Unlocking the Potential for Financial Inclusion through a National Decentralised Digital Currency
For quite some time now, decentralised digital currencies have held long-term promise to change the way nations, corporations, and people transact. Some of which, benefit from disintermediation, high speed, coupled with low cost of transactions. As well as qualities of traditional currencies, such as price stability and the ability to act as legal tender, challenge the concept of traditional financial systems at their core. While the first generation of digital currencies only delivers incremental improvements, such as the reduction in transfer fees (Both domestic and cross-border remittance) and lowering the adoption cost for onboarding the unbanked across nations.
Currently, the responsibility for the monetary system lies under the jurisdiction of nation states and international agreements. For a decentralised monetary system to be adopted in any country, it must first comply with the regulations of that particular country. Central banks, while curious about central bank digital currency (CBDC), are wary of digital currencies that introduce decentralized ownership or governance, and that makes traditional centralized governance structures a challenging task. Despite this, they continue to explore the transformative potential of distributed ledger technology, smart contracts, and decentralised apps (dApps), the interest in this space isn’t limited to a niche of tech-savvy crypto savants any more, it’s now fully gone o the moon.
This journal entry will outline the following concepts and how they pertain to the plausibility of implementing a National Decentralised Digital Currency:
- What is Money?
- The advent of fiat money
- Benefits of digital currencies VS fiat currency
- The Orwellian Battlefield of Central Bank Digital Currencies
- Delivering on the Dream of a Decentralised National Digital Currency
- Surpassing the Scalability Trilemma in Blockchain
- Concluding the Fiat Monetary System
What is Money?
To make a well-formulated argument for the case for decentralization, we first need to understand what the features and functions of money actually are. Without delving too deeply into the weeds, money is something that people use every day. We earn it and spend it but don’t often think much about it. Economists define money as any good that is widely accepted as final payment for goods and services. Money has taken different forms through the ages; examples include cowry shells in Africa, to large stone wheels on the Pacific island of Yap. The question is, what do these forms of money have in common? Ultimately they share the three functions of money:
Money is a store of value. Money obtained through labour, inheritance, or by other means can hold its value over time. In fact, holding money is a more effective way of storing value than holding other items of value such as corn, which might perish. Although it is an efficient store of value, money is not a perfect store of value. Certain monetary policies cause inflation which slowly erodes away at the purchasing power of money over time.
Money is a unit of account. You can think of money as a yardstick-type device we use to measure value in economic transactions. It allows us to avoid quoting transactions in terms of t-shirts, bicycles, or corn. So, we find it helpful if the price is set in terms of money because it is a common measure of value across the economy.
Money is a medium of exchange. This means that money is widely accepted as a method of payment. Allowing citizens to maintain ubiquitous confidence that vendors will accept the payment of money. In fact, U.S. paper money carries this statement: “This note is legal tender for all debts, public and private.” This means that the U.S. government protects the right to pay for goods and services with U.S. dollars. Similar principles apply all over the world in various forms.
In order to appreciate the conveniences that money brings to an economy, we need to consider life without it. Economists say that the invention of money was such a monumental invention for civilization, that it belongs in the same category as the great inventions of ancient times, such as the wheel. The question then is, how did money develop? Early forms of money were often commodity-based money, that had value because it was derived from a substance that had value. Examples of commodity-based money are gold and silver coins. Gold coins were valuable because they could be used in exchange for other goods or services, but also because the gold itself was valued and had other uses. Commodity money gave way to the next stage, representative money.
Representative money is a certificate or token that can be exchanged for the underlying commodity. There are various interesting stories of how this came about, but ultimately instead of carrying the gold commodity money with you, the gold might have been stored in a bank vault. A well-known version of this was known as the “Gold Standard”. With the gold standard, countries agreed to convert paper money into a fixed amount of gold. A country that uses the gold standard sets a fixed price for gold and buys and sells gold at that price. That fixed price is used to determine the value of the currency. For example, if the U.S. set the price of gold at $500 an ounce, the value of the dollar would be 1/500th of an ounce of gold.
This allowed citizens to carry a paper certificate that represents or was “backed” by the value of the gold in the vault. Within the community, It was understood that the certificate could be redeemed for gold at any time. Over time people grew to trust the paper certificates as much as the gold, and the certificate practically functioned as an easier and safer method to carrying the actual gold. Representative money ultimately led to the use of fiat money, which is the type widely used in modern economies today.
The Advent of Fiat Money.
Fiat money is money that does not have intrinsic value and does not represent an underlying asset. Its value comes from being declared “legal tender” and an acceptable form of payment by the government of the issuing country. In this case, we accept the value of the money because the government says it has value, and other citizens value it to the extent that they accept it as payment and have faith in its use as money. There have been many forms of money in history, some of which have worked better than others due to characteristics that make them more useful. Overall, the characteristics of fiat money are durability, portability, divisibility, uniformity, limited supply, and acceptability. Let’s compare two examples of possible forms of money:
As historically, cattle and various livestock have been used as money. For argument’s sake, let’s say that a $100 bill is equal to the value of one cow. We can pragmatically compare them both and see how each of their characteristic stacks up:
Durability. The durability of cows makes them great for transporting, but the constant transportation can jeopardize their health. This is not as much of a risk for the $100 bill, which is durable enough to be replaced if worn, and there’s no chance that a long trip could do any serious damage to the value or health of these bills.
Portability. While a cow, from a practical standpoint, may be difficult to transport and store, the $100 dollar bill can be easily be placed into a wallet and stored on an individual’s person.
Divisibility. A $100 bill is divisible in many ways. A cow however, is not very divisible and cannot be exchanged for other denominations like 20s, 10s, fives 1 dollar bills.
Uniformity. Currencies come in different forms just like cows do – some might be coins, paper bills, or something else, and they can vary greatly by size and shape. One form of currency can also have differing values which makes them less all-encompassing like U.S. dollars, whereas one twenty dollar bill will always have the same size and value regardless of year minted or who owns it because they’re uniform representations of monetary worth.
Limited supply. Without controls, currency can lose value. Many commodities—like cows—have a limited supply which makes it hard to maintain their worth, although the money in your wallet remains of constant value thanks to government legislation.
Acceptability. Though cattle are seen as a form of currency in many countries, they may not be accepted as payment for goods and services by all parties. In contrast, people seem to trust United States dollars more than any other type of national currency.
Based on the 6 key features of money, it is clear that the $100 bill, or any unit of currency, is a much better form of money than cattle version in the hypothetical scenario that was just described. Even though money has taken many forms through the ages, money consistently has three functions: a store of value, a unit of account, and medium of exchange. The use of fiat currency in contemporary economies is a benefit to society because it has fewer limitations and can be managed with more flexibility. But is neither a commodity nor represented or “backed” by a commodity.
Benefits of digital currencies VS fiat currency.
The future of money may be digital, and we might not have to wait very long for this. Within the coming years, currency issued by central banks in digital form will shift from a bold speculative concept to a seeming inevitability one. Eight out of ten banks polled by the Bank for International Settlements in 2019, reported to have engaged with Central Bank Digital Currency (CBDC) projects. With 10% of the world’s banks say they would offer a CBDC within the next three years.
Central Bank Digital Currencies promise to realize a broad range of new capabilities, including direct government disbursements to citizens, frictionless consumer payment and money-transfer systems, and a range of new financial instruments and monetary policy levers. Ultimately, the key motives for issuing retail CBDC range from broadening financial inclusion to increasing the efficiency and stability of payment systems.
CBDC could also significantly enhance the development of monetary policies in a country. Understanding the real macroeconomic trends is challenging for most countries, often only visible after many months of analysis. This means that economies, which by definition must be planned with efficiency in mind, is made more difficult for governments.
Through the power of greater oversight and real-time monitoring, central bank digital currency could go a long way to boost these processes. CBDCs also have the added benefit of allowing governments to better combat illegal activities, such as payments frauds, more efficiently, offering people a greater sense of security regarding their funds.
But in a world of increasing awareness of the intrusion to the privacy of the public, both by corporations and institutions. A major downside is the strong control that the state would retain over the blockchain network within which the digital currency would operate upon introduction. Central banks would have increased control over money issuance and greater insight into how people spend their money, potentially depriving users of their privacy.
The Orwellian Battlefield of Central Bank Digital Currencies
It’s been a millennium since China invented paper currency, and in a world with increasing international tensions, the Chinese government is leading the reimagining of money that could ultimately shake global power to it’s core. In an article published by China Finance, a magazine run by the People’s Bank of China (PBOC), said the rights to issue and control a digital currency would become a “new battlefield” of competition between sovereign countries.
China’s eagerness to establish its own digital currency through an internationalised version of the Yuan. Is a concerted effort to lessen its dependence on the global dollar system by becoming the first country to issue a digital currency. However, as we stand at the doorstep of a monumental technological innovation, it highlights a very contentious point. Should governments be given even more power?
Using China as an example, since 2012 Xi Jinping has been has served as General Secretary of the Chinese Communist Party, China has utilized technology to further reinforced the authority of the state. The government has implemented a network of laws and technical systems dubbed the Great Firewall, which censors many foreign websites as well as any political dissent in the country. While a tool called the Great Cannon is used to overload the servers and disable any website the government regards as hostile toward the state. Artificial intelligence and facial recognition technologies are being combined with public CCTV systems to monitor citizens, including the persecution of minority Uighur Muslims in Xinjiang province in what has been called reinforced the authority of the state automated racism.
It is still not yet clear what the digital Yuan, also known as Digital Currency Electronic Payment (DCEP), will be based on, whether it will be based on blockchain or an alternative digital ledger technology. What is apparent is that it won’t be open or decentralized. “We know the demand from the public is to keep anonymity by using paper money and coins… we will give those people who demand it anonymity in their transactions,” said Mu Changchun, head of the digital currency research institute at the People’s Bank of China, at a 2019 conference in Singapore. “At the same time we will keep the balance between ‘controllable anonymity’ and anti–money laundering, counter terrorist financing, tax issues, online gambling, and any electronic criminal activities.”
The digital Yuan’s beguiling narrative of “convenience and modernity,” is actually delivering an ideal system for tracking dissidents and political protesters via their financial transactions. The double-edged sword of giving the Chinese government vast new tools to monitor both its economy and its people. Ultimately highlighting that some versions of CBDCs show the worrying pitfalls of proposed authoritarian centrally issued digital currencies could take the world closer to dystopia.
Delivering on the Dream of a National Decentralised Digital Currency
With all the advantages a Central Bank Digital Currency offers, many cryptocurrency enthusiasts argue that blockchain the technology allows for the separation of money and state, in a manner that’s never been seen before. Satoshi Nakamoto, the pseudonym of the Bitcoin creator, argued that national central banks abused trust placed in them. He wrote in his 2008 white paper that the peer-to-peer digital currency would revolutionize finance by skirting centralized systems and giving people more control over how they use their money, which was highlighted throughout the 2008 Financial Crisis. He also stated that
“The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve.”
Some cryptocurrencies are designed with decentralisation as part of their core principles, such as Bitcoin which uses Proof-of-Work (PoW) consensus mechanisms which does not require trust between parties in order to transact.
Some cryptocurrencies have been designed with a more centralised approach, such as Ripple which has explicit roles for gateways and nodes in order to provide trust between parties when transacting on the network.
Whilst some cryptocurrencies have been designed with a more fair and democratic approach, such as ETH V2 & EOS which has token holders within a Proof-of-Stake or Delegated-Proof-of-Stake (DPoS) network are able to cast votes proportional to their stake to appoint delegates to serve on a panel of witnesses. .
The benefits of a National Decentralised Digital Currency are that it provides transparency around the supply and demand of currencies within its ecosystem, through publicly distributed ledgers (blockchain). These can be inspected by anyone who is part of the network of this new system. The transactions cannot be changed or tampered with, without making all previous blocks invalid thus providing a widespread immutable record of transaction history, something not achievable using traditional fiat currency systems. This also means there is no need for third-party intermediaries to validate any transactions within the blockchains meaning cheaper fees, faster transaction times and ultimately the potential for financial inclusion at a national level.
A national decentralised digital currency would not be controlled by any national government and would instead rely on a decentralised peer-to-peer network. Maintained by a network of its citizens either through a secure digital wallet their smartphones or some other method. This would mean that the value of the currency could not be manipulated by a central bank. Which at minimum would serve as a prevention against inflation, as there are no more printing out money to fund economic growth at all costs.
Along with a National Decentralised Digital Identity this new system would also ensure universal access for people without bank accounts. Who currently have limited participation in the economy, giving them an opportunity to engage with formal markets and provide a unified national payment instrument for anyone regardless of where they are.
Surpassing the Scalability Trilemma in Blockchain
The Scalability Trilemma, a term coined by Vitalik Buterin, is the idea that these three factors, which all contribute to blockchain technology’s success are inherently in conflict with one another.
- Scalability: The degree of network scalability is an important factor because it dictates the eventual capacity of any blockchain network. In the context of a National Decentralised Digital Currency, it would refer to the ability of the blockchain to process transactions quickly.
- Decentralization : Decentralization, as the word suggests, refers to the degree of diversification in ownership of the network. In the context of a National Decentralised Digital Currency, the control is administered by the users. Users collectively have the ability to use their stakes to vote, to use services on the platform, and to benefit financially.
- Security: The degree to which the system can avoid central points of failure and continue operating even if some parts fail. Along with the level of defensibility a blockchain has against attacks from external sources, and its ability to protect users from unauthorized or fraudulent access. Internal security, is a measure of how immutable the system is to change.
The idea here is that an increase in any two of these factors will have negative consequences for the third. A decentralized system cannot be as scalable because there needs to be consensus across more computers (nodes), therefore even though transactions speeds are slower the network is less vulnerable against attacks. Similarly, scalability comes at the cost of security which is diminished when there are many computers (nodes) involved in the network.
Since the need for security and decentralization are in opposition, it would be wise to find an appropriate balance between these two factors. In the context of a National Decentralised Digital Currency, it’s not enough to have a decentralized system. The nodes potentially need to have some sort of restricted distribution around the globe, in order for it to maintain security. The network nodes can’t all reside in certain regions such as China or Russia etc. If security becomes compromised due to centralization like this, then we could see many people lose trust in these systems and the risk of a potential geopolitical disaster could ensue.
Concluding the Fiat Monetary System
A National Decentralized Digital Currency makes sense when you consider how much power governments already wield over money transactions: currencies are centralized and controlled by national banks with little transparency or accountability to the public. Only a National Decentralized Digital Currency can provide this transparency, accountability and democratic access that is needed in order to create more financial inclusion around the world. We are at an exciting time in history where we have the opportunity to rethink how money works both for and with us!