Crypto- Currencies and the Future of Money

Cryptocurrencies and the Future of Money 1 Crypto- CURRENCIES AND THE FUTURE OF MONEY GOING BEYOND THE HYPE: HOW CAN DIGITAL CURRENCIES SERVE SOCIETY? 2019 Contents 03 Executive Summary 04 Introduction / preface 07 Chapter 1 — the Nature of Money and possibility of Cryptocurrency Money 17 Chapter 2 — A Brief History of Money in the 20th Century 35 Chapter 3 — Money in the 21st Century 45 Chapter 4 — What are Cryptocurrencies? 69 Chapter 5 — Central Bank Digital Currencies 79 Chapter 6 — perceptions of Money and the Future of Cryptocurrencies 96 Conclusion 98 List of Figures / List of Tables 100 References 105 Annex Cryptocurrencies and the Future of Money 3 Executive Summary The shortcomings of existing financial systems became In addition to these technical challenges, the value widely criticised in the aftermath of the 2007–08 added in this report comes from a unique empirical financial crisis leading to an unprecedented wave of examination of how citizens undertand cryptocurrencies interest in new ways of efficiently executing economic and trust in different institutions to issue and manage transactions while ensuring high levels of transparency money across a unique sample of eight countries and accountability. With over 2,000 in existence at including Argentina, Brazil, France, Germany, Mexico, the time of writing this report, cryptocurrencies have Spain, the UK and the US. received a great deal of attention as a potential tool for radically altering financial landscapes for the betterment Some of the main findings include: of society. The purpose of this report is to provide a comprehensive overview of how crypto-currencies Knowledge, use, and understanding, of crypto- could be used to achieve this purpose. This includes currencies remains highly limited in all countries. how cryptocurrencies currently function relative to the intentions of their pioneers, and how the general public, The vast majority of citizens in all countries agree that use, understand, and trust them. money should continue to be issued by central banks. Some of the main findings include: While all central banks enjoy a significant trust premium when it comes to the creation and Modern discussions and debates about crypto- management of money, large differences exists currencies tend to confuse ‘money’ with ‘systems of between Latin American countries (Argentina, payments’ or, the mechanism by which transactions Brazil, Mexico) and European countries (France, are processed and settled. Germany, Spain, UK) and the US. Cryptocurrencies have the potential to vastly improve Countries where central banks experience lower trust systems of payments if designed and implemented premiums are more open to adopting new digital correctly. currencies issued by alternative institutions In practice, existing cryptocurrencies have failed to Trust in Facebook to issue and manage a currency achive the objectives envisioned by their pioneers and remains very limited, especially in Europe and the US. would generally not be considered as money. The degree of acceptability and price stability play New innovations (stablecoins, proof of stake, CBDCs) a key role in determining preferences for holding of are helping to make digital currencies more realistic money, regardless of who is issuing it. candidates to replace traditional money and create benefis for users across large volumes of transactions. 4 Introduction/ preface Since their inception in 2008 and the subsequent en- thusiasm, media attention, delusion, reflection, and continuous innovation, ‘cryptocurrencies’ have become one of the most interesting and perhaps most misunderstood phenomena of the early 21st century. Their popularity and potential for ‘disrupting’ and improving traditional financial systems, however, have led to an expanding list of media commentaries, re- w search papers, and policy reports. Unfortunately, many id e of these contributions have tended to focus on the ly a c contemporary positivist side of cryptocurrency without c e considering the normative intentions of its creators or, ss ib perhaps more importantly, the historical context under le which money and monetary systems have evolved. These contributions have also tended to focus on digital money from a single disciplinary viewpoint (com- puter science, economics, finance) without a great deal of consideration or integration of the valuable inputs from other perspectives. The idea of money has evolved continously over time. In the context of the technological innovations of the 21st century, it has become a phenomenon with a wider range of feasible possibilities, some of which were in fact proposed as far back as the early 20th century. To give some idea of the new range of types of money, the Bank for International Settlements (BIS) published a series of taxonomies including the ‘money flower’ and more general taxonomies that distinguish between central bank-issued currencies (which are a liability on the central bank balance sheet) and private-sector issued digital currencies (which are not the liability of anyone). Within this wider context, there exists a va- riety of types of money, each of which has different underlying characteristics, or attributes. Cryptocurrencies and the Future of Money 5 tal central bank igi -is d su e d Virtual currency Central bank reserves and Bank settlement deposits accounts Central Central bank bank deposited digital currency currencies accounts (wholesale) Central bank digital currencies (retail) Cryptocurrency (permissioned DLt) Crypto- Cash currency (permissionless DLT) w id Commodity money e r ly e a e c -p c o e -t ss r ib ee le p CrypToCurrenCy, CpmI (2015) CenTraL Bank dIgitaL CurrenCy, Bjerg (2017) Not the Central bank- liability of issued anyone Commodity Cash Reserves money Central bank Crypto- digital currency currency Cash Bank deposits Bank account Peer-to-peer Electronic Universally money Electronic accesible © Bank for International Settlements Source: Bank for International Settlements (BIS) 6 For example, a physical cash transaction is issued and The second chapter will provide a brief history of is backed by (a liability of) the central bank and is sub- money over the 20th century, including the gold stan- ject to some degree of inflation over time, has low dard era, the design of Bretton Woods and the adop- transaction costs and is accepted by all sellers of goods tion of fiat currencies. This chapter will also touch on and services. On the other hand, a credit card transac- some of the historical themes that have re-emerged tion is backed by (a liability of) a commercial bank, is in the context of cryptocurrencies, including Hayek’s subject to the same degree of depreciation as cash, may idea relating to currency competition and some of the come with some (explicit or implicit) transaction costs, challenges involved with fractional reserve banking and is accepted by all sellers of goods and services. systems. Given some of the shortcomings of money and existing Moving into the 21st century, Chapter 3 will consider financial systems that became apparent in the after- the possibility of realistic possibility that ‘money’ will math of the 2007-08 financial crisis, Nakamoto (2008) dramatically change in the coming years with the proposed a new type of money which would effectively evolution of cryptocurrencies. This chapter will con- remove many of the third-party participants in trans- sider some of the arguments against the use of phys- actions, making a more efficient, and less costly, way ical and untraceable cash including fraud and health to make transactions with strangers. With over 2,000 concerns. More generally, this chapter will consider cryptocurrencies in existence at the time of writing this the social benefits of moving towards digital curren- report, cryptocurrencies have since become progres- cies and the associated risks/barriers. sively embraced by speculative investors and growing market caps, but have yet to be adopted by the wider Chapter 4 will provide an overview of how cryptocur- public as a viable form of money due to practical tech- rencies work in terms of their degree of centralization, nical challenges along with a lack of trust in the issuing security and anonymity, token supply and governance authorities and understanding of how to use them. (consensus protocols). This chapter will examine cryptocurrencies in terms of what they were meant to be Some of the more fundamental questions that deserve from the perspective of Nakamoto (2008) and what closer attention within ‘monetary ecosystems’ revolve they have become in practice. This chapter will large- around who creates the money and what is their rela- ly draw on the case of Bitcoin, but will also discuss tionship with the entity who creates and obtains value briefly new generation tokens (stablecoins, Libra). from it. This is especially important in a fiat currency environment where the value of money (digital or phys- Chapter 5 will consider the arguments for the issuance ical) depends on the degree of trust users have in those of Central Bank Digital Currencies, including a review who issued or back the currency. The purpose of this of the literature and survey of what Central Banks are report is to provide a more comprehensive overview of currently doing in terms of the adoption of a central how cryptocurrencies could be used for the betterment bank-backed cryptocurrency. This chapter will also of society, how they currently function and how the discuss the implications for monetary policy and fi- general public uses, understands and trusts cryptocur- nancial stability from adopting this new type of dig- rencies across a sample of eight countries. ital money. The first chapter of this report will examine the nor- Lastly, Chapter 6 will discuss the results of the new mative nature of money including the role of commu- IE Survey on ‘Cryptocurrencies and The Future of nity trust and the role that government plays in ensur- Money’ in the context of Chapters 1--5. From a diverse ing this trust. In this normative framework, we can sample of countries (Argentina, Brazil, Mexico, think about the possibility of cryptocurrency as money France, Germany, Spain, UK, USA).

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