which it is used, perhaps even rewarding or punishing activities contingent on their social impact. In extremis, I imagine we will have a currency which is fully intelligent, gathers data and evolves its own rules of distribution and growth. .

As you will deduce from the subtitle of my recent book “Before Babylon, Beyond Bitcoin – From money that we understand to money that understand us” I agree. What’s more, as Eric says, “my sense is that it [intelligent money] is inevitable – indeed it could be the basis of an edge for digital currency over existing state-backed money”. That’s a pretty interesting statement from someone who is a thorough student of money. If he is right, and money becomes more closely connected with the social goals of the communities that it serves, then the future of money will look very different from both the Washington Consensus and Star Trek (that is, there won’t be a “galactic credit” or whatever, but very many different kinds of money).

Don’t listen to me, listen to Christine Lagarde

Now, you may think that all this talk about digital currencies is just unhinged techno-determinism when it comes from me, and you can safely ignore it, but when it comes from Christine Lagarde, the head of the International Monetary Fund (IMF) and pillar of the Washington Consensus, you have to take it seriously. In a talk given to the Bank of England conference on “Central Banking and Fintech” (29th September 2017), she said that virtual currencies [by which she means digital currencies in my taxonomy] could actually become more stable than fiat currencies. She says “for instance, they could be issued one-for-one for dollars, or a stable basket of currencies”. This idea of creating a what is strictly speaking a digital currency board is not new and I was interested to see Ms. Lagarde’s mention of a basket of currencies as a viable option. In my recent book “Before Babylon, Beyond Bitcoin” I discuss this as one of the potential futures for money, with reference to the vision of a former Chancellor of the Exchequer. Many years ago, John Major proposed just such an extremely sensible alternative to the euro, which at the time was labelled the “hard ECU”.

The idea of the hard ECU was to have a pan-European digital currency (it would never exist in physical form) but still be accepted in all member states. I am not alone in thinking that this was a missed opportunity. Keith Hart, author of the brilliant “The Memory Bank“, a book about money from an anthropological perspective, wrote that it was a big mistake to replace national currencies with the euro. He further pointed out that the hard ECU would have meant politically-managed fiat currencies alongside a low-inflation alternative, a plural option enjoyed by countries that didn’t join the euro, like Britain and Switzerland. I couldn’t agree with Keith more.

The hard ECU, or as I used to like calling it, the e-ecu was always a better idea than the Euro but when John Major proposed it, he was ignored. He envisaged a cross-border currency for businesses and tourists to use. Thus, businesses could keep accounts in hard ECUs and trade them cross-border with minimal transaction costs and no foreign exchange risk and tourists could have hard ECU payment cards that they could use across the continent. But each state would continue with its own national currency — you would still be able to use Sterling notes and coins and Sterling-denominated cards — and the cost of replacing them would have been saved.

 Global money

Real Money.

When researching the hard ECU concept for my book, I discovered that the proposal goes back well before Ms. Lagarde and Mr. Major and back into the early days of Margaret Thatcher’s government, in a 1983 report of the European Parliament on the European Monetary System. The proposal was at that time supported across the political and national groups in the parliament, including by the Germans so long as the central bank only concerned itself with stability of the currency (as subsequently transpired). It was taken up by Mrs. Thatcher’s government as a practical single currency for Europe, a means to expand the UK’s financial services industry across a European single market. But it never made it and the later political drive for the euro sidelined it. 

The point is, though, that it was a feasible option and that a digital currency that is backed by a reserve (whether of dollars or some basket of currencies or, indeed, commodities) is a sensible idea. In fact, it’s already being tried in a couple of places. In Kenya, where M-PESA is a private currency backed 1-1 by Kenyan shillings. And in Ecuador, where the government has been trying to launch a Central Bank digital currency. Any Ecuadorian over the age of 18 can open an account for free and transfer money to other people for free. 

An interesting aspect of this otherwise fairly straightforward value transfer system is that is denominated in US Dollars. The US Dollar has been legal tender in Ecuador since 2000, when the post-gold standard “Sucre” was abandoned although, apparently, the “centavo” coins are still in use. This is a practical solution to the big problem of small change under “dollarisation” and most countries that use the dollar still mint local coins: thus, Ecuador uses the dollar as legal tender but mints centavo coins. The government guarantees that anyone who wants to exchange 100 Ecuadorean centavos for a genuine United States dollar can do so. As the economist John Kay noted when he reflected on the coins in his pocket in Ecuador, is in itself an interesting comment on the subject of money. He also pointed out that there is a 50 cent coin minted for the government of Ecuador while the US does not issue 50 cent coins. So “while everyone in the Galápagos or the national capital Quito would accept my 50 cent coin, no one in Washington would”. He went on to note the curiosity that “genuine dollar coins, minted for the US Treasury, have not proved popular in the US but are widely circulated in Ecuador”. It is important to understand that the US Federal Reserve banknotes that are in circulation in Ecuador, stuffed under mattresses in Ecuador and fuelling the less-formal sections of the Ecuadorian economy are in essence an interest-free loan to Uncle Sam. By replacing these with digital currency, the Ecuadorian central bank can reclaim the seigniorage for itself.

All well and good and the ability to transact electronically will also be of the great benefit to the citizens and should cut transaction costs across the economy. If the central bank were to ask the advice of people with knowledge of the creation of a national non-bank mobile payment system (e.g., my colleagues at Consult Hyperion) I am sure that they would be advised to make the system a platform for innovation to encourage entrepreneurs to build local solutions on top of it. The lack of APIs in the initial roll-out of M-PESA was, in hindsight, a mistake and Ecuador could clearly learn from this to capture even more benefits from its transition to digital currency.

Ecuador Demo

 

Unreal Money.

The Ecuadorian Digital Dollar has, I have to say, not been universally well-received. A suggestion for governments thinking of introducing such a system in the future is that it  would benefit greatly from transparent auditing as citizens will not hold the electronic currency unless they are sure that it will remain redeemable at par for US dollars (or other basket of currencies or commodities) themselves. Any suspicion of fractional reserve is disastrous. If the government were to fall prey to the temptation to put more of the digital dollars in circulation than they have (or have the equivalent of) in reserve then, as the Wall Street Journal observed at the time of launch, they will simply be creating doomed electronic assignats that will never obtain traction in the wider economy and Ecuador will be unable to reap the many benefits of its transition away from cash. Christine makes this point herself, saying that the issuing of such a digital currency could be “fully transparent, governed by a credible, pre-defined rule, an algorithm that can be monitored…or even a ‘smart rule’ that might reflect changing macroeconomic circumstances”. I agree strongly: the use of shared ledgers and other such technology may be of maximum benefit in delivering the robustness and availability that a national cash replacement system and the radical transparency that it is required to give people faith in the system.

P.S. In case you see any tweets, newspaper comment or learned articles that refer to the Ecuadorean digital experiment in monetary futures as a “cryptocurrency” please bear in mind that it isn’t.

They are where the money isn’t

When most of us think about bank robbery, we think about people inventing complex derivates and amassing fortunes while the institutions that house them amass fine, bankruptcies and bailouts. But it turns out that your grandparent’s bank robberies are coming back into fashion. American Banker says that violent bank crime has become increasingly less common in the past decade, but that the rate of robberies has ticked back up in recent years.

At first I thought this might be a hipster revolt, like with vinyl records, but that doesn’t seem to be the case. So I’ve no idea. I don’t understand bank robbery. I remember getting into an interesting discussion about bank robbery at a lunch a while back. We were talking about risk and risk analysis. I was trying to make some points about why proper risk analysis like this is a more cost-effective way to proceed than (for example) panicking about newspaper stories on hacking, and that led to a train of thought around cost-benefit analysis for the robber, not the bank. Are robbers put off by thick doors and barred windows and such like? Are robbers deterred by visible, physical symbols of security? Come to that, should be bother with physical security at all in banks?

This is a fair point. So it set me thinking: if you are an amoral sociopath desperate to amass as much money as possible, are you better off robbing a bank or working for it? As a responsible father, I want to help my sons chart the best course for life. Right now, they are at University studying socially useful subjects in science and engineering. Having myself studied science only to become trapped in mortgage serfdom and forced to work until I drop, I am trying to persuade them to become Somali pirates or Wolves of Wall Street, without much success so far. So I understand that side of the equation, but am less certain of the other. Remember that old paper “The Decision-Making Practices of Armed Robbers” by Morrison and O’Donnell. It’s a study of armed robbery in London and one of my favourite papers. It is based on first-hand research (viz, the analysis of over 1,000 police reports and interviews with 88 incarcerated armed robbers).

While it’s about the UK rather than the US, I’m sure the thought processes of the perpetrators must have some similarities. Crucially, the paper notes that “almost all of these robbers evaluated the offence as having been financially worthwhile (aside from the fact that they were eventually caught and punished for their crime)”. So robbing a bank seems like good idea, if you exclude the possibility (in fact, the likelihood) of being caught. I suppose this is standard Jordan Belfort, Bernie Madoff thinking thought isn’t it? Unless people believe they will be caught (and these people don’t) then they only consider the upside.

(One of the interesting snippets it contains is that a great many of the armed robbers in the UK use imitation firearms even though they could have access to real ones. I imagine that in the US the use of imitations is vastly less prevalent, since it’s presumably harder to buy an imitation gun than a real one there.)

So, what to do? While glancing back over the paper I note that the authors say that it doesn’t seem practical to “expect financial institutions and commercial properties to reduce counter cash much more than they already have”. That may have been true when the paper was written a few years ago, but it clearly isn’t true now, since both bank branches and businesses in many countries are becoming cash free. And this is a good thing, because as we all know there is a direct and measurable relationship between the amount of cash out there (more on this later) and the amount of crime. As the paper says, “even when the amount of money obtained was quite small (an element often touted in support of the irrationality of economic criminals), it must be recognised that even apparently small sums may be adequate for the offender’s immediate needs. Hence, gains may be subjectively much larger than they appear”.

Bank robber or management consultant?

 

It’s a stick up

The rewards of armed robbery seem to me, then, as an educated middle-class professional, to be rather low. Yet they are still sufficient to attract the robbers, because their needs are immediate and limited. I want a holiday home in the South of France but the guy in the Nixon mask isn’t robbing a bank to pay his way through college or to obtain seed finance for a start up, he just needs to buy a car or some drugs or whatever. This paper seems, then, to indicate that so long as there is some cash in the till, there will be robberies. This is not an observation confined to banking. A study of the American Electronic Benefit Transfer (EBT) program found that “the EBT program had a negative and significant effect on the overall crime rate as well as burglary, assault, and larceny”.

What they are talking about here are US programmes where benefit recipients are paid electronically and given cards that they can use in shops instead of being given cash. The authors found a 10% drop in crime correlated with the switch to EBT. It seems pretty overwhelming evidence, and even more so if you read the paper, which notes no impact on crimes that do not involve the acquisition of cash. If we can to stop armed robberies, that would surely be an excellent social benefit to the move to cashlessness and would help us to explain the nature of appropriate regulation to legislators.

But back to the specific point about the relationship between bank cash and robberies. With the rewards from robbing banks and businesses falling  armed robbers, like everyone else, follow the money – literally – and so cash-in-transit (CIT) robberies are now the preferred option. We see the same in Europe where countries that have much higher usage of ATMs have much higher CIT robbery rates than countries that have lower ATM usage (see, for example, Sweden and Denmark).

Overall, then, we see another early indication of the emerging post-cash era: Spending on physical bank security is being reduced and spending on virtual bank security is being increased. We do, indeed, live in interesting times.

Central bank digital currency again

Greg Medcraft, the Chair of the Australian Securities and Investment Commission, recently said that “traditional” bank current accounts may disappear in the next decade because central banks will create digital currencies and provide payment accounts to customers directly (Australian Financial Review, 3rd September 2017). This is a topic that I examined in some detail in my recent book, Before Babylon, Beyond Bitcoin. Did I mention that I have a new book out, by the way? This is what the noted British magazine Prospect said about it:

When a book comes along with glowing praise on its sleeve from Kenneth Rogoff and an introduction by Andrew Haldane, Chief Economist at the Bank of England, you know you’ve got something hot on your hands. This analysis of money by one of the world’s leading experts on the subject does not disappoint…

Birch is brilliant at bringing together these disparate historical strands, through the birth of the great European trading centres, up to the present day. The central insight of all this is that money is essentially a technology, just like any other and that technologies change—and improve—over time. In other words, money is not fixed. And it is certainly not just coins and notes.

And what of the future of money—will it be characterised by a drive towards a small number of unified currencies, or towards a multitude? Birch opts for the latter. In future, communities will develop their own stores of value, Birch says, independent of governments and central banks. The growing popularity of crypto-currencies such as Bitcoin suggests that he may have as good a handle on the future as he does on the past.

From What actually is money? A new book examines early civilisations to find out | Prospect Magazine

As you will deduce from this, I think that the way that money works now is, essentially, a blip. It’s a temporary institutional arrangement and it must necessity change as technology, business and society change. These sentiments are not restricted to technological determinists of my ilk. As the former governor of the Bank Of England, Mervyn King, wrote in his book The End of Alchemy”, although central banks have matured, they have not yet reached old age. But their extinction cannot be ruled out altogether. Societies were managed without central banks in the past”. I was reminded of this when I listened to the excellent London FinTech Podcast series produced by my good friend Mike Baliman. In Episode 85 “The Nature of Money, Economic Imbalances & will Central Bank Digital Cash alleviate them?” which Mike made with David Clarke of Positive Money, the idea of central bank digital currency is discussed in some detail. While I understand the reasons why a digital currency is attractive to a central bank (and there are many of them) I’m not convinced that in the long run central banks will retain any sort of monopoly over digital currency. And if they don’t have a monopoly, what can they do to keep the value of their money up and therefore attractive as a store of value?

 I had to think about this sort of thing in some detail when the kind people from Amsterdam Institute of Finance (AIF) and the Dutch central bank (Die Nederlandsche Bank, DNB) invited me to Amsterdam to launch my book in their fair city, so I took the opportunity to run through the “5Cs” model of money issuing from the book and take questions from a very well-informed audience.

DNB_Amsterdam

 

One of the points that I made was that technology is no longer a barrier. The idea of the DNB running something like M-PESA but for Dutch residents is hardly far fetched. There are 26 million M-PESA users in Kenya (as of 2Q17) and Facebook can manage a couple of billion accounts, so I’m sure that DNB could download an app from somewhere to run a few million accounts for the Netherlands. There is a middle way though. The central bank could create the digital currency but it could still distribute it through commercial banks. The commercial banks would not be able to create money as they do now (only the central bank would be able to do this) but they would use their existing systems to manage it. Yao Qian, from the technology department of People’s Bank of China, wrote about this earlier this year.

“To offset the shock to the current banking system imposed by an independent digital currency system (and to protect the investment made by commercial banks on infrastructure), it is possible to incorporate digital currency wallet attributes into the existing commercial bank account system so that electronic currency and digital currency are managed under the same account.”

PBOC Researcher: Can Cryptocurrency & Central Banks Coexist? – Bitcoin Magnates

We had a go at this sort of thing a couple of decades ago with Mondex and its ilk in the first attempts to get bank-issued electronic cash into the mass market. Those efforts failed for a number of reasons but primarily because of a lack of acceptance. It was easy to give people cards but hard to give people terminals. That’s all changed now. M-PESA doesn’t use cards and terminals, it uses mobile phones. I’m sure that when future historians write about the evolution of money, they will see that the mobile phone, not the plastic card, was the nail in the coffin of cash. But back to the point, which is… why bother? What if the Chair of the Australian Securities and Investment Commission is right? Why bother with the commercial banks in this context? Now we are clear about the differences between cryptocurrency and a digital currency, let’s review a few of the key issues:

  • A monetary regime with central bank-issued national digital currency (i.e., digital fiat) has never existed anywhere, a major reason being that the technology to make it feasible and resilient has until now not been available. But now technology is available, and we should use it.

  • The monetary aspects of private digital currencies (a competing currency with an exogenous predetermined money supply) may be seen as undesirable from the perspective of policymakers. Also, as I have mentioned before, the phrase “digital currency” is perhaps a regrettable one as it may invite a number of misunderstandings among casual readers.

  • Digital fiat means a central bank granting universal, electronic, 24 x 7, national currency denominated and interest-bearing access to its balance sheet.

  • The cheapest alternative for running such a system would clearly be a fully centralised architecture like M-PESA but there may be other reasons for want to use some form of shared ledger implementation instead (e.g., resilience).

  • A feature of such a shared ledger system is that the entire history of transactions is available to all verifiers and potentially to the public at large in real time. It would therefore provide vastly more data to policymakers including the ability to observe the response of the economy to shock sort of policy changes almost immediately.

Were we to decide to create a new central bank digital currency issued and managed by commercial banks (let’s call it Brit-PESA) now, of course, we wouldn’t use the basic SIM toolkit and SMS technology of M-PESA. We’d use chat bots and AI and biometrics and voice recognition and all that jazz. I don’t think it would that difficult or that complicated: there would be a system shared by the commercial banks with the funds held in a central account.

There’s a very good reason for doing so. I’m sure you’re all familiar with the Bank of England Staff Working Paper No. 605 by John Barrdear and Michael Kumhof, “The macroeconomics of central bank issued digital currencies”. It says (amongst other things) that 

…we find that CBDC issuance of 30% of GDP, against government bonds, could permanently raise GDP by as much as 3%, due to reductions in real interest rates, distortionary taxes, and monetary transaction costs. Countercyclical CBDC price or quantity rules, as a second monetary policy instrument, could substantially improve the central bank’s ability to stabilise the business cycle.

Did you see that? Permanently raise GDP by as much as 3%. Scatchamagowza. Permanently raise GDP by as much as 3%. Why aren’t we doing it right now! Let’s draw a line under the money of the past and focus on the money of the future. Talking of which, back to my presentation at DNB.

dnb slide

Whether digital fiat is the long term future of money or not (and I think it isn’t), let’s get on with it, whether Brit-PESA or Brit-Ledger or Brit-Dex, and give everyone access to payment accounts without credit risk.  And there’s another reason, beyond GDP growth, for doing so. Writing in the Bank of England’s “Bank Underground” blog, Simon Scorer from the Digital Currencies Division makes a number of very interesting points about the requirement for some form of digital fiat. He remarks on the transition from dumb money to smart money, and the consequent potential for the implementation of digital fiat to become a platform for innovation (something I strongly agree with), saying that:

Other possible areas of innovation relate to the potential programmability of payments; for instance, it might be possible to automate some tax payments (e.g. when buying a coffee, the net amount could be paid directly to the coffee shop, with a 20% VAT payment routed directly to HMRC), or parents may be able to set limits on their children’s spending or restrict them to trusted stores or websites.

From Beyond blockchain: what are the technology requirements for a Central Bank Digital Currency? – Bank Underground

If digital fiat were to be managed via some form of shared ledger, then Simon’s insight here suggests that it is not the shared ledger but the shared ledger applications (what some people still, annoyingly, insist on calling “smart contracts”) that will become the nexus for radical innovation.

Estonia is a real place

My little corner of the internet seems awash with tales of a mythical utopia that goes by the name of Estonia. Since my little corner is the digital identity corner, I’ve been hearing about digital identity in Estonia more and more. At meetings and conferences, on social media and in conversation, I hear people talking about the Estonian national identity scheme that uses a blockchain. The Harvard Business Review, for example, tells us that “since 2007 Estonia has been operating a universal national digital identity scheme using blockchain”. This sort of thing crops up on Twitter from time to time. I’m not sure if some of the people tweeting about the Estonian national digital identity blockchain know that Estonia is actually a real place and that some people (e.g., me) have been there. In fact, here is a picture of me in Tallin to prove it.

 Me in Tallin

The Estonian national digital ID scheme launched in 2002. A decade ago a colleague of mine at Consult Hyperion, Margaret Ford, interviewed Mart Parve from the Estonian “Look@World” Foundation in the long standing “Tomorrow’s Transactions” podcast series (available here). Mart was responsible for using the smart ID service (both online and offline) to help Estonia develop its e-society. If you listen carefully to them talking, you will notice that they never mention the blockchain, which is unsurprising since Satoshi’s Nakamoto’s paper on the subject was not published until more than a year later, in October 2008.

The strangeness of the obsession with Estonia in blockchain circles began to bother me after I was invited along to a blockchain breakfast (seriously) at the House of Lords last year. The invitation came because I had been asked to contribute to the Parliamentary Office of Science and Technology (POST) work on distributed ledger and the purpose of the breakfast was to discuss this report. The breakfast was hosted by Stephen Metcalfe MP, chair of the Science and Technology Committee. Sir Mark Walport, the Government’s Chief Scientific Adviser (GCSA), opened the proceedings. Sir Mark had authored the Government Office for Science report on “Distributed Ledger Technology: beyond blockchain” earlier in the year. In it, he focused on a particular kind of distributed ledger, the Bitcoin blockchain, and attempted to explain it to the general reader and then explore some of the potential uses.

(From here on I insist to sticking to the term that Richard Brown of R3 and I started using a couple of years ago “shared ledger technology” (SLT) as the general description because I feel that the fact that multiple organisations share the ledger is more important than its architecture.)

Personally, I found the report slightly confusing because it was jumping between ledgers, blockchains, the bitcoin blockchain and bitcoin almost on a paragraph by paragraph basis. What’s more, and I realise that I read the document from a very technical perspective and that I may see some of these things therefore in the wrong context, I think the report might have benefited from some more description of shared ledgers, and the reasons why Moore’s Law and falling communications costs have made the core idea of everyone storing every transaction a plausible architecture. Here’s the way that my colleagues at Consult Hyperion and I started to think about the ledger a couple of years ago, the “4Cs” model that has worked rather well.

Consensus Computer Model

I prefer to use this layered approach to explain the key components of a shared ledger and then develop ideas around different choices in those layers. Different choices in consensus technology, for example, lead to a variety of different possibilities for implementing a shared ledger. In order to help categorise these possibilities, and narrow them down to make useful discussions between the strategists and technologists, I use the taxonomy that Consult Hyperion developed to distinguish between different kinds of public and private ledgers. Rather flatteringly, Sir Mark used a simplified version of the this model on page 19 of his report.

When the report came out I said that it might be considered reckless to disagree with the GCSA, but I just did not (and do not) see cryptocurrency as a sensible government option for digital currency. Anyway putting my nerdy criticisms to one side, Sir Mark’s conclusions (which were essentially that the technology is worth exploring in government contexts) were surely correct. He said that permissioned ledgers (i.e., not the Bitcoin blockchain) are appealing for government applications and I’m sure he was right about this, although I remain sceptical about some of the suggested government uses that are based on costs or efficiency. I think that his suggestions around applications that focus on transparency are the more interesting areas to explore in the short term and they would be my focus if I were looking to start exploratory or pilot projects in the field. I share the Open Data Institute’s view on this, which is that blockchains could be used to build confidence in government services, through public auditability.

House of Blockchain

When it came time for my contribution, by the way, I said that it wasn’t at all clear to me that it was accurate to describe Bitcoin as a decentralised system since almost all of the hashing power resides with a very small number of unaccountable mining pools based in China but, more importantly that

  1. It seems to me that many of the efforts to move shared ledgers into the marketplace have concentrated on shaping shared ledgers to emulate existing solutions in the hope that SLTs will be faster, higher or stronger. These are all unproven assertions. It is possible that a shared ledger replacement for RTGS might be cheaper, or more resilient or more functional that the currency centralised solution, but who knows?

  2. The transparency of the shared ledger, the aspect that most doesn’t work for current solutions in current markets, may well turn out to be the most important characteristic because it allows for ambient accountability and therefore opens up the potential for new kinds of markets that are far less costly and complex to regulate, manage, inspect and audit. This is the “shared ledger as regtech not fintech meme” that I am rather fond of.

  3. Just as the invention of double-entry bookkeeping allowed for the creation of new kinds of enterprise, so it seems to me that the shared ledger will similarly lead to new kinds of enterprise that use the shared ledger application (the SLAPP) as the engine of progress and the focus of innovation. I assume that there are kids in basements experimenting with SLAPPs right now and that this is where the breakthrough use case will come from. As I said some time ago in a discussion about shared ledgers for land registry, turning the ledger into a platform may be the most important reason for shifting to this implementation.

At the breakfast, Sir Mark said that the goal of the POST reports is to demystify technology for policy makers although I have to report that in his closing remarks he said that we had not been entirely successful in this enterprise and I fully concur with his opinion. That’s not why I’m talking about it breakfast at the House of Lords here though. Back to Estonia! At one point, the breakfast discussion moved on to the Estonian electronic identity system. At this point I expressed some scepticism as to whether the Estonian electronic identity system was on a blockchain. The conversation continued on the basis that it was. Then to my shame I lost it and began babbling “it’s not a blockchain” until the chairman, in an appropriate, gentlemanly and parliamentary, told me to shut up.

The point that I was trying to make was that the Estonian ID scheme, launched in 2002, has nothing to do with shared ledgers or mutual distributed ledgers or blockchains. As it happens, a some time after my breakfast with their lordships, I had another breakfast, this time with the new CIO of Estonia, Siim Sikkut

sikkut17 

I asked Siim where this “Estonian blockchain ID” myth came from, since I find it absolutely baffling that this urban legend has obtained such traction.  He said that it might be something to do with people misunderstanding the use of hashes to protect the integrity of data in the Estonian system. Aha! Then I remembered something… More than decade ago I edited the book “Digital Identity Management” and Taarvi Martens (one of the architects of the Estonian scheme) was kind enough submit a case study for it. Here is an extract from that very case study:

Long-time validity of these [digitally-signed] documents is secured by logging of issued validity confirmations by the Validation Authority. This log is cryptographically secured by one-way hash-function and newspaper-publication to prevent back-dating and carefully backed up to preserve digital history of mankind.

Well, there we have it. It looks as if the mention of the record of document hashes has triggered an inappropriate correlation amongst observers and, as Siim observed, it may indeed be the origin of the fake news about Estonia’s non-existent digital identity blockchain.

(This is a revised and edited version of post that first appeared on Consult Hyperion’s “Tomorrow’s Transactions” blog in March 2017.)