Posts in Central Banks

A SWIFT Response

September 22nd, 2016 Posted by Central Banks, Cryptofinance technologies 0 comments on “A SWIFT Response”

The SWIFT Institute recently published a working paper titled, “Virtual Currencies: Media of Exchange or Speculative Asset?” It examines whether or not virtual currencies–most prominently Bitcoin–posed a threat to macroeconomics or fiat currency.

The paper, however, illustrates the analysis of an innovative technology from the perspective of those with experiential bias mired in years spent in the industry and hinders the ability to see the “full picture.” In this brief, I will analyze some of the points brought forth by the SWIFT Institute and add the missing perspective needed to realize the full potential of this technology.

“An empirical analysis of prices and user accounts (wallets) of Bitcoin supports the theoretical result and finds that Bitcoin is mainly used as a speculative investment rather than a medium of exchange.”

Keywords: Bitcoin; virtual currency; digital currency; alternative currency; medium of exchange; asset class; safe haven”

Vocabulary is key to communicate anything and especially so when attempting to convey the specifics of such an innovative technology. Now, let’s talk about whyaccounts, virtual currency, and digital currency are misleading, or outright wrong when describing both the currency and technology of Bitcoin.

Digital (and virtual) currency has been around since the digitization of communication. Today, nearly all currency is digital; only a fraction of sovereign currency exists in the physical medium. Although Bitcoin is considered a digital currency, it is more accurately described as a cryptocurrency. Cryptography is what makes Bitcoin unique; it is where the differentiation between every other virtual or digital currency becomes apparent. Cryptography is what controls nearly every aspect of Bitcoin–from the production to the distribution. As there is no central entity or bank controlling the production of Bitcoin, one of the greatest values comes from trusting the math and not the centralized institutions’ policy decisions.

Referring to where one stores their Bitcoin as an account is akin to saying that you have a leather account in your back pocket or purse. A key differentiation between cryptocurrencies and digital currencies (the digital value held in your online checking account) is not the medium in which it exists, but instead the platform it exists on. Moving from a liability-based system (one which is based on account management) to asset-based (in the form of bearer instruments), trade has the potential to usher in even more substantial and advantageous differences.

An account is managed by a third party, a bank. A wallet holds value directly and is only accessible by the person who is in control of it. Although a seemingly inconsequential word choice, the reality of the difference is of crucial importance.

“Virtual currencies open up a new type of dual currency regime in which two currencies with no intrinsic value, virtual currency and fiat currency, coexist.”

Intrinsic value refers to the actual value of an asset based on an underlying perception of its true value. In terms of both tangible and intangible factors, intrinsic value is subjective and only determined by the value someone is willing to pay for an asset at a given time. How valuable is a glass of water to a man sitting in a boat in the middle of an alpine lake? How valuable is that same glass of water to that same man after being stranded in the middle of the Sahara for 4 days, without another glass in sight?

Value is based on circumstances. The authors of the paper are blinded by privilege and sit on top of crystal clear alpine lake, with more water to drink than is imaginable by most. Not only can they already complete their day-to-day transactions digitally, but they can access financial products custom made to fit their financial needs. Their investment portfolios are tailored to reduce risk and allow for steady growth over a lifetime, guaranteeing stability upon retirement. They make monthly contributions to different investments, automatically, based on the risk they want to assume and the return they seek.

This reality is a given for those privileged enough to be born in a geographic location with institutions in place. For the vast majority of humans, however, the possibilities of financial security are completely unimaginable. As of writing this article, there are 18 countries in Africa alone that have inflation rates over 7%. Financial services are not yet accessible to billions of people on earth, an opportunity that is many times greater than the userbase of Facebook.

There is intrinsic value in a technology that has the potential to help someone escape generational poverty, especially in countries where the national value evaporates at 7%+ per year.

The final point misidentified by the SWIFT Institute is the presence of a Central Bank Digital Currency. We’ve recently seen Adam Ludwin of Chain address over 100 central bankers at the Federal Reserve about why they should be racing to adopt new cryptofinance technologies. The World Economic Forum  states that there are working groups at 90 central banks around the world looking into the topic.

In July, the Bank of England (BoE) published a report on the macroeconomics of central bank issued digital currencies which fleshes out the pros and cons of central banks issuing their own digital currencies. The BoE concludes that there are numerous benefits, which you can read in detail in an earlier post.

Upon the introduction of a CBDC, the BoE predicts many consumers will switch from storing value in bank deposits to holding it in a digital currency.

This is the analysis that the SWIFT Institute should be conducting. When our assets and national currencies go digital, they will compete with their counterpart- liabilities. The digitization of legal tender will have widespread impact on macroeconomic conditions. Today’s financial services are liability and account-based. They require central switches, reconciliation between institutions, and plenty more on top of counterparty risk. An asset-based system changes all of this however, as people start transacting as they do with cash today, except in a completely digital medium that reduces costs to near-zero.

Bitcoin may not be a threat as a transactional medium to national currencies, but how will the digitization of national currencies impact fractional reserve banking and consumer deposits?

Disclaimer: Blog posts reflect the views of the respective authors, and do not necessarily represent the official view of Monetas

Next Generation Digital Financial Services Will Drive Internet Use in Africa

August 30th, 2016 Posted by Central Banks, Cryptofinance technologies, Mobile money 0 comments on “Next Generation Digital Financial Services Will Drive Internet Use in Africa”

Last week, the Internet for All initiative by World Economic Forum (WEF) presented their objectives in Nairobi, Kenya. Over the next 3 years, they plan to incorporate an additional 25 million internet users in Northern Corridor East African countries (Kenya, Uganda, Rwanda, South Sudan) and bring total internet adoption to 70%.

The group determined to make this ambitious goal a reality by including stakeholders from Information and Communications Technology ministries, mobile network companies, hardware manufacturers, software and content producers, multinational NGOs, entrepreneurs and innovators. Their approach is to target broad sectors that are helping to drive demand for internet access and lobby infrastructure providers to help curtail high barriers to entry.

So, why is the WEF focused on increasing internet usage in countries that are also busy trying to increase food security, gender development, and basic healthcare?

Well, the internet is more than cat memes and a way to follow your favorite celebrity on Instagram. The internet democratises communication, education, and enables even the poorest and most vulnerable to be heard. Not long ago, information was held in libraries and universities. Only those with the privilege and means had the ability to access that information. The internet, however, opens the library doors and allows anyone to benefit from the knowledge humanity has created over thousands of years. Now, a girl in a remote village in Kenya can use her smartphone to stream a lecture at MIT to learn computer science and a mother in rural Uganda can learn about proper nutrition without have to spend money or time traveling to a health center to talk to a nurse.

The projects underway in the Northern Corridor are impressive. Many aim at increasing digital literacy across all segments of the population. To generate demand and gain awareness for those not yet connected, new programs teach students how to access the internet for things as simple as opening a social media account. A Facebook profile piques youth interest and teaches the value of the internet at a young age. The interest gained from gratification on social networks can be leveraged to learn job skills, e.g., software coding via gamification.

In a digital world, national borders dissolve and people become more connected. The global nature of the internet shatters location and geographic glass ceilings. As more citizens of the world learn to utilize digital skills, the ability to access education materials and make income from global sources becomes less of an ambitious goal and more of a reality.

The WEF released a favorable and forward-thinking report 2 weeks ago titled, “The future of financial infrastructure: An ambitious look at how blockchain can reshape financial services”. The key takeaways are very much in-line with the vision ofMonetas:

Distributed Ledger Technology (blockchain) is not a panacea. Instead, it should be viewed as one of many technologies that will form the foundation of next-generation financial services infrastructure.

Cryptofinance consists of many different technologies that utilize and complement different technologies in order to deliver an optimal final product for the end customer. The hammer isn’t the ideal tool for every job, and blockchain technology isn’t ideal for every user story. At the WEF, many people spoke about the use of  cryptofinance and blockchain tech in various cases from digital identity management to better sharing health records. Even though I was the only person in the room from the cryptofinance sector, I sat back and listened to an array of stakeholders speak about what is needed to allow for widespread uptake of digital financial services. The three factors consensually agreed upon were straight forward:

  1. Interoperability is vital. Today, users in most markets can’t send value from one mobile network to users of another. We need to unify financial service providers so users can send money to anyone they want, regardless of what bank or mobile network they use. Sending and receiving money internationally will also further increase usability.
  2. Low value payments must be able to be made at affordable levels. With 50% of payment volume taking place below USD 1 in Kenya, users today face fees in excess of 10%. With the inability to complete day-to-day transactions, all mobile money platforms today require users to immediately withdraw funds and leave the digital medium.
  3. Mobile money today barely qualifies as financial inclusion. Financial inclusion isn’t just payments; it’s financial products, savings, loans, investments, and more. Products like M-Shwari offered by MPesa are a start, but users only receive between 2%-5% in interest in a market with +7% inflation.

The speakers at the WEF who thought they were addressing mobile money needs were actually (perhaps not even to their own knowledge) describing the benefits of cryptofinance. It’s encouraging to know that a product our engineers have been making for the last 3 years fulfils these requirements plus much, much more. Monetas looks forward to further participation in working groups at the World Economic Forum to help drive awareness of the capabilities and benefits of cryptofinance amongst the stakeholders, central banks, and financial service institutions.

Bank of England Sees Potential of a Sovereign Digital Currency

August 15th, 2016 Posted by Central Banks, Cryptofinance technologies 0 comments on “Bank of England Sees Potential of a Sovereign Digital Currency”

In July, the Bank of England published a report on the macroeconomics of central bank issued digital currencies which fleshes out the pros and cons of central banks issuing their own digital currencies. It’s not often that we see these bastions of conservatism speaking out about innovation, but the technologies made possible by Bitcoin have created the toolbox that will allow a sovereign monetary policy to continue to flourish in our increasingly digital world.

The BoE report concludes that the issuance of a Central Bank Digital Currency (CBDC) could permanently raise GDP by as much as 3 percent–from a reduction in real interest rates, distortionary taxes, and monetary transaction costs. Their position puts forward an opportunity for central banks to digitally stabilize the business cycle within an economy.

The world’s financial institutions, which haven’t yet truly joined the digital revolution brought forth by the internet. Over the last century, our banking system has seen innovation, however, the technology it is built upon an antiquated foundation. Continuing to embellish outmoded technology is akin to attempting to increase the performance of a candle. If we had spent our time improving the candle, we would never have created the light bulb. Today we have the ability to start fresh and deliver incredible, new functionalities. With the near elimination of production, replication, and distribution costs, these functions are only possible in a digital medium. They will drastically reduce barriers to financial services and enable the transfer of value as simply and quickly as sending a WhatsApp message.

If you’re holding a paper note in your hand, you’re holding a contract between yourself and a central bank. The value held in your consumer checking account (or any other digital medium), isn’t cash in your possession. Depositing your cash into a checking account, you are lending your money to a financial institution. The number representing this amount in your online checking account is a promise from the financial institution that they will pay back the value which you have lent them. In this relationship, the bank is a trusted third party keeping your value safe. They have been doing this for thousands of years because it works for them. The model enables fractional reserve banking, which increases systemic risk and leaves consumers at the fate of the institution. Banks create new money and are only required to have a fraction (1/10th) of money lent in their physical reserves. If too many people withdraw money from their checking accounts, the bank will become illiquid due to the fact that most of their liabilities have been lent out in the form of debt. We’ve seen this problem countless times before, but most recently in Cyprus, Greece, and Kenya.

With a CBDC, anyone is able to safely hold and transact their wealth as if it were physical cash and without the necessity of a third party. The BoE sees tremendous benefits in this model which allows more base money to circulate in a economy and in turn reducing liabilities in commercial banks. With the ability to transact cash digitally, the need for reconciliation between financial institutions and their associated counterparty risks, as well as the capital required to insure these risks, can be eliminated. There is always the option for central banks to print more physical cash. However, banknotes require storage and a physical exchange for payment. Their very nature makes them expensive and impractical for a globally-connected and digital world.

Bank of America alone spends $1 billion a year to “shuffle paper (cash) around and transport money in armored trucks.”  While speaking at “The Future of Global Trade” event in Worms, Germany, I asked a crowd of 200 university students how many of them had been inside their bank in the last 6 months. No hands. Customer support? They do it online. Writing a check? That’s a thing of the past. It’s not only young people who have no need for a bank building. The infrastructure costs of today’s retail networks are so huge that they have raised the barriers to financial services to a level which excludes over 2 billion people worldwide.

Upon the introduction of a CBDC, the BoE predicts many consumers will switch from storing value in bank deposits to holding it in a digital currency. As consumers don’t keep their money in a checking account for the sole perk of a 2% annual interest, they may find greater value in keeping their money in their pocket. In the near future, commercial banks will be looking to the wholesale market to finance a growing portion of their banks. Relying on lending directly from central banks would reduce the spread between the wholesale interest rate on government bonds and that of consumer checking accounts. This offers central banks a more precise tool to better manage economic cycles.

With this report, it’s safe to say that there is now widespread attention paid by central bankers toward the possibilities of issuing their own digital legal tender. It will be intriguing to see the innovations brought forth by institutions best known for their obstinate conservatism. We’ve recently seen Adam Ludwin of Chain address over 100 central bankers at the Federal Reserve about why they should be racing to adopt new cryptofinance technologies. There are now working groups within central banks around the world looking into how it can happen and why it must happen.

In keeping with their history of intransigence, each central bank prefers to be the second to make a move. Who will be first? Innovations in emerging markets are already leapfrogging policy makers in mature markets. In East Africa, for example, policy makers have created an innovative fintech climate where friendly telco policies have lowered the barriers to financial services and demonstrated their commitment to foster a more inclusive economy. In Kenya, there is “an emerging pattern suggesting widespread systemic challenges: questionable governance practices, weak supervision and rampant fraudulent activities.” Kenya and countries like it are fertile ground for such inclusivity. Uniting all financial service providers–banks and the networks that offer mobile money–under a CBDC and reducing systemic risk, emerging markets are enabling their citizens to hold national currency directly and digitally in their pocket.

Disclaimer: Blog posts reflect the views of the respective authors, and do not necessarily represent the official view of Monetas.

Digital Legal Tender: The Foundation of Future Digital Trading and Finance

June 21st, 2016 Posted by Central Banks, Cryptofinance technologies 0 comments on “Digital Legal Tender: The Foundation of Future Digital Trading and Finance”

With the rapid increase of digital financial services, the urgent need for a central bank issued digital currency has become apparent in order to create inclusive, frictionless, and efficient national economies. A national digital currency will provide a  boost to economic growth allowing all financial service providers to participate and leverage their niche, while benefiting from unified global system.

Mobile money operators have made huge progress leapfrogging traditional brick-and-mortar banks providing digital financial services directly to users via mobile phones across underbanked regions such as Sub-Saharan Africa. Mobile money has done more to expand financial services in the past year than banking in the past decade.

With over 271 mobile money services now in operation, we are experiencing the same problem economies faced years ago before the existence of central banks. As the economy evolved from the exchange of fundamentally valuable assets such as gold, commercial banks began to issue their own private banknotes (based on deposits). Issues of interoperability arose – trust held in different institutions played a role in when and where your private bank note could be spent and interbank settlement was costly and problematic.

Central bank issuance of one national unit of account solved all these problems. Remove a five pound note from your wallet and you will read the fine writing – ‘I promise to pay the bearer on demand the sum of 5 pounds’, followed by the signature from the chief cashier of the Bank of England. This note is a bearer instrument – whoever physically holds it is assumed to be the owner of the property and the note is backed by our trust in the central bank.

Mobile money services are fragmenting national financial ecosystems through the issuance of private digital currencies – network specific tokens’ representing the national currency based on deposit accounts are issued onto their systems. These tokens are only tradable within the network they are issued into – in Kenya for example Safaricom M-Pesa customers can only transact with other customers of the same network. Any interoperable solutions that are arising are based on complicated technical bridging solutions between networks. Friction in the economy is occurring as the funds kept within these systems are not legal tender. They are not insured by the central bank and there is a systematic risk of loss. Certain methods of payment can only be used in certain places for certain things and a constant cycle of exchange between the digital world and physical legal tender exists.

There is a way to solve this problem – the same solution the central banks used years ago with the creation of physical legal tender. Central bank issued digital legal tender.

For conceptual purposes, the issuance, storage, and transacting of digital legal tender works in an identical manner to physical legal tender today (just safer and without the limitations of space and time). It provides one unit of account fully backed by the central bank, that can be utilized by digital financial service providers nationwide. Moving from multiple private issuers to a single issuer totally eradicates the need for privately issued ‘tokens’ and provides seamless interoperability between all systems.

Central Banks have been investigating this opportunity in the past year. On a macroeconomic level, the opportunity to take advantage of the digital economy whilst maintaining regulation and reducing costs is an undeniably attractive prospect.

The burden of managing an economy based on physical cash is heavy – a study by theFinance Ministry of Indiaestimated the cost of cash to the economy as 5-7% of the GDP in developing countries. The production, security, distribution, and eventual destruction of notes and metal coinage is expensive. Switching to a digital payment systems will reduce costs drastically whilst expanding the size of the formal economy through the provision of more accessible digital financial service offerings. The new found option for unbanked and underbanked individuals to forgo their reliance on physical cash (read here how cash based economies hits the poorest hardest) and enter the formal economy will reap large economic benefits for a country. A study by Tufts University estimates that in Mexico every 1% of the informal economy that is formalized represents US $560 million of new revenues with no change to tax rates.

In today’s fragmented digital systems, central banks are unable to keep track of the amount of privately issued digital currency in circulation. Digital legal tender will contribute to the ability of central banks to maintain security and stability within the national economy through execution of monetary policy in an efficient and targeted manner across all digital financial service providers. Furthermore, counterfeiting will be totally eliminated. The use of digital legal tender will create a more transparent system. Financial service providers can implement tiered AML/KYC regulations for domestic and international transactions offering far more reliable and complete identification than traditional paper-based systems.

It is clear that digital legal tender will not replace physical notes and coins completely in the near future. Central banks however must adapt and embrace the digital economy in order to fulfill important economic goals for growth and financial inclusion. Digital legal tender will move through the economy in a complementary manner to notes and coins. The emergence of cryptofinance technologies provides the ideal platform on which this new format of national currencies can be created and used in the most secure and efficient manner. I outline briefly the three key steps in the creation of a truly digitized financial system through the use of digital legal tender below:

1. Issuance: Central banks are the exclusive party to have the required software and hardware for the issuance of digital legal tender. The issuance process is identical to how physical money is issued today. Cryptographically secured, digital cash cannot be counterfeited. Digital legal tender enters the economy alongside, and in the same manner, as physical cash.

  1. 2. Storage: Digital legal tender is held by users in digital wallets exactly as cash is held in a physical wallet. Digital wallets hold bearer instruments (digital legal tender) directly on a mobile phone, can exclusively be accessed by the individual in physical possession, eliminate counterparty risk, and allow the user to be the sole party in complete control of their assets at all times.
  2. 3. Transacting: Legal tender is transacted between wallets in the same manner as physical cash today – directly from person to person with no involvement of financial intermediaries. Each transaction is a direct value transfer.

Disclaimer: Blog posts reflect the views of the respective authors, and do not necessarily represent the official view of Monetas.

CeBIT Global Conferences: An Interview with Johann Gevers, Monetas Founder and CEO

April 1st, 2016 Posted by Central Banks, Cryptofinance technologies, Mobile money 0 comments on “CeBIT Global Conferences: An Interview with Johann Gevers, Monetas Founder and CEO”

In this short interview, Johann discusses Monetas’ digital contracting technology and the benefits of creating Crypto Valley as a hub for digital finance.