Following all the media attention around Cryptocurrency, Yosee’s Divya Sornaraja (DSo) & Ankur Gupta(AG) started an email thread discussing whether cryptocurrency can go mainstream for future transactions or not and also, whether it had the potential in becoming a formal legal tender. Further, we got into the concept of CBDC (Central Bank Digital Currency) also called Government Coins (GovCoins). We explore Thought-experiments on whether Govcoins can play a role in the future of Global Finance. In this dialogues & discussion (D&D), we explore these concepts hypothetically from the fundamentals with more questions and perspectives. We will continue this series by including more views from the world of finance, economics & cryptocurrency to help our readers see the possible Financial World of Tomorrow better.
To help build the context, here’s a little backstory:
Bitcoins (BTC): Bitcoins, a cryptocurrency, is a form of payment that can be exchanged online for goods and services. It works using a technology called blockchain. Blockchain is a ‘decentralizing’ technology wherein bank-like transactions and records are managed by many computers across the world. Transactions and records are registered in cryptographically-secured ‘blocks’ that are ‘linked’ to create a bank-like ledger but written in a secure distributed manner as shown below:
Bitcoins came into the picture in 2008 through Satoshi Nakamoto, the currency began coming into usage in 2009 when the implementation was released as an open-source software. Since then, more people have started using it as a currency, and the price of BTC has risen multifold but with a lot of volatility. If we talk about the recent developments, Tesla invested $1.5B in BTC and many companies are now accepting bitcoin-like cryptocurrencies as payment. But it’s not all walk in the park for BTC, the world seems divided into two: one who sees bitcoin-like cryptocurrencies as a flag bearer of future finance and another who sees it as a threat to the global currency system.
CBDCs or GovCoins: Governments across the world call it Central Bank Digital Currency. As the likes of bitcoin and altcoins (crypto coins other than bitcoins), start making noise and become more adapted into retail transactions every day, central banks around the world became wary of it and in retrospection, a few of them banned these coins entirely, a few put some partial restrictions and a few accepted them with open arms. But most of them had one thing in common, they also pioneered the concept of CBDCs, where they’re planning and testing out the digital currency rolled out by indigenous central banks hence completely regulated by themselves, unlike crypto coins.
Now since we’re familiar with lead anchors, the dialogues below will make a lot more sense:
AG: It wasn’t long ago when Raghuram Rajan cautioned about Bitcoin and the Tesla rally, now Tesla is for sure overvalued for what it brings to the table in terms of stock price valuation and even with what prospects it has for the future. How does one filter the noise and look in terms of the sheer value a company creates?
DSo: We have to get to the very foundation underneath the stories like Bitcoin-Tesla. They all tend to be a reaction to Stock Market speculations. Oftentimes, such over-valuations happen from a lack of growth-promising businesses available in the stock market for investors to invest in. Imagine the money in the markets to be like the fixed flow of blood circulating within the body. Suddenly, when many organs stop working and they don’t consume blood, then the blood starts over-flowing into the few organs that work. Thereby, overloading it to the extent of even breaking it. Similarly, as every industry gets hit by the Pandemic, the few stocks or commodities that appear to be or are speculated to be doing well, will see most of the money dumped into it by the herd mentality, and the value of those stocks or commodities tend to get inflated.
We have to remember that the entire world’s economy & businesses are built on Financial Products that ultimately depend on growth. In such a case, when there is no growth, all the borrowing interest multiplies. In such a situation, if a business is already on a lot more borrowed money trying to make up for its losses, and has borrowed in hopes to grow/expand its business big enough to accommodate the previous losses, then those businesses are likely to end up in a much larger trouble. Hence, many of the commonly performing companies with larger debts in stock markets started underperforming leading investors to re-organise their investment portfolio and dump a lot more money into the few promising ones.
Say, for example, X runs a Hedge Fund of 100M$, & the Fund Manager of X has promised its investors that X would return R% every year for 10 years. X has been managing the portfolio by investing in the regular markets. Suddenly, as the pandemic induced the human world to stop working, and as economies paused, all Balance Sheets bled & industries on credit potentially began crashing sooner. Companies already in debt may never recover or may take a long while to recover and grow. So, a few investments doing well may appear to be a good long-run bet to invest but they too may have a dependency on the available cash flow.
From an investor’s point of view, the reference is mostly to that of the Market’s value of different companies. So, if X doesn’t adjust the Fund’s portfolio to the updated current market valuation of different companies or diversify to these new hyped market interests sufficiently, the results could bleed the Fund’s books. So, X would most likely rush into the growing/inflating stocks and may dump some of that 100M$ into those inflating shares to show better value in books to keep investors happy. If X doesn’t buy/sell a growing Stock, X may have a lesser chance of getting that R% return. This could be a similar behaviour to that of the smaller Stock-market investors: The herd behaviour.
Investors, in general, ride the bubble or tide. In such a scenario, the timing of entering & leaving makes the difference between profit and loss. If someone knowingly rides it, then their timing better be right; while there may be exceptions who may ride it best against the herd, maybe in the Derivatives or other secondary markets? This could include all Financial tools that are not directly tied to Stocks/Shares of actually performing corporations or entities, so they could very well be fed by speculations.
IMHO, fundamental to Investments is like Physics: invested money has to convert to ‘useful work’. When I invest in, say, ‘Company Z’, and Z is expected to grow 5 times (5x) in 3 years; Z’s data, team-performance-so-far suggest that Z can deliver its plans. Then I’d invest, say, 50$ per share at Z’s 1.62B$ Market value. This implies that this new investment on 1 share would grow 5-times as the company grows. This investment gets rewarded for giving Financial ‘value’ power or speculating a ‘potential value’ in the next 5yrs. Some disciplined companies keep their word and deliver as expected. However, sometimes, after 5yrs newer unrealistic speculated expectations could inflate the same value. More, from an angle of Physics: every penny added or value expected to be realised, gets translated to useful work, which could then serve as the promise for the next goal or pole, as decided by the Corporations or entities. This is an overall outline of this structure, from the way I understand.
AG: Fair enough, makes a lot more sense now. What I am not able to understand is how world finance will integrate itself one day with/without a common ledger (surely, $ will not be universally accepted) and how will it all resonate with the probable BTC rise.
DSo: This exactly has been my line of thought too. Every time I had questions of a potential transition to a new Financial Modus operandi, I usually try to refer to history. Think every country’s transition from colonisation to independence could be one angle for reference. In India’s case, although there was a different currency that evolved out of it, the value of that currency stabilised by a Central Bank (RBI in our case) is based on the signals that they receive from the economy. The value of a currency has to be based on demand in the international & local market – believing that the Central Bank’s *promise of value* is subscribed in good proportion: i.e. export-import currency transaction-velocity or volume, & local currency velocity.
For volume & velocity, the fundamental is acceptance by a wider audience of markets accepting the ‘financial tender’ as a reference. From this angle, I’d imagine that a Blockchain-style decentralised ledger would begin being managed by a set of Geographical Laws i.e. every country may start its currency maintained and transacted via Block-chains. That may be one way to look at potential transactions? I do believe that regulatory networks or authoritative interveners referring to some Governing Law is a base to have a structured functional economy. That’s how trust and stability are usually built and not random dark-alley Bit-coin-hoarders whose source of value is based on pure speculation or perception or just illegal dumping of currencies.
AG: What if the integration would just not happen and the current trend of deglobalization will continue and what at most we’d observe is sinusoidal highs and lows but never anything beyond that? I’m very intrigued by the concept of Financial Integration because of multiple reasons. Across the border, trade is really difficult and it opens up a relatively risky derivatives game in play. To set things in perspective,
As historian Melvin Kranzberg’s famous aphorism goes: “Technology is neither good nor bad; nor is it neutral.”
Secondly, with more and more financial inclusion, country-nations with similar cultural backgrounds would probably opt for a similar financial setup as well subjecting to their then globalization-deglobalization conditions and binational ties.
DSo: This border trade could continue to exist, primarily because not all economies are disciplined. If we allow the international currency to free flow without regulators, then the countries which have inflated currency may mess that international blockchain economy. We have to keep in mind that for all of humanity to have one legal tender other than the USD, there needs to be a Regulator/Negotiator to make sure that every member country is disciplined and adheres to the set of governing laws so that the financial ethics sustain. Mismanaged, embezzling countries should not be able to hack the system like how China tried to peg its currency, maybe? The IMF still could not control geopolitically complex systems. Gaming the Blockchain arena won’t be so difficult.
However, I think we may see the rise of alternate decentralized currency that may run based on voluntary participation (eg; Dogecoin). As more of humanity starts valuing that alternative, regulators and international bodies would walk in to set the terms there. The cost & complexity of such a system may be much cheaper than the ones we have today. So, there may be a clean-up in the processing cost and complexity from Block-chains is something I suspect is headed towards international treaties and re-negotiations. If the IMF takes charge, then my guess would be to set conditions for member-nations and also add Geography-markers to those currencies. That way, they can issue sanctions or penalize fraudulent activities from nation-states. This sure is one possibility, provided there are some base rules and governance-legalities associated. For example, if say, some amount of currency gets hacked, and lost. Where would you file a case? Who takes that accountability? For nation-states, their constitution also holds accountability alongside their RBI (Central Bank) to make sure that Indian Rupee’s “Promissory Note” and its value in every transaction is justified and is protected. But in a common decentralized world, if the currency got snatched at Romania in transit from the Blocks, then which law protects it? These are questions that need deeper thoughts and perhaps, they may develop in our lifetime just like this Financial System that we live by today got built, within the last 200 years maybe? The question is: how long can this evolve independently of Geopolitical influences.
AG: With an ever-increasing population, the middleman jobs are going to bubble up and integration and inclusion would offer just that! Wouldn’t that be the case?
DSo: Job transitions may happen from traditional Banking systems to potentially a different line of Complex Financial instruments. The rate/speed of transactions would increase greatly. That speed may have an impact on the Economic Growth rate too?
I agree with the possibility of Global Common Decentralised Currencies – but the question is how & how long would it take to frame the rules for that system to evolve and pervasively become universally acceptable/reliable by most humans on this planet. Also, to what uses would those GovCoins be restricted to, if you can write at the back of each of those “Promissory GovCoins” along where it can or cannot be used.
AG: I agree with what you’ve pointed out about BTC. It’s rallying have more or less confirmed that as well. Guess, these crypto coins valuation will always be subjugated to people’s perception and speculation in a larger sense but would be interesting to see how this pans out on a wider time scale.
I want to focus on how world finance would integrate itself with the parallel evolution of blockchain currencies. Before we dwell on this thought, just adding a few facts below which can provide important validation to a few of our hypothesis :
- After Facebook’s Diem, also known as Libra before, there are reports that Amazon will be coming up with their cryptocurrency. They haven’t formally announced it yet but the speculation is that it’ll operate exclusively within the bounds of the Amazon ecosystem and initially only in a small selection of markets.
- 60% of the world’s central banks are now evaluating their digital currency and possibly be advancing with that thought very shortly considering how big a success ‘e-Yuan’ in China has been so far.
- Indian govt is in process of banning the international crypto for transactions within India
Continuing what you’ve summarized above, ‘Acceptance by a wider audience‘ is the objective for any of the global currencies under development. Now with many of the central banks trying out their own CBDCs (central bank digital currency), the first step is obviously to gain the local trust which will be/has been facilitated by tech or emerging payment technologies. Post this, they’ll probably form some sort of alliance across friendly countries like how these exist in trade markets and defence (ASEAN, BARC, QUAD, EU etc), maybe by setting off a commonly accepted exchange rate or by universally accepting one digital currency. This, as you said, in turn, will evolve gradually into a widely accepted financial instrument globally and one day we probably will see a globally accepted digital currency. My only contention is, every country operates their finances within their own system of setup, chances are we might see some of them failing miserably at it, which then brings the question to how will the inflow and outflow of our new currency be monitored and more importantly controlled since the usual sanctions and exchange rate options will mostly be nullified/neutralised to a large extent?
If we imagine on a large scale, this has the potential to make or break an economy and the more you think of it, you understand why people at central banks are playing safe.
I’m trying to think this through the decentralized apps analogy. They’re open source but protect value since the data is secured by blockchain consensus. Every new project plugs into every other project and a new feature anywhere becomes available everywhere. At one point, potential decentralised apps may overwhelm legacy centralized use of currencies which are based on unsecured internally sourced data.
This brings me to the question of what would happen to core banking. Correct me here if I’m wrong, most of the banking revenue still and will largely be coming from retail and corporate lending.
Once this CBDC makes its way into the market, then :
- Will it overwhelm the banknotes to such an extent that people would be willing to switch entirely or largely to CBDC? After all, it’s cost-effective and easy to consume for both parties. So, it’s a win-win situation but given the lack of infrastructure (more than 20% population still not having access to internet and ~30% not having a bank account, in India) will create a parallel gap which I’m not sure but might resemble the one which we know as economic inequality drawing parallels to digital inequality. Before wider acceptance, what comes is financial inclusion and there’s still a lot to be done in this aspect in the Indian context.
People can shift their savings to CBDC with just a click. Could this create some serious liquidity issues for banks? Let’s take a real-life example: Fast forward ten years, say, the bank has low liquidity, hence high-interest rate for a business person, inflated prices of commodities and assets, problems in payments to daily wage workers, non-account holders and many others. Also, more importantly, banks will have to find new avenues of compensating for this revenue loss (frankly, I don’t think the interest rates will go high to cover up for liquidity given regulations in place).
- People take time to adopt a new system, especially if it caters to their finances. Like how digital wallets have been there for a while but it took a demonetization to get people to use it and for a large audience, to even hear about its existence. I understand CBDC development will be a gradual process but do you think we as a nation would adapt it to a global rate? If we don’t, will there be any consequences? Would we be missing out favourable terms, early adopter advantage, etc.?
- What if the consensus switches to unregulated but globally accepted BTC? Wouldn’t that make a mockery of the central bank’s digital coin as there will always be players like Paypal, crypto exchanges where you can convert your crypto into INR and make that money flow into the general market?
- What would happen to the emerging FinTechs, payment companies like VISA, ANT Pay etc. once CBDCs start flowing into the market? We have a theory of simultaneous existence of these two systems together (like theatres and streaming services) and another theory of one’s demise to another’s glory. Which way will it pan out? Wouldn’t this hurt the job market considerably or probably not.
The chain of thoughts are still very naive but there’s surely some value we can add and extract out of these. I realize Divya had covered a very broad spectrum of thoughts in our initial mail conversation so I tried to contain that for this instance and have missed out on some fancy ideas ( cross border acceptance, laws and regulations/treaties, mostly the last part of that mail thread).
DSo: I think based on your inputs, we can draw a few more questions. Answers them will land us in a more vivid thought space.
- What can CBDC’s relationship with regular Fiat Currency be? Could it be a simple extension of Promissory Notes issued by the same country’s Central Bank? Or will 1USD = 0.5 e-USD?
- Not all CBDCs have to be decentralised block-chain style instruments. Implying that they could simply be a new way of infusion of ‘liquidity’ into every economy – instead of ‘minting money, Central Banks issue it directly into the Bonds-market via Digital Means through centralised Databases, perhaps?
- IMHO, CBDCs may still have to explain more clearly how it’s not another Digital Fiat Currency. If so, how?
- If the Central Bank backs the CBDC, then it’s again a Centralised Currency, unlike the decentralised anarchic philosophies of the Ethereum or Bitcoin world. In that case, it may create the opposite effect and make Finance extremely centralised. How would this be different is something the CBDCs of different countries have to explain/think/show/prove.
- In matters of money, Geopolitics and Governance play a vital role. This means if a country’s public loses confidence in their own Central Bank or Government’s economics, then they’d massively move to alternatives they trust. Example: Zimbabwe or Venezuela’s hyper-inflation that led them to adopt crypto more quickly or move to USD. So, in all these Financial factors, Politics and Governance gravely intertwines and impacts the working of the entire financial eco-system. The vice-versa can happen too: where the architecture of this Global CBDC can influence the undercurrents of Geopolitics too, maybe? That’s worth an exclusive thought-experiment.
- Referring ECB: European Central Bank is the one best reference we can look for a dream of some Earth-Currency (One Currency for the entire planet) that we are envisioning. The ECB was set up only in 1998 after the European Union was formed. The best case study is the Greek-economic crisis when the Euro was having a major difficulty because Greece mismanaged their economy. As Greece did not have a separate currency, Greece’s mismanagement of Finance could have been felt in another corner of Germany or France. However, England, from the start, always continued to use their own currency in addition to the Euro. So, if England gets into economic trouble, they can quickly mint their currency and handle inflation or deflation or liquidity crisis independently. However, the rest of Europe may not be able to do the same, if the Euro is all the only transactional reference. Countries tend to lose their Financial independence in managing economic crises if economies of the world get overly centralised. If say, Mozambique does not honor and maintain Economic fundamentals and mismanages their fund, it could very well impact Nigeria which may have been run efficiently and disciplined. ECB may have major answers to this line of questioning, I think. Questions along how do you maintain local financial stability when we get too interconnected?
The world of finance runs on the merit of trust. As long as the governments and central banks can keep people’s trust in the CBDCs they roll out, it may flourish and prosper. Of course, they will have to come to a solution to the problems that seem to arise with the coexistence of CBDCs and paper money. On one hand, the scope and autonomy associated with CBDCs may help bridge the financial distance and lower the costs but on the other hand, it cannot take a free run and get involved in financial malpractices vis-a-vis BTC. The future of CBDCs in the context of crypto and altcoins will have a much larger say in which way the financial integration will turn, how soon the geopolitical boundaries will not bother any longer, how complex or simple the cross border trade become and how the costs associated with transactions costs can go down significantly. However, other questions that may come back to haunt us could be: if the entire Global Economy gets centralised, then how can one benefit from our demographic dividend and what about local Financial independence in determining the collective value of that nation or group’s growth factors? That could be another D&D worth exploring with more minds, perhaps.
On the earlier discussed speculation part, the article below is worth reading.