The topic of Central Bank Digital Currency (CBDC) is gaining momentum. Across the globe, many CBDC initiatives aim to digitalise payments, support financial inclusion, make cross border payments faster and cheaper, support fiscal transfer, etc. What is firing up discussions around CBDC and why is it important today?
Adoption of new technologies and understanding of their huge potential to support and stimulate our life has caused the world to change a lot in the last year. The current pandemic has triggered the decline of cash usage to avoid getting the virus and safeguard the most vulnerable ones (health-wise). Economic wise, as many governments wanted to protect their citizens and directly stimulate the economy down to every citizen, they offered ‘helicopter money’ via digital wallets.
What did you think of the US election? I don’t mean the candidates and the outcome. What did you think of the election process? Should it be possible for national elections of this type to be done online? Last week the IET published a paper on internet voting in the UK, led by our good friend at the University of Surrey, Professor Steve Schneider. It’s well worth a read. As the paper explains, internet voting for statutory political elections is a uniquely challenging problem. Firstly voting systems have exacting requirements and secondly, the stakes are high with the threat of state level interference.
It’s that time of year again. I’ve had a chat with my colleagues at Consult Hyperion, gone back over my notes from the year’s events, taken a look at our most interesting projects around the world and brought together our “live five” for 2019. Now, as in previous years, I don’t expect you to pay any attention to our prognostications without first reviewing our previous attempts, otherwise you won’t have any basis for taking us seriously! So, let’s begin by looking back over the past year and then we’ll take a shot at the future.
As we start to wind down 2018, let’s see how we did…
1. Open Banking. Well, it was hardly a tough call and we were bang on with this one. We’ve been working on open banking projects in the UK, on the continent and beyond. What seems to be an obviously European issue, is of course a global one and we’ve been helping the global payment brands understand the opportunities. Helping existing market participants and new market entrants to develop and implement responses to open banking has turned out to be intellectually challenging and complex, and we continue to build our expertise in the field. Planning for the unintended consequences of open banking and the potentially un-level playing field that’s been created by the asymmetry of data, was not the obvious angle of opportunity for traditional tier one banks.
2. Conversational Transactions. Yes, we were spot on with this one and not only in financial services. Many organisations are shifting to messaging channels for customer support and for transactions, in both the banking and retail sectors. The opportunity for this continues with the advancements of new messaging enablers, such as the GSMA backed RCS. But as new channels for support and service are introduced to the customer experience, so are new points of vulnerability.
3. The Internet of Cars. This is evolving although the security concerns that we spoke about before, continue to add friction to the development of new products and services in this area. Vulnerabilities to card payments or building entry systems are security threats, vulnerabilities to connected or autonomous vehicles are potentially public safety threats.
4. Artificial Intelligence. Again, this was an easy prediction because many of our clients were already active. Where we did add to thinking this past year, it was about the interactive landscape of the future (i.e. bots interacting with bots) and how the identity infrastructure needs to evolve to support this.
5. Tokens/ICOs. Well, we were right to highlight the importance of “tokens” (the basis of Initial Coin Offerings, or ICOs) and our prediction that once the craziness is out of the way, then regulated token markets will become significant looks to be borne out by mainstream commentary. At Money2020 Asia in Singapore, I had the privilege of interviewing Jonathan Larsen, Corporate Venture Capital Manager at Ping An and CEO of their Global Voyager Fund (which has a $billion or so under management). When I put to him that the tokenisation of assets will be a revolution, he said that “tokenisation is a really massive trend… a much bigger story than cryptocurrencies, initial coin offerings (ICOs), and even blockchain”.
As we said, 2018 has seen disruption because the shift to open banking, starting in the UK,has meant the reshaping of financial services while at the same time the advance of AI into the transaction flow (transactions of all types, from buying a train ticket to selling corporate bonds) begins to reshape the way we do business.
This year we are organising our “live five” in a slightly different way, listing them by priority to our clients rather than as a simple list. So here are the four key technologies that we think will be hot throughout the coming year together with the new technology that we are looking at out of the corner of our eyes, so to speak. The mainstream technologies are authentication,cross-sector digital identity, digital wallets for ticketing and secure IoT in the insurance sector. The one coming up on the outside is post-quantum cryptography.
So here we go…
1. With our financial services customers we are moving from developing strategies about open banking to developing implementation plans and supporting the development of new systems and services. The most important technology at the customer interface from the secure transactions perspective is going to be the technology of Strong Customer Authentication (SCA). Understanding the rules around which transactions need SCA or not is complicated enough, and that’s before you even start working out which technologies have the right balance of security and convenience for the relevant customer journeys. Luckily, we know how to help on both counts!
As it happens, better authentication technology is going to make life easier for clients in a number of ways, not only because of PSD2. We are already planning 3D Secure v2 (3DSv2) and Secure Remote Commerce (SRC) implementations for customers. Preventing “authentication friction” (using e.g. FIDO) is central to the new customer journeys.
2. Forward thinking jurisdictions such as Canada and Australia have already started to deliver cross-sector digital identity (where in both cases we’ve been advising stakeholders). New technologies such as machine learning, shared ledgers and self-sovereign identity, if implemented correctly, will start to address the real issues and improvements in know your customer (KYC), anti-money laundering (AML), counter-terrorist financing (CTF) and the management of a politically-exposed person (PEP). The skewed cost-benefit around regtech and the friction that flawed digitised identity systems cause, mean that there is considerable pressure to shift the balance and in the coming year I think more organisations around the world will look at models adopted and take action.
3. In our work on ticketing around the world, we see a renewed focus on the deployment of real digital wallets. Transit and other forms of ticketing (such as for
sporting events) are the effective anchor tenants of the digital wallet, not payments. In the UK and in some other countries there has been little traction for the smartphone digital wallet because of the effectiveness of the deployment and use of contactless cards. If you look in your real wallets, most of what your find isn’t really about payments. In our markets, payments alone do not drive consumers to digital wallets, but take-up might be about to accelerate. It’s one thing to have xPay put cards into a digital wallet but putting your train tickets, your sports rights and your concert passes into a digital wallet makes all the difference to take-up and means serious traction. Our expertise in using the digital wallets for applications beyond payments will give our clients confidence in setting their strategies.
4. In the insurance world we see the business cases building around the Internet of Things (IoT). The recent landmark decision of John Hancock, one of the oldest and largest North American life insurers, to stop selling traditional life insurance and instead sell only “interactive” policies that track fitness and health data through wearable devices and smartphones is a significant step both in terms of business model and security infrastructure. We think more organisations in the insurance sector will develop similar new services. Securing IoT systems becomes a priority. Fortunately, our very structured
risk analysis for IoT and considerable experience in the
practical assessment of countermeasures, deliver a cost-effective
5. In our core field of security, we think it’s time to start taking post-quantum cryptography (PQC) seriously not as a research topic but as a strategic imperative around the development and deployment of new transaction systems. As many of you will know, Consult Hyperion’s reputation has been founded on the mass-market deployments of new transactions systems and services and this means we understand the long-term planning of secure platforms. We’re proud to say that we have helped to develop the security infrastructure for services ranging from the Hong Kong smart identity card, to the Euroclear settlement system and from contactless payments to open loop ticketing in major cities. Systems going into service now may well find themselves overlapping with the first practical quantum computer systems that render certain kinds of cryptography worthless, so it’s time to add PQC to strategies for the mass market.
And there you have it! Consult Hyperion’s Live 5 for 2019. Brexit does not mean the end of SCA in the UK (since PSD2 has already been transcribed into UK law) and SCA means that secure digital identities can support transactions conducted from digital wallets, and those digital wallets will contain things other than payment instruments. They might also start to store transit tickets or your right to travel, health and fitness data for your insurance company. Oh, and all of that data will end up in the public sphere unless the organisations charged with protecting it start thinking about post-quantum cryptography or,as Adi Shamir (one of the inventors of public key cryptography) said five years ago, post-cryptographysecurity.
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, Genghis’ grandson Kublai Khan became Emporer and determined that it was a burden to commerce and taxation to have all sorts of currencies in use, ranging from copper ‘cash’ to iron bars, to pearls to salt to specie, so he decided to implement a new currency. The Khan decided to replace copper, iron, commodity and specie cash with a paper currency. A paper currency! Imagine how crazy that must have sounded! Replacing stuff with printing!”
Just as Marco Polo and other medieval travellers returned along the Silk Road breathless with astonishing tales of paper money, so commentators (e.g., me) are 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 is well on the way to becoming a cashless society, with the end of its thousand year experiment with paper money in sight.
“14% of China’s population relies on mobile payments to get around, carrying no cash, according to a survey conducted by Renmin University of China”
The natural step from here is to create digital currency so that settlement is in central bank money and there are no credit risks. Last year, the Governor of the People’s Bank of China (PBOC), Zhou Xiaochuan, set out their thinking about digital currency. He said:
[Zhou] said 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 issued 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 cash went to state clearly that “he has plans how to gradually phase out paper money”. 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 should they do this? Yao Qian, from the PBOC technology department wrote on the subject earlier this year.
To offset the shock to the current banking system imposed by an independent digital currency system (and to protect the investment made by commercial banks on infrastructure), it is possible to incorporate digital currency wallet attributes into the existing commercial bank account system so that electronic currency and digital currency are managed under the same account.
I understand the rationale completely. The Chinese central bank wants the efficiencies that come from having a digital currency but also understands the implications of removing the exorbitant privilege of money creation from the commercial banks. If the commercial banks cannot create money by creating credit, then they can only provide loans from their deposits. Imagine if Bitcoin were the only currency in the world: I’d still need to borrow a few of them to buy a new car, but since Barclays can’t create Bitcoins they can only lend me Bitcoins that they have taken in deposit from other people. Fair enough. But here, as in so many other things, China is a window into the future.
Alipay, WeChat Wallet, and other Chinese third party payment platforms use financial incentives to encourage users to take money out of their bank accounts and temporarily store it on the platform itself.
You can see the potential problem with digital currency created by the central bank. 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 and therefore understand the PBOC position.
Following this line of thinking, then, central banks are not going to issue cryptocurrencies and they are not going to issue digital currencies either (at least in the foreseeable future). But what they might do is to allow commercial banks to create digital currency under central bank control. You could have the central bank provide commercial banks with some sort of tamper-resistant smart chip that would mint commercial bank money under the control of the central bank. Wait a moment, that reminds me of something…
Would a central bank go for this? Some form of digital cash that can be passed directly from person to person like Bitcoin rather than some form of digital money like M-PESA, using hardware rather than proof-of-work to prevent double spending? Well…
“It’s not that you use the phone to order money transfers, as is done today, but having bills in the cellular and being able to pass them on from one user to another,” he said.
Clearly at least one of them would! So here’s a “what if” and I’m genuinely curious as to your comments…
What if we dust off the old Mondex specifications (not difficult for us because some of the people who wrote them still work at Consult Hyperion) but this time implement it in SIMs and Secure Elements instead of contactless smart cards? Then we would have genuine digital currency that could work online and offline, work for inter-personal transactions as well as business transactions and allow things to pay other things. With the 20th anniversary of Multos just gone, maybe Mondex’s time has finally come!
I must say, I tend to agree with Andy Haldane on the wisdom of crowds. These are crowds which, in the UK at least, are wrong about almost everything*. There is no hope, to be honest, unless the robots take over pretty sharpish. But that’s by the by. Andy is once again on the money (literally – he’s the Executive Director, Monetary Analysis & Statistics at the Bank of England) commenting on the public’s opinion on matters of high finance:
“The public should not have a direct say in setting interest rates because they can show ‘madness’ when making collective decisions – just look at Boaty McBoatface, the Bank of England’s chief economist has warned.”
Now, as a general rule, I don’t think that the general public should have a direct say in anything at all, including who should run the country. More evidence for the triumph of shameless populism over the reasoned arguments of actual experts came at the recent CityChain17 event in London.
“it was Gideon Greenspan CEO CoinSciences and brains behind MultiChain that for me stole the show, although Dave Birch at Consult Hyperion was the audience’s favourite “
As I said, it is important not to listen to the wisdom of crowds. Had I paid to go to the event, it would have been to listen to Gideon, not me. His excellent presentation on the difference between a blockchain and database and the niches that the former ought to fill stole the show for me, and illustrated clearly why Multichain is growing in the corporate market.
The point of my presentation, on the other hand, wasn’t to discuss which particular shared ledger architecture was best or which particular kind of blockchain implementation of a shared ledger architecture might be most appropriate in different circumstances, but to draw on Consult Hyperion’s practical experiences advising clients in the financial sector to ask where the biggest impact of shared ledger technologies might be.
I used the example of supply chain applications in my talk because it was something that I happened to write about a few days ago and made the point that shared ledger technologies make more sense as a regtech rather than as a fintech, Since these technologies are about sharing information between companies, and between companies and regulators, then it seems to me that they will be more effective at reducing the aggregate costs of a market than the private costs of individual stakeholders.
How, though, can we create a new kind of market where competitors can share sensitive information yet keep it confidential? The idea of translucent transactions is key to all of this. Companies trading with each other may not want the details of those trades to be public, but the public may want to know that those trades are legal. Hence we need to find a way to audit information that remains hidden from us. This is an idea that I first heard expressed a couple of decades ago by one of the cypherpunk founding fathers, Eric Hughes.
I had the pleasant experience of having dinner with Nicholas Negroponte, John Barlow and Eric Hughes, author of the cypherpunk manifesto, at a seminar in Palm Springs. This was in, I think, 1995. I can remember Eric talking about ‘encrypted open books’, a topic that now seems fantastically prescient.
Eric’s ideas date back to 1993. A decade on, Nick Szabo was inspired by these ideas to write about confidential auditing, which in turn inspired my colleagues and I to explore ideas of ambient accountability a decade later. Now in the 1990s and 2000s, techniques such as homomorphic encryption and zero-knowledge proofs may have seemed for the lab only, but shared ledgers need these technologies and can exploit them to create new ways to solve old problems. And the business case is there too. For all the talk of the blockchain being instant and free (it isn’t), the ability to send money across the internet as quickly and as cheaply as, say, M-PESA doesn’t create anything like the cost-benefit disruption as the ability to reduce compliance costs does.
RegTech has been supplying some of the best use cases in banking. From the early customer engagement stages like KYC and Identity to compliance management, risk and reporting, the potential to reduce costs and create new customer engagement opportunities is tremendous for RegTech. Banks are also actively looking for solutions to better interfaces with regulators.
This idea makes sense to me much more than using a blockchain for (for example) payments. The idea of shared ledger that allows the FCA to continually monitor a bank’s books to see that it is solvent without being able to see the private information of creditors or debtors is very, very appealing. And it doesn’t shoehorn this fascinating new technology into emulating existing structures but allows us instead to create new and more efficient markets.
By the way, the blockchain as a regtech is something that will be explored at Consult Hyperion’s 20th (yes, twentieth) annual Tomorrow’s Transactions Forum in London next week where my colleague Steve Pannifer and our good friend Vasily Suvorov from Luxoft will be presenting a white paper on the use of shared ledger technology to cut KYC costs and reduce the risks of fraud. And that’s not all. Thanks to the generous support of our Platinum sponsors Vocalink and Worldpay, our Gold sponsor Paysafe and our Silver sponsor CMS (and with the help of our superb communication partner ccgroup) we will be continuing our tradition of information discussion, expert comment and honest debate with a variety of leading-edge perspectives on topics ranging from W3C web payments and KYC in developing markets to zero-knowledge proofs and PSD2. And, thanks to those sponsors once again, the closing keynote on the first day will be Professor Lisa Servon from the University of Pennsylvania, a leading thinker on financial inclusion and the author of “The Unbanking of America”. There are also speakers and panelists from Lloyds, Visa, IBM, Discover, Onfido, Omidyar Network, SecureKey, QED-it, the Cabinet Office, HSBC, Sovrin, MasterCard, Masabi, Transport for the North, the Dutch Payment Association, Zopa and Yandex.
You’d be mad to miss it, so head on over here and grab yourself one of the few remaining delegate places. See you first thing next Wednesday, 26th April for another great Forum.
I stuck my head around the corner of a conference session, and to my surprise found that it was people talking about the blockchain again. Someone said that putting identity on the blockchain would help refugees and I said that I thought that might well be true, but I couldn’t be sure as no-one had defined what they meant by “identity” or “the blockchain”. I wasn’t entirely sure what they meant by “refugees” either. Talking of which, I found one wandering aimlessly through the corridors of the Venetian. Since I couldn’t offer him an identity, I decided to offer him breakfast instead.
Mr X, as I shall call him, was a refugee from IBM’s World of Watson. I’d been sent an invitation for this and had registered, but I never got a confirmation. I’m not sure why, but it might have been something to do with the form I had to fill in. The form said that if you told Watson the reason for your visit, then Watson would set up an agenda for you at the event. So I told Watson that the reason for my visit was to overthrow the United States government and to set up a workers and peasants’ anarcho-syndicalist commune. So not only did I not get my invite, but now I’m on the no-fly list as well. Anyway, Mr. X told me that there was a lot of fun stuff going on over in the AI world and I don’t doubt it. But I didn’t have time to stay and chat because I was off to the theatre.
It turns out that I couldn’t get a ticket for the actual theatre so I decided to set up a security theatre instead. All week, I kept getting asked for “photo ID”. The first time it happened, I explained to the young woman that carrying identity around with you is something that I associate with continental socialism and that since I came from the Disunited Kingdom and not North Korea I was not in the habit of carrying and presenting my papers. In fact, as I further explained to her, since my identity is important and valuable and hard to replace, I had locked it up in the safe in my hotel room. She remained unmoved and demanded photo ID. So I showed her the expired building pass for CHYP Tower in New York. This is apparently perfectly acceptable as proof of identity throughout the continental United States and the woman was happy to charge my card following its presentation. Throughout the rest of my visit, every time I was asked for photo ID I presented by expired building pass and every time it was accepted without question. Every. time.
Meanwhile, it was time to go downtown and get involved in some serious fintech shenanigans. I decided to sniff around payments, but most of the camp fire talk was about the transition to in-app and the use of tokenisation to move chip and PIN security online (see the MasterCard announcement, for example) and I read one of the chaps from Bell ID talking about “in-apptitude” (which I rather like) to describe the new strategies for secure and convenient remote payments. But this is old hat. I’ve been boring our clients to death with this stuff for years. And no-one would disagree that #appandpay is going to be more important than #tapandpay. Right?
I decided to seek out more controversial opinions. Here I am engaged in a heated debate with a noted retail banker over the likely future identity and verification ecosystem. He said that given the dynamics of the space, and given that banks already have to carry out rigorous KYC, it makes sense for banks to develop a co-operative sector-wide kind of financial services passport that could be used cost-effectively by third-parties while the underlying identities are strongly protected by tried and tested cryptographic techniques including tokenisation and blinding. I said “wha-hey you’re my best mate you are! Up the Blues!” and we agreed that Terry Phelan was a great player.
By the final morning, I was going about my normal business, albeit in a persistent vegetative state, when I ran into the shy and retiring head of the Emerging Payments Association. We had a fruitful discussion about using strong biometric authentication against revocable tokens to use pseudonyms (with strongly-attested attributes) in transactional environments and making it the de facto model that will deliver both security and privacy for transactions of many kinds. He said that he thought that this might be where the blockchain makes sense because the transparency around shared reputation management was a positive, whereas sharing private transactions was a negative and would require complex strategies to maintain commercial confidence. I said “stop shouting”.
I think that for our clients and friends in the USA, the most important commercial announcement was the launch of Zelle by EarlyWarning. Zelle will launch in 2017, the equivalent of Paym/PingIt in the UK: instant account-to-account payments. It launched with 19 banks: Ally Bank, Bank of America, Bank of the West, BB&T, BECU, Capital One, Citi, Fifth Third Bank, FirstBank, First Tech Federal Credit Union, Frost Bank, JP Morgan Chase, Morgan Stanley, PNC, USAA, U.S. Bank and Wells Fargo. Pretty impressive. If you look at Venmo’s hockey stick, it’s clear that a P2P proposition has a ready market. But my sense of Venmo is that it suceeded because of social media integration so I suspect that Zelle’s long term role will be as an API for other platforms (e.g., Facebook) to use rather than as a standalone app or something that is tucked away in bank apps. This is the sort of thing that is best considered with a Mai Tai, by the way.
I was left trying to work out exactly how much I lost in the casinos. I think it might have been as much as $80, because I’m pretty much of a high roller, especially when egged on by VocaLink Vixens and Money2020 Molls. It’s well known that men take risks in the presence of attractive women and I have a suspicion that this may form part of the casinos’ business model. Just a suspicion. Still. Vegas.
It’s amazing who you bump into at Money2020. I caught up with a great many old friends and made quite a few new ones. It’s hard for me to say what the key takeaways from the event were this year but I’ll try to name a top three and then see if any of you agree with me via the comments section!
Fintech isn’t the wild west any more and the use of new technologies to drive new business models in financial services is mainstream. Yes, legacy profit pools will be attacked, but unless the incumbents are totally stupid (and the ones that Consult Hyperion works for are, I can assure you, not) they will assimilate them: biometrics, chatbots, AI etc. The threats to my clients’ businesses are not their traditional competitors and not the fintechs, but Amazon, Apple, Google, Facebook and Alipay because these are where customers check in but may well never check out. Bumper sticker: It’s the discovery, stupid.
People talk a lot of rubbish about the blockchain. Bumper sticker: They’re not smart and they’re not contracts.
On which topic, one last tale.
The Tale of the Emporer’s New Blockchain
Once up time, there was an Emperor. He ran a marvellous financial institution. One day, a stranger came to town and she went to see the Emperor and showed him a blockchain. The Emperor said “I can’t see anything”. The stranger told him that only very clever people and management consultants could see the blockchain. The Emperor didn’t want to seem stupid, or provincial, or behind the times, so he told himself that he could see the blockchain after all and that it was beautiful.
The Emperor went and told all of the people about his blockchain and the people were very happy.
After a while, though, the people shouted that they wanted to see the blockchain, so the Emperor decided that he would show it to them and impress them. And he took out the blockchain that the stranger had given him and showed it to the crowed.
But then one small boy consultant standing at the back said “I can’t see a blockchain. And you have only one node so there is no need for a consensus mechanism”. And then everyone in crowd realised that was the boy said was true. There was no blockchain, just a database run by the Emperor as before.
The Emperor was upset at first, because everyone else had a blockchain and he didn’t. But then he realised that no-one else had one either, so he cheered up and started to invest in artificial intelligence chatbots instead and he lived happily ever after because he had a defined benefit pension.
Thinking about it, almost all of the interesting things I saw or heard about weren’t really about fintech and payments, they were about regtech and identity. It’s almost as if Identity2020 is the new Money2020, so to speak. See you next year.
Look, I don’t mean to imply that everyone who wants to keep cash, and in particular high-value banknotes, in circulation is doing so only to help to minimise the costs of criminal enterprise and to facilitate money laundering on a grand scale. That would be ridiculous, On the other hand, though, there does seem to be some correlation between flipping great wodges of cash and at least the suspicion of not entirely above board entrepreneurship. But that aside…
Police arrested Dmitry Zakharchenko, the deputy head of the Energy Industry Department of the General Administration of Economic Security and Combating the Corruption (GAESCC)… According to investigators, police seized a sum of some $120 million and € 2 million ($2.2 million).
Who knew a life in public service could be so rewarding? I’m sure there are entirely innocent reasons why Dmitry had a A HUNDRED AND TWENTY MILLION DOLLARS in cash in his apartment. Perhaps he didn’t get time to pop to the bank, or perhaps the night safe was broken. Either way, I imagine it must have been rather inconvenient to step over flipping great wodges of cash to get to the bathroom in the middle of the night, so it makes me wonder why he didn’t either deposit the money in a bank (although I imagine yellow press scare stories about negative interest rates might have put him off) or convert it to something with less volume. Bitcoin might have been a good choice, but I suspect that like most people in a similar situation, the untraceable nature of cash must have been appealing for some reason.
I keep my cash under the bed but I’ve put some on the top of the bed ready for Money2020.
While people often refer to bitcoin as anonymous, it really isn’t. Ah, you might say. But in the world of bitcoin, smart criminals will use mixers and such like to obfuscate the origin of coins and thus confound the authorities. Yeah, whatever. That’s because criminals aren’t using it for large scale enterprise. As soon as they do, I don’t doubt that the relevant authorities will take quick and simple action. Bitcoins lack of fungibility makes it vulnerable to straightforward regulation in that respect.
But what if law enforcement goes to the biggest miners in the world (representing at least 51% of the hashpower) and tells them that if they continue to confirm easily identifiable mixing transactions, they will be accused of money laundering.
That’s that then. If bitcoin isn’t going to be used for money laundering, then what is it going to be used for? Certainly not the purchase of goods or services, not as a store of value (except for speculators) and certainly not as a mechanism for deferred payments, since there is no real reason to imagine that it will still be around a decade from now.
“The total addressable market of people who want to buy bitcoin is very, very thin,”
Indeed. And most of them aren’t in America or any other developed market. I don’t have time to go and check the latest figures but as far as I know pretty much all of the Bitcoins in the world are being bought for Yuan and traded on Chinese exchanges. It’s easy to understand why.
Bitcoin is more expensive and inconvenient than regular banking is, and far more expensive and inconvenient than regular banking could be if it starts supporting smart transactions on public ledgers without bothering with the baggage of mining.
This robust (and accurate) remark from Bram Cohen (the chap who invented BitTorrent) is just what the Bitcoin chaps don’t want to hear. As I’ve said before, and will say again (having being falsely accused of being “anti-Bitcoin” today), I think Craig Wright’s observations on this topic are that ones that resonate with me.
The mining of bitcoin is a security service that alone creates no wealth. Consequently, those using the network pay for the service.
A shared security service that people will pay to use seems like a much better way to imagine Bitcoin than as a new form of payment or a new kind of currency. This shared security service may be used for a great many things, most of them as yet undiscovered, and I don’t doubt that people will try and possibly succeed to build a viable payment service on top of Bitcoin, but I am unconvinced that Bitcoin itself will be that mass market payment service to take on Visa and MasterCard.
Once again I’ve been involved in a series of Twitter exchanges about the relationship between cash and anonymity. Many in the Bitcoin community see Bitcoin’s sort-of-anonymity as an important characteristic because it defends the individual against state power and they berate me for wanting to replace cash “in circulation” with a digital alternative. Cash, they claim, is freedom. One odd aspect of this argument is that the cash is, of course, a byproduct of the leviathan they affect to despise.
Narayana Kocherlakota, formerly the head of the Federal Reserve Bank of Minneapolis and now a prolific economics blogger, penned a recent article on the abolition of cash. Kocherlakota makes the point that if you don’t like government meddling in the proper functioning of free markets, then you shouldn’t be a big fan of central bank-issued banknotes.
I’m not, as it happens. In fact, I think we should start to consign them to the dustbin of history, beginning with the $100 bill, the £50 note and that affront to law-abiding people everywhere, the Swiss 1,000 franc note. There are an increasing number of people coming around to my way of thinking, including the former chief economist to the International Monetary Fund (IMF) Kenneth Rogoff, who recently published a book entitled “The Curse of Cash” in which he argues that banknotes should be withdrawn not only because of their use in criminal endeavours but because they prevent central banks from using their full range of monetary policy tools.
Kocherlakota doesn’t mention it explicitly, but should cash be abolished in order to remove the lower bound to interest rates, a potential replacement would be a new central bank-issued emoney, either Fedcoin or what Dave Birch has dubbed FedPesa.
But without wishing to be accused of pedantry, what does he mean by “central bank-issued electronic money”? In his presentation on ’The Zero Lower Bound and Anonymity”, Kocherlakota tends toward some form of cryptocurrency to replace fiat currency rather than a central bank digital currency and one of the reasons for this is his (entirely reasonable) concern about anonymity. This point is illustrated by literary reference.
In Atwood’s dystopian Handmaid’s Tale, a theocratic government named the Republic of Gilead has taken away many of the rights that women currently enjoy. One of the tools the Republic uses to control women is a ban on cash, all transactions now being routed digitally through something called the Compubank
It’s been many, many years since I read “The Handmaid’s Tale” so I went to my bookshelf to dig it out and re-read that part. The narrator talks about how the evil junta in charge of future America took over and says that it would have been harder if there had still been paper money. I don’t see how. North Korea has everyone using paper money and virtually no cards. Denmark has virtually no paper money and everyone uses cards (and phones). To be frank, in the modern world, I don’t think cash is that closely related to dictatorship.
The point I wanted to make here, though, is that it is wrong to present the alternatives as total surveillance and anonymity. I simply do not accept that the alternative to the unconditional anonymity of cash and the crime that goes with it is a dystopian, totalitarian nightmare. That’s only one way to design a circulating medium of exchange and it’s not the way that I would design it. I would opt for something along the lines of a universal pseudonymous mechanism capable of supporting an arbitrary number of currencies, a Mondex de nos jours, an M-PESA with go-faster stripes. In a world where there are completely, unconditionally anonymous payment mechanisms in widespread use there’s no way to stop very bad people from using them to do very bad things, so I’d prefer a world in which there are pseudonymous mechanisms that defend against routine surveillance and petty intrusion but allow societies legitimate interests to protect against crime.
Does this mean that anonymous mechanisms should be banned? Probably not, for the good reason that it would be impossible to do so. More likely would be a situation shown in the diagram below where there is an anonymous layer that has a pseudonymous layer on top of it and a absonymous (I made this word up) on top of that. People, governments and businesses would use this pseudonymous layer: the anonymous money would be useless for almost all transactions for almost all people since no-one would accept it. I would love to give this kind of anonymous money the generic name ZeroCash, after the William Gibson novel (“Count Zero”) in which one of my all-time favourite quotes about the future of money appears:
‘He had his cash money, but you couldn’t pay for food with that. It wasn’t actually illegal to have the stuff, it was just that no- body ever did anything legitimate with it.’
Unfortunately, someone else has already beaten me to it and not as a generic name! [See E. Ben-Sasson, A. Chiesa, C. Garman, M. Green,I. Miers, E. Tromer, and M. Virza, “Zerocash: Decentralized anonymous payments from bitcoin” in IEEE Symposium on Security and Privacy, SP 2014, Berkeley, CA, USA, May 18-21, 2014. IEEE Computer Society, pp.459–474 (2014)]. Well, I’m fighting back by starting use zerocash (with the lower case initial) to mean generic unconditionally anonymous electronic cash. The wallet that this electronic cash is stored in is an anonymous digital identity. It’s just a string of bits.
Now, you could imagine some form of zerocash in circulation as a cash alternative but not accepted in polite society (i.e., any attempt to spend it would be regarded as prima facie evidence of money laundering and exchanges would be barred from handling it). Polite society instead decides to protect privacy through managed conditional anonymity, or pseudonymity. A pseudonymous currency that is managed by a central bank but where transactions take place on a distributed ledger is much more like “RSCoin”, the cryptocurrency proposed by George Danezis and Sarah Meiklejohn at UCL [Danzis, G. and S. Meiklejohn. “Centrally Banked Cryptocurrencies”, NDSS ’16, 21-24 February 2016, San Diego, CA, USA] using Ben Laurie’s “mintettes” concept. By creating a pseudonym that is bound to the zerocash digital identity, we make it useful (provided that the binding is done by someone who trusted in the relevant transactional use cases).
Why bind it in this way? Well, there is the usual privacy paradox to be dealt with here: I want my transactions to be anonymous, but everyone else’s to be not anonymous in case they turn out to be criminals. I cannot see any way round this other than pseudonymity. There are people out there (e.g., my colleagues at Consult Hyperion) that know how to design systems that work like this, so there’s nothing stop the FATF, Bank of England, or Barclays or anyone else from starting to design the future, privacy-enhancing electronic money system that we need.
Let’s move on. For certain purposes, pseudonymity might be deemed insufficient (e.g., KYC) and so that nym layer is needed too. This means we need to bind the pseudonym to real-world legal entity. A bank is a good place to form this binding, since they’ve already done the KYC and know who I am. So I give present my pseudonym to them and they can bind it to my “real” name to form a nym. In the example below, Barclays know who I really am, and I can present my Barclays nym where needed, but most transactions with counterparties take place at the pseudonymous layer and I can present my Vodafone pseudonym “Neuromancer” there if I want to. My counterparty doesn’t know that I am Dave Birch, only that Vodafone know who (and presumably, where) I am. For the overwhelming majority of day-to-day transactions, this is more than adequate. This layered approach (show below) seems to me a viable vision of a working infrastructure. Few transactions in the top layer (for privacy), most transactions in the middle layer, few transactions at the lower layer.
So in this made-up example, Barclays know my “real” identity and Vodafone knows a persistent pseudonym tied to my phone number. (Of course, I could go to Barclays and choose to bind my Vodafone identity to my Barclays identity, but we don’t need to think about this sort of thing here.) I’m going to reflect on how these bindings might work in practice more in the future, but for now I want to circle back to that opening concern about losing the anonymity of cash. Here’s another version of that meme that I read I day or two ago.
Cash—the familiar, anonymous paper money and metallic coins that most of us grew up using—isn’t just convenient, it’s also a powerful shield for our autonomy and our privacy.
It really isn’t. Your privacy is being taken away because of Facebook, people wearing Snapchat shades and drones, not because of debit cards. And none of this has anything to do with dictatorship. I wouldn’t want to live in the America of the “The Handmaid’s Tale” whether it had anonymous payments or not. I understand the concerns of those concerned with privacy (as I am) that there might be an inevitable tendency for a government to want to trespass on the pseudonymous infrastructure in the name of money laundering or terrorism, but that’s a problem that needs to be dealt with by society, not by technology. I don’t know what the answer to that is, but I do know that we need to get the conversation started in a more sophisticated way.
Yesterday we were chatting about the Governor of the Bank of England’s comments about central bank digital currency. I said I thought this was a good thing. Other people think the same.
The new Positive Money report on Digital Cash recommends that central banks should issue digital cash for six main reasons: it widens the range of options for monetary policy, it can make the financial system safer, it can encourage innovation in the payment system, it can recapture a portion of seigniorage, it can help to develop alternative finance businesses and it can improve financial inclusion.
This was part of a session that also included evidence from my good friend Simon Taylor, formerly of Barclays Bank, and the noted financier Blythe Masters who is in charge of Digital Asset Holdings (DAH) and you can see it all online here.
OK, so far so good. I’ve written about this topic in exhausting detail before, and the truth is I’m rather a fan of a strategic and planned shift towards digital currency. But the article goes on to say…
Earlier this year Broadbent floated the idea of using distributed ledger technology to enable individuals to hold digital currency accounts with the central bank.
Surely use or otherwise of distributed ledgers is tangential and irrelevant to the issue of digital currency. The payment mechanism has nothing to do with the currency. So, if Dr. Broadbent means that the Bank is thinking of using a shared ledger to manage personal accounts for individuals, where account transfers are settled instantly in central bank balances, then all to the well and good.
I simply do not see the efficiency of “a digital form of legal tender” as being evidence that the government might issue a UK cryptocurrency as some in the Bitcoin world have said.
On the other hand, if Dr. Broadbent means that the Bank his going to set up a shared ledger that will be implemented using a blockchain that incentivises consensus-forming work with an on-chain asset (i.e., a Bitcoin-like Britcoin) then I think he must have been inadequately briefed. Why on Earth would a central bank abandon its money supply management duties to a cryptographic algorithm? That makes no sense at all.
Since the latter explanation is implausible — and if you listen to his evidence to the Lords you will notice that deputy governors of the Bank of England are very well-briefed indeed — the only explanation for the “Britcoin” tag is journalists confusing digital currency and cryptography and jumbling up the use of double-permissionless shared ledgers with double-permissioned shared ledgers. I suppose it’s an easy mistake to make, so let’s put it to bed once and for all. Here is a handy cut-out-n-keep guide:
Would the Bank of England get behind a Sterling-backed Bitcoin? I think not. In fact, I think I’m coming round to Robert Sam’s thinking about the role of Bitcoin in the greater scheme of things with respect to the co-evolution of money and technology. Robert wrote a very good note about this called “Some crypto quibbles with Threadneedle Street” in response to one of the early Bank of England research notes about Bitcoin back in 2014, suggesting that, as he put it, “digital currency with a deterministic money supply function” is not a feature but a limitation of early cryptocurrency designs (and that a capped supply function such as Bitcoin’s is a “bug” on economic grounds).
As to the key question of whether a central bank or someone else should provide money, Robert alludes to the problem with the marginal cost of the production of competing private monies, what I often refer to in blog posts and talks as the big problem of small change. The problem is this. If privately produced money is successful as a means of exchange and earns a profit for its producer in the form of seigniorage (it is hard to see how cash replacement can earn transaction fees so in the long term I imagine these to be asymptotic to zero) then it will invite competitors and those competitors, provided the monies they produce are reasonable substitutes for each other, will drive down the cost of the private money to its marginal cost of production. In our digital world, however, the marginal cost of production is to all intents and purposes zero and so that private companies will bail and only the state can deliver the a sustainable money as a means of exchange (remember, this has nothing to do with it being a currency or not).
Hence it is very difficult to imagine how competing private currencies that are nothing more than direct substitutes for national fiat currencies can obtain any traction at all. This nudges me further towards thinking that if the imperfections of fiat currency are to be addressed in the free market it will be by currencies that are more closely linked to the communities that use them and that embody some values of those communities. I often use the example of a gold-backed interest-free electronic currency for the Islamic diaspora as a simple thought experiment, a sort of hard ECU for the new millennium, a currency that will be widely used but never exist in physical form. But that’s for another time.
Suppose, however, that we stay with fiat currency and central banks. Now, if Bitcoin is to be used in that role (i.e. as a medium of exchange) it’s volatility is undesirable but that does not mean that it needs to display the long-term stability that is required of a store of value. That’s a different function of money and can be implemented in a different way. It does however mean that Gresham’s Law will come in to play and drive Bitcoins out of the marketplace (to speculators, at least in the short term) and that no-one will hold them for transaction purposes. As far as I can tell, this is where we are now anyway.
So what does all of this mean? Well I’m not sure I have any more insight into this than any other commentators but my take on it is that while the marginal cost of production of Bitcoin is undeniably higher than the marginal cost of production of other kinds of private money, that doesn’t really mean anything because Bitcoin will never be used as money in the same way. On the other hand it does mean that it is hard to imagine why anyone who wants to produce private money, and in particular a digital version of a fiat currency, will use it even if they want to use a shared ledger for other reasons (something I personally favour). On the contrary, since we have no reason to suspect that the proof-of-work and blockchain structure is the best consensus mechanism, it seems more likely that if (say) the Bank of England were to decide to implement a digital sterling, then it is highly likely that they would use some other mechanism that relies on validators (e.g., commercial banks) rather than miners. Let’s come back to this in a minute.
I don’t think there’s ever going to be a Britcoin. Central-bank digital currency is about balances and an appropriately private protocol for moving value between accounts. My prediction is that this would look more like the bastard child of Ripple and M-PESA than a blockchain cryptocurrency with a 1-1 reserve in Sterling. And guess what…
As I was sitting down to finish off this post, what should flow in through the internet tubes but Bank of England Staff Working Paper No. 605 by John Barrdear and Michael Kumhof, “The macroeconomics of central bank issued digital currencies”. This is referred to in Dr. Broadbent’s evidence to the House of Lords. It says that (amongst other things) that
We study the macroeconomic consequences of issuing central bank digital currency (CBDC) — a universally accessible and interest-bearing central bank liability, implemented via distributed ledgers, that competes with bank deposits as medium of exchange. In a DSGE model calibrated to match the pre-crisis United States, we find that CBDC issuance of 30% of GDP, against government bonds, could permanently raise GDP by as much as 3%, due to reductions in real interest rates, distortionary taxes, and monetary transaction costs. Countercyclical CBDC price or quantity rules, as a second monetary policy instrument, could substantially improve the central bank’s ability to stabilise the business cycle.
Did you see that? Permanently raise GDP by as much as 3%. Scatchamagowza. Permanently raise GDP by as much as 3%. Why aren’t we doing it right now! Let’s draw a line under the money of the past and focus on the money of the future.
I’ve read the working paper and while I don’t understand the economic model at the heart of it (I have no idea what “credit cycle shocks policy rate corridors” are) I do understand the implications and the observations of the authors. I have come to similar conclusions but from the technological direction. Since the observations of the Bank from an economic perspective correlate so closely with my observations from the technological perspective (I think I may have mentioned that I’m writing a book about this at the moment) I think I’ll finish here just by highlighting a few key points that I have mentioned on the blog before.
A monetary regime with central bank-issued national digital currency (i.e., digital fiat) has never existed anywhere, a major reason being that the technology to make it feasible and resilient has until now not been available.
The monetary aspects of private digital currencies (a competing currency with an exogenous predetermined money supply) are undesirable from the perspective of policymakers. Also the phrase “digital currency” is perhaps a regrettable one as it may invite a number of misunderstandings among casual readers.
Digital fiat means a central bank granting universal, electronic, 24 x 7, national currency denominated and interest-bearing access to its balance sheet. The Bank says that they envisage the majority of transaction balances will continue to be held as deposits with commercial banks and observes as I did above that digital currency has nothing to do with shared ledgers, distributed ledgers or blockchains.
The cheapest alternative for running such a system would clearly be a fully centralised architecture (M-PESA in Keyna is the obvious example) but as the Bank notes this will come with increased resiliency risks that are likely to be deemed unacceptable. However, options that are distributed but permissioned would provide an improvement in the efficiency of settlement and serve to improve resiliency relative to the status quo, both of which would represent a reduction in cost the real economy.
The key feature of such a permissionless shared ledger system is that the entire history of transactions is available to all verifiers and potentially to the public at large in real time. It would therefore provide vastly more data to policymakers including the ability to observe the response of the economy to shock sort of policy changes almost immediately.
There is no sane argument against digital fiat. Let’s get on with it. And let’s have no limit on the number of different currencies that the ledger might hold.
In the speech that the Governor of the Bank of England eh, Mark Carney, didn’t give to the Mansion House in June he devoted some considerable time to the general topic of shared ledger technology, even going so far as to say that
In the extreme, a [shared ledger] for everyone could open the possibility of creating a central bank digital currency.
I am not sure that I completely follow Mr Carney’s logic here and I don’t have the benefit of the expert advice that he must have received in connection with this statement but as far as I can tell, there are two entirely separate issues to examine here. The use of the distributed ledger for RTGS, which is the context in which it is mentioned earlier in Mr. Carney’s speech, is wholly unrelated to the provision of a central bank electronic currency and whether it might or might not be a good idea for the Bank of England to create such is nothing to do with the technology.
I suspect that the confusion may have arisen because of the tendency amongst management consultants (and others) to conflate the two entirely different kinds of electronic money: a crypto currency and a digital currency are very different things. If Mr Carney were genuinely suggesting that one of the scenarios under consideration by the Bank of England is that it abandons its responsibility for managing the creation of money and instead turns to a crypto currency, even if it is a crypto currency that is produced as a byproduct of a double permissionless shared ledger spawned by the Bank of England itself, then the value of that currency would not only be beyond political control it would be beyond the Bank’s control and one might imagine the Bank to be somewhat redundant in such circumstances.
The Bank of England is absolutely right to be exploring this new technology and I certainly think that it has something to offer. But that does not mean that the Bank of England is going to start using Bitcoin as a settlement system or that bitcoins will replace Sterling!
On the other hand if Mr Carney were genuinely suggesting that one of the scenarios under consideration by the Bank of England is that it creates a digital currency, then I say more power to him. I cannot think of a single reason why such a digital currency would be a crypto currency or why it would be in any way related to the shared ledger used to process the payments, but that doesn’t mean it wouldn’t be a cracking idea. A digital currency platform with right APIs in place (providing risk-free, genuinely instant and zero-cost transfers between accounts with final settlement in central bank balances) would be an amazing platform for a Digital Britain.
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