Mixing oil and water

    23 Nov 2021

    The current situation in the financial market is like oil and water. The blockchain-based digital economy does not mix with the fiat economy and old finance. With one exception – CBDCs. But what future awaits them?

    “Over the past few years, I had some run-ins with regulators. And there are two sides to this coin. On the one hand, I still deeply believe both in cryptocurrency and in decentralization generally. On the other, central banks definitely don’t welcome blockchain technology, –told the author of these lines the CEO of one of the European investment funds, Nextury Ventures. –If you look at the central banks that affect the financial climate in the world from America to Europe, the central banks of large countries, they all purposefully kill any cryptocurrency initiative.”

    He used an example of Lithuania, where all commercial banks refuse to work with people who buy cryptocurrencies, say through MasterCard.

    “My bank, a Swedish bank, blocks all transactions aimed at buying cryptocurrencies. And if there is a startup with “blockchain” in its name or business model, the bank refuses them its services”, — added the fund head.

    Indeed, government regulators are always unambiguous in saying, “We are for digital innovations, for the future.” In stark contrast, central banks have specific written instructions that no regulated market player has the right to use cryptocurrencies or is allowed to conduct crypto transactions.

    It comes as no surprise, as the financial systems of modern countries are based on the concept of a single central bank. Central banks have become the dominant approach over the past couple hundred years, allowing the state to easily raise (create) money and cover any deficit. The US regularly just “exports” dollars all over the planet. And it is impossible to imagine the American dollar being voluntarily replaced by some universal global currency.

    But central banks cannot ignore the progress, just as they cannot disregard the benefits of blockchain technology. That is why the topic of central bank digital currencies (CBDC), which the media often incorrectly calls “national cryptocurrencies”, has been increasingly discussed over the past five years.

    In mid-October in Washington, the heads of the G7 state financial departments approved 13 policy principles for the banking and IT sectors – the rules for regulating national digital currencies (CBDC). The G7 has set the task of preventing global economy destabilization following the emergence of central bank tokens. The finance ministers agreed to cooperate and ensure control over innovative instruments. The countries’ joint statement also notes that CBDCs could become liquid settlement instruments. In addition, regulators will receive legal and technical means to control fiat-backed digital currencies.

    The G7 finance ministers and heads of central banks signed a joint 27-page document (https://www.mof.go.jp/english/policy/international_policy/convention/g7/g7_20211013_2.pdf), which outlined recommendations for creating and handling digital currencies. We will analyze and comment on its main theses.

    – CBDCs must not impede monetary and financial stability

    It depends on what you have in mind. Many central bank leaders and other well-known bankers believe that cryptocurrencies or DeFi are damaging financial stability. We disagree. So it is pointless to try and predict how the world will actually be affected by CBDC.

    – Any CBDC must be based on a public commitment to transparency, the rule of law, and sound economic governance

    Beautiful words, almost like “liberty, equality, fraternity”. Yes, it must. Now go out and ask the first 100 people you see if they think their government is operating on the principles of “transparency, the rule of law, and sound economic governance”. You can guess what the answer will be. So is it really worth expecting those principles to be upheld by the creators of CBDCs?

    – Central bank digital currency must complement cash and be pegged to existing payment systems

    This is logical, reasonable, and inevitable in the existing fiat money paradigm.

    – Any CBDC infrastructure must be as energy-efficient as possible

    Well, what’s the problem? Base them on the PoS algorithm, and there you go.

    – CBDC must meet strict reporting standards

    If the central bank that issues it can count money, then its digital currency will certainly meet these standards.

    – Central bank digital currencies must meet strict privacy standards

    It is not clear how this is consistent with the authorities’ desire to make all financial circulation in the country completely transparent. China had the most success in this area; the European Union is not far behind…

    The head of the Bank for International Settlements (BIS), Agustin Carstens, openly calls CBDCs “absolute control over finance”.

    – CBDC must not be used to aid crime

    And how does that fit with the previous point about privacy? That’s right: it doesn’t. Likely, we will get assurances that the confidentiality of personal financial data will be respected, but in practice, everything will be entirely transparent for government officials.

    – CBDC must be made cheaper, safer, and faster for regular users

    Well, that’s what blockchain is for, isn’t it? But using it to give fiat money a fresh coat of paint is concerning. It is no coincidence, perhaps, that former CIA employee Edward Snowden called CBDC “the newest threat looming over society.” According to Snowden, those digital currencies pervert the very nature of cryptocurrencies, as they deprive users of ownership over their money. He also described CBDC as “crypto-fascist currency”.

    Overall, as you can see, our impression and comments were somewhat skeptical. By creating CBDCs, central banks want not only to maintain control over fiat money but also to strengthen it, to make financial flows transparent, including at an individual level for each person. It would fundamentally defy the very philosophy of blockchain and cryptocurrencies.

    But the G7 finance heads are trying hard to mix water and oil…

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