Digital Currency Means Pennies For People, Bills For Banks and… Moolah For Machines.
When the industrial revolution caused an explosion in population and commerce in Georgian England, the lack of money for transactions (coins, basically) shifted from being an annoyance to being a major national problem. There had been money for the wealthy (bank notes and gold and silver coins) but no money for the masses.
You couldn’t buy a loaf of bread or pint of beer with a gold coin, so private industry stepped in to mint token money (ie, base metals and alloys worth a fraction of the face value), and this token money circulated to (very successfully) facilitate wage payments and retail spending. The private sector delivered the new money for the new economy. For a while, at least…
Factories had no coins to pay their workers, workers had no coins to buy their essentials and the economy was suffering. While the government did nothing, the private sector responded. The innovators responsible were those at the centre of the industrialisation storm, largely from the centre of England around Birmingham, and they used the latest technology (which was then the steam-powered press) to create money.
(I recommend George Selgin’s superb book “Good Money” on this topic.)
These private sector “tokens” (copper coins that had a face value above their metallic worth) gained rapid acceptance and by 1795 the problem of small change was almost solved with the government’s own coins trading at a discount against the private tokens! A generation on, the official government mint adopted token currency and began issuing modern coins.
MORE FOR YOU
Why am I telling you this? Well, it’s because economic history would tend to indicate that as the margins on the tokens used for transactions are slim (and tend to zero) so eventually the transaction money has to be provided as a public good. This is what economists call “the problem of small change”.
(And there’s a very good book on this too: “The Big Problem of Small Change” by Thomas Sargent and Francois Velde.)
Fast forward to our post-industrial revolution. Both traditional financial services providers (let’s tease them and call them centralised finance, or “CeFi”) and their blockchain-based rebellious cousins in decentralised finance (or “DeFi”) already use stablecoins of one form or another. This demonstrates a real need for digital dollars, pounds and euros that can be traded between blockchain applications hence the evolution of Circle’s USDC and Tether’s USDT and a great many others.
It is reasonable to ask again why these should be provided by central banks. The Bank of England view is that digital currency currency could be a public Central Bank Digital Currency (CBDC) or privately-provided “stablecoins” and says that a “secure regulatory environment” for stablecoins would form the foundation for sustainable innovation. But the big problem of small change means that I am sceptical whether a private digital pound could in the long run compete with a Bank of England digital pound or whether a private digital dollar could in the long run compete with a Fed digital dollar.
Would stablecoin users continue to hold them if risk-free central bank money were available as an alternative? Writing in the BIS’ annual economic report, head of research and economic advisor Hyun Song Shin says “CBDCs are a concept whose time has come” and predicts that they will be adopted over cryptocurrencies (which he calls speculative assets rather than money).
The Centre for Macroeconomics panel of experts on the UK economy was nearly unanimous in their June 2021 survey in agreeing that a CBDC would benefit the British economy (and half of the panel also believes that such a CBDC would have limited impact on the banking system). Well, things are moving along and Bank of England has announced a new kind of settlement account, known as an “omnibus” account, that allows for the wholesale use of central bank money in interesting new ways. The operator of a payment system can hold funds in one of these omnibus accounts on behalf of their participants to support a wide range of high-value payments.
One of the first users of such an account will be Fnality, formerly known as the the Utility Settlement Coin (USC). Fnality is now backed by 15 major financial institutions, ranging from Barclays and State Street to UBS and ING, and plans to go live once its application for an omnibus account is approved, bringing programmable money to the wholesale markets. As Huw van Steenis, who was an advisor to Mark Carney, said “this is what to watch, not the Bahamas’ sand dollar”.
But should CBDC be used solely in wholesale transactions just as those Bank of England banknotes were in the industrial revolution or also by retail customers to replace that token money from private presses? As the Financial Times noted recently, the answer has to be the latter. It has always been problematic that the benefit of holding safe government money goes to financial institutions, not the public (other than via cash).
I agree. But are wholesale and retail the only two kinds of digital currency needed? I was very interested to read a commentary on the topic of central-bank digital currency set out in a policy paper on the design of a digital euro from the German Banking Industry Committee (GBIC) . Now, I have to say that it caught my attention to see such a conservative organisation discussing a third kind of digital currency. In addition to a wholesale CBDC designed for financial institutions and a retail CBDC designed for people, they called for an industrial CBDC that is designed for machines.
They set out the need for what they call “tokenised commercial bank money” to complement the two forms of CBDC already widely discussed. In particular, they identify a demand arising from the Internet of Things. In order to facilitate more sophisticated interactions within that environment they suggest a digital currency optimised to allow transactions based on automated “contracts” to increase process efficiency. They see what they refer to as “Industry 4.0” as an essential part of our future because it is a critical platform for the increases in productivity we will need to deliver economic growth and prosperity across society,
To return to the experiences of the Industrial Revolution and the steady transition from the innovative private money of the “Birmingham button makers” to the standardised and utilitarian money of the Royal Mint, then, I think it is not a difficult prediction to make that experiments in the retail space will feed into and inform the design of the inevitable digital dollar for retail payments while the experiences of the great financial crash will feed into and inform the design of the inevitable digital tokens for wholesale market. But what will inform the design of the industrial money?
In addition to the thinking underway at the Fed, at the Bank of England and the European Central Bank, it’s time to start looking at not only what the people want or what the banks want but what the robots want.