What is the future of banking, central banking and financial intermediation ter a world ter which cryptocurrency is prominent? Let’s speculate a bit, with the proviso that no one can fully anticipate how thesis markets will evolve.
Wij can find hints te the speech by IMF head Christine Lagarde at a Canap of England conference te September 2018. She dropped some words that likely sent some chills down a few spines ter the audience. She explained that cryptocurrency is not a passing fad but a genuine innovation te money. The only remaining barriers to widespread adoption are technical, fixable and likely to be overcome spil the sector develops. This, she argued, has profound implications for the future of financial intermediation and central banks.
“In the future,” she explained, “we might keep minimal balances for payment services on electronic wallets. The remaining balances may be kept te mutual funds, or invested ter peer-to-peer lending platforms with an edge te big gegevens and artificial intelligence for automatic credit scoring … Some would argue that this puts a question mark on the fractional banking prototype wij know today, if there are fewer canap deposits and money flows into the economy through fresh channels.”
She continued to press the point, spil it relates directly to the Bankgebouw of England and the Federal Reserve.
“How would monetary policy be set ter this setting? Today’s central banks typically affect asset prices through primary dealers, or big banks, to which they provide liquidity at immobile prices — so-called open-market operations. But if thesis banks were to become less relevant te the fresh financial world, and request for central bankgebouw balances were to diminish, could monetary policy transmission remain spil effective?”
She waterput a question mark after that last sentence, but she might spil well have made the statement: Monetary policy cannot be effective te this world. Ter fact, it is worse. It might not matter at all.
It’s an astonishing thing to consider. For more than a century, academics, regulators, captains of finance and high-level government officials have worked to find the flawless monetary policy to stabilize the macroeconomy, provide liquidity for growth without inflation and otherwise become masters of economic programma.
But this entire machinery is premised on two significant conditions. Very first, the government voorwaarde have the monopoly on money. It has held this for more than a century. Government prints the money, controls its supply, imposes legal tender and regulates against the enforcement of contracts denominated te unofficial currency. And 2nd, most of this money has to be held te some way ter the banking system. If you take away both of those, the cause of central banking has a serious problem pursuing any form of monetary programma at all.
That is indeed a very different world. And it is no wonder that the ruling class is worried.
Today, banks like JPMorgan and Goldman Sachs are experimenting with blockchain technology and cryptoassets. And Lagarde’s own statement might be seen to portend the issuance of a fresh global cryptocurrency to substitute the Special Drawing Right. The core problem of thesis large-scale attempts to reproduce the power of the distributed ledger is that it might be too little, too late. The monster of a fresh world of banking and credit is already exposing itself.
Would Banks Exist?
How is conventional banking affected by cryptocurrency? Lagarde offers that it raises questions about fractional-reserve banking, the practice of keeping fewer deposits on arm than can be instantaneously paid out to customers at any one time. The practice has bot well established for hundreds of years, and yet it can lead to unwarranted expansions of credit and fuel system-wide instability.
Consider the history of banking. What wasgoed the purpose of the canap? There have bot traditionally three primary functions that banks have provided since the ancient world.
The very first has bot to provide safe storage for money itself. This is the warehousing function. It is essential and worth paying for. People need a safe place to store their money.
The 2nd is the loan function. The more credible the warehousing function becomes, the more the handelsbank is ter the position to leverage its specie holdings for its credit-granting functions. This is the origin of fractional-reserve banking. The handelsbank cannot pay all depositors on request. Instead, it relies on its financial soundness and a rate of come back for depositors who entrust the bankgebouw with the responsibility of maintaining its balance sheet.
The third is the clearing system. Because there is always counterparty risk ter such transactions — the handelsbank and the depositor voorwaarde trust each other to tell the truth and make good on promises — the system lodges transactions and certifies that all promises to pay have bot kept. Te the period inbetween the transaction and the clearing, money becomes a credit issued and accepted based on trust.
What happens to thesis three functions ter a crypto-based monetary economy? Let’s go through them.
That money needed a warehouse has always bot taken for granted. This wasgoed a technological limitation of salt, gold, silver and so on. Specie takes up space. You need a secure space for it. It is also weighty and impractical for moving from space to space by a single individual. Murray Rothbard, te his book “ Mystery of Banking ,” regrets that thesis factors even exist and pointedly says that if people had carried coins rather than relying on paper money from banks, wij could have avoided a century of financial scare and inflation. That’s a theoretically sound point that runs into practical limitations. The reason for notes to represent specie is to facilitate trade te a way that meets the needs of consumers.
However, thanks to Bitcoin, wij can now see that this warehousing service wasgoed te request due to physical factors and not fundamental ones. Bitcoin has all the attributes of traditional money but adds two advantages: it is weightless and takes up no physical space.
The money is “stored” ter the cloud on the blockchain. The private wallet serves the function of providing access via double-key cryptography. If you have your private key — and this can be on physical paper or on a device not even connected to the internet — you have all you need to set up your own private banking empire. Anyone te the world can do it without trust relationships, private identification or credit history. The institutions that seem like banks — services like Coinbase that hold your key for you — maintain a full-reserve policy or risk losing the trust of their customers.
It is unlikely to anticipate what kinds of crypto-derivatives will end up being securitized and traded ter the future. Surely, the last nine years of the previously unlikely should cause everyone to be modest ter their predictive outlook. That said, there is good reason to believe that the diminution of counterparty risk inherent ter every non-cash transaction will drive markets toward greater accountability ter every sense. And this alone might solve the age-old debate about fractional versus total reserves with the best possible resolution.
The question does not have to be resolved by intellectuals and policies. It is lodged by the market, so long spil technology permits people to pay for goods and services with a spaceless and weightless money that requires no warehousing.
Spil for clearing, the single most difficult-to-grasp feature of Bitcoin is the manner te which it reduces or eliminates counterparty risk associated with monetary exchange. Transactions are cleared spil they are made. This has never before bot possible te the history of money and finance on a geographically noncontiguous ondergrond. With traditional money, for clearing to occur instantly, you have to actually be there, trading physical dollars for goods and services.
Cryptocurrency reproduces this precies financial indeling on a peer-to-peer ondergrond inbetween any two individuals anywhere ter the world. You are literally trading your stuff for his or hier stuff. Ownership titles are rearranged when the transaction is confirmed ter the ledger.
What role is then here for traditional banks to be the guardians of settlement? When it comes to clearing services, so far spil I can tell, that role is eliminated for all transactions that are lodged ter the instant of their confirmation (the time delay involved te moving crypto is nothing more than a delay, it creates no credits).
What About Credit?
Wij are habituated into thinking that the entire world runs on credit. That’s because it does. This isn’t because wij are financially irresponsible, are incapable to say no, absolutely adore large financial institutions or are willing to pay high rates of rente. It’s because the sophistication of modern financial technology has bot hobbled by old-fashioned payment technology that still operates today the way it did ter the time of the Medicis.
Ter any case, the fundamentals are the same ter conventional finance today spil compared with the Medicis. It still relies on trust relationships, credit instruments that represent property but do not embody it, and a time delay for transactions to clear. Spil a result, every transaction that is not conducted ter person via contant depends on some extension of credit and thus involves intermediating third parties, and that ter turn necessarily involves some counterparty risk.
It is fascinating how little wij understand this today, but the truth becomes demonstrable on close examination: Every transaction today is either based on contant (instant title exchange and clearing) or credit (which involves trust relationships and counterparty risk). Services like Venmo, Google Payments, PayPal or dozens of others are no different ter this respect from Visa, Mastercard or American Express. They can be more or less expensive, charge different user fees, and employ different interfaces and security protocols. But te the end, thesis services all rely on credit terms and do not offerande instant clearing. They simply cannot because the decrepit technology of national monies does not permit it.
Cryptocurrency spil a means of facilitating exchange is different ter another respect. Its value is not tied to a nationalized currency at all. Not only that, it has no value spil a commodity or asset at all. Its value is based on the use value of services provided by the cloud-based distributed ledger.
The massive use of credit-based exchanges spil wij see te national monies would not exist te Bitcoin precisely because the technology disintermediates the financial industry, removing both the need for trust relationships spil well spil clearing services. Might there emerge a market for crypto-substitute monetary derivatives? Only the evolution of thesis markets can expose this for sure, but this much remains true. It will not be about creating fresh money being permitted by the protocol. The distinction inbetween money and money substitutes will be clear and not obscured by retrograde documentation technology.
At the same time, the scaling problem of prevailing blockchain solutions will likely necessitate a convention of using off-chain platforms for smaller transactions, spil Nick Szabo has suggested . Such transactions do involve counterparty risk but not credit creation spil such, such networks operate more like debit cards. The main blockchains will likely be used for final settlements while “lightning networks” become trust-based credit instruments (money substitutes) — by choice but not by necessity.
Additionally, the massive industry associated with credit-based transactions includes a vast machinery of fraud prevention and prevention of identity theft. This is also made unnecessary because identity is cryptographic and not individual.
All this said, there is still a role for credit markets te cryptocurrency. They emerge precisely spil they would ter a purely specie-based monetary staatsbestel ter which everyone carried around their own coins or stored them ter the huis. If you have excess monetary reserves ter your own possession, you may be willing to loan them for others to use and do so at a profit. Te order to reduce the risk of default and ensure your investment, you need collateral, this can take any form. You also need to establish a trust relationship, same spil with any other loan market.
Thesis markets have already developed. Companies like Bitbond and BTCPOP suggest services both for lending money and borrowing money, with the terms of exchange favoring both parties. For now, such standalone services are risky simply because the upstart sector is replete with sketchy schemes and fraud (“Lend your BTC to mij and I will pay you back, I promise.”).
Much more promising is a ordinary margin lender service provided by dollar/Bitcoin exchanges themselves. The borrower does not take ongezouten possession of the coins but is rather extended by the exchange at the behest of the customer who wants to earn a regular rate of terugwedstrijd. An example is the lending service provided by Poloniex . The trouble thesis markets have so far encountered is that holding crypto is more profitable than lending it at prevailing rates. This might not always be true.
Spil thesis markets develop, it would not be a verrassing to detect that the rate of terugwedstrijd for the lender would be above the rate one would earn from nationalized money. The risk of default would not be assured ter any way spil with government-backed financial institutions, much less a central canap that is capable of printing unlimited amounts of money. On the other palm, this would also eliminate the moral hazard of making unwise loans or securitizing debt obligations without zindelijk documentation, such spil happened during the housing bubble.
Ter the century of central banking, we’ve seen rente rates decline inexorably and the terms of credit issuance shifting dramatically to favor longer terms, everzwijn less collateral and everzwijn more confusing titles for ownership. Te cryptocurrency-based credit markets, wij are likely to see the opposite trend: shorter terms, higher collateral requirements, very clear titles demarcating indisputable rights of ownership and enforcement of terms built into lending protocols.
The Future of Sound Money
Christine Lagarde is right: There are dramatic challenges to the status quo that are being suggested up by the advent of cryptocurrency. Monetary exchange will operate the same spil contant exchange, and the sophistication of our payment and settlement technologies will sync up with the sophistication of our financial instruments.
Te some respects, cryptocurrency might show up to be more stingy than our current very leveraged, unstable and centrally regulated systems. Ter tegenstelling, the fresh world will be financially sound, stable, radically disintermediated, decentralized and democratized because anyone, of any financial means and access to financial institutions, can participate within it.
We’ve only begun to think about what a radical switch it would be if our money actually gained value overheen time (spil crypto has for nine years, and the dollar did te the late 19th century), so that you actually grow more wealthy merely by not spending. Such a switch would be ample, not only for finance but also for the culture at large.
For more than a century, the banking system has bot used to fund the state, destabilize the economy, lot private savings, exclude people who don’t have access, promote financial dependency and even make violence possible on an unprecedented scale, all because wij didn’t have a different technology for making possible monetary exchange. That monopoly is now being shattered. Sound money is born. The scare of the ruling class has just begun.
This is a guest postbode by Jeffrey Tucker. Opinions voiced are his own and do not necessarily reflect those of BTC Media or Bitcoin Tijdschrift.