Victoria Cleland, Chief Cashier at the Bank of England, opened up a question today with far reaching implications while speaking at the 2nd International Workshop P2P Financial Systems 2016.
After briefly reminding us of the longevity of this 322 years old institution, stating that they were ahead of time in issuing its first bank note in 1694 – “essentially an IOU from the central bank” says Cleland, which offers a “very widely accepted, fully distributed, peer to peer payment mechanism” – she states the central bank is undertaking “fundamental long-term research on the wide range of questions posed by the potential of a central bank-issued digital currency (CBDC).”
A fundamental question with profound implications is the level of access to CBDC. The central bank could replicate the current system and limit access to a handful of banks who then distribute it to everyone by charging interest, but the central bank is considering opening up the bank issued currency, central bank deposit accounts – otherwise known as reserves – to ordinary men and women, in effect digitizing cash. Cleland says:
“The really big questions arise… where CBDC is available to everybody, allowing businesses and households to hold balances in central bank money and to pay each other in real time with full and final settlement, in an electronic format. While households are able to achieve this today directly with banknotes, they must use commercial banks or other financial institutions to make electronic payments.”
This could “fundamentally change the structure of the financial system,” says Cleland, who adds they are considering whether CBDC can and should be delivered through blockchain technology.
The Bank of England has already “undertaken a proof of concept using this technology and we are looking for new opportunities through our FinTech accelerator,” according to Cleland, but how would a central bank issued digital currency be delivered?
The scale, of course, would be enormous – millions of people and trillions of funds, but the rollout could be slow and gradual for new money only. However, such digital cash may have tremendous value if they are far too rare compared to overall supply. Access may need to be immediately available to everyone.
Assuming the question of security is satisfactorily resolved for say 98-99% of the population, and that’s a big assumption, both in regards to lost keys and in regards to more complex considerations – such as physical theft – it’s not clear how the network would operate in practice.
One option may be to have just one node by the central bank with everyone else connecting through SPV wallets, but if anyone gains access to that node, they would have the wealth of the nation on their hand. Many nodes would probably be necessary, with say 100 or 500 banks/institutions running the system and everyone else connecting through SPV wallets.
If the system can work in a centrally managed way and does, in effect, turn pound sterling into bitcoin or eth like tokens, money would turn into permissionless information. You would not need a bank account and you would not need an intermediary to transfer value. Anyone with a sterling address, including a fridge, a robot, a car, can send it to anyone they wish.
There would no longer be any need for clearing houses. Settlement and transfers would be instant. Digital cash would, in effect, gain e-mail like qualities over analogue, just as e-mail did over postal services. Combined with smart contracts and other functionalities, new capabilities would be available which in combination are likely to have a transformational effect at probably the same or bigger scale as when the Bank of England issued their first banknote, which was followed by the industrial revolution.
Moreover, complex algorithms can be employed to feed from price levels and other economic information that allows for more informed policy decisions on monetary supply and provides a better indication of economic activity.
There are dangers, however, as with any tool man has created, and potential for dystopian abuse. The bank may have the ability to censor any transaction. They may be able to track all activity. They could direct funds to specific uses through smart contracts, potentially curtailing liberty and, presuming the system is closed, there would be little if any accountability.
As always, such misuse relies on the willingness of the public and depends on their consent, not least because the centrally issued currency has no option but to compete with free market money, like bitcoin or eth.
A central bank issued digital cash would be just one of many, including many others issued by other central banks. At scale, this would create a very different monetary system and would implement Hayek’s insight.
Hayek, one of the greatest economist of the last century, acquired an insight on the nature of money while battling double digit inflation in Britain in the 70s. He expressed his findings most forcefully in The Denationalization of Money:
“If we want free enterprise and a market economy to survive (as even the supporters of a so-called ‘mixed economy’ presumably also wish), we have no choice but to replace the governmental currency monopoly and national currency systems by free competition.”
This is now possible because digital currencies can easily be transferred and exchanged, allowing for easy choice, with economic actors responding to monetary management or mismanagement by wider adoption or by transferring to another digital currency.
A central bank issued currency is, however, a decade or more away, but the Bank of England has opened an important debate which can be further extended by asking whether Barclays should issue their own currency, or Santander, or Microsoft, or other institutions, alongside the central bank.
Hayek thinks so – he actually thinks it’s the only way the free market can survive based on his conclusion that the regulator of the free market mechanism, money, itself must be regulated by the free market.