By Francesco Roda, Chief Risk Officer at Koine
Libra generated a lot of interest since its announcement on a Tuesday in June 2019. That morning I was speaking at a panel on the future of digital assets and I immediately raised the challenges that such a product poses to regulators of the countries in which it is used – potentially the entire world.
Libra can be described simply as a new cryptocurrency to settle payments or, from a regulatory point of view, as an e-money product. The difference is subtle; cryptocurrencies may try to mimic certain features of sovereign ones (fiat). but they are not issued by any specific country. Rather they are issued by an algorithm (which governments have not yet figured out a method to regulate) or by unregulated entities who operate on the borders of legality. E-money products, in contrast, are issued by institutions regulated by the governments in which they operate. The “e” refers to their specific nature, but “money” clearly points to the fact that they serve the same purpose – at least in the country in which they are authorised.
I argued that Libra is an e-money product that will require obtaining specific authorisation from regulators of the countries in which it operates – more or less the entire world – or be seen with suspicion by regulators.
The majority of fiat money is already “electronic” as national payment flows, measured in value, are predominantly executed by updating computer records rather than moving physical cash. What is the missing ingredient for fiat money to turn into digital?
Central banks of the UK and Sweden, among other countries, have researched the adoption of blockchain technologies extensively but have yet to come to firm plans for their issuance.
A cryptocurrency from China's central bank?
Rumours have circulated that China’s central bank will launch a state-backed cryptocurrency and issue it to seven intermediaries in the coming months. Among those are Alibaba (a Chinese online market place turned into one of the largest banks in the world) and Tencent (a Chinese social media platform turned into one the largest e-money institution in the world) together with other large traditional banks.
The timing of the announcements may not be a coincidence: Libra has revived interest in cryptocurrencies, prompting people to think about the consequences of a private currency issued by a large US company.
What makes the e-renminbi - or Digital Currency/Electronic Payments (“DC/EP”) - different from any renminbi-denominated electronic payment flow has not yet been fully disclosed. I am thinking about issues around privacy of transactions: blockchains are immutable and – in the long run – account numbers may lose their anonymity, as identities can be inferred by looking at flows and public information that invariably businesses and people leak online. Other interesting elements are the degree of control by the issuer (other than the legitimate control over rates and supply) and the freedom of circulation. The choice of blockchain technologies made by DC/EP suggests that it will enable peer to peer payments, thus removing the need for intermediaries. This makes it an efficient tool for legitimate businesses and criminal enterprises alike.
A growing interest from central banks?
Libra is probably not the only catalyst for the increased interest in central bank-issued digital currencies. The Governor of the Bank of England believes that the current international monetary system contributes to lower global interest rates and has amplified the difficulties central bankers face in addressing downturns. In a recent speech at the gathering of central bankers in Jackson Hole, he observed that the US accounts for only 10 per cent of global trade and 15 per cent of global GDP but half of trade invoices and two-thirds of global securities issuance.
Carney observed that “US developments have significant spillovers onto both the trade performance and the financial conditions of countries even with relatively limited direct exposure to the US economy".
According to Carney, a Synthetic Hegemonic Currency, provided by a network of central bank digital currencies, could dampen the domineering influence of the U.S. dollar on global trade.
Furthermore, “while the world economy is being reordered, the US dollar remains as important as when Bretton Woods collapsed”.
The dollar peg to gold and semi-fixed exchange rates for other currencies was, in short, the proposal made by the American delegation at the Bretton Woods conference held in 1944 to help prevent a recurrence of the Great Depression.
John Maynard Keynes presented, on behalf of the British delegation, the "International Clearing Union" – an organisation that potentially every country in the world could join. It would create a new reserve currency, the "Bancor," that could be used for settling international accounts – removing the need for the Dollar (or other currency) to be adopted as global reserve currency.
The similarities between the Synthetic Hegemonic Currency and Bancor are striking, not least the issues that the two proposals are trying to address.
The exponential increase in global trade and the ability of blockchain technologies to distribute value globally are pushing central banks and regulators to rethink their approach. The IMF too, in a recent survey, learned that central banks are increasingly interested in issuing digital currencies to lower costs, increas efficiency of monetary policy implementation, counter competition from cryptocurrencies, ensure contestability of the payment market, and offer a risk-free payment instrument to the public.