On Mondex and CBDCs (again)


We were delighted to get a lot of good feedback on Neil’s previous blog on Mondex Memories and CBDCs and its relevance to CBDCs and thought it would be interesting to respond to some of the more interesting – and difficult – points raised in a follow-up blog. Before addressing those I wanted to put the Mondex program into some historical context. They were very different days – we didn’t have an intranet until 1996, let alone internet access. There were no SDKs – although actually we did build a precursor to one of those – or APIs and the idea of remote payments was still in its infancy (although we did that too).

Mondex Memories and CBDC

Mondex paraphernalia

Deep in the mists of time (that is to say, the early-1990s), I led the team from Consult Hyperion responsible for Mondex specification, design and development. For those not familiar with paleo-payments, it was one of a clutch of (contact) smart card based electronic cash systems, none of which survived beyond, let’s say, early adolescence. There were two main reasons for their demise, one technological and one business. The concept was ahead of the capabilities of the underlying technology. Transactions took about the same amount of time as cash plus change, which wasn’t a compelling reason for anyone to leave their wallet behind. The promoters of the schemes (retail banks and payment brands) did not target particular niches where there may have been a business case (I always thought car parking might work) but instead blanketed retail outlets in particular cities or small countries. So, mostly unused devices were put under the counter, and people forgot about the schemes after an initial blaze of publicity.

How Could Digital Currency Work?

The Bank of England and the UK Treasury have announced a Central Bank Digital Currency (CBDC) Taskforce to coordinate the exploration of a potential British CBDC. But how could a digital Pound actually work? As it happens, this is something that Consult Hyperion knows rather a lot about. Apart from our work on the first British central bank digital currency (Mondex) back in the 1990s, our work on the first population-scale mobile money scheme (M-PESA) in the 2000s and our work on the most transformational contactless payment roll-out (Transport for London) in the 2010s, our practical experience across implementation platforms means that we understand the architectural options better than anyone.

What will a Chinese digital currency look like?

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!”

Introducing a new currency is easy – dgwbirch – Medium

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”

Alibaba’s (BABA) “cashless week” to boost mobile payments is angering China’s central bank — Quartz

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.”

From Chinese Central Bank Goes Full Steam Ahead with its Own Cryptocurrency | Finance Magnates

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.

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

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.

China’s Future is Definitely Cashless – The News Lens International Edition

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.

From Latin American Herald Tribune – Uruguayan Central Bank to Test Digital Currency

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!

Bitcoin and banks

My old friend Alistair Milne has just published a very interesting paper on Cryptocurrencies from an Austrian Perspective (SSRN, 12th April 2017) in which he explores the use of new technology to reimplement money by taking away money creation from commercial banks and proposes 

using [cryptocurrency] to move both bank money and money-financed bank loans off balance sheet onto a single shared cryptocurrency ledger, together with government issued fiat money. This stops bank failures disrupting money and payments and hence helps achieve monetary outcomes desired by the Austrian school of economics: reducing excessive state interference in the market for credit (through bank regulation, lender of last resort and bail-out) and discouraging unsustainable money and credit expansions (leading to financial crisis and depression).

From Cryptocurrencies from an Austrian Perspective by Alistair Milne :: SSRN

As part of this interesting proposal, he talks about the “Austrian cryptocurrency myth” that tokens created in the operation of a double permissionless shared ledger could compete with fiat currencies in everyday use and concludes that for reasons relating to both technology and governance they could not. Other people disagree. Bitcoin pioneer Hal Finney (who sadly passed away in 2014) wrote this about Bitcoin back in 2010. (It’s a long quote but I need to include it in full to give context to some later comments.)

“Actually there is a very good reason for Bitcoin-backed banks to exist, issuing their own digital cash currency, redeemable for bitcoins. Bitcoin itself cannot scale to have every single financial transaction in the world be broadcast to everyone and included in the block chain. There needs to be a secondary level of payment systems which is lighter weight and more efficient. Likewise, the time needed for Bitcoin transactions to finalize will be impractical for medium to large value purchases.

Bitcoin backed banks will solve these problems. They can work like banks did before nationalization of currency. Different banks can have different policies, some more aggressive, some more conservative. Some would be fractional reserve while others may be 100% Bitcoin backed. Interest rates may vary. Cash from some banks may trade at a discount to that from others.

George Selgin has worked out the theory of competitive free banking in detail, and he argues that such a system would be stable, inflation resistant and self-regulating.

Bitcoin Bank

In my new book “Before Babylon, Beyond Bitcoin” I explore the “5Cs” who might create digital money in the future: central banks, commercial banks, companies, cryptography and communities. Hal is here talking about the second case, that of what is called “free banking”, and is right to point to George Selgin as a leading scholar in this field (here’s a podcast I recorded with George a few years ago) and his books are a must-read if you are serious about money. (You should probably also read Lawrence White’s Free banking in Scotland before 1844 to understand the relationship between competition and innovation under such circumstances.) Hal went on to talk further about this Hayekian scenario with cryptocurrency replacing gold or central bank balances for settlement.

I believe this will be the ultimate fate of Bitcoin, to be the ‘high-powered money’ that serves as a reserve currency for banks that issue their own digital cash. Most Bitcoin transactions will occur between banks, to settle net transfers. Bitcoin transactions by private individuals will be as rare as… well, as Bitcoin based purchases are today.”

Bitcoin Bank

Hal Finney was a much smarter guy than I am so I feel rather sheepish about disagreeing with him on this point. It is entirely possible that cryptocurrency will come to exist as a settlement money that connects other different monies (although my suspicion is that these will be community-based more than simply bank-based). But is this a role for Bitcoin? This kind of settlement role for blockchain technology is mentioned in BBVA Research’s recent paper on central bank digital currencies (Central Bank Digital Currencies, Gouveia et al, March 2017) which concludes that the most likely near-term use of “digital fiat” is precisely for such inter-bank payments, saying that

The most likely option in the short term is the use of blockchain technology only for wholesale payment systems. Under this scheme the CBDC would be held by banks and other participants in wholesale payment systems (but not by the general public), identified (as opposed to anonymous) and non-interest bearing. This scenario would increase the efficiency of wholesale payment systems, and has few drawbacks for the public at large or for policy makers, although banks could be hit due to higher competition with non-bank payment institutions.

While the BBVA report talks in general about central bank digital currency, it refers repeatedly to distributed ledger technology as the mechanism for managing this currency. Note that in the summary above, however, it refers specifically to “blockchain technology”. I would have thought this the least-likely form of distributed ledger to implement such a system. The main reason for using a blockchain is that it is resistant to attacks from untrusted actors who are part of the consensus-forming network. But if the central bank is going to, for example, use commercial banks as the nodes in the consensus-forming network then surely these must be trusted actors? If a rogue bank starts introducing bogus transactions, the central bank has a lot more to worry about than maintaining retail balances. But that’s by the by.

If BBVA are correct, and the future involves an inter-bank “high powered” digital fiat, then was Hal right to think that this would be Bitcoin? Here I agree with Alistair. It is not clear to me at all, even if we do get past the issues with mining centralisation, segregated witness, lightning networks and hard forks, that Bitcoin (or Bitcoin-like) blockchain-based cryptocurrencies are the way to do it but I’m open to informed debate on this point. And I imagine I’ll get it at the 20th annual Consult Hyperion “Tomorrow’s Transactions” Forum in London on April 26th and 27th. 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”.

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 on 26th April for another great Forum.

If bitcoin can’t succeed at money laundering, what can it succeed at?

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).

From Money bag: Police raid on anti-corruption official uncovers over $120mn in cash — RT News

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.

From On Fungibility, Bitcoin, Monero and why ZCash is a bad idea. – We Use Cash

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,”

From What a Tech Startup’s Pivots Say About Bitcoin’s Future | American Banker

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.

From Bram Cohen’s answer to Bram Cohen: What is the state of Bitcoin in 2016? – Quora

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.

From Bitcoin and the costs of consumption – Dr. Craig Wright Blog

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.

Blockchain as a public technology service

When people say “blockchain” they mean different things. And some of the things they mean are just absolutely, categorically different. Implications of public open blockchain designs and private blockchain designs vary drastically. I emphasis this distinction because it is key – the different designs assume and imply totally different things.

Both types are important but for different reasons, for different markets and for different use cases. I think we have passed the time when “Bitcoin bad – Blockchain good” seemed an eye opener. What this kind of argument did is it drew the attention of financial incumbents from the Bitcoin-like permissionless space to the private, permissioned space. Which makes sense for their business models. But I think they are not paying enough attention to the permissionless space. I think you are not either!

A brave slide from the Consensus conference in New York this year (unfortunately, can’t remember the name of the speaker! – let know and I’ll update), where I chaired the panel on post-trade and my colleague Dave Birch chaired panels on Identity. This illustrates that “Bitcoin bad, Blockchain good” is not set in stone.

I bet you hadn’t anticipated such a steep rise of Ethereum (the price of native Ethereum currency soared 10 times from the beginning of 2015 and Ethereum’s market cap reached 1.5 billion dollars). You may have even missed the creation of the first human-free organisation. Even if you try to keep an eye on the public blockchain world, you only get reminded of its existence when Bitcoin price surges to its 2-year high (it now trades at over 700$) and all the mainstream media cover this.

Both public and private shared ledgers (Blockchains) are essentially shared book-keeping (and computing) systems, one class – open for everyone to use (public), another – restricted to a certain group of members (private). And this is it. Open for everyone to use means lower entry barriers, it means identity-free and regulation-free shared book-keeping (and computing). What could be restricted by identity policies and financial regulations goes around this. You can, say, restrict a person from buying bitcoins by setting high KYC requirements to online exchanges (for users not to be able to change dollars for bitcoins if they are not KYC’d). You can even cut his or her internet connection. You can issue a court order to close a business that accepts bitcoins as money. And so on and so forth.

A lot of this effort looks similar to trying to stop the Internet, but I suppose the regulators can dream!

Public technology service and native digital rights

“Proof-of-work is inefficient”. So what? Let it go! Think of what’s the idea behind it and what it tries to achieve, regardless of this inefficiency. Regardless – because even if proof-of-work is not ideal, there are other permissionless technologies already developed and many more that are work in progress. Some of best minds in the world are looking to provide the benefits of permissionless shared ledger environment without the drawbacks of original Bitcoin’s proof-of-work. Just assume that they will solve that problem and move your thinking on.

What the blockchain delivers is permissionless book-keeping (and computing) public technology service (with the unchangeable and transparent transaction history as an incredibly valuable side effect). When I say “public service”, I do not mean that a company or public organisation provides it, I mean technology itself and collaborative user effort provide it. In a sense – everyone and no one. The protocol acts as the service provider.

And this is crucial. In traditional financial world, the basic value transfer layer that cryptocurrencies (i.e. everyone and no one) provide as a public technology service, is provided by companies – service providers, and is not accessible to anyone. For example, PayPal provides digital value transfer service.

Here I want to make a point that permissionless cryptocurrency systems have a promise of a digital environment in which value transfer is intrinsic, embedded on the protocol level – and so, for users the ability to make a transfer could become what I call a native digital right. Just to give you an analogy (it’s not a very accurate analogy but you’ll like it!) – take a guess what you see on the picture below. Well, it’s a standard residential elevator in my mother country Georgia, where you need to pay every time you use it! Up and down. Every time up, every time down!

Georgian elevator. Each time you go up and down, you need to pay!

So maybe we all (all internet users) live in our kind of Georgia, where every time we want to make a deal (economic agreement) in the online world we have to go through a cumbersome process and pay an unreasonable fee (each time!) for it. We need to get our bag out, fill in our card details, merchant’s acquirer (if it’s a merchant – even more obstacles with peer transfers) needs to send a request, card issuer needs to approve the transaction etc. Our today’s economic life online is based on this very complex e-commerce domain. And to me, it looks a lot like Georgian elevator. Think about it: on top of the obvious, that elevator only accepts certain denominations of Georgian coins – very specific, and is broken every once in a while – so even if you want to use a paid elevator sometimes you just can’t. So familiar.

How great would it be if we had a native digital right to make a value transfer online that noone could take from us (or grant us!), on a protocol level. How many applications could be built on top (at Consult Hyperion we call them SLAPPs -shared ledger applications)!

Persistence of permissionless

At the heart of the public shared ledgers is value transfer. This is because in order to assure the liveliness and self-sufficiency of the system, while providing non-restricted access to it, there needs to be an intrinsic economic incentive for those who maintain it. In other words, there should be a positive value to maintaining consensus. Most public shared ledgers for this reason can be described as currencies (decentralised cryptocurrencies) because they provide this incentive as a reward on the ledger in the ledger’s own “money”.

The canonical example of such a decentralised cryptocurrency is, of course, Bitcoin (remember, there are hundreds of them though!).  As Bitcoin was intended to exist and evolve out of the reach of regulatory, corporate or any other centralised command, the technology includes mechanisms that ensure it persistently “survives” and proves its robustness and self-sufficiency. (Disclaimer: I’m not a Bitcoin maximalist)

This persistence is a differentiating characteristic of a public shared ledger system. The technology does not need people at tables making decisions in order to survive, it is “permissionless” (nevertheless, the way it evolves to an extent is influenced by “people at the tables” – just different people).

Virtual economy

Potentially the principal implication of this persistence is the permissionless ascent of alternative virtual economy on top of decentralised protocols. Cryptocurrencies are not just a new form of payment – but rather, it’s a potential foundation for a new virtual economy, with new forms of economic interactions coming into place. When I say “new”, I don’t mean substitutive – I mean additional.

Virtual economic activity could become something fundamental to the Internet. Similar to the way the ability to communicate transformed into the ability to communicate over the Internet – it could grow into the ability to make friction-less economic arrangements (“economically” communicate) in the virtual world.

Thanks to the shared ledger technology and “smart contracts” innovation, not only the emergence of alternative economy is permissionless (and so – non-stoppable), but if it happens at certain scale, the very nature of economic relationships in this economy could be drastically different from what we are used to. A good depiction of such transformation is content monetisation on the web through the use of “invisible” micropayments. Another good example is seamless online payments in video games:

Breakout Coin provides for seamless in-game payments anywhere in the world, while the blockchain technology behind it, Breakout Chain, uses smart contracts and sidechains to enforce these financial agreements between parties.

From http://www.ibtimes.co.uk/poker-gaming-token-breakout-coin-opens-crowdsale-bittrex-1565331

Shared ledger technology could even turn our things (as in “Internet of Things”) into active economic agents through smart contracts.

Public shared ledger technology may help to turn a big part of our (as it seems) non-economic life into an economic activities. 

Although there are many “if” in that, we should not dismiss this possibility quite yet and keep an eye on the permissionless space. You can observe or get involved, but it would be a mistake to put your head in the sand and deny that something incredible is happening.

China, cash and cryptocurrency

The Governor of the People’s Bank of China (PBOC), Zhou Xiaochuan, has given an extensive interview [transcript] in which he sets out the Bank’s current thinking about digital currency. 

[Zhou] said that “it is an irresistible trend that paper money will be replaced by new products and new technologies.”

From Chinese Central Bank Goes Full Steam Ahead with its Own Cryptocurrency | Finance Magnates

Couldn’t agree more. I am in complete alignment with the Party about this. I do not understand why reactionary forces defend physical cash against the march of progress. The governor goes on to set some broad parameters around just how such a digital currency might operate and, let us simply observe, it’s no bitcoin.

From the central bank’s perspective, a digital currency should be designed in a way that can best protect people’s privacy, but we also need to pay attention to social security and social order

From Chinese Central Bank Goes Full Steam Ahead with its Own Cryptocurrency | Finance Magnates

Couldn’t agree more. Society should set the dial, not technologists, no matter how much we think we know better. The governor’s argument here isn’t about where the privacy dial should be set (I expect I might disagree with his position on the precise setting), but about who should set it. And I agree with him that society is the right answer. Whether this means through democratic vote or some other mechanism I leave as an exercise for the reader. (Yes, it is true that a great many voters are ignorant and easily swayed by propagandists, and I for one think some form of permissioned voting is crucial if we are stave off economic doom in the long run, but I am just one voice in this matter

We think, therefore, as a legal tender, digital currency must be issued by the central bank.

From Chinese Central Bank Goes Full Steam Ahead with its Own Cryptocurrency | Finance Magnates

Couldn’t agree more. It looks as if the Chinese Communist Party read my blog about the new report from Positive Money. If a country wants a digital currency, then it makes complete sense for the central bank to provide it.

Xiaochuan believes it will take about ten years for a digital currency to fully replace cash in China but he has plans how to gradually phase out paper money

From Chinese Central Bank Goes Full Steam Ahead with its Own Cryptocurrency | Finance Magnates

Couldn’t agree more. We need a national plan to deal with this, and I only wish the stooges of post-imperialist corporatism at the Bank of England had such vision. We too need a plan on how to gradually phase out paper money.

What I don’t understand is why this announcement by the PBOC governor attracted so much attention in cryptocurrency circles. This is for two reasons. First of all, the whole point of a cryptocurrency is that it derives its value from cryptography not from some external unit of account. There is actually no point in a central bank issuing cryptocurrency, whether it’s BritCoin or Remibicoid, when what they should actually be doing is issuing a digital currency that they are responsible for managing the value of. (Well, whether they should be issuing digital currency or not depends on your macroeconomic perspective and I don’t propose to sidetrack into that here: let’s just say that they should for the sake of argument.)

Governor Zhou Xiaochuan is clear in his reasoning. He says that the PBOC spent a lot of effort researching blockchain technology and has concluded that blockchains are too resource intensive and too limited in throughput to form a practical mechanism, for exchange. This does not mean that some future blockchain technology that is based on some cryptocurrency, that is based on a double-spending solution that is not based on proof-of-work, might not be suitable. That’s entirely possible, although it seems to me unlikely that any such cryptocurrency would offer cost or efficiency advantages over account-based systems because, apart from anything else, that’s not a design goal.

To reiterate: the governor said that he has plans to gradually phase out paper money. Wowza. The costs for cash transactions will increase, as the banks start charging fees for accounting physical cash, but he is realistic in saying that digital currency and physical currency will coexist for a long time. 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 and with the guidance of the central bank, China could easily achieve this goal.

I say this with complete confidence, because they were able to affect the transition from specie to paper money effectively and in a short time. In the mid-13th century, Kublai Khan instituted a system of paper money (I refer to Marco Polo’s description of the system here). The Khan had a robust acceptance policy: if you didn’t take the paper money at par, he would kill you. In a short time, paper money overcame the inconvenience of coins with the very positive effect that trade (and therefore the economy) grew. I won’t mention how the story ended (that’s in my forthcoming book) except to note that it didn’t end well, a reflection of the problems occur when the central bank succumbs to the temptation to over-issue.

Obviously I’m not suggesting that we adopt Kublai Khan’s stern but clear policy on the acceptance of new payment instruments. Personally I would favour executing people who do not accept electronic payments only as a last resort, but it does seem to me that if the Chinese government were to go down the digital currency route, it really would not take that long to have the world’s first large-scale national digital currency up and running. If the Chinese can abolish cash, so can we.

Britcoin or Brit-PESA?

Remember last year when some Bitcoin chaps apparently used a “freedom of information” request to get hold of Citi’s response to the UK government’s consultation on digital currencies and the like. Apparently, Citi told the government that digital currency is a good idea.

The greatest benefits of digital currencies can be realised through the government issuing a digital form of legal tender. This currency would be less expensive, more efficient, and provide greater transparency than current physical legal tender or electronic methods.

[From The UK government is being urged to create its own digital currency | Business Insider]

As I have said on a number of occasions, 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. First of all, in the UK almost all Sterling is already digital other than the rump 3% or so that is needed for crime and tax evasion so it’s not clear the government needs to issue a digital currency at all (they could just let banks and electronic money issuers do it). Secondly, I don’t think government interest in digital currency means anything for cryptocurrency since digital Sterling wouldn’t be implemented using Bitcoins anyway. And thirdly, legal tender is an irrelevant concept in this context.

When I read this report, though, I remember being curious as to whether Citi economists had any input into it. If cash is to be replaced by a digital currency created by the government — rather than by the commercial banks, as it is now — then one might imagine that the economic consequences would be significant. Removing the zero floor on interest rates, for one thing, which is in fact what Citi’s chief economist wrote about in April last year.

Willem Buiter, global chief economist at Citi, is arguing in a new research note that central banks should be prepared to set negative rates… A key reason that central banks can’t set rates as low as they would like is cash. The theory is that savers would take all of their money out of banks rather than be charged a negative rate. What to do? Well, one idea is to get rid of cash and move to digital payments.

[From Why central banks should embrace negative interest rates — and get rid of currency – MarketWatch]

Suppose that the government decided to go down this route. (Not as a big bang thing: there’s no need to abolish cash immediately. We can start by getting rid of £50 notes that are really only used for shady purposes and we can get rid of the 1p and 2p coins at the same time.) Whether we leave the digital currency to the banks or to the central bank is a really, really huge political decision. Really huge. What should we do? David Andolfatto, VP at the Federal Reserve Bank of St. Louis, wrote in Newsweek recently that

My own recommendation is for central banks to consider offering digital money services (possibly even a cryptocurrency) at the retail and wholesale level. There is no reason why, in principle, a central bank could not offer online accounts… These accounts would obviously not have to be insured. They would provide firms with a safe place to manage their cash without resorting to the banking or shadow banking sector. They would give monetary policy an additional instrument—the ability to pay interest on low-denomination money (possibly at a negative rate). To the extent paper money is displaced, there would be large cost savings as well.

[From Should the Fed Issue Its Own Bitcoin?]

Now, I have to say that I am extremely sympathetic with this point of view. I rather think that the creation of money should be under government control and there are many reasons for thinking that allowing commercial banks to create money does not always lead to the best possible outcomes for society. But should central bank money be the only money? Probably not, and I’m also sympathetic to the view that David (and other eminent thinkers in the field) puts forward, that having competing currency substitutes would serve to act as a bound on government policy options.

It’s hard (for me) to see what the downsides are in having a central bank supply digital money. Critics might argue that it leaves people exposed to potentially poor monetary policy. This may be true and, for these people, currency substitutes should be available (including Bitcoin).

[From Should the Fed Issue Its Own Bitcoin?]

If people want to use Bitcoin, let them. If people want to use cowrie shells, let them. The only thing that they would legally compelled to use Sterling for would be the payment of taxes. But how should this Sterling be implemented?

In terms of payments, critics might argue that central bank accounts will be permissioned accounts, requiring the release of personal information, application efforts, that KYC restrictions will apply (so not censorship resistant) and so on. To address these concerns, a central bank could go one step further and issue a cryptocurrency (Fedcoin) offered at a fixed exchange rate where payments are cleared using a Bitcoin-inspired anonymous communal consensus algorithm.

[From Should the Fed Issue Its Own Bitcoin?]

This is where I disagree with David. New thinking is needed here, new thinking about the relationship between identity and money. Let’s unpick the three issues he touches on in the paragraph above.

  1. KYC and Permission. Clearly anything that is intended to replace physical cash must be inclusive. That means that there cannot be any KYC, nor any other conventional form of account application process. Personally, I do not see this as a negative. On the whole, I think that society benefits more from having all transactions electronic than it loses from affording a very limited form of economic anonymity for very limited transaction values. You might, for example, allow people to open digital payment accounts at the Bank of England and store amounts up to £1,000 with no identification at all, perhaps requiring only a mobile phone number or a postal address to activate the account. I see this as being a bit like getting a Gmail account! I log into the Bank of England, create a new account in the name of “DaveBirch” and get a message telling me that that account already exists so I choose “DGWBirch” instead. Then, anyone can pay me through the national digital payment system by sending money to £dgwbirch.

    I’d also get another account as “Lord Tantamount Horseposture” that I could use for gambling or buying drugs whatever else it is that people do with cash. If I want the account balance to exceed £1,000 then I would have to provide some other form of valid and acceptable identification, such as a Facebook account, and if I want the account balance to exceed £10,000 (the suspicious transaction reporting limit) then I would have to present a passport or something. The point is that everyone should be able to get an account.

    These accounts could pay interest and the interest could be negative. I can easily imagine economic circumstances leading to a tiered system whereby accounts below £10,000 pay 0.5% interest and accounts above £10,000 pay -0.5% interest. Why? Because you want people with surplus money to invest it in productive enterprise but you want to help the poor at the same time.

  2. Censorship resistance. Neither the central bank nor society as a whole wants censorship resistance when it comes to value transfer and I cannot see any reason why this would be implemented. I can certainly see the argument in favour of pseudonymity, which is why I would be allowed to have an account in the name of Lord Tantamount Horseposture, but of course that account would be linked to my mobile phone number or my Apple ID or my LinkedIn account or whatever, so that if I were to use that account to fund terrorism or evade tax then the authorities would be able to obtain a warrant and uncover that link. This is what I have previously referred to as a “smash the glass” form of conditional anonymity. So, I might make a bet with someone who doesn’t know who £horseposture actually is, but if that bet turns out to be linked with suspicious activity and a far-Eastern betting syndicate, then the police could easily get hold of me.

  3. Cryptocurrency. Given that I am obviously in favour of such an account-based system, which would have absolutely minimal transaction costs since the transfer of a hundred pounds between £dgwbirch and £horseposture would use absolutely minuscule amounts of resources, and given that I do not see censorship resistance as a requirement, I do not see why cryptocurrency would make sense as a potential implementation. Now, I understand perfectly well that there are arguments in favour: people might for example argue that a single point of failure for this important national resource would mitigate in favour of a replicated distributed shared ledger to defend against cyberattack or (as is traditional in the UK) government incompetence in the procurement and operation of large-scale computer and communication systems. I am open to evidence on this matter, but my first thought is that the cost of maintaining consensus for a system replacing cash on this scale far outweighs the cost of moving from “five nines” availability to 100% availability.

    Note also that if censorship resistance is going to be implemented using a cryptocurrency (e.g., Bitcoin) then I simply cannot imagine a scenario where central banks would allow proof-of-work mining to be controlled by anonymous, largely Far Eastern mining pools.

So: imagine something like M-PESA but run by the Bank of England. Everyone has an account and you can transfer money from one account to another by a mobile phone app (that uses the secure TEE in modern mobile phones) or by logging in with two factor authentication to any one of a number of service providers that use the Bank of England API to access the accounts or by phoning a voice recognition and authentication service. Drawing on our experiences from M-PESA, TAP and other population-scale mobile-centric system that we have advised on, I think that this API might actually the most important single thing that a Brit-PESA might deliver to the British economy.

Payments in the Sharing Economy

In addition to the obvious benefits to trade and industry, and in addition to the obvious benefits to law enforcement, it would mean that the Bank of England would have a real-time dashboard of economic activity that could be added to the real-time retail payment dashboards of the banks (I’m joking of course: they don’t actually have these) so that when the Chancellor of the Exchequer gets up in the morning he can see exactly what consumer spending was the day before. Exactly. So, Brit-PESA is not only a means to obtain the cost-effective efficiency that Citi referred to but it ought to be a great improvement in helping to manage the economy.

Ethereum DevCon1 – let’s play around on the Blockchain ground.

Last week I went to Ethereum’s DevCon1 conference which was held in central London. I enjoyed the talks, atmosphere and public and quite frankly was surprised by the size of the audience. Having attended events and participated in discussions with both financial organisations and the developer community, I saw noticeable differences in perceptions, terminology and attitude towards Blockchain-related tech.

Non-crypto fintech firms and traditional financial sector players are still trying to make sense of Blockchain and Bitcoin: “What? Wait, what again? How? Really?”. The terminology grows around this subject culminating in sacral “shared ledgers”, “distributed / replicated shared ledgers”, “private / permissioned Blockchain”, “inspired by Blockchain” (Our Director of Innovation, Dave Birch, recently encountered a new amusing way to say this – “Blockchain type of technology”).

In the “world” delved into on Friday, the developers’ and crypto enthusiasts’ world, this foundational layer has long been understood (to the extent it was assumed needed) and built upon. They don’t need that “shared ledger” terminology because they know from the context what they are talking about using good old “Blockchain” word. And they actually do not seem to be discussing it much. Smart contracts – that’s where the thinking concentrated on the event. Ethereum is their platform of choice and there does not seem to be any viable alternative because of the promised “Turing-completeness” (how “complete” is Ethereum’s “Turing-completeness” I am still going to investigate).

Where a lot of people describe what they have been doing about this topic as “playing around with it” to understand the full potential of the technology, Ethereum is considered by many a good play ground. Stephan Karpischek from UBS’s Crypto 2.0 lab emphasized on the DevCon1:

Ethereum… is a powerful technology that we can use. We like the flexibility that it provides so we can basically implement arbitrary complex business logic, we can put a lot of different types of assets on the blockchain and model the whole lifecycle of financial instruments.

– Stephan Karpischek, at DevCon1, Nov 2015

As evidenced by the size of audience, there are many “kids” on this playground – Ethereum’s community is evolving and as many predict will be increasing further. Someone told me at the tea break that we are at the right place at right time. I know what they meant – if this thing flies, we are here to make sure we will contribute to and benefit from it. And most of the people at the conference (around 400 at a glance) seemed to be absolutely confident Ethereum will fly.

Briefly touching on the detail, my thinking refocused from ledger hierarchies, transparency and efficiency implications (all the stuff around reconciliation/non-repudiation/data integrity across organisation etc.) to challenges of provisioning best-suited consensus protocols, creation of interoperability environment (or tools) and at the tech around zero-knowledge proofs and decentralisation of sensitive identity data.

… because otherwise it’s almost inevitably wind up with biometric panopticons where somebody’s bank is hacked and they release half a million DNA records. There are unthinkable privacy implications as that kind of stuff goes onwards. … There is really no other way of doing this. We have to accept we are going to build these systems, but we have to do it with the expectations that they are robust.

– Vinay Gupta, at DevCon1, Nov 2015

I think Gavin Wood, co-founder of Ethereum, noted that “we need to implement in order to understand the full potential of this technology”, and I agree. Let’s brainstorm and play around and someone will probably eventually find the (or most likely – “a”) formula.

Oh, and of course! One of the most exciting things was to see Nick Szabo talking about the history of Blockchain. He started from Ayn Rand’s Galt’s Gulch, Tim May’s idea of Galt’s Gulch in cyberspace using cryptography and Friedrich Hayek’s ideas around “protocols” underlying societies that require property, contracts, money etc. So here we are, if it was not for these brilliant people, we would probably not be talking about Blockchain today. And I know how I feel about these words:

We wanted to apply computer science, apply the new technology, take advantage of Moore’s law to minimise vulnerabilities to strangers and maximize security and in doing so solve the ambitious problems of hierarchy in nature such as to privatise money and non-violently enforce property and contracts. And so that’s where the ideas like smart contracts, the first blockchain designs and the first cryptocurrency designs came out of.

– Nick Szabo, at DevCon1, Nov 2015

I guess by “we” Nick meant computer scientists but I don’t know… may be a modest confession? 🙂

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