The unrelenting tsunami of crypto money is unsettling central banks around the world. It's all in the wake of the spectacular success of a money protocol that dictates not only how money is being traded but also how money is being generated -- from thin air. It's magic, and people are swayed. Bitcoin prices swing up and lure in traders who have no solid understanding what they are in to.
The truth is, and that is the main point of this article, that nobody does. A currency that does not exist outside the protocol that defines it is trading with a one trillion dollar capitalization. No titular expert had ever predicted it. Now that it happened, you have hindsight theses galore. And no one has a real grasp on the mysterious crowd dynamics that keeps Bitcoin afloat. Crypto money was hailed as freedom money, privacy money, “power to the people, not the elite”. Bitcoin delivered in the eyes of many, but it also gave aid and comfort to fraudsters and abusers, while it is far from being ‘the people currency' with 0.01% of traders owning almost one third of its capitalization. In fact, the criminal element in society has never had it so convenient, financially speaking. A whole new class of extortion and ransomware is hundred percent traded on Bitcoin.
It's beyond anyone to ascertain with confidence what will be the impact on society if all central banks will rush to mint CBDC on a basis of a Bitcoin variant. Central banks leadership is nervous, rightly so. That is why they sponsor countless conferences, and studies, and commissions. A multi disciplinary discussion evolved: cryptographers, programmers, cloud experts, economists, financial mavens, politicians too -- all pitch in, hoping for the fog to be lifted.
The experts on these matters are sharply divided: technologists on one hand, and policy people on the other hand. The former are IT experts, programmers, cryptographers, with little insight into socio-economic factors. The latter have strong credentials in economics, finance, social matters, etc. with little or no grasp of the subtle technological precepts underlying the concept. Naturally the technology people focus on the technology -- saying the policy will develop later, while the policy people say we need to figure out what the money will do to society, and once we decide that, we will summon some engineers to handle the bits and bytes, and get it done.
Who is right?
Neither, technology and policy are interwoven here, that is part of the inherent complexity of the subject.
The standard way to handle such a confounding challenge is to move forward with baby steps: learn, build confidence and move forward.
Digital money is run on a protocol. What is special about a protocol is that it can be duplicated time and again (exactly or with variants). As with any innovation, digital dollar rollout may cause financial disruptions or even financial instability. Technical problems with CBDC could harm public confidence in the Fed’s overall competence.
To test a protocol one can implement it many times over, run it with some variations towards finding a perfect implementation. Fortunately money can be minted on a small scale, for a limited distribution.
Right now the Federal Reserve is taking constructive initiatives, like the partnership with MIT, and is soliciting opinions from the public, commenting on the implementation ideas described in the report [https://www.federalreserve.gov/publications/files/money-and-payments-20220120.pdf ]. There would be no doubt a flood of ideas, some overlapping, some contrasting, some well stated, others too cloudy, etc. It is notoriously difficult to sort such an avalanche of opinions. What is more, the Federal Reserve is vested with the responsibility to make the transition to digital money right, while armchair academics speak without this burden on their shoulders.
This brings us to proposing a different route. Let the marketplace speak! Invite market forces to mint each their own digital coin, and then let these coins compete among payors and payees -- a winner will emerge!
Clearly the central bank is interested in no other except stable coins. However the major offerings for stable coins today [Tether, Circle (USDC), Binance USD, DAI, TerraUSD, TrueUSD] are acting like an unregulated bank. They are free to establish a fractional reserve or drain liquidity from their backup assets. Accountability is murky, fraud and foul play are lurking. Now what if the guidance from the Federal Reserve is for the marketplace to offer risk-free stable coins? Coins where the mint pledges and keeps all the money paid to it against the minted coins in perfect liquidity, ready for an all out run on the bank. Such a setup will create digital coins in the status of a dollar claim check. Trader 1 will give say $100 to the mint, and will get a 'claim check', a digital obligatory note to pay to the party that submits the claim check for redemption the exact sum of $100, and without delay. This claim check will then be passed around to trader 2, 3, and on. It will be split as needed, and eventually, it will be returned to the mint for redemption. Trade with digital dollar claim checks will not impact the money supply. The claim checks will amount to equivalent forms of liquidity. They should not have a worrisome economic impact.
Who will those mints be? The answer here is critical to this proposal: anyone enjoying a measure of public trust can announce itself a mint and offer digital dollar claim checks, redeemable anytime 24/7; not only commercial banks or formal financial institutions. What protocol, how to manage the payments, blockchain, public ledger, centralized database -- these are all open questions and different mints will come forth with their own solutions.
The public will start to pay with these digital claim checks, if they will offer some advantage, say speed, privacy, instant settlement etc. The Federal Reserve will be perched up high and watch the competing issuers, before taking the next step.
The proposal then says, let's defer the question of how to make go of the vision of CBDC, and first invite the creative forces in the financial community to show their ideas in an operating stable coin.
It is important to cast this move towards open market digital dollar claim checks, as a homomorphic replacement of an existing practice, so no major conceptual thinking (and debate), nor hesitation (and fear) is coming along.
An estimated $90 billion was withdrawn from the roughly 225,000 nonbank ATMs in the U.S. in 2020, according to the latest data from research and consulting firm RBR. Rural areas have few banks, and ATMs are very popular. Virtually all the users have a cellphone, in fact many authenticate themselves via their phone. Everything that ATM can do can be done with existing digital cash technology. Let the old and new technologies slug it out. All that is required of the Fed is to let it loose, put no barriers. The marketplace will tell us. Are digital dollar claim checks more popular? More convenient? Safer?
Another base: gift cards. Merchants offer them as cash equivalent for merchandise in their store. The old paper gift cards cannot be split though. The digital dollar claim check will be homomorphic to the gift card, but allow for split and may be reversible. That means that a holder could reclaim the par value of the gift card in cash - 24/7. Once a gift card is splittable, and cash reversible, it becomes homomorphic with cash. A similar argument can be made over loyalty money.
These are means to cast the new technology as a seamless shift from old technologies with no impact on money supply or risk balance, and other big issues concerning the Federal Reserve. What is needed from the government is broad guidance, for example:
1. Any entity striving to become an issuer (mint) for digital dollar claim checks will have to register and be confirmed by the Fed, checking for integrity, and competence.
2. All outstanding digital claim checks will have to be backed up with liquid assets to meet any spike is demand for claim checks redemption.
3. Peer to Peer transactions of the digital dollar claim checks should provide privacy to law abiding citizens, yet allow for compliance with court ordered unmasking of suspicious transactions.
4. There will be a set limit on total amount of circulating digital dollar claim checks from each mint
5. InterMint: all mints will honor each other's digital dollar claim checks, much as banks honor each other's checks.
There likely would be a few more regulations, but other than such high level guidance the various mints coming forth with their choice technology will be allowed to compete and lure the customer with convenience, speed, safety, and other points of attraction. Many will implement blockchain protocols, others will be closer to credit card procedures. Some will have robust security, ready for quantum cryptanalysis, others will rely on RSA or Elliptic curve cryptography -- let a fair competition run its course.
Very shortly it will become clear: does the consumer embrace the new vision? How much benefit it brings? What can be done with digital dollar claim checks that could not have been done before? Are people using digital dollar claim checks just for coffee and gas, or also for purchasing big appliances and more expensive merchandise and services? It is the practice of day-to-day payment that will become the cornerstone for the digitization of cash, and the foundation for the next steps: using digital cash technology for investment management, for IoT payments, for cross border accounts. How about escrow, perhaps purpose-designated money will be a good place to use digital dollar claim checks?
When the practice takes place in Main Street, the question of whether or not the Federal Reserve needs to make this colossal move and redefine the dollar digitally, will become a clearer question to answer. It might well be that the Federal Reserve can keep things the way they are. Or it might be (as is the opinion of this writer) that the Federal Reserve will simply choose to adopt a new cyber language for money to be used throughout the financial landscape. Today money is held in computer storage as a number. A digital coin comprises a value and an identity all expressed in bits. This fusion of identity and value may be a good idea for expression of money everywhere, including traditional bank accounts.
The main idea here is that the federal reserve should create a path for the free market to come forth with competing solutions to the digitalization of money -- supervised and regulated by the Fed, while the Federal Reserve keeps watching, evaluating, and encouraging free market innovation to keep America number one in everything financial.