Crime, Coins, Cryptography and the Quantum Future

There are people who prefer to exist in a cash economy for reasons other than their negative economic analysis of central bank monetary policies or an attachment to the iconography of banknotes. Criminals and corrupt politicians, for example. Cash works rather well for them, but can sometimes be quite inconvenient.

Last year I wrote about two Californian working-from-home pharmaceutical freelancers who were arrested after police caught them dumping nearly $1 million in cash which was intended to buy Mary Jane for business purposes. Dumping a million bucks in notes is time-consuming and inconvenient, which set me thinking.

I can understand why the disconnected, marginalised poor in remote parts of the world eschew the benefits of electronic payments for the currency of choice for the global criminal on the go, the $100 bill. But in California? Don’t they have Bitcoin there? Given the huge hassle of counting, bagging and transporting the Benjamins, why didn’t these wacky baccy impressarios simply buy a few Bitcoins, drive to the drop zones and press the “giddy up” button when the goods were in place!

They stayed analogue. They packed up the greenbacks and set off in their car. It could have been that they’d read that quantum computers will be able to break Bitcoin’s cryptography next year and decided that the trunk of a car was the more secure alternative. The point is they were not interested in friction-free instant dollar dollars. So I must ask the obvious question: if drug dealers won’t use Bitcoin for purchases, who will? How can it be more convenient to cart around great wodges of cash than to zip some magic internet money through the interweb tubes?

It is important to note that Bitcoin is far from being a perfect solution for criminal on the go, though. Speaking at this year’s virtual Davos, Glenn Hutchin (co-founder of global technology investment firm, Silver Lake) said that Bitcoin is not the best choice for criminals and that “a drug dealer, for example, would not want to have to speculate on the price of bitcoin while selling his wares”. This clearly not true for all drug dealers: a counterexample being the Irish drug dealer who wisely decided to invest in cryptocurrency rather than euros and who amassed a fortune in digital loot. He hid the passwords to the digital wallets holding his ill-gotten gains in his fishing rod.

The drug dealer in question, Mr. Collins, was stopped but the Irish police in the early hours of the morning by chance. Unfortunately for him, he had €2,000-worth of weed in the car and he was arrrested. His properties were searched, and industrial scale cannabis farming was discovered.

He got five years.

Meanwhile, his 12 Bitcoin wallets, containing 6,000 Bitcoin (then worth $50m-ish but now worth $200m-ish) were seized by Ireland’s Criminal Assets Bureau (CAB). Unfortunately the fishing rod with the scribbled passwords had “gone missing” but CAB believes it is “only a matter of time” before computer advances allow them open the digital treasure chest.


with kind permission of TheOfficeMuse (CC-BY-ND 4.0)

Presumably, by “only a matter of time” they mean that they are waiting for the quantum computers to come along a unlock the wallets. They are in good company, because a great many other people (eg, organised crime, unscrupulous “whales” and the tax authorities of many nations) are waiting for them too. Now, code-cracking quantum computers will happen (as I wrote 15 years ago), but they won’t happen tomorrow. Professor John Martinis, who used to be the top scientist in the Google quantum computing team, says that Google’s plan in this field is to build a million-qubit system with sufficiently a low error rate that error correction will be effective. He says that at this point, about a decade away, then the system will have enough logical quits that the system will be able to execute powerful algorithms that attack problems that are beyond the capability of classical supercomputers.

By “only a matter of time” they mean that they are waiting for quantum computers to come along a unlock the Bitcoin wallets. Click To Tweet

For technical reasons to do with public keys and things, the accountants Deloitte reckon that about four million Bitcoins could be stolen by a quantum computer. With Bitcoin at $30,000 that means a pot of a hundred billion dollars or so is at the end of the quantum rainbow. Well worth spending a few billion to build such a device if you are a criminal, well worth spending tens of billions or even hundreds of billions on such a device when Bitcoin has taken over and has become the need digital gold worth $1m each or whatever.

It’s a serious threat, and plenty of people have already started work on plans to migrate Bitcoin to more quantum-resistant forms of cryptography (see, for example, “Committing to quantum resistance: a slow defence for Bitcoin against a fast quantum computing attack” from 2018) but these schemes still need access to the old, vulnerable wallets to transfer the cryptocurrency to the new, less vulnerable wallets.

The idea of using quantum technology to make better electronic money is not a new idea, b the way. As the Swedish Central Bank’s recent working paper on Quantum Technology for Economists points out, out the original concept of quantum money (dating back to the early 1980s) exploits “the no-cloning theorem” proven by Wootters and Zurek (1982). This means that it is not possible to clone an unknown quantum state so a counterfeiter with unlimited resources will still not be able to copy a quantum coin. Therefore quantum cryptocoins can act more like actual coins (that cannot be double-spent) and that opens up some pretty interesting thinking. As my digital currency technology tree (below) shows, this opens up an interesting third way to pan-galactic digital currency in the future: we can prevent double spending of person-to-person digital cash in hardware (using chips), in software (using blockchains) or in nature (using qubits).

Digital Currency Taxonomy with Quantum

Still, assuming that the Irish police get hold a quantum computer before the Mafia do, there is a tidy amount sitting not only in Mr. Collins wallets (as there is in Mr. Satoshi’s) and the next time the Gardai pull someone over in the middle of the night it will be in a Lambo.

[An edited version of this post appeared on Forbes, 10th January 2020.]

Legal and illegal tender

China is home to not one but two fascinating experiments in what people have taken to calling “stablecoins”. One of them is the public electronic cash system run by the People’s Bank of China (PBOC), known as the Digital Currency/Electronic Payment (DC/EP) or the digital Yuan. The other is the private electronic cash system run by Hong Kong-based Tether Limited, the cryptocurrency stablecoin known as the Tether. The main use case for the former is currently retail purchases whereas the main use of the latter appears to be market manipulation and money-laundering.

We can learn a lot from studying the dynamics of these to help us to understand how the world of digital currency might develop and whether cryptocurrency might one day become legal tender.

Let’s have a look at illegal tender first. In 2019, USDT surpassed Bitcoin as the most-traded cryptocurrency on the market by volume. This is not, as you might imagine, because consumers prefer to USDT to Visa for ordering a taxi to take mother to church on a Sunday. As reported by Nikkei Asia, USDT is widely used in money laundering, gambling and other illegal activities. China’s Ministry of Public Security has reported that in the first nine months of 2020, police cracked down on 1,700 online gambling platforms and 1,400 underground banks involving more than $153 billion in illegal transactions. Now, not all of this was in Tether, of course. But the number did catch my eye, because I am always interested in use cases for cryptocurrency other the speculation.


with kind permission of TheOfficeMuse (CC-BY-ND 4.0)

Now on to legal tender. Suzhou has long been spearheading trials of DC/EP and in a recent experiment the local municipal government gave away 100,000 digital “red packets”, each containing RMB 200 (around $30) in a lottery, to encourage resident and retailers to try out the electronic cash for themselves. The South China Morning Post reports on the roll-out of the digital Yuan with the example of “shopkeeper Ma” who said that he found the digital currency to be a convenient way to receive and make payments. Not that it matters whether he finds it convenient or not, to be fair, because according to an “operational guidance” document given to the retailers in the pilot programme, they are allowed to decline payment in Alipay or WeChat Pay, but they “cannot decline payment in e-yuan”.

You can see the trajectory. The PBOC published a revised draft of the People’s Bank of China Law in October, laying out the legal foundations for the e-Yuan. The law, in essence, already says that the e-Yuan has the same legal status as the Yuan. Indeed, last year the PBoC issued a formal notice clarifying that cash is legal tender in China and that refusing it is illegal. More recently, it has called for wider acceptance of cash in economic activities and “vowed to punish” those who refuse to accept cash payments. So in China, both the Yuan and e-Yuan will be legal tender and retailers will have to accept both.

Legal Tender

I remember a story about a schoolboy who was refused access to a bus in Wales for trying to pay with a Scottish banknote. The bus company was pressured and apologised, saying that “Scottish currency is legal tender”. Actually, it isn’t. Scottish banknotes are not legal tender in England or, for that matter, Wales any more than Bitcoins or e-Yuan are. Only Bank of England banknotes are legal tender in England and Wales. But there are Sterling banknotes printed by banks in Scotland and in Northern Ireland that are not. Scottish banknotes are not legal tender anywhere, even in Scotland. In fact, Bank of England banknotes are not legal tender in Scotland either, because Scotland has a separate legal system to England and has no legal tender law at all.

This quaint monetary arrangement might seem odd to Americans, but it helps me to make a point. In America as in Britain, legal tender does not mean what you think it means. wrote about this in some detail after someone on Twitter told me that Bitcoin was legal tender in Germany. It isn’t, of course. In fact, Bitcoin isn’t legal tender anywhere and it never will be any more than British Airways frequent flier miles will be (and I’ve bought more cups of coffee with British Airways frequent flier miles than I’ve ever bought with Bitcoin).

Let’s dive in!

Section 31 U.S.C. 5103 on “Legal tender” states that “United States coins and currency [including Federal reserve notes and circulating notes of Federal reserve banks and national banks] are legal tender for all debts, public charges, taxes, and dues”. Here is chapter and verse from The Fed commenting on what that means: “This statute means that all United States money as identified above is a valid and legal offer of payment for debts when tendered to a creditor. There is, however, no Federal statute mandating that a private business, a person, or an organization must accept currency or coins as payment for goods or services. Private businesses are free to develop their own policies on whether to accept cash unless there is a state law which says otherwise”.

So… would a U.S. central bank digital currency (e$, for short) might become legal tender in the future. Here, I think the answer is unequivocal: yes, and in unlimited amounts, because there is no credit risk attached. I predict that a transfer of e$ will be considered legal tender all debts, public charges, taxes and dues. In time, Section 31 U.S.C. 5013 will undoubtedly be extended to say so.

But so what if a digital dollar become legal tender? The physical dollar is legal tender in the U.S. right now and plenty of retailers won't take it. Click To Tweet

There is no federal law that forces people to accept dollars as it is, which is why you see municipalities passing local ordinances to force retailers to accept cash. (These ordinances are, by the way, a bad idea but that’s a story for another day.)

Would the U.S. amend legal tender law to go as far as China and force merchants to accept a CBDC? I doubt it. Would the Fed declare any digital currency that meets regulatory approval to be legal tender and retailers will have to accept both physical dollars and digital dollars? It seems unlikely. Would the US accept CBDC for the payment of tax? Actually, that day might not be so far away, as far I as am concerned what is or isn’t accepted for the payment of taxes is a much better measure of what is or isn’t a currency than outdated concepts of legal tender!

[An edited version of this post appeared on Forbes, 4th January 2020.]

Stablecoins and Soft Power

The Libra Association has rebranded as the Diem Association and plans to launch its first digital currency, a USD dollar “stablecoin”, early this year so it’s time to think again about the implications of stablecoins. But first of all… here’s wishing you Happy Holidays and all the best for 2021 from all at 15Mb Ltd!

Stable small

with kind permission of TheOfficeMuse (CC-BY-ND 4.0)

You’ll remember Libra, the global currency proposed by Facebook. It met with some pretty negative reactions from central banks, regulators and many other stakeholders. Visa, MasterCard and PayPal dropped out of the initial group of Libra Network members and things went a bit quiet. Then the Libra Association produced a revised version of their White Paper, adding “stablecoins” in national currencies to the original plan for a single Libra currency based on a basket of currencies and making an interesting offer from the consortium to the world’s central banks. It says that the consortium hopes that “as central banks develop central bank digital currencies (CBDCs), these CBDCs could be directly integrated with the Libra network, removing the need for Libra Networks to manage the associated Reserves”.

There’s no need to waste resources of your own on CBDC, Diem is telling central bankers. If a couple of billion people around the world are going to store digital currency in Facebook, Instagram and WhatsApp wallets, then why build an alternative? Use us. You set the policies on inclusion and so on, we’ll do the heavy lifting.

You can be the NASA of money, Diem is telling the Fed, and we'll be the Space-X. Click To Tweet

The Bank of England’s December 2020 Financial Stability Report devotes a section to stablecoins and says the bank is considering the potential effects on financial stability if stablecoins were to be adopted widely. It notes that if stablecoins were backed with central bank money in one form or another it would be “economically similar” to a CBDC. A member of the European Central Bank (ECB) board, Fabio Panetta, referred to this issue of at a recent Bundesbank-convened event about the future of payments noting that allowing something like Diem would be “tantamount to outsourcing the provision of central bank money”. But why is that such a bad idea? After all, as Simon Lelieveldt pointed out to me, while we might assume that the ECB would be the issuer of an electronic euro it is not currently in their mandate.

The truth is that stablecoins are coming. Whether provided by private companies or as a public good, the DC/EP cat is out of the bag, the USDC genie is out of the bottle, the Libra horse has bolted and the question for the world’s central banks is not whether there should be digital currencies or not but what is the best way to deliver them. In which context, outsourcing is a viable option. Recall the Mondex experiment of the 1990s: it was the Bank of England that controlled the issuing of the digital currency, but the Mondex system itself and the Mondex cards issued to consumers were provided by commercial banks.

Personally, I can see the attraction of using such an outsourced stablecoin such as Diem. The ability for me to send money to a cousin in Australia by sending a few Facebucks directly from my Facebook Novi wallet to her Instagram Novi wallet would be useful and convenient. The ability for me to buy shareware from a Swedish software developer and pay instantly by transferring Facebucks by WhatsApp would stimulate trade and the economy. Joking aside, with a good user interface, a good customer experience and a good API to satisfy regulators, Novi and Diem together could indeed provide a viable global alternative to SWIFT.

Dollars and Dominance

Perhaps more importantly, though, US dollar stablecoins — whether provided by central banks themselves as in China, by banks or mobile operators, or by other organisations such as the Diem Assocation — would also reinforce the global dominance of the US dollar ahead of digital competitors (including everyone’s favourite unstablecoin, Bitcoin) in the post-pandemic world where online transactions are the new normal.

The German Minister of Finance calls Diem “a wolf in sheep’s clothing”. If you look at it though, what Diem propose to do is basically that same as is already allowed under European electronic money regulation. Provided that Diem segregate the customer deposits and hold them in the form of bank deposits and other appropriate asset classes, then issuing a digital dollar (or euro or or pound) is no big deal. What the Minister and others are presumably concerned about is the loss of monetary sovereignty if European citizens opt to shift their cash holdings from euros to dollars whether intermediated by Diem, Circle or anyone else.

If you want to understand some of the bigger picture around currencies, competition and what the eminent historian and Hoover Institution senior fellow Niall Ferguson refers to as “Cold War 2”, then you should take the time to listen to this conversation between Ferguson and CoinDesk’s Michael Casey. As the author of one of the best books on the history of finance, The Ascent of Money, Ferguson has a very wide and well-informed perspective on the issues and I have quoted him more than once in my book on the topic.

In this conversation, Ferguson observes that one of the lessons of history is that with globalisation comes a tendency for a particular currency to become the dominant currency, the Prime Currency, for transactions for trade. In the 19th century it was the British Pound, in the 20th century it became the US Dollar, and in the 21st century it will be… well, who knows but as globalisation moves into a period of obvious crisis it is being talked about as it wasn’t before. Ruchir Sharma, Morgan Stanley Investment Management’s chief global strategist, recently wrote in the Financial Times that only five currencies had been top dog in post-medieval times: those of Portugal, Spain, the Netherlands, France and our United Kingdom. Those reigns lasted 94 years on average, by which measure the Dollar is overdue for overthrow.

Public or Private? Local or Global?

Many people think that the only thing keeping the Dollar in place is the lack of a successor. Ferguson points toward China as the place where the new world may be forged, saying that “if I’m right and that trend continues and they become more dominant in not just domestic consumer payments in China but increasingly in payments around the world” then we may start to see a shift in the “tectonic plates of the international monetary system” and I couldn’t agree more.

Ferguson also refers to former Bank of England governor Mark Carney’s call for a synthetic hegemonic currency (SHC), which he rates as more plausible than Diem as the future of the international financial system. It would be a victory for John Maynard Keynes from beyond the grave. Keynes, as you will recall, was in favour of an SHC (the “bancor”) from the very beginning of the current international monetary regime and (correctly) reasoned at the time of Bretton Woods that the lack of such an international reserve currency would deliver control to the United States (at the expense of the United Kingdom).

In Ed Conway’s excellent book on Bretton Woods “The Summit” he talks about how the dollar becoming top dog gave America what the recently-deceased former French President Valery Giscard d’Estaing called the “exorbitant privilege” of borrowing in its own currency. But finance is not the only reason why the coming currency Cold War is of vital importance to the US (and to the West as whole) and control over currency is important.

Currency competition is about politics, because the use of the dollar to settle global transactions gives the US unparalleled lever of “soft power”. As Ferguson puts it, “I think we probably mostly underestimate how extraordinarily effective this lever has been, it’s actually been a much more effective weapon of US foreign policy than the boots on the ground of the U.S. Army and Marine Corps”. Hence a digital dollar (whether a NASA Digital Dollar or a Space-X Facebuck) should be an important policy discussion in the United States right now. Should a future US administration with a global perspective accept the compromise of an SHC as a means to retain some control or can they launch a digital dollar into global orbit first?

[An edited version of this piece first appeared on Forbes, 14th December 2020.]

China and America both need new fintech regulation

In a recent episode of Professor Scott Galloway’s podcast, he talked with one of my favourite writers: the eminent historian and Hoover Institution senior fellow Niall Ferguson. The subject of the conversation was the relationship between the United States and China. Their fascinating and informative discussion ranged across many fields, including financial services and fintech. Ferguson touched on a particular aspect of what he calls “Cold War 2” in context of finance, saying that American regulators “have allowed the fintech revolution to happen everywhere else” by which I think he meant that the nature of financial regulation in America has been to preserve the status quo and allow the promulgation of entrenched interests while the costs of financial intermediation have not be reduced by competition. He went on to say that “China has established an important lead in, for example, payments”, clearly referring to the dominance of mobile payments in China and the role of (in particular) Alipay in bringing financial services. He made this comment around the same time that the Chinese government pulled the plug on the Alipay IPO, what would have been the biggest IPO in history.


with kind permission of TheOfficeMuse (CC-BY-ND 4.0)

As an aside, if you want to understand some of the big picture around the coronavirus, currency (and what I call “The Currency Cold War” in my book of the same name), then you might want listen to this Coindesk podcast with Ferguson and the journalist and author Michael Casey. They talk about the current state of the world and what it could mean for money. As the author of one of the best books on the history of finance, The Ascent of Money, Ferguson has a very wide and well-informed perspective on the issues and, indeed I quote him more than once in my book!

At a time when America is finally beginning to at least think about opening up financial services to allow real competition, China is heading in the opposite direction by clamping down on fintechs. Click To Tweet

Ferguson’s point about payments is particularly interesting to me. One way to provide more fintech competition to the incumbents would be to provide a more relaxed environment for payments. America lacks a regulatory construct equivalent to the EU’s “Payment Institution” and it really needs one if it is to move forward. The EU regulatory framework has just been battle-tested with the collapse of Wirecard following massive fraud. No customer funds were lost in the collapse of the badly-regulated non-bank because the customer funds were ring fenced in well-regulated bank and, as I will suggest later, this might be the right regulatory balance for new US regulation.

One place to look for this new regulation might be the OCC, which has developed the concept of the Special Purpose National Bank (SPNB) charter. I don’t want to sidetrack into the controversy around these charters, except to note that the OCC expects a fintech company with such a charter to comply with capital and other requirements that seem unlikely to generate the innovation and competition that America wants. This was obvious from the comments on the original proposals, when fintechs made it clear they would be reluctant to invest in such an OCC license unless such a licence would require the Federal Reserve to give them access to the payments system (so they will not have to depend on banks to intermediate and route money for them). The fees associated with such intermediation are significant (ie, top five) operating cost for many fintechs.

I agree wholehearted with Prof. Dan Lawry of Cornell Law School, Lev Menard of Columbia Law School and James McAndrews of Wharton Financial Institutions Center who in their response to the OCC’s proposal labelled it “fundamentally flawed” and called for the organisation to instead look at strengthening the regime for non-bank financial institutions. The focus on banking regulation, though, seems entrenched. I notice that Congresswoman Rashida Tlaib (MI-13), along with Congressmen Jesús “Chuy” García (IL-04) and Chairman of Task Force on Financial Technology Rep. Stephen Lynch (MA-08), have just introduced the Stablecoin Tethering and Bank Licensing Enforcement (STABLE) Act, which similarly propagates this outdated (and inappropriate) regulatory perspective by requiring any prospective issuer of a “stablecoin” (let’s not even get into what is or is not a stablecoin) to obtain a banking charter.

There is an alternative. The idea of another kind of federal charter that would allow regulated institutions access to payment systems, but would not allow them to provide credit, seems much more appealing for not only stablecoin issuers but almost all other fintechs as well. Such a charter would separate the systemically risky provision of credit from the less risky provision of payment services, a very different concept to the SPNB charter. The economist George Selgin, Senior Fellow and Director of the Cato Institute’s Center for Monetary and Financial Alternatives, recently posted a similar point on Twitter, arguing for the Federal Reserve to give fintechs direct access to payment systems (instead of having to go through banks). This was the approach taken in the UK when the Bank of England decided to give settlement accounts to fintechs, where examples of fintechs who took advantage of this opportunity to deliver a better and cheaper service to customers range from the $5 billion+ Transferwise money transfer business to the open banking startup Modulr (which just recieved a $9 million investment from PayPal Ventures). Interestingly, Singapore has just announced that it will go this way as well, so that non-banks that are licenced as payment institutions will be allowed access to the instant payment infrastructure from February 2021.

My good friend Chris Skinner was right to say that many US fintechs will follow the likes of Varo, apply for new licenses and become more and more like traditional banks, but that’s because the traditional bank licence is all that is on offer to them. But this is an accident of history that jumbles together money creation, deposit taking and payments. It’s time to disentangle them and to stop, as Jack Ma (the billionaire behind Alibaba and Ant Group) recently said, regulating airports the way we regulate train stations. He said this was shortly before Chinese regulators halted Mr. Ma’s IPO, following his comments  questioning financial regulation, clearly signalling that their relaxed attitude toward the growth of China’s financial giants is coming to an end.

The Chinese regulatory environment is changing. Whereas China was happy to see its techfins grow in order to help them scale while American enterprises were kept at bay, it is now beginning to rein them in. The new players are now having to build up capital and review business structures as those regulators focus on issues such as data privacy, banking partnerships and lending. With respect to that latter point, note that the concerns around the Alipay IPO were related to lending and leverage, not payments. Although heading towards half of Ant’s revenues came from the lending, facilitated by their vast quantities of data, but they only came up with 2% themselves (if they were were a bank, they would be required to provide something like a third) passing the rest of the exposure onto banks.

Meanwhile, in September, the European Commission (EC) adopted an expansive new “Digital Finance Package” to improve the competitiveness of the fintech sector while ensuring financial stability. The proposed framework includes a legislative approach to the general issue of crypto-assets, called Markets in Crypto-assets (MiCA). I’ll spare you the whole 168 pages, but note that it introduces the concept of crypto-asset service providers (CASPs) and defines stablecoins as being either “asset-referenced tokens” that refer to money, commodities or crypto-assets (although how this can be called “stable”, I am not at all clear) or “e-money tokens” that refer to one single fiat currency only.  E-money tokens (eg, Diem) are a good way to bring innovation to financial services because they are a way to bring genuine competition.

I think the EU may be charting a reasonable course here. China needs to regulate lending more, the US needs to regulate payments less. America needs more competition in the core of financial services and now is a good time to start. With the Biden administration on the way, they can tackle this core issue that, as The Hill says, the U.S. government has “ignored and neglected” the need for a regulatory framework that will support American technological innovation around cryptocurrency, setting aside an embarrassing and “outdated regulatory approach to fintech”. Prof. Lawry suggest a simple and practical response for the US regulators, which is to amend the state-level regulatory frameworks around money services businesses (MSBs), which they say “are the product of a bygone age”, and learn from M-PESA and Alipay where a 100% reserve requirement seems to have proved very successful. There is no evidence that such a requirement stifles growth. Congress need only introduce a uniform requirement that MSB hold a 100% in insured deposits at a bank that holds account balances at the Federal Reserve, which is in essence the same as an EU Electronic Money License and therefore ought to lead to mutual acceptance.

In short, China needs tighter regulation of non-bank credit, America needs lighter regulation of non-bank payments. The way forward is to separate the regulation of payments from the regulation of credit from the regulation of investments. This is the way to get competition and innovation in financial services.

Tokens, tokens everywhere

You don’t have to be a cryptocurrency believer to think that the underlying technology of cryptocurrencies (value transfer without an intermediary, with double-spending prevented through distributed consensus) is going to change the financial sector. Indeed, the use of that underlying technology may well mean that cryptocurrencies in their current form are never needed, because more general digital asset transfer platforms will supplant them. These platforms, which enable the exchange of digital assets without clearing or settlement (let’s call these digital assets “tokens” for short), have real potential.

I wrote in my book “Before Babylon, Beyond Blockchain” back in 2017 that tokens may make a real difference to the way the economy works and the subsequent evolution of the cryptocurrency world has reinforced my view. Not that my opinion counts for much. But the opinion of Jay Clayton, the chairman of the U.S. Securities and Exchange Commission (SEC), counts for a lot more and he is saying the same thing: in time, everything will be tokenised.

When the current craziness is past and digital asset tokens have become a well-regulated but wholly new kind of digital asset, a cross between corporate paper and a loyalty scheme, they will present an opportunity to remake markets in a new and better way. 

It’s a view that is supported not only by wide-eyed techno-utopian hype-merchants (eg, me) but by the sensible, forward-looking and rational financial sector leaders. I remember interviewing Jonathan Larsen (chief innovation officer of Ping An Group and head of the Ping An Global Voyager Fund) on stage at Money20/20 Asia. He told me that “Tokenization is a really massive trend… a much bigger story that cryptocurrencies, initial coin offerings (ICOs), and even blockchain” and confirmed my suspicion that long-term planning in the financial services sector must include some radically different scenarios. Jonathan spoke eloquently about the characteristics of the new asset class (including fractionalisation, which fascinates me) but went on to talk about the key characteristics of a digital asset platform that can fundamentally change the way the world of finance works: “transparency and universal access and the ability to reduce frictional costs”. I see this as a way to more efficient and liquid markets, and I am hardly alone in this.

Digital assets that are bound to “real world” value by regulated institution present not only the mechanism for a different financial sector but an innovative approach to a better financial sector. A sector that serves wider society more effectively and attacks the stubbornly high cost of financial intermediation in a modern economy. In a speech, Banque de France first deputy governor Denis Beau touched on inefficiencies in the sector and said that tokenisation could be a way to “answer the market’s demands”. I agree, obviously.

At the World Economic Forum this year, there was a discussion about what assets might be tokenised, with examples ranging from property to owning a fraction of a piece of art by Andy Warhol, although the ones that attracted the most discussion were enabling farmers in emerging markets to raise finance by selling future crop yields and sports stars selling the rights to their future income. I can foresee a rich and varied marketplace. Some tokens will be assets, and fractional ownership of assets. Some tokens will be claims on future products and services. Some tokens will be the currencies of communities.Who knows which of these might become a real markets, but one candidate for a successful token class (for which there appears to be real demand) is central bank digital currency (CBDC).


with kind permission of TheOfficeMuse (CC-BY-ND 4.0)

Don’t Listen to Me

Now, when people like me or the head of Ping An VC fund or a deputy governor of the French central bank talk about the inevitability of tokenisation, that’s one thing. But when Jay Clayton said at the beginning of October that while there were once stock certificates, today there are database entries representing stocks and “it may be very well the case that those all become tokenized” (my italics), I think it’s time to begin some serious planning for a reformed financial sector that is more efficient, more effective in serving the wider economy and more resistant to bad behaviour of all kinds.

That last point is important. Jonathan’s mention of transparency highlights one of the key reasons that we should all want to see this kind of financial sector. Look at some of the recent problems in the world of finance, such as the collapse of Wirecard. Corporate accounts included assets that simply did not exist. Since auditors and the regulators and the board were unable to prevent criminality on a grand scale here, it is reasonable to ask whether technology might be able to do better job. Well, I think the answer is yes, and I think tokenisation is part of consistent vision of just how it might do so: if I claim to own one-thousandth of the Mona Lisa it is easy for you to check on the digital asset platform to see that the token representing one-thousandth of the Mona Lisa is in my wallet.

Thus, while the tokenisation of financial assets and the creation of what I heard Jeremy Allaire of Circle call the “long tail” of capital markets is a much broader topic than CBDC its apparent inevitability means we should begin to explore this concept of CBDC as simply one kind of a more generalised digital asset, albeit one that is bound to risk-free central bank money. Even that most conservative of organisations, the Association of German Banks, says that in order to “maintain Europe’s competitiveness, satisfy customers’ needs and reduce transaction costs, the introduction of euro-based, programmable digital money should be considered”.

What they refer to a programmable digital money, and what I call smart money, is money built on tokens. In this model of the world, one might imagine using a platform built from cryptocurrency technologies to trade thousands or millions of different tokens, with one form of these tokens being digital currency and one category of token issuers being central banks. This is no crazy cryptomaximalist conjecture but a reasoned and reasonable projection of capitalism’s use of the new technology of value transfer.

Huw van Steenis of UBS, who I take very seriously on these matters because of his work at the Bank of England, says that there will be a “three-horse race” around the future of money with private tokens and CBDCs developing in parallel with efforts to improve the current system (see, for example, SWIFT gpi and the UK’s new payments architecture). This is wise counsel, and there is indeed every possibility of competition between these approaches stimulating innovation in the short-term but then a longer-term convergence as the platforms for exchanging digital asset tokens are used to implement both private tokens and public tokens (including CBDCs).

In this appealing vision of the future, there will be nothing technological to distinguish central bank digital currency from other digital assets that will be functionally equivalent to money, such as corporate currencies. Dollar bills from Bill’s dollars (I never get tired of this trope): one will be tokens backed by risk-free central bank money, the other tokens backed by Microsoft revenues. But they will both be tokens, exchanged without clearing or settlement through the same secure global digital asset platform.

[This is an edited version of a piece that first appeared on, 2nd November 2020.]

PayPal’s Bitcoin strategy is about much more than bitcoin

Given that the people who are great supporters of bitcoin often talk about its key characteristic being that it is person-to-person, uncensorable value transfer you do have to wonder who will be using the new PayPal service that will allow them to pay merchants using the cryptocurrency. My good friend Ron Shevlin drew on a survey of 3,000 US consumers conducted by Cornerstone Advisors and FICO which found that around two-thirds of US smartphone users have the PayPal app installed (as I do), a seventh of all PayPal users already own some form of cryptocurrency and of those PayPal users, half of them used Bitcoin to buy products or services in the past year. So does this mean that the mass market use of cryptocurrency for payments is just around the corner?

I think not. The overwhelming majority of all cryptocurrency transactions are purely speculative and the people who think that bitcoin is a good investment* are never going to use it for payments. Bitcoin was originally billed as an elecronic cash system but most bitcoins aren’t used as currency in transactions for goods and services. Surveys have shown that the majority of bitcoin are held for speculative purposes and while some retailers accept Bitcoin, they see cryptocurrency purchases having a higher drop-out rate than cards and cash payments.


with kind permission of TheOfficeMuse (CC-BY-ND 4.0)

So this can’t be much of a payments play. Think about it. If you think that the bitcoin is going to the moon (and will be worth $1 million each within five years, as this former Goldman Sachs hedge fund person has just predicted) then why would you waste even a tiny fraction of a bitcoin buying the pizza or a Pez dispenser? No, the people who will use their PayPal wallet to exchange bank dollars for PayPal bitcoin are simply investing. If they choose to pay a merchant using bitcoin from their wallet, PayPal gives the merchant dollars anyway. Neither the consumer nor the merchant ever has any actual bitcoins in their possession.

When people do use bitcoin to buy things it tends to be things they can't buy using PayPal anyway. Click To Tweet

The amount of cryptocurrency spent on “dark markets” rose two-thirds to reach a new high in the final quarter of 2019, according to Chainalysis and the New York Times says that this data is likely to understate the number transactions for illegal purposes because the company cannot identify all activities relating to drugs, ransomware, tax evasion and money laundering. If I use bitcoin to buy illegal drugs, example, because of its “anonymity” and uncensorability, then I am hardly likely to start buying drugs using PayPal. The example of adult services makes this point rather well. Adult performers who are engaged in a perfectly legal business complain that PayPal refuses to allow payments to them and so they are forced to use third-parties who, according to the New York Times, take anywhere from a third to four-fifths of performers earnings in fees. Those people still won’t be able to use PayPal, whether in dollar or bitcoin, so the new service won’t make any difference to them.

PayPal’s Big Picture

Well, since the people who run PayPal are much richer and much smarter than I am, I am forced to conclude that they must have a plan that goes beyond earning some spreads from buying and selling cryptocurrency for retail speculators. I have no knowledge what PayPal are doing or why, but I do have some experience looking at strategies for financial institutions exploiting new technology, so I think I can make some informed guesses.

First of all, PayPal’s move is to be admired purely in marketing terms. The announcement put five percent on their stock price and garnered gazillions of column inches, links and commentary such as this. Even if they never turn a profit on bitcoin itself, their investment in software and licences has already paid off. I worked on a project for a global financial services financial services organisation a couple of years ago and I can remember the calculations around brand and exposure. To old-timers like me, PayPal is the grandparent of fintech, an upstart storming the walls of the entrenched incumbent financial services giants. But to youngsters, such as the son who I just asked about the company, PayPal are part of the establishment, no different to Wells Fargo or Barclaycard. A bit of cryptocurrency glitter does not hurt the brand, even if it is cosmetic.

Secondly, the technologies of cryptocurrency (shared ledgers, cryptographic proofs and so on) are going to be the foundations of a longer term shift to the trading of digital bearer instruments that are exchanged without clearing or settlement networks so building up institutional expertise is valuable. It’s reasonable to imagine that these instruments might well be implemented as tokens traded across decentralised networks, so exploring the trade-offs around infrastructures and interfaces is a good investment of time and effort.

Thirdly, and much more importantly though, I suspect that PayPal are making two much more strategic and long-term plays around the wallet and its contents. They are no doubt looking enviously across the water to the Asian “super apps” and thinking about the impending Alipay IPO. Turning PayPal from being a repository of balances to fund payments into a financial hub managing a number of different assets for a broad range of consumers is attractive to them. In their scenario planning, PayPal undoubtably started to think about the opportunities that will arise from the trading and management of digital assets (in the form of tokens) in the not-too-distant future. By gaining expertise in decentralised alternatives to commercial bank money and the regulation that does with them, PayPal is being very smart.

I don’t think PayPal’s experiment with bitcoin is really much about bitcoin at all. I think this is a measured and intelligent step towards the transactional environments of the future where digital assets compete with digital fiat across a payments landscape that is utterly different to that of today. As Ajit Tripathi pointed out, crypto-believers might feel they have occupied Wall Street but the reverse is true. Banks (and their regulators) have won and some of these interesting new digital assets are on their way to becoming part of the financial mainstream.

There is one particular category of digital asset that is inevitable: Central Bank Digital Currency (CBDC). In the run-up to the biggest IPO in history, Jack Ma talked about how digital currencies may play an important role in building the type of a financial system that will be needed for the coming generation and said that digital currency could “create value and we should think about how to establish a new type of financial system through digital currency”. Just as the Chinese government have begun to distribute their digital currency through third parties, including commercial banks and apps, so PayPal might reasonably expect to be an invaluable partner to the US government when it finally gets its act together to deliver some sort of digital dollar. If PayPal were to pivot away from the traditional infrastructure of banks and accounts, payments cards and interchange towards an infrastructure of wallets exchanging digital dollars (or perhaps, as Meltem Demirors speculates from a very well-informed perspective, their own alternative to Facebook’s Libra private currency) that would be a significant shift in the dynamics of the payments sector.

* I am not saying that I do or do not think cryptocurrency is a good investment. I am not making any comments that might be misconstrued as financial advice. Please note that any comments I make about cryptocurrencies as an asset class are for entertainment purposes only.

[This is an edited version of a piece that first appeared on, 25th October 2020.]

Helicopter money (and Hitler)

Pressure groups, reformers and economists (such as Positive Money) have long argued that “Helicopter Money”, a term coined by Milton Friedman in his 1969 work “The Quantity Theory of Money” (although to be fair Hitler had had the same idea a generation before so I don’t know why they don’t call it Heinkel Money), is better than Quantitative Easing (QE) in circumstances of disaster and distress. Their argument is that instead of pumping money into financial markets (as central banks did with QE in response to the Great Financial Crisis of 2008), it would stimulate the real economy by transferring money directly to citizens.

As I wrote in Financial World magazine, the traditional financial system is of course an option. Instant cash handouts work well in an economy where everyone has a bank account (let’s say Denmark, for example, where 99.92% of the population over 15 has one) and some form of widely-accepted digital identity (let’s say Denmark, where 92% of the population over 15 has one) it’s quite straightforward. The central bank harvests from the magic money tree and sends the fruit to the commercial banks, the commercial banks add it to the accounts of individuals who register for it with their digital IDs (as in “I am Dave Birch and I claim my £5”). And for the the few remaining people who feel that they have missed out on the free cash, well, they can go to a Post Office or whatever. But what if you are in a country where not everyone has a bank account? The UK, for example, where the Financial Inclusion Commission reckons that there are one-and-a-half million adults without a bank account (and the World Bank puts us in the world top ten for banking inclusion!). Only half of them actually want a bank account although I suppose they might be persuaded to get one for the purposes of receiving a stimulus payment.

It can’t go on like this.

When the next pandemic arrives, things will be different. Or at least they will be different in some countries. The ones with digital currency. In report on digital currency for the CSFI, back in April, I wrote that central banks have long considered it a key advantage of digital currency that it adds to their policy toolkit in interesting ways. It removes the zero-lower bound on interest rates, increases economic activity (the Bank of England Staff Working Paper No. 605 by John Barrdear and Michael Kumhof, “The macroeconomics of central bank issued digital currencies” estimated that substituting only a third of the cash in circulation by digital currency would raise GDP by 3%) and, of course, enables helicopter money. If every citizen has an electronic wallet, then sending electronic cash over the airwaves and directly into those wallets becomes simple.

One of the unexpected consequences of the COVID crisis and the international response to it may well be to accelerate the transition to digital currency. Click To Tweet

One of the unexpected consequences of the COVID crisis and the international response to it may therefore be to accelerate the transition to digital currency that can be delivered directly to citizens. This may have seemed the province of Bitcoin fans until quite recently. However, in the Spring the People’s Bank of China began testing their “DC/EP” system (it stands for Digital Currency/Electronic Payment) in four cities: Shenzen, Chengdu, Suzhou and Xiong’an. The uses will vary, but we already know that in Suzhou, the pilot began in May by paying half of the travel subsidies given to public sector workers as digital currency.

DCEP phone

with the kind permission of Matthew Graham @mattysino

At the virtual SIBOS 2020, PBOC’s deputy governor Fan Yifei said that by late August, the bank had already processed more than three million DC/EP transactions worth some $160+ million, with over  6,700 pilot use cases implemented. He went on to say that “113,300 personal digital wallets and 8,859 corporate digital wallets have been opened”.

Lets hope the Bank of England don’t take this laying down. When the next pandemic rolls in, Andrew Bailey should be able to juggle his spreadsheets and have the stimulus Sterling in our pockets like greased lightning, no helicopter (or commercial banks) needed.

Me with patriotic cushion

Hitler’s plan for Helicopter Money failed.

If you are curious about Hitler’s plan for helicopter money, by the way, the story is told in the brilliant film “The Counterfeiters”, which won the 2007 Oscar for best foreign film. It is the true story of Operation Bernhard, which was the name of that Nazi plan to devastate the British economy by printing money. The idea, conceived at the very start of the Second World War, was to drop worthless counterfeit banknotes over England, thus causing economic instability, inflation and recession.

The film is based on a memoir written by Adolf Burger, a Jewish Slovak typographer who was imprisoned in 1942 for forging baptismal certificates to save Jews from deportation. The Nazis took Burger and more than a hundred other Jews from a variety of trades — printing, engraving and at least one convicted master counterfeiter, Salomon Smolianoff — and moved them from different death camps to a special unit: “Block 19” in Sachsenhausen concentration camp. There they set about forging first the British and then the American currency.

(The BBC produced a comedy drama series based on Operation Berhard in the early 1980s, “Private Schulz”. The characters were based on the real inmates of Sachsenhausen, where 30,000 people were murdered during the course of the war.)

In the end, the prisoners forged around £132 million, which is about five billion dollars in today’s prices. The forgeries were perfect, but the Nazi plan probably wouldn’t have worked. They were churning out £5, £10, £20 and £50 notes at a time when the average weekly wage in Britain was a fiver. The Bank of England though were so concerned that should the Sachsenhausen operation switch to lower denominations then there could be trouble. For this reason, it had to make a contigency plan to withdraw the £1 note and the ten shilling note! So British Intelligence asked Waddingtons Games (who made Monopoly) to print five shilling (25p) and two-and-half shilling (12.5p) notes to replace coins instead of its usual game currency money.

These notes were never used and were destroyed at the end of the war, because the Nazis were never able to put their plot into operation. They packed up all the printers’ plates and counterfeit bills into crates which they dumped into Lake Toplitz in Austria, from which they were subsequently retrieved, which is how it is that I have one of the real fakes hanging in my study.

[An edited version of this piece appeared on, 26th July 2020].

No consensus on CBDCs

Earlier this year, Jeff Wilser was kind enough to write an article about me called “The Man Who Forecast a Currency Cold War” for Coindesk in the run-up to the annual Consensus blockchain conference, which is sort of like SIBOS but for blockchainers rather than bankers.

Screenshot 2020 05 18 12 21 20

Consensus Distributed 2020

It is an annual event in New York and, like many other events, it went virtual this year. I took part in the “Money Re-imagined” session with Michael Casey. Mike chatted to former Treasury Secretary Larry Summers (who is on record as saying that the US should invest in improving SWIFT rather than a digital dollar), digital dollar visionary Chris Giancarlo, Dante Disparte of the Libra Foundation and crypto-industry luminaries Joe Lubin and Caitlin Long. I took part in a discussion with Sheila Warren of the World Economic Forum.

Summers too much privacy

Larry Summers said there may be “too much privacy” in payments.

(If you are curious, I used this discussion session as a case study for my new Fintech Writer’s Workshop video series, so do head over to my Youtube channel DaveFlix and take a look.)

Mersch tokens

Yves Mersch talked about using tokens to implement CBDC.

What particularly caught my eye was the contribution of Yves Mersch from the European Central Bank who talked about the idea of using tokens to implement a Central Bank Digital Currency (CBDC). When I first wrote about this a few years ago, it was probably seen as something out of left-field but by the time I gave a talk about it at the Blockchain Innovation Conference in 2018 it had become if not mainstream, exactly, certainly a topic for discussion in polite society, so it was very interesting to see such a well-informed “insider” talk about this approach.

More likely are the use-cases that don’t even exist today and can’t exist without smart money Click To Tweet

Anyway, the reason that was thinking about Yves’ comments was that Martin Walker, Director of Banking and Finance at the Center for Evidence-Based Management wrote a great piece exploring these issues for the LSE Business Review. He reflects on the idea of using some form shared ledger, digital asset tokens and “smart” “contracts” to implement a digital currency, what I referred to in my book “Before Babylon, Beyond Bitcoin” as smart money, and quotes Robert Sams points on the potential for innovation: “More likely are the use-cases that don’t even exist today and can’t exist without [smart money]”. I am very sympathetic to this view and can’t help but feel that this is where we should focus. Walker goes on to observe that while there probably is scope to “create more mechanisms for adding more conditionality in the financial system, locking up funds until an event happens or creating more easily accessible escrow arrangements” it is not obvious that autonomous consensus applications are the best way forward. Indeed, the early lessons learned from the world of “decentralised finance” (or “DeFi”) suggest that there’s a lot of work to be done to bring working, population-scale schemes to fruition.

I think Martin’s words of caution are entirely justified but along with Yves, I also think that the concepts should be explored. Yes, we could implement digital currency without tokens, but if we are going to create digital currency, then surely we want it to be a platform for new products and services, designed for the economy to come and not simply an mimetic electronic echo of what we already have?

Who needs a digital currency when you have a Coin Task Force?

Well, anyone interested in money or technology or the future will have been following the evolution of Central Bank Digital Currency (CBDC) in China, where the largest state-owned banks have begun testing the “electronic wallet” component of the digital yuan. The tests are being conducted in cities including Shenzhen, which borders Hong Kong. Meanwhile, in America, there’s a Coin Task Force. And it’s been busy urging patriots to return their spare change to circulation by using it for retail transactions because there’s shortage. According to NPR, “Banks and laundromats are scrambling. Arcades and gumball machine operators are bracing for the worst”. Other sectors are adopting a more European approach (where rounding is common) and some stores are rounding their prices to even dollars or (as is common in London) just giving up on cash completely. But why? Where have the coins gone? The shops have none left and customers can’t be bothered to search down the back of the furniture to find them. Banks, lacking the usual coin deposits from the public, requested coins from the Mint which was unable to produce enough coins (and, in fact, fell short of its usual levels)  and… there’s a coin shortage.

America’s coin shortage isn’t a problem, it’s an opportunity to take a step forward. Click To Tweet

In developed economies, this sort of thing doesn’t matter. In Australia, for example, tens of millions of coins may never even go into circulation because their Mint has seen “virtually no demand” for coins in 2020 as physical retail closed down. Same in the UK. Even if there was a coin shortage, most people would never notice since pandemic-accelerated cashlessness is pervasive. Everything I want to buy, I can buy with Apple Pay. I never take a wallet out of the house with me, let alone coins.

Problems are opportunities

with kind permission of TheOfficeMuse (CC-BY-ND 4.0)

Frankly, the continued use of pennies and even nickels baffles me. There’s something that economists call “the big problem of small change”. If you’re interested, there’s a very good book about this, which is called “The Big Problem of Small Change”. In essence, the problem is it’s hard to make a living out of producing small change, so no-one does it, so therefore the government has to do it and bear the cost in the interests of the economy.  But should they continue to do this in a world of contactless card and QR codes? The US Mint lost 0.99 cents on each penny it sold in 2019 but continued to produce more pennies than any other coin in circulation!

The Cato Institute says that the case for producing these pointless coins is weak and they they are only minted because lobbyists harness nostalgia and “junk arguments” about rounding.  If you are interested in the subject of rounding, there is a very good paper on rounding written by Robert Whaples called “Time to Eliminate the Penny from the U.S. Coinage System: New Evidence” that was published in the Eastern Economic Journal way back in 2007. This confirms the European experience that dumping low-value coins and rounding prices is economically neuter. Rounding is not that complicated! Whaples wrote that a detailed study of convenience stores found the final digit of purchases, which usually involves multiple products and sales tax, was pretty much random so that “if you round it to the nearest nickel, the customer wouldn’t get gouged”. Sometime you’d round up, sometimes you’d round down. It balances out.

(Here is how they do it in Belgium where total amount payable in cash has been rounded up or down to the nearest five cents since December 2019: if the total amount payable in cash ends in one or two cents, it is rounded down to zero,  if it ends in three, four, six or seven cents then it is rounded to five cents and if it ends in eight or nine cents then it is rounded up to one euro. As far as I know, Belgian civil society has not collapsed and shops are operating normally under the circumstances.)

Pennies and nickels are scrap metal and a private coin industry would not be able to waste taxpayer cash on subsidising miners to keep producing them. And if you think I’m exaggerating by calling coins “scrap” then you should, as the man says, follow the money. Which in this case goes to China. I remember reading a fascinating news story about this a few years ago, which really set me thinking. The story concerned two Chinese people who were arrested in Denmark after they tried to exchange a hoard of scrap Danish coins that were mistaken for counterfeits. I thought it was a pretty unusual incident and I mentally filed it away to use as a conference anecdote, but then I spotted another similar case in which two Chinese tourists were arrested in France for suspected forgery after trying to pay a hotel bill in coins. The police found 3,700 one-euro coins in their room! The men said they had got the money from scrapyard dealers in China, who often find forgotten euros in cars sent from Europe. This tallied with the Danish story. Sufficiently large amounts of coins from Europe end up as scrap that it makes for a worthwhile enterprise (in China) to collect up these coins and ship them back here to use! Not all the coins coming from China are real though. I remember when the Italian police discovered half a million counterfeit euro coins in a container. Hardly surprising, because if container-loads of coins are coming out of China, then it’s inevitable that this trade will attract counterfeiters. And this gave me an idea.

I don’t know if the US Coin Task Force has been thinking out of the box, but may I suggest that they make a virtue out of necessity. Since the Chinese counterfeiters can presumably produce these coins at a lower cost than collecting them as scrap metal (otherwise they wouldn’t make them, they’d just collect them), why doesn’t the US mint just stop producing coins above face value and sending them for scrap and instead let the Chinese counterfeits circulate in their place? Think about it. It costs the US Mint two cents to make a penny that no-one cares is real or not. So why bother? If the Chinese can produce one for half a cent, ship it to the US in a container and make a profit of 0.2 cents on it, then let them and let the US Mint do something more useful instead: $1 coins. There is no $1 note in Canada, no £1 note in the UK, no €1 note in Europe. There are already more $100 bills in circulation than $1 bills, so let the $1 bill die a long overdue death and replace it with the more cost-effective $1 coin instead. A decade ago, the GAO calculated that the replacement of dollar bills with dollar coins would save an estimated $5.5 billion in costs over a generation. It’s time.

[This is an edited version of an article that first appeared on Forbes, 24th August 2020.]

The great Chinese money experiment is over

The Chinese were first with the great transition from commodity money to paper money. They had the necessary technologies (you can’t have paper money without paper and you can’t do it at scale without printing) and, more importantly, they had the bureaucracy. In 1260, the new Emporer Kublai Khan  determined that it was a burden on commerce and drag on taxation to have all sorts of currencies in use, ranging from copper coins to iron bars, to pearls to salt to gold and silver, so he decided to implement a new currency. The Khan decided to replace metal, commodities, precious jewels and specie with a paper currency. A paper currency! Imagine how crazy that must have sounded!

China and paper money

with kind permission of TheOfficeMuse (CC-BY-ND 4.0)

Just as Marco Polo and other medieval travellers returned along the Silk Road breathless with astonishing tales of paper money, so modern commentators (e.g., me) came tumbling off of flights from Shanghai with equally astonishing tales of a land of mobile payments, where paper money is vanishing and consumers pay for everything with smartphones.

China was first in to paper money and eight hundred years later looks like being first out of it. Click To Tweet

This thinking has been evolving for some time. Back in 2016, the Governor of the People’s Bank of China (PBOC), Zhou Xiaochuan, set out the Bank’s thinking about digital currency, saying that it is an irresistible trend that paper money will be replaced by new products and new technologies. He went on to say that as a legal tender, digital currency should be controlled by the central bank and after noting that he thought it would take a decade or so for digital currency to completely replace cash in China, he went to state clearly that the bank was working out “how to gradually phase out paper money”. Rather than simply let the cashless society happen, which may not led to the optimum implementation for society, they were developing a plan for a cashless society.

As I have written before, I don’t think a “cashless society” means a society in which notes and coins are outlawed, but a society in which they are irrelevant. Under this definition the PBOC could easily achieve this goal for China. But how will they do it? I got a window into the tactics when I listened to Kevin C. Desouza (Professor of Business, Technology and Strategy in the School of Management at the QUT Business School, a Nonresident Senior Fellow in the Governance Studies Program at the Brookings Institution and a Distinguished Research Fellow at the China Institute for Urban Governance at Shanghai Jiao Tong University), someone who has pretty informed perspectives. I heard him in conversation with Bonnie S. Glaser (senior adviser for Asia and the director of the China Power Project at the Center for Strategic and International Studies, CSIS) on the ChinaPower PODCAST. Kevin and Bonnie were discussing China’s plan to develop a Central Bank Digital Currency (CBDC). I have looked at China’s CBDC system (the Digital Currency/Electronic Payment, DC/EP) in some detail and have speculated on its impact myself, so naturally I wanted to double-check my views (coming from a more technological background) against Kevin and Bonnie’s informed strategic, foreign policy perspective.

One particular part of their discussion concerned China’s ability to advance in digital currency deployment and use because of the co-ordinated plans of the technology providers, the institutions and the state. The technological possibilities are a spectrum, there are a wide variety of business models and there are many institutional arrangements to investigate, balance and optimise. Take, for example, the specific issue of the relationship between central bank money and commercial bank money. Yao Qian, from the PBOC technology department wrote on the subject in 2017, saying that to “offset the shock” to commercial banks that would come from introducing an independent digital currency system (and to protect the investment made by commercial banks on infrastructure), it would be 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.

This rationale is clear and, well, rational. The Chinese central bank wants the efficiencies that come from having a digital currency but also understands the implications of removing the privilege of money creation from the commercial banks. Thus you can see the potential problem with digital currency created by the central bank, even if it is now technologically feasible for them to do so. If commercial banks lose both deposits and the privilege of creating money, then their functionality and role in the economy is much reduced. Whether you think that is a good idea or not, you can see that it’s a big step to take. Hence the PBOC position, reinforced by Fan Yifei, Deputy Governor of the People’s Bank of China writing that the PBOC digital currency should adopt a “double-tier delivery system” which allows commercial banks to distribute digital currency under central bank control. I don’t doubt that this will be the approach adopted by the Federal Reserve when the US eventually decides to issue a digital dollar, which is why we in the West should be studying it and learning from it.

I’m fascinated by China’s long experiment with paper money and its imminent demise. This will come about not because of Bitcoin or Libra but because the PBOC has been strategic in its thinking and tactical in its governance, co-ordinating practical solutions the will make digital currency work to the benefit of the nation.  Their comments on the topic from 2016 to now have been consistent. Digital currency is coming and China will take the lead in digital currency just as it did in digital paper currency.

[This is an edited version of an article that first appeared on Forbes, 9th August 2020.]