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!

Making money for the masses

The discussions around digital currency continue. I had an interesting sort-of-argument with someone about this recently, and I mentioned in passing the dynamics of the shift from specie to token money during the industrial revolution. I think it’s worth expanding on this here, as to my mind it informs the debates about central bank digital currency vs. private digital money, an important debate for our times. There’s lots more about this on the blog and there’s a podcast about it too if you are interested in learning more.

Forum friend George Selgin gave an excellent talk on this at [Consult Hyperion’s 2010 Forum], exploring the transition to industrial-age money.

[From The problem of change | Consult Hyperion]

The essence of George’s talk was that industrialing Britain saw unexpected changes in the way that money worked as it strove to re-invent money for its new economy. As the nature of that economy had changed, so the nature of money had needed to change too, but there is a lag and a tension between the needs of the economy and the money that the economy has inherited from an earlier age. At the time, it was not clear exactly what needed doing. People could see that there were problems, but not what do to about them.

Naturally I refer to this time because the Internet, mobile phones and online commerce are creating a vortex that is sucking in monetary innovation at an accelerating rate. My point is that we have been there before and can learn from those distant times. Consider the relationship between private and public provision of small change (coins, essentially) that has been brought back into focus by discussions about micropayments in an online world before. When that industrial revolution caused an explosion in population and commerce in Georgian England, the lack of small change shifted from being an annoyance to being a major national problem, holding back growth and development. Factories had no coins to pay their workers, workers had no coins buy their essentials and the economy was suffering. Josset’s description from “Money in Britain” (1962) is lovely:

Rarely was any transaction made without an argument. No trader would sell goods without stipulating the weight of the coins in which he was to be paid. Quarrels over money values were continuous; market days and fairs were regularly scenes of brawls. Wages paid by employers to their workers were the cause of many Saturday night disputes regarding the value of their money. Such was the result of the apathy and ignorance of the government in so neglecting the currency.

Essentially, as I wrote before, it was Main Street vs. Wall Street as usual (there you go brining class into it again):

What happened in that case was that there was money for the wealthy (bank notes and gold and silver coins) but there was no money for the masses. You couldn’t by a loaf of bread or pint of beer with the banknote or a silver coin, so private industry stepped in to mint copper token money, and this money circulated particularly in industrial centres in order to (very successfully) facilitate wage payments and retail spending.

[From Up a gum tree | Consult Hyperion]

By the end of the eighteenth century, most of the coins in circulation in the Britain were counterfeits. Gresham’s Law meant that there was widespread acceptance of counterfeits because there were no legal coins in circulation and that the good counterfeits served a useful economic purpose. A shopkeeper might have four copper trays in his till: pennies, ha’pennies, good counterfeits of same and “raps”, or counterfeits that could not easily be passed on.

The government did nothing about it. The people who did do something about were technologists: those at the centre of the industrialisation storm, largely from Birmingham, which was the Georgian Silicon Valley. The nascent metal-bashing industry there, the emergence of organised production (Matthew Boulton’s factory) and the expanding skill base meant that the skills, techniques and supply chain for medals, buttons (and the machines to make them) could be readily adapted to coins. The industrialists used the latest technology of steam presses whereas the government did not. At the same time, the supply of copper (the world’s largest copper mine was in Anglesey in those days) meant that the right raw material was in the right place at the right time.

What was the result of this technological change? It was that coins changed from commodity money (ie, gold and silver to the face value) to token money (ie, base metals and alloys worth a fraction of the face value). And it was, crucially, the private sector that caused the shift, with the public happy to accept the token money that, presumably, no-one in the government would. (As an aside, George Selgin asks in his splendid book why the private mints put so much effort and invention into creating such good quality tokens and suggests that part of it was marketing: good-quality tokens were good publicity and advert for the skills of the companies.)

These tokens gained rapid acceptance and by the end of the 18th century  the problem of small change was almost solved with the official (or “Tower”) coins trading at a discount against the private alternatives. What happened then? Well around two decades later, the official government mint adopted token currency and began issuing modern coins. This is, I think, a marker for our age and one of the reasons why I am so certain that, at some point in the future, the government will adopt a digital money that is in widespread use in the private sector (let us set aside exactly which technology for the time being) as a national digital currency and make the final shift of cash from atoms to bits.

The reason that I am so interested in this particular case study is that I think it has tremendous resonance in the current day. We are living through the post-industrial revolution but we are still using the money of a different age. Just as people in the early 17th century couldn’t have imagined the Bank of England, paper money and the Gold Standard that were just around the corner, so we can’t imagine the money of the near future.

Bank of England Charter sealing 1694

Somewhere out there, private enterprise (a student in a garage or a researcher in a regtech) is working on the money for the post-industrial age but we don’t yet know what it is. I’m pretty sure it’s not Bitcoin, and I’m pretty sure it will have something more to do with the communities that it serves than the fiat currencies of the nation-state do, but I don’t know what it is any more than anyone else does. However, it is interesting to speculate that the trajectory might replay. There will be competition to produce the money that the new economy needs and then when that competition means it’s no longer possible to make a living from the means of exchange because the transactions fees are driven down to zero, it will become some form of public good (even if the definition of public is more limited to “public within multiple overlapping communities”).

In which case, the world’s central banks might at well starting providing digital money as a public good now! Seriously, how much would it cost to set up Bank of England PESA? They might even look at some form of shared ledger solution, where copies of the “national ledger” are maintain by regulated financial institutions (e.g., banks – whereby taking part in the consensus-forming process would be a condition of a banking licence) and the entries in those ledgers related to transfers between pseudonymous accounts (i.e., your bank would know who you are but the central bank, other banks and auditors would not). I think this is just the sort of topic that we should explore at the twentieth annual Consult Hyperion “Tomorrow’s Transactions Forum” in London on the 26th and 27th April 2017, so you should probably block those days out in your diary right now…

Enough with the “Britcoin” already!

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.

From Are central banks a relic of the Industrial Revolution? | Consult Hyperion

As it happens, Dr. Ben Broadbent, who deputy governor of monetary policy at the BofE, appeared before the Lords economic affairs committee today. He was scheduled to

“explore the prospect of a central bank digital currency and the effect it could have on commercial banks”.

From House of Lords asks BofE deputy governor: Time for ‘Britcoin’?

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.

From House of Lords asks BofE deputy governor: Time for ‘Britcoin’?

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.

From Britcoin or Brit-PESA? | Consult Hyperion

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:

Birch-Brown-Parulava Colour


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.

Money Typology v2


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.

  1. 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. 

  2. 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.

  3. 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.

  4. 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.

  5. 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.

Cryptocentralbankdigitalcurrency, or something similar

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.

From Mark Carney: Enabling the FinTech transformation – revolution, restoration, or reformation?

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!

From RTGS NBG OMG SOS SLT PDQ SLAP | Consult Hyperion

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. 

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.

Are central banks a relic of the Industrial Revolution?

Are central banks artefacts of the Industrial Revolution, like canal networks or newspapers, or are they indispensable to the operation of the modern economy? To be honest, I tend to the more revolutionary perspective. National currency and central banks were of their time. We didn’t used to have them and we won’t have them in the future. (I’m writing a book about this at the moment.) But in the short term, should these relics of a bygone monetary era embrace digital cash? Here’s why I’m asking, as summarised nicely in the Deutsche Bank Research note on the “Instant Revolution of Payments”. They say:

When looking at the potential long-term effects of payment market evolution, a new question arises: which money will we pay with? Today, we mostly pay with commercial bank money… Given the wide range of potential instant payment services, bank deposits as the main form of money could lose importance if non-bank providers gain a dominant position in the retail payments market.

You can see the broad outline of the debate forming. Should central banks issue their own digital money? Should they allow commercial banks to continue to do it? Or should they sit back and let a thousand flowers bloom as Facebook, Amazon, Verifone and Apple issue digital money? They have to do something. After all, there is a steady decline in the use of physical cash. If the Bank of England does not replace physical cash with its own electronic equivalent then it is in effect supervising the slow motion privatisation of the nation’s currency.

Let’s examine a case for central banks to stay involved. 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.

(They use the term digital cash to refer to electronic central bank money, whereas I would prefer the term digital currency to distinguish the unit of account from other forms of digital cash.)

At the heart of the Positive Money argument is the idea that digital currency should be the province of specialist payment service providers rather than banks, because banks are primarily lenders and should be focused on that. How would banks compete with specialist providers? Until now banks have had an effective monopoly on payment services. Consequently, banks have had very little competition for the provision of basic payment accounts. In my opinion, it’s a business they might not want to be in at all, frankly, and they could focus on their core banking businesses instead, leaving payments to the specialist providers (that might, of course, include their own subsidiaries operating under Payment Institution licences).

What would the business model of the specialist providers be? Should digital currency be remunerated? Should these specialist providers be paid by the central bank? The Positive Money people feel strongly that it should not, which means that other players in the digital currency supply chain would need to find their own ways of raising revenue. I doubt this would ever come from fees so it would be more to do with the information around payments and flows, but that’s not really what I wanted to talk about here, which is the question of issuing the digital currency.

Why have these specialist providers at all? Why not just get the Bank of England to do it? The report notes digital that digital currency does not mean cryptocurrency or require the distributed ledger, there a plenty of existing technologies that could do the job. As I wrote recently, the Bank of England could provide accounts for all citizens, along with payment cards and Internet access and so on.

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.

From Britcoin or Brit-PESA? | Consult Hyperion

However the Bank of England, the Positive Money report says, is likely to see this as something of a burden. Personally I’m not sure about that line of thinking. I’m not sure it would be that much of a burden because if everyone had such an account, that you wouldn’t need payment cards or checks or giro payments or anything else, because all payments would be transferred between these accounts through transactions that would be initiated in most cases by a mobile app or through a call centre. The Positive Money guys prefer the idea of digital cash account providers, which would essentially be something like Electronic Money Institutions (ELMIs) are now but with a 100% reserve in central bank money.

(In the report they also talk about the concept of helicopter drops of digital cash to citizens via these accounts, as an alternative to “traditional” quantitive easing., but that’s a topic for another day.)

Anyway, on to a quick run through the key points. 

Why might central banks choose to issue digital currency?

The six main reasons that are presented in the report are:

  1. Overcoming the zero lower bound on interest rates. Enabling new instruments of monetary policy such as that helicopter money.
  2. Promoting innovation in payment system. I’ve written a couple of times before, both when looking at the options for central-bank digital cash and also when reflecting on our experiences with population scale schemes such as M-PESA in Kenya, that providing a good API on top of the system and allowing innovators to build new products and services on top is transformational and, to my mind, much more likely to lead to real innovation, making the payment system serve the wider economy more efficiently and more effectively.
  3. Increasing financial stability by providing a risk-free alternative to bank accounts. Increasing financial stability by reducing the concentration of liquidity risk and credit risk. Non-bank financial institutions, in particular, would benefit from being able to hold funds in central bank money rather than the form of uninsured bank account. The implications of having competing currencies might be uninteresting in usual times, just as the competition between cash and bank money is uninteresting in usual times, but it will be important to understand the implications in times of crisis to make sure that the system would not collapse. This is because the existence of digital cash might well exacerbate bank runs as people, for whatever reasons, retreat from other forms of liquidity to risk-free central bank money. The existence of risk-free digital currency in the UK could plausibly lead to an inflow of funds from foreign banks into sterling digital cash and that could push up exchange rates.
  4. Recapturing a portion of seigniorage. In the UK, the interest earned on physical currency peaked at £2.4 billion just before the financial crisis. I see this as a kind of stealth tax although although I suppose it might be fairly argued that it’s a pretty reasonable stealth tax as it falls largely on drug dealers and money-launderers. In the current year seigniorage will be in the region of only 500 million or so. Cash in circulation in the UK currently stands at around £67 billion (and it’s increasing about £15 million per month) of the total amount of cash in circulation at any one time around £10 billion is sitting in bank tills and in ATMs (in the UK about £15 billion is withdrawn from cash machines every month). This suggests that the other £42 billion is circulating hand-to-hand outside the banking system (in the Bank of England classifications this money is either being hoarded, stashed or exported). The banks cash flow to £10 billion can be taken as the best estimate for the population’s preference for cash over above immediate spending needs. All things considered I think that the seigniorage argument is not terribly persuasive one way or the other. It is plausible that the Bank of England might roughly double its seigniorage revenue if most people switch most of their spending from bank accounts to digital cash.
  5. Alternative finance. Separating the creation of money from bank loans might mean a reduction in lending which would have implications for the economy. There are implications for banks in the supply of credit but also implications for the potential for alternative finance to fill the gap.
  6. Increasing financial inclusion. I don’t want to get into the complexities of the relationship between financial and social inclusion, and the implications for other regulatory frameworks such as KYC and AML, but I see financial inclusion through ready access to low-value digital currency accounts as one of the main reasons for wanting to do it. Remember people who are trapped in a cash economy on the margins are the people who suffer most from its existence.

So What?

Well, I thought the report was very interesting  and thought provoking, so I am very happy to say that Ben Dyson from Positive Money will be giving a talk based on the report at this year’s 19th annual Consult Hyperion Tomorrow’s Transactions Forum in London on 20th-21st April 2016. Thanks to the amazing generosity of our sponsors, this year the tickets for the Forum are only £295 + VAT. Not a misprint: I really do mean the negligible sum of only two hundred and ninety five great British pounds Sterling.

As always, the Forum will be limited to 100 places, so book your place now!

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.

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