Unlikely disruptors

Central banks, believe it or not, could play a key role in making money more competitive. 

Our weekly opinion piece and overview View this email in your browser   CoinDesk Weekly is sponsored by  June 17, 2018 Bridge to the future While the thought may disappoint cypherpunks, the first phase of a transition toward a true "money of the people" will be implemented by central banks themselves, Michael J. Casey argues.   Read more in THE TAKEAWAY below.   TOP TRENDS ON COINDESK Token and their discontents Quantstamp, maker of a protocol that seeks to decentralize smart contracts auditing, is facing an outcry from community members who accuse the company of undermining the value of its $65 million token. The controversy concerns Quantstamp's acceptance of U.S. dollars and ether, instead of its token, QSP, as payment for smart contract audits it has performed, a practice which appears to have run afoul of user expectations. Quantstamp says it's accepted these other currencies out of "necessity" and that the concerns stem from a misunderstanding of the difference between two of its projects. Similarly, Tezos, the blockchain project that sought to fix crypto's broken governance models, is also under fire. Nearly a year after its ICO, Tezos announced it will carry out know-your-customer and anti-money laundering (KYC/AML) checks on "contributors" (i.e. investors) who bought in. The team apparently wants to comply with a developing regulatory landscape, but the decision has enraged many investors. And after blockchain startup Swarm announced that it was about to launch new "equity tokens" representing ownership in notable blockchain startups like Coinbase and Ripple, those companies pushed back swiftly against the idea. Coinbase has sent Swarm a cease-and-desist letter, saying it doesn't allow trading of its stock on secondary markets. REKT After two weeks of relative stability, the prices of bitcoin and other cryptocurrencies took a beating. There are several possible reasons behind the tumble that started last Sunday. Some blame the news that came out that day (Coinrail, a cryptocurrency exchange in South Korea, was hacked, sparking renewed concerns around security at crypto exchanges), while others argue it was a price correction following an extended period of consolidation. While the bulls still struggled to regain poise, additional headlines put further downward pressure on the price. On Wednesday news broke of an academic paper that found tether, the dollar-pegged cryptocurrency, has been used to inflate the price of bitcoin, as many have long suspected. The world's largest cryptocurrency by market value reached four-month lows before a moderate rebound on Thursday. The crash in bitcoin also rippled through markets for other cryptocurrencies, with ethereum, the second-biggest cryptocurrency by market value, and XRP, the No. 3, tumbling over 20% during the period from June 9 to June 13. Litecoin, the world's sixth largest cryptocurrency, also hit fresh 2018 lows on Wednesday, but it soon rallied as the drop reached oversold conditions. The whole sector partially recovered later in the week when an official at the U.S. Securities and Exchange Commission remarked that ether isn't a security. Regulatory blotter After William Hinman, head of the division of corporate finance at the SEC, weighed in that ether isn't a security, the online crypto community offered no shortage of opinions, interpretations and prognostications. Read our rundown of the reactions. The U.K.'s financial regulator sent a letter to bank CEOs warning them about the risks posed by clients that deal in cryptocurrencies and urging greater scrutiny of their activities. Lithuania's Ministry of Finance issued guidelines on initial coin offerings (ICOs), outlining when these cryptographic tokens would be viewed as securities and how each aspect of a token sale should be regulated by different laws in the country. See all CoinDesk stories  ⭐ CoinDesk Weekly Sponsor ⭐   Your Data. Your Life In the current system, your personal data is sourced, held, used and swapped by third-party providers. The Pillar Project is an ambitious project to return ownership of personal data to you. We do this through decentralized blockchain technology, starting with a token wallet. Learn More QUOTE OF THE WEEK "Based on my understanding of the present state of ether, the ethereum network and its decentralized structure, current offers and sales of ether are not securities transactions." – William Hinman, director of the SEC's division of corporation finance   THE TAKEAWAY Michael J. Casey is the chairman of CoinDesk's advisory board and a senior advisor for blockchain research at MIT's Digital Currency Initiative. Whether bitcoin or its imitators eventually achieve global ubiquity, they have already achieved success in one fundamental way: forcing humans to rethink their relationship with money and banks.    Cryptocurrencies weren't on the ballot during Switzerland's "sovereign money" referendum last weekend, in which Swiss citizens rejected by a ratio of three to one a proposal to end fractional reserve banking and give sole money-creation authority to the Swiss National Bank. But they were the elephant in the room. The very presence of the crypto alternative, I believe, will eventually force economies worldwide to disintermediate banks from money, yet the direct authors of that change won't be activist voters wielding ill-conceived referenda or crypto enthusiasts voting with their wallets. The first phase of a transition toward a true "money of the people" will be implemented by central banks themselves, striving and competing to remain relevant in a post-crisis, post-trust, digitally connected global economy.   That might disappoint adherents of the cypherpunk dream who birthed bitcoin. But the good news for those who want governments out of money altogether is that when currencies become digital – and enjoy all the bells and whistles of programmable money – they will foster more intense global competition among themselves. When smart contracts can manage exchange rate volatility, for example, people and businesses involved in international trade will not need to rely solely on the dollar as the cross-border currency of choice. This more competitive environment will ultimately open the door to non-government digital alternatives such a bitcoin.   Backlash against CBDCs To be sure, official enthusiasm for central bank-issued digital currency, or CBDC as it has become known, has waned somewhat as the old guard of central banking has dug in its heels. At the Bank of England, which spearheaded research into the idea three years ago, Governor Mark Carney has lately warned of financial instability if his institution were to directly provide digital wallets to ordinary citizens – a change that would, in effect, give everyone the same right to hold reserves at the central bank as regulated commercial banks. The Bank of International Settlements – a kind of international club for central banks – has echoed Carney's concerns, as have other officials.    This backlash, which suggests that the bank supervisory teams within central bank bureaucracies have regained ascendancy over technologists and innovators in their internal debates over CBDC, stems from a well-founded expectation: bank runs would be a real possibility. Why hold your money at risky, friction-laden institutions paying near-zero interest when you can store at zero risk with the central bank itself and trade it automatically with other fiat digital wallet holders?  But why, also, should we care what happens to banks? Bank are the problem The only reason to promote digital fiat currencies is precisely to bypass the banks. Whether the currency is fiat or decentralized, banks are the problem. The technical, social and regulatory infrastructure upon which they operate is decades old and fraught with unnecessary compliance costs. Banks maintain centralized, non-interoperable databases on outdated, clunky COBOL mainframes. They rely on multiple intermediaries to process payments, each managing their own, siloed ledgers that must be reconciled against each other through time-consuming fraud-prevention mechanisms.    All these inefficient systems, instituted to address the problem of trust, merely add to the cost of trust in the system. "Why, in a digital age, can't we move money around 24/7? Because we have bad middleware, and that bad middleware is existing financial infrastructure," says Charles Cascarilla, CEO of Paxos, which is building blockchain-based trading infrastructure for the financial system.  In addition, there's the massive political risk that comes with banks' involvement in our payments system. The reason why it was deemed necessary for governments to bail out the world's banks to the tune of trillions of dollars in 2008 was that not doing so would have thrust our highly complex payments systems into chaos. The global economy would have had a cardiac arrest. It's that threat of bringing us all down with them that gives "too-big-to-fail" banks a hold over policymaking.    Many central bankers, still smarting from the fallout from that crisis, know this is the problem. Many see real benefits in removing banks from payments and recognize that digital currencies can help. The question is how to get there without fomenting chaos.  Gradual solutions   One solution: a phased approach over time. You don't provide CBDC to everyone at first; you start with large non-bank financial institutions, follow it up with a certain class of large corporations, then move to smaller businesses, and only make it available to individuals as a last step.  Another solution: the introduction of a unique, central bank-determined CBDC interest rate. This would be an addition to the central bank toolkit for managing money supply, which currently hinges on a combination of a policy rate imposed on banks' reserves and interventions in the two-way market for buying and selling government securities with banks.   A separate CBDC interest rate would provide a means to calibrate the flow of money between banks and digital fiat wallets, potentially within a long-term plan to gradually shift it from the former to the latter without overly disrupting the system.    As Sheila Bair, the former Chair of the Federal Deposit Insurance Corp., argued in a recent op-ed, this new interest rate tool could enhance monetary policy, as central banks could use it to either stimulate or cool the economy. By directly affecting the rate at which people's currency holdings grow, incentives to save or spend could be directly implemented.    Still, I don't see developed-world central banks rushing to do this. Their relationships to commercial banks are too entrenched. And, for now at least, it's hard for many in that system to even conceive of a monetary system that doesn't revolve around them.    But it's different for developing-world central banks. For too long those countries' monetary policy has been driven by the policies of the world's biggest central bank, the Federal Reserve. If the Fed cuts rates, foreign, inflationary money floods into their bank-centric financial systems; if it hikes rates, they face deflationary risks. In theory, a fiat digital currency could allow them to offset those forces.    Now, of course, all of this could go wrong. A new tool for profligate governments to debase their citizens' money does not look desirable. For proof, look no further than the rogue state of Venezuela and its new, centrally controlled digital currency, the petro.    Yet that may also be what ultimately gives bitcoin, or some other viable altcoin, a chance to shine, especially as Layer 2 solutions start to help with scalability and liquidity. Central banks can't put the cryptocurrency genie back in the bottle. Their potential embrace of digital fiat currencies will happen in an era when their citizens have a choice – they can shift to these new decentralized solutions, with increasing ease.     Whether they take over the world or not, the power of the market in a more open system of currency choice will mean that cryptocurrencies will hopefully play a vital role in forcing these politicized, centralized institutions to better manage their people's money.  – Michael J. Casey Share Tweet Beyond CoinDesk...   OTHERS ARE TALKING ABOUT Former White House Chief Strategist Stephen K. Bannon has floated the idea of creating a new virtual currency called "deplorables coin," named after the pejorative term Hillary Clinton used to describe Trump supporters –  "a basket of deplorables" – during the 2016 campaign. Crypto is a polarizing topic: most people either love it or hate it. Jim Chanos, a noted short-seller and expert on financial fraud (he was one of the first to question Enron's finances), falls squarely in the latter category. He claimed cryptocurrency is a "speculation game masquerading as a technological breakthrough" in a lengthy interview with the Institute for New Economic Thinking. See also this point-by-point rebuttal in a CoinDesk op-ed. Even Ripple's own chief cryptographer, David Schwartz, is sounding lukewarm about distributed ledgers' readiness for the big time. Reuters quotes him as saying banks are not ready to use the technology for cross-border payments in the near future, citing scalability and privacy issues.  UPCOMING FROM COINDESK We're taking Consensus on the road. Join us on September 18-20 at the Marina Bay Sands in Singapore for the first international Consensus event. Register here. Send feedback on this newsletter to marc@coindesk.com. Follow @CoinDeskMarkets for price updates and market analysis. And everyone interested in keeping up with this rapidly evolving field of technology should follow our main Twitter handle, @CoinDesk.    Thanks for reading! Until next week... Copyright © 2018 CoinDesk, All rights reserved. You're receiving this email because you subscribed for updates on our website. Our mailing address is: CoinDesk 636 Avenue of the Americas New York City, NY 10011 Add us to your address book Want to change how you receive these emails? 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