Private v Public Digital Money
One of the reasons the central banks are so keen to popularise CBDCs is the fear that investment and digital banks will privatise the money supply.
The private sector is scrambling to popularise cryptocurrency. Fast-expanding “challenger” bank Revolut offers digital wallets as a standard service for its individual clients. In March, Goldman Sachs re-activated its crypto trading desk after detecting very strong institutional demand for cryptocurrencies among its client base.
The interface between fiat currency and cryptos massively inflates the money supply – and the central banks only control the fiat side of the equation. That might seem blindingly obvious, but kudos to the Bank of England’s Sir Jon Cunliffe for pointing out the important ramifications in a speech in May.
Sir Jon looks at the common assumption that money is created by the state, but argues that private-sector banks create the vast majority of money in the economy through the credit on which they charge interest. He argues that this can be seen as a form of digital money: “The majority of the money held and used by people in the UK today is not physical ‘public money’, issued by the state, but digital ‘private money’ issued by commercial banks. Around 95% of the funds people hold that can be used to make payments are now held as bank deposits rather than cash. In everyday use, only 23 per cent of payments [even] pre-pandemic were made using public money in the form of cash, down from close to 60 per cent a decade earlier.”
Not surprisingly, Sir Jon argued that “a well-designed and effective public money alternative in combination with regulation where necessary would provide a more efficient and a more robust answer.”
It would certainly be more efficient for central banks, which could charge a fee for creation of its money and its transfer – with of course the added benefit of oversight of ultimate beneficial ownership.
This is a massive challenge for central banks and their nations states. As yet, only the Chinese, untroubled by tiresome democratic processes as they are, seem to be addressing it.
Another way of dealing with the public/private conflict is to pretend it doesn’t exist. This was the effective posture of the government of El Salvador. In a move apparently originally motivated at extinguishing the high cost of dollar remittances (lots of expat El Slvadorians wire money home) the government achieved “a world-first as it adopts the cryptocurrency for use across all goods and services – even taxes”.
The Future of DLT and DeFi
Cryptos are opaque – their beneficial owners, with the possible exception of the relatively little-used currency Monero, are traceable. The blockchain might have been devised by Jeremy Bentham: it works on an all-can-see-all panopticon principle. The inventor of Bitcoin, if he exists as the single person known as Satoshi Yakomoto, can prove his identity by moving Bitcoin known to be registered in his name. The transactions are transparently clear, the identity of the owner of the assets is opaque (although not in the case of the Satoshi stash).
There was much brouhaha over the FBI’s recovery of a Bitcoin ransom paid by US energy company Colonial Pipeline in late May. A contemporary report in Bankinfosecurity.com puts it well: “Cryptocurrency has a reputation for being tough to trace, which is just one reason anonymity-craving criminals favour using it. In reality, however, Bitcoin and other cryptocurrencies don’t make users anonymous. Thanks to the blockchain, transactions can be traced, and especially when users convert cryptocurrency to cash, law enforcement and intelligence agencies have extra opportunities to tie the transaction to an individual’s identity.”
To trace ownership to an individual requires access to the private key to open an individual wallet, which it seems the FBI must have done by some smart piece of subterfuge. But the message is clear: the transactions are transparent – and cryptos, by virtue of the nature of DLT, aka the blockchain, offer opacity not anonymity.
The great hope for a genuinely independent financial system and combatting creeping accountability is decentralised finance (DeFi). DeFi was recently characterised in a Fortune article  as “an umbrella term encompassing the vision of a financial system that functions without any intermediaries, such as banks, insurances or clearinghouses, and is operated just by the power of smart contracts. DeFi applications strive to fulfil the services of traditional finance…in a completely permissionless, global and transparent manner… DeFi protocols enable for the first time to borrow or lend money on a large scale between unknown participants and without any intermediaries.”
The trades in DeFi take place in seconds, and all the participants are notionally servants of the smart contracts (nearly all written in Ether). The profits are generated by the algorithm finding best prices and inefficiencies in the markets. My best (and it’s limited) understanding of how DeFi markets work is as a kind of cryptocurrency swaps market with a little bit of arbitrage (aka shopping around for price discrepancies) thrown in – all done by the smart contract. The profits are generated by the machines.
The great fear here of course is that bad actors will interfere with the machines, just as they tamper with blockchains and the money supply of cryptocurrencies. There are what purport to be artificial intelligence programs out there that promise to generate DeFi profits for their owners. I for one do not fully understand these programs. Consequently, I have not subscribed, and have no intention of doing so until I can work out what’s really going on. Which may well be never.