The idea of fiat currency is something of a historical anomaly.
Around 5,000 years ago, shiny metals became a store of value for goods and services. Those were soon fabricated into standardized tokens, becoming media of exchange. It wasn’t for another 2,000 years, though, that anyone engraved the king’s face on those tokens. Money derived from the producers, not governments. So why should governments today have a monopoly on their local money supply?
Moreover, why should that be a controversial question? The Federal Reserve is not the United States’ first attempt at a central bank – it’s the fourth. The 1913 founding of the Fed culminated a 50-year concentration of banking power, a process that started with the National Banking Act of 1863 that Congress had passed to help fund the Civil War. Prior to that point, banks and private businesses were free to issue their own currencies. It was chaotic and there were a lot of failures, but the system worked for 25 years and provided individuals with choice.
Even after the act was passed, not everyone trusted the new national dollar. Local banks, railroads and state governments couldn’t legally issue money anymore so they issued bearer bonds, a practice that lasted into the 1980s. Bearer bonds were liquid, scalable and backed by the reputation of the issuer rather than by gold, silver or the guarantee of a central bank.
Just like crypto.
Fiat currency and bearer bonds existed side by side for decades. During that time, what most people now blindly accept as “money” had to compete. Federal Reserve notes were not inherently superior or more trusted than those of the Montana Territory, the Michigan Central Railroad or the Weehawken Ferry Co. The greenback had to prove itself in the marketplace, first against these non-fiat instruments, then against other national currencies once the gold standard came to an end in the early 1970s.
To be fair, the U.S. dollar emerged from the chaos of war mixed with inflation, imbalance of payments, foreign exchange speculation and strategic devaluation to be the world’s leading reserve currency. But that was then. We’re now in the 50th year of the post-Bretton Woods era – 1% of the entire history of money – and much has changed.
The reasons for the dollar’s success are fading. In 1960, America accounted for 40% of the world’s economic output; today it’s 24%. And while non-reserve currencies have done well to peg to the U.S. dollar, the other reserve currencies have always swung wildly against it. It has only been a relative “stablecoin,” if you will, against the yen and euro since 2014 and against the pound since 2017.
While that maps to the advent of cryptocurrencies, we mustn’t mistake coincidence with causality. The value of the entire space was still aspiring to breach $700 billion at the time, so its direct impact on the wealth of nations couldn’t possibly have been material. Still, it would be interesting to look into how simply the threat of emerging non-fiat currencies caused the major reserve currencies to narrow their trading bands.
Giving Davos its due
It’s a threat we now know monetary policy makers are taking seriously, with all the talk – and lately action – around central bank digital currencies (CBDC). China leads a list of more than 10 countries – including France, Canada and South Africa – piloting CBDCs. The monetary authorities in a handful of other countries are in the proof-of-concept phase, while much of the rest of the world, the U.S. included, is researching the feasibility of their own sovereign cryptocurrency.
The wisdom of this entire enterprise is questionable.
“While future proofs of concept may rely on different system designs, more experimentation and experience would be required before central banks can usefully and safely implement new technologies supporting a wholesale CBDC variant,” according to a Bank for International Settlements paper published in 2018, when this idea was still theoretical. “CBDC raises old questions about the role of central bank money, the scope of direct access to central bank liabilities and the structure of financial intermediation.”
Crypto enthusiasts rarely find agreement with the BIS, but every now and again they must tip their caps to the central banks’ central bank. “Old questions” must be asked anew.
How to do it better
Theoretically, there’s nothing inherently wrong with CBDCs. Yet, while they could eventually lead to more efficient payment processing throughout the economy, the potential cost to personal autonomy must be considered. If the Fed could trace every dollar bill you ever spent by tracking serial numbers, you’d have moved all your financial resources into privacy coins years ago. Of course, such tracking would be impractical. If the Fed were to issue a CBDC, though, that could suddenly become a standard procedure.
The currently available alternatives to fiat currencies are stablecoins. Still, they are unlikely, in their current form, to supplant government-issued money. Before they can, they need to provide the same full-faith-and-credit assurance provided by central bank notes.
“Creating a highly compliant blockchain could offer an alternative to state-backed blockchain initiatives such as CBDCs,” says Graeme Moore, head of tokenization for Polymath, a blockchain company that develops tools for regulated assets. “It’s important that innovators can continue to provide value for end consumers by providing them with options, while still maintaining regulatory compliance in an increasingly complex, global economy.”
Although the offering is initially focused on security tokens, Polymesh’s use case extends beyond security tokens into all regulated assets, with one of the most important being money. There’s no reason why the blockchain, built from the ground up, with compliance as a key design principle, can’t work for any instrument which requires regulatory compliance related to transfers, documentation, notification and fungibility.
Regulated assets, from money to securities, finally have a home on a blockchain purpose-built with regulatory compliance at its core.