Crypto Market Commentary
18 February 2020
Doc's Daily Commentary
The 12 February ReadySetLive session with Doc and Mav is listed below.
Mind Of Mav
A Look At The Crypto Euro
The world is shifting towards increasingly digital payments and commerce.
2019 was a bellwether of this change, starting with the announcement of Facebook’s Libra.
Social media giant Facebook sent shockwaves throughout the crypto ecosystem and beyond when it unveiled its plans for Libra, a digital asset that it said would be pegged to a basket of fiat currencies and other assets.
The goal: to bring to market an alternative currency that could help bank individuals in the most financially deprived corners of the world. The unveiling created a media firestorm and drew the eye – and, in some cases, ire – of regulators and policymakers around the world. Indeed, Federal Reserve chairman Jerome Powell said on Feb. 11 that the unveiling “really lit a fire” under efforts to create a central bank-issued digital currency.
As often is the case with cryptocurrencies, plans change.
The non-profit Libra Association – which oversees development of the project – is considering whether it should abandon the proposed model in favor of a purely U.S. dollar-backed model. Potentially, this could mollify the concerns of American regulators and lawmakers, some of whom view Facebook’s plans as a direct threat to the US Dollar.
Indeed, concerns about “Zuckbucks” flooded Washington last summer, precipitating two hearings on Capitol Hill during which Facebook blockchain lead David Marcus defended the would-be stablecoin.
While Facebook’s privacy concerns are a serious issue, the true impact of Libra is playing out before us now.
With the rise of decentralized currencies like Bitcoin, and now the advent of centralized “corpo-currencies” like Libra, governments of the world are realizing they are woefully unprepared for the digital economy of the near future.
Indeed, following the announcement of Libra and with the start of Christine Lagarde’s presidency of the European Central Bank (ECB) in November 2019, the ECB’s efforts in the area of “central bank digital currencies” (CBDCs) have intensified noticeably.
First, what separates a CBDC from the digital versions of USD or Euro (digital fiat) today?
Well, the basic idea behind CBDC is ultimately the transfer of physical cash into the digital world. Instead of the fragmented and often broken system that digital fiat employs today, CBDC’s and their design will have a massive impact on the banking and financial sector, social acceptance and the monetary policy options of the central bank.
And, we don’t have to speculate much as to the design of a Crypto Euro.
In the last two months, the ECB has published concrete CBDC concepts. Although these are not final, they do provide a good indication of where the “crypto-ization” journey for the Euro could lead.
Let’s take a glimpse at this brave new world.
In response to the emergence of Bitcoin and other cryptocurrency projects, the first central banks began to analyze a possible introduction of their own digital currency as early as 2014.
The announcement of Libra in the summer of 2019 has further accelerated this process, with more and more central banks now considering the introduction of their own CBDC. Based on research by the Bank for International Settlements (BIS), 70% of the world’s central banks are currently investigating the implications of introducing a CBDC — 10% of the world’s central banks even expect to introduce a CBDC in the short term (1–3 years), and as much as 20% in the medium-term (up to 6 years) [Boar, Holden, Wadsworth, 2020].
A couple of notable examples stand out.
Since 2017, the Swedish central bank (Riksbank) has been analyzing the introduction of its own CBDC to strengthen the role of central bank money in the context of a sharp decline in cash demand and thus reduce the dependence on digital bank money (bank deposits). The Swedish central bankers argue that — in a world without their own CBDC — turbulences in the financial sector could have a more negative impact on their economy.
The US has similar plans to use a CBDC to maintain the status quo of the USD.
A month ago, a group headed by former Chair of the Commodity Futures Trading Commission (CFTC) and so-called “Crypto Dad”, Christopher Giancarlo, launched a website with materials explaining what Digital Dollar project is and isn’t. The materials further delineate the group’s vision and separate them as a private venture.
To be clear, the Digital Dollar exploration comes from the private sector. While a statement from the project acknowledges that there would inevitably have to be involvement from the U.S. Federal Reserve, the project remains a hub of experts and ideas without formal ties to the public sector.
Because of the early stage of the project, technical questions such as which technology the currency will be built have yet to be solidified. The Digital Dollar Project is currently focused on gathering information and being what Giancarlo called a “thought leader” on the topic.
Clearly, the US aims to let other nations take the first step and iterate their own solution accordingly — similar to their broad and ongoing approach to cryptocurrency.
Of course, we also have to mention China.
The Chinese central bank (PBoC) announced in 2019 that it would introduce its own CBDC soon to reduce its dependence on the financial sector and to be able to offer digital transactions in central bank money. While that announcement seems to have been tied to pressures from the US-China trade war (and as we’ve discussed, FinTech is the new battleground of trade wars), those tensions have since abated somewhat.
Presumably, the aim is to expand upon the existing digital payments system (WeChat / AliPay) and monitor citizens’ financial transactions even more closely to “pool” them at the central bank. This solution could further exercise control on citizens and pairs well with the ongoing rollout of the social credit score system the Chinese are using.
Other smaller central banks (in Cambodia or the Marshall Islands) have also announced the issuance of a CBDC soon.
The direction is clear: more and more central banks are looking into the introduction of their own digital central bank currency. 2020 could, therefore, be the year in which the first CBDC is launched.
One of the leading candidates for that is the Euro.
Before we discuss the Crypto Euro, we should first define was CBDCs actually are.
Central Bank Digital Currencies (CBDC)
CBDC is, simply put, digitized cash. But, like we covered, this is more than just “digital fiat”.
The ECB defines CBDC as “a liability to a central bank that is made available to individual citizens in digital form” (ECB, 2019). CBDCs would thus represent a third form of central bank money, alongside banks’ reserves at the central bank and physical cash. Mind you, the goal would be to obfuscate that distinction as much as possible from end users — CBDCs, as the ECB see it, are first and foremost taking advantage of the triple-accounting nature of crypto.
In addition, a CBDC can generally be classified according to the following design features:
? Interest payment: A CBDC can be either interest-bearing or non-interest-bearing. A non-interest-bearing CBDC would not yield interest and would be similar to physical cash. Negative interest rates are also possible.
? Access: Access to CBDC can be restricted to certain actors in an economy, such as banks or other financial institutions. In this case, the CBDC is called “wholesale CBDC”. A CBDC that is available to the general public is called “retail CBDC”.
? Operational set-up: A CBDC can be either account-based or value-based. In the case of account-based CBDC, customers keep their funds in an account with the central bank. In the case of a value-based CBDC (also called token-based CBDC), the CBDC would be issued directly to the real economy as a token, similar to physical cash.
? Technology: A CBDC can be issued via a distributed database (Distributed Ledger Technology, DLT) or a conventional centralized database. Issuance via a DLT would also lead to the CBDC being made more programmable and to the use of euro-denominated smart contracts.
The Crypto Euro
So, what needs to happen to see a Crypto Euro genesis?
Well, today common payment methods, such as bank transfers, payments via ApplePay / PayPal, or cash transactions, differ vastly in their data security and anonymity. For example, if a transaction is processed via Apple’s payment service ApplePay, the transaction data is visible to Apple. In case of a bank transfer, the processing banks can view the payment details.
In short, it’s a mess, and a real concern regarding data privacy.
As we’ve talked about regarding Libra in the past, the combination of consumer data and user data in one profile would create the most valuable — and powerful — company on the planet. That’s why Google, Facebook, Amazon, Apple, and every other tech company are scrambling to grab as much data as they can — data is literally the new oil.
However, there has been a completely anonymous payment method for centuries: cash.
Cash transactions are carried out without the involvement of an intermediary, so the transaction details are only available to the two transaction partners. The level of data security and anonymity is also of great importance in the context of CBDC.
In the publication published in December 2019, the ECB presented a concrete retail CBDC prototype which — similar to cash — (partially) guarantees anonymous payments while at the same time takes into account anti-money laundering (AML) regulations. It is noteworthy that the proposed CBDC prototype is based on a DLT and uses the Corda framework (with Corda, all participants in the network can interact with each other and record and manage agreements with each other).
Only the ECB issues the CBDC here; a decentralized network of intermediaries such as banks takes over the “heavy lifting” by requesting AML checks, providing the necessary applications and storing the cryptographic keys for initiating payments in their own wallets.
Figure 1: Two-tiered system: division of labor between the ECB and banks
In the proposed system, the identity and transaction history of a user is therefore not disclosed to the central bank and some transactions (although limited in amount) can be carried out without the AML authority’s knowledge.
Technically, this pseudo-anonymity is implemented by not transmitting the identity of the user to the AML authority when so-called anonymity vouchers are attached to a transaction. These vouchers are issued by an AML authority at regular intervals, are valid for a certain period of time and allow anonymous transfers of funds for a limited CBDC amount over a pre-defined period of time. Each citizen is endowed with a certain number of anonymity vouchers. Once all vouchers have been redeemed, transactions are no longer processed anonymously.
However, it should be noted that the transactions are not entirely anonymous. The banks involved have insight into the transactions, which is why such a CBDC system would have a much lower degree of anonymity than cash.
Completely anonymous transactions could theoretically be technically implemented in DLT systems. There are also already initial test trials (including so-called zero-knowledge proofs), but these could take several years before they are market-ready in Corda.
What A Post ECB-CBDC World Looks Like
The ECB’s concepts presented are by no means final, but nevertheless provide a good indication of where the journey in the euro area could lead. In summary, the following points become apparent:
? The ECB seeks to allow — in contrast to the PBoC, for example — at least a certain amount of anonymity and privacy for payments with CBDC. Currently, however, the differences versus cash would still be tremendous. Payments would not be possible in the current proof of concept without the knowledge of the banks involved, but anonymity could theoretically be technically implemented in the future.
? The ECB is keeping a close eye on the implications of a CBDC introduction for banks. The considerations of a two-tier CBDC system, with potentially very negative interest rates for those CBDCs that are not used as payment instruments but as store of value, show that the ECB does not wish to cause large-scale deposit withdrawals from the financial sector. However, a directed shift from bank to central bank money still seems likely.
? A two-tier system could also arise between the ECB and the commercial banks. For example, the central bank does not appear to be very keen on handling payment processing with CBDCs itself and storing the cryptographic keys for households. In the future, banks could take over or have to take over these tasks (if it became necessary for regulatory reasons). This gives the crypto custody licence introduced in Germany at the beginning of this year an additional significance. Since, in the end, this licence could be necessary not only for the custody of Bitcoin and Co. but also for the custody of CBDCs. The software solutions that have been available in the Bitcoin world for years, for example for wallets or custody solutions, could ultimately be used not only for the secure storage and sending and receiving of Bitcoins for customers, but also for CBDCs.
? The CBDC ambitions of central banks are also likely to have monetary policy motives. According to the motto: once physical cash has largely been replaced by digital cash, any negative interest rate can be set for digital cash without giving customers an option to “escape” these negative interest rates. In this regard, the introduction of CDBC could be a first step. Despite all the technical difficulties, this step is likely to be much less controversial than a ban on physical cash. However, central banks would have to make other store of values — such as gold or Bitcoin — correspondingly unattractive as well. The current ECB publications also do not suggest that drastic negative interest rates are imminent in the event of a CBDC introduction. But, when it comes to monetary policy, we know by now: “Never say never!”
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