Lex Sokolin, a CoinDesk columnist, is Global Fintech co-head at ConsenSys, a Brooklyn, N.Y.-based blockchain software company. The following is adapted from his Fintech Blueprint newsletter.
The war over money is reaching a new height.
And yet, the shape of what is to come has never been more obvious. I can’t tell you how the cookie will crumble yet, but I can tell you the ingredients and the flavor. If you are not preparing for this world, your head is in the sand and you will miss a generational opportunity.
COVID-19 has made transparent the playbook of sovereign states and their macroeconomic responses. Students of history will know that money has always been an instrument of the State, and that debt is how you build an Empire. To wage war, you must borrow from the Iron Bank. Taxes are the royal lifeblood, and we are economic appendages for the body politic. In this frame, regulatory licensing is the granting of monopoly power over State privilege. Privilege enforced by the sword.
At times it may be sufficient to regulate reserve banking and oversee money flows with inflation and unemployment targeting. You would bat away at technology upstarts trying to weasel their way into the financial rivers. But sometimes you need to hand out $2 trillion in bailout money for a quarantine that you have mandated. One hand takes, the other hand gives. Sometimes the giving hand allows PayPal, Intuit, and Square to direct money without traditional licensing, because they are faster and more efficient.
But sometimes the money runs out and you’ve killed all the small businesses anway.
The money seems to be doing some weird things these days, if you are a country. Like, some really weird things! For example, the money keeps trying to transform itself into private cash equivalents and hide out in blockchains. Strange new companies, which are definitely not licensed to lend and borrow, keep buying up money, putting it into a box, and launching tokenized versions of units of account. It’s not even clear that it is companies doing this – sometimes it is just a bunch of open source-obsessed strangers on the internet.
About $3 billion of tokenized cash sweep, in large part on the Ethereum blockchain and used in trading and decentralized finance, now sits in crypto exchanges. Tether alone is $7 billion of market capitalization today (not all is on exchanges). This is a sign of people entering the ecosystem to access new financial instruments. Note, these are not investment trends. This is not about a stablecoin ever being worth more than one dollar per unit. Rather, it is about flows and where the money is going. This cash is the rounding error in your asset allocation. Cash should be 5-10 percent of your net worth depending on risk tolerance.
Meanwhile, Facebook and Silicon Valley startups with billions of users are also trying to reinvent money. As a country, you may have a few hundred million people here and there. But the technology platforms are global and far better coordinated than international political bodies. They have people’s attentions and hearts; you just have taxes and the sword.
If you haven’t seen it yet, the Libra Association released a second version of its white paper reflecting the input of regulators. The initial cut was focused on a technology council that issued a currency basket as an initial reserve, and then tech company users would contribute to that currency basket from across the world. Net interest income would flow to the council, yielding billions as balances reached trillions. The new cut is both more modest, and more dangerous.
The libra coin will be a mere basket (i.e., an allocation container) of underlying central bank digital currencies represented on the network (for my prior take on CBDCs, see here). This means there will be a digital dollar, a digital euro and a digital sterling all traveling on the Libra blockchain rails. This is analogous to today’s stablecoins traveling on the Ethereum rails. The white paper update is less ambitious in that it will not create a new form of money, and that the Libra rails will be fully permissioned. There is no decentralization and self-sovereignty in this proposal.
And that is precisely what makes it so dangerous and likely to be adopted. You certainly have heard that many central banks across the world are looking into, or already deploying, various digital currencies. The candidate technologies are R3 Corda, IBM Fabric, Libra, and Ethereum (Hyperledger Besu+). No central bank wants the chaos of billions of users having unfettered access to the royal lifeblood of money. Access should be parsed, compliant and rigorous. It makes people safe. And it makes things orderly.
The Libra network is a strong candidate to subsume CBDC innovation, and see the launch of various regulated fiat coins on its protocol. The compliance bend highlighted above is not accidental. Features of public chains, like transparent audit and smart contracts language, are replicated and made available to licensed participants. If the crypto ecosystem thinks it will have exclusive rights to distribute small business loans or provide universal basic income in a post-COVID world, it is for a rude awakening on libra’s launch. PayPal, Square and Intuit barely eked through to approval. Facebook will crowbar the wedge further in its favor. Binance and Coinbase will need to wait in line.
The East is using the same playbook, just with more purpose and efficiency. Unlike the girations of animal spirits in American and European stock markets, blockchain rails are being laid by China. Innovation, digital transformation and national growth are core priorities for the Communist Party. Hundreds of billions of dollars are directed towards R&D and experimental technology, the type of technology American regulators see as a systemic threat to sovereign systems. Further, that technology is exported to the smaller Asian economies and given as infrastructure to EMEA. China has just launched the BSN Alliance, a supergroup to rival libra. Members include government powerhouses like the State Information Center, as well as fintechs like Ant Financial, Tencent, and Ping An, which have blockchains that will eventually plug into this group. For example, Ant runs “Open Chain” (irony of ironies!), which was just released to SMEs and developers. Some public chains, like Ethereum and EOS, will also be accessible through intermediation.
Interestingly, the BSN is not focused on one particular protocol or network, but instead on a multi-protocol integration layer that allows developers to build Web3 applications above all these infrastructures. So you might build a single application into APIs that write data into Hyperledger Fabric or Ant Open Chain, and abstract away the complexity beneath. The upside is efficiency and an ability to quickly deploy software. The downside is that you are using software with compliance and audit tools built by the CCP.
That contrasts with what ConsenSys and Codefi are trying to do. We are working on APIs and developer tools that let anyone use the open, permissionless Ethereum to build decentralized financial machines. Already, Infura provides developers a gateway to deploying on Ethereum, and MetaMask gives access to a massive footprint of users. To get millions of people writing code, a simplifying toolkit is needed. I’d rather have the free market build it, than it be designed and managed as a government service. Similarly, I would rather have free market telecom companies provide us with the internet, rather than sit behind the Great Firewall.
This is the war for money. This is the war for finance. Who gets to build the fortress?
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