Blockchains and virtual bridging currencies
You may have come across this story about
Barclays partnering up with a “Goldman-backed” bitcoin payments app
called Circle International Financial, which uses bitcoin to transfer
central bank currencies as digital money increasingly moves into
mainstream finance, and thought “wow” that sounds innovative and
exciting.
But is it? Is it really all that innovative?
Let’s break down some of the key claims being made.
Number one, that digital money is increasingly moving into the mainstream.
Nope. Central bank money has been digital for decades. Look, here’s a Federal Reserve Bank of New York paper from 1995 talking about policy issues raised by electronic money.
The paper also references media speculation about electronic payment systems displacing physical currency with the roll-out of electronic bearer money stored on prepaid cards or digital wallets, explaining this would in reality open the door to a number of policy concerns.
First, there are consumer issues centered around general protections (whose responsibility are issued tokens?), privacy, the reclamation of inactive bank accounts, deposit insurance and access more generally. Second, there’s the scope for criminal exploitation via counterfeiting, money laundering, and the scope for value held on extensive non-bank networks being readily moved to several remote locations and deposited in smaller amounts to avoid detection (perhaps for tax efficiency reasons). Third, there’s the impact on monetary policy of such systems, especially with regards to reserve requirements, the displacement of seigniorage earnings, the removal of funds from the banking sector in general and the prudent investment of the remaining float that resides on the network.
Also, as we’ve argued here more generally, there’s a case to be made that it was the digitisation of money — specifically that associated with a move to real-time gross settlement clearing — which contributed to the systemic nature of the 2008 crisis.
Number two, that using bitcoin provides a neutral bridging currency for frictionless exchange of central bank currencies and that this is somehow innovative.
Nope. The eurodollar/currency system has provided a neutral currency platform for frictionless exchange of multiple currencies for decades. One of the issues with that system, we now know, was that it didn’t square perfectly, nor was it supported by any guarantor in the event of a crisis.
To the contrary, the float which everyone presumed was supported by the US balance sheet, was technically an offshore arrangement outside of the responsibility of the Fed. If it was supported by anything it was the capital of wealthy investors, who — when the system buckled in 2008 — weren’t prepared to absorb the imbalance risk after all.
Replacing the eurodollar float with a bitcoin float replicates this arrangement almost precisely. Furthermore, there’s no reason to presume bitcoin investors would be any more willing to absorb losses in a capital crisis than the eurodollar investors who came before them (indeed, the highly publicised compensation claims against MtGox suggest quite the opposite). If and when bitcoin morphed into an entangled multi-trillion dollar clearing system, the pressure for sovereigns to bailout private investors would arguably be just as great in a capital crisis as it was in 2008.
Number three, that using blockchain means money can be exchanged without the need of a central bank clearing system.
Unlikely. In as much as the business of FX and cross-border banking is the business of swapping sovereign cash-flows against each other — which are ultimately underpinned by taxpayer revenues, local laws, regulations, and consequently the national central bank systems which support those structures — the idea that you can exchange money without central bank involvement is about as probable as the idea that border controls will be abolished in our lifetimes.
Bankers can propagate the fiction that a financial no-man’s land wherein value is exchanged neutrally and free of sovereign controls, interventions or balance-sheet risk is possible. More so, that such a commons can be funded on a voluntary wiki-level by unwitting “speculator investors” or even by a voluntary alliance of tax-payer supported balance sheets. But… the experiment which was the euro-project suggests exactly the opposite.
Assumptions should never be made about the capacity of a culturally diverse group of people to subsidise each other’s imbalances on a permanent basis. In that regard, do see this 2004 paper by Patrick McGuire at the BIS regarding a much overlooked indirect consequence of the introduction of the neutral no-man’s land which was the euro clearing system. As McGuire notes, despite the fact that the eurosystem no longer needed the same scale of dollar deposits to support the european exchange system, the fact that dollar flows continued to be forthcoming proved too much to resist:
That bankers are rushing to exploit a clearing platform whose imbalances are (for now at least) being absorbed by unsuspecting bitcoin investors who perhaps don’t understand the extent to which they’re funding the costs of the system should hardly be a surprise.
What we should really be asking is whether an uncapitalised bitcoin-backed system is likely to square itself any more efficiently or cheaply in the long-run than the system it is replacing, and more pertinently, whether the systemic implications of a funding hole being discovered in such a network are likely to be any less destabilising than those experienced in 2008.
On both fronts, we’re yet to be convinced.
But is it? Is it really all that innovative?
Let’s break down some of the key claims being made.
Number one, that digital money is increasingly moving into the mainstream.
Nope. Central bank money has been digital for decades. Look, here’s a Federal Reserve Bank of New York paper from 1995 talking about policy issues raised by electronic money.
The paper also references media speculation about electronic payment systems displacing physical currency with the roll-out of electronic bearer money stored on prepaid cards or digital wallets, explaining this would in reality open the door to a number of policy concerns.
First, there are consumer issues centered around general protections (whose responsibility are issued tokens?), privacy, the reclamation of inactive bank accounts, deposit insurance and access more generally. Second, there’s the scope for criminal exploitation via counterfeiting, money laundering, and the scope for value held on extensive non-bank networks being readily moved to several remote locations and deposited in smaller amounts to avoid detection (perhaps for tax efficiency reasons). Third, there’s the impact on monetary policy of such systems, especially with regards to reserve requirements, the displacement of seigniorage earnings, the removal of funds from the banking sector in general and the prudent investment of the remaining float that resides on the network.
Also, as we’ve argued here more generally, there’s a case to be made that it was the digitisation of money — specifically that associated with a move to real-time gross settlement clearing — which contributed to the systemic nature of the 2008 crisis.
Number two, that using bitcoin provides a neutral bridging currency for frictionless exchange of central bank currencies and that this is somehow innovative.
Nope. The eurodollar/currency system has provided a neutral currency platform for frictionless exchange of multiple currencies for decades. One of the issues with that system, we now know, was that it didn’t square perfectly, nor was it supported by any guarantor in the event of a crisis.
To the contrary, the float which everyone presumed was supported by the US balance sheet, was technically an offshore arrangement outside of the responsibility of the Fed. If it was supported by anything it was the capital of wealthy investors, who — when the system buckled in 2008 — weren’t prepared to absorb the imbalance risk after all.
Replacing the eurodollar float with a bitcoin float replicates this arrangement almost precisely. Furthermore, there’s no reason to presume bitcoin investors would be any more willing to absorb losses in a capital crisis than the eurodollar investors who came before them (indeed, the highly publicised compensation claims against MtGox suggest quite the opposite). If and when bitcoin morphed into an entangled multi-trillion dollar clearing system, the pressure for sovereigns to bailout private investors would arguably be just as great in a capital crisis as it was in 2008.
Number three, that using blockchain means money can be exchanged without the need of a central bank clearing system.
Unlikely. In as much as the business of FX and cross-border banking is the business of swapping sovereign cash-flows against each other — which are ultimately underpinned by taxpayer revenues, local laws, regulations, and consequently the national central bank systems which support those structures — the idea that you can exchange money without central bank involvement is about as probable as the idea that border controls will be abolished in our lifetimes.
Bankers can propagate the fiction that a financial no-man’s land wherein value is exchanged neutrally and free of sovereign controls, interventions or balance-sheet risk is possible. More so, that such a commons can be funded on a voluntary wiki-level by unwitting “speculator investors” or even by a voluntary alliance of tax-payer supported balance sheets. But… the experiment which was the euro-project suggests exactly the opposite.
Assumptions should never be made about the capacity of a culturally diverse group of people to subsidise each other’s imbalances on a permanent basis. In that regard, do see this 2004 paper by Patrick McGuire at the BIS regarding a much overlooked indirect consequence of the introduction of the neutral no-man’s land which was the euro clearing system. As McGuire notes, despite the fact that the eurosystem no longer needed the same scale of dollar deposits to support the european exchange system, the fact that dollar flows continued to be forthcoming proved too much to resist:
Banks in London continue to receive US dollar deposits from banks abroad, but are directing increasingly large portions of these deposits to non-bank borrowers, primarily in the United States. Reduced interbank dealing in the currency markets, a broadening of the menu of services offered by major commercial banks, and the financing of securities houses, particularly in the United States, have coincided with the shift towards non-bank borrowers.The above, we think, eloquently encapsulates the trouble with overly relying on un-regulated neutral floats for the clearing of cross-border claims and liabilities. Too little flow and your system can’t cover its costs, creating a system-destabilising payment crisis. Too much flow, and the capital windfall begins to resemble a free lunch — opening the door to mal-investment.
That bankers are rushing to exploit a clearing platform whose imbalances are (for now at least) being absorbed by unsuspecting bitcoin investors who perhaps don’t understand the extent to which they’re funding the costs of the system should hardly be a surprise.
What we should really be asking is whether an uncapitalised bitcoin-backed system is likely to square itself any more efficiently or cheaply in the long-run than the system it is replacing, and more pertinently, whether the systemic implications of a funding hole being discovered in such a network are likely to be any less destabilising than those experienced in 2008.
On both fronts, we’re yet to be convinced.
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