The Evolution of Money – Part 3

Currently, government money (e.g., USD, ZAR, GBP) can only be held in two forms: physical cash (physical bearer instrument) or digital money in a bank account (digital registered instrument). Crypto currency is a new form of money that can be offered as a third form of central bank issued money. It is only a matter of time before central banks issue their own crypto instruments in the form of central bank issued crypto currencies (CBCCs).

(This is a continuation of my earlier blogs “The Evolution of Money – Part 1 ” and “Part 2 ”)

Currently, government money (e.g., USD, ZAR, GBP) can only be held in two forms: physical cash (physical bearer instrument) or digital money in a bank account (digital registered instrument). Crypto currency is a new form of money that can be offered as a third form of central bank issued money. It is only a matter of time before central banks issue their own crypto instruments in the form of central bank issued crypto currencies (CBCCs).

While the term CBCC may scare some in the regulated space as “crypto currencies” have become associated with unregulated tokens of value, the term merely differentiates it from the digital money that sits on commercial banks’ balance sheets as liabilities. Its name is derived from the cryptography that allows it to be a crypto instrument.

Just as no distinction is made between the value of a physical $100 bill and $100 in digital money that appears in an online bank account, so too would the value of $100 in CBCC be the same as the first two forms of money. The currency would remain the same. Only the form would change. The emergence of CBCC would not change the money supply[i] in an economy.

The introduction of a third form of regulated money, CBCC, would replace another form of money to keep the money supply constant ceteris paribus. Just as one deposits a $50 note at the bank which gets replaced by $50 in an online bank account, so too would $50 in CBCC have to replace some other form of money already in circulation. A central bank could easily set up a trust account to receive digital money (which it could take out of circulation) and issue a corresponding amount of CBCC to be sent to a wallet address of the digital money sender. In this way, the form of money as we know it could migrate from digital money to CBCC.

By migrating the predominant form of money in an economy to CBCC on a sovereign blockchain (a shared ledger under the jurisdiction of a central bank), a central bank could observe real time transactions in an economy to better understand the velocity of money and gauge the health of the economy on a daily or even hourly basis. Once a sovereign blockchain is created with a CBCC, other financial instruments such as bonds, equities, derivatives and even land and car registries could migrate to the same sovereign blockchain. This would allow the central bank to conceivably see the creation of all commercial bank assets in an economy in real-time, including the categorisation of those assets (e.g., collateralised loans vs. unsecured loans). Such transparency is invaluable to any central bank and would make decision-making more informed, timely and effective.

With a view of all transactions in an economy, anti-money laundering initiatives would be greatly enhanced. As it stands, payments from customers at a single bank are not always seen by the regulator as they are updates to that particular bank’s ledger and do not get processed through a national payments system, making the historical flow of money difficult to track. In contrast, a sovereign blockchain would allow the movement of money to be traced through a historical path of transactions on a single decentralised ledger.

Tax collection could be revolutionised through the use of smart contracts on a blockchain. Tax could be collected at the point of transaction in real time, changing the entire system of tax collection from “after-the-fact collection” to “in-the-moment payment”. Imagine every payment to a retailer being automatically split at the time of payment so that 10% (a sales tax for example) would be paid directly to a government address with no inconvenience or cost to the customer or merchant. This would significantly reduce the burden and cost of tax compliance for the merchant (as they would be paying their taxes automatically throughout the year) and improve collections for the tax authority.

This is just one example of how tax could be streamlined, but other examples abound – automated Capital Gains Tax when a vanilla asset is sold (the blockchain would have the history of what the asset was initially bought for and a smart contract could calculate the tax owed and pay both the seller and the tax authority in a single transaction); automated transfer duty on property sales; automated income tax payments when salaries are paid etc. The very notion of a withholding tax could become obsolete.

The blockchain would also allow the “codification of money”. Imagine a world in which the money paid into the account of the Department of Education could only be disbursed to accounts associated with schools or where money sitting in the government’s social grant account could only be paid to accounts of individuals flagged as eligible to receive those grants. The combination of the codification of money and the transparency that the blockchain allows would go a long way in combatting corruption.


[i] Money supply is defined as the total amount of monetary assets in an economy’s currency, the summation of physical notes and coins as well as digital money (the nuances of narrow and broad money definitions of M0, M1, M2 and M3 are not pertinent to the point at hand).

by Farzam Ehsani

Proliferation of cryptocurrencies: which currencies should you invest in?

Most people in the banking world today are familiar with the term blockchain. The first thing that springs to mind when blockchain is mentioned is Bitcoin. It is the cryptocurrency and digital payment system created by the mysterious Satoshi Nakamoto, which has grown exponentially since its inception in 2009.

Most people in the banking world today are familiar with the term blockchain. The first thing that springs to mind when blockchain is mentioned is Bitcoin. It is the cryptocurrency and digital payment system created by the mysterious Satoshi Nakamoto, which has grown exponentially since its inception in 2009.

https://coinmarketcap.com/currencies/bitcoin/#charts

The value of Bitcoin has grown from around USD 2/Bitcoin in December 2011 to above USD 2,300/Bitcoin this year. Investment in Bitcoin sky-rocketed after a surge in traded volumes and increased Bitcoin prices in the Asian Market.

Investors are opening up Bitcoin wallets in the fear of missing out. As investors rush to ride the wave, not only has investment in Bitcoin spiked, but so too has the investment in “altcoins” (the cryptocurrency alternatives to Bitcoin). Some of the largest and most dominant of these are, inter alia, Litecoin, Ethereum, Ripple and Monero. Each cryptocurrency offers something different, and if deciding to invest in these long-term, it would only be prudent to understand more about what they do.

https://bitcoin.org/img/icons/opengraph.png

Let’s start with the world’s leading cryptocurrency, Bitcoin. In addition to boosting financial inclusion, Bitcoin aims to make near real-time cross-border transactions possible on a global scale. In South Africa there are already online merchants that are accepting Bitcoin payments. Some of them are well known brands: BidorBuy, Takealot, Superbalist, Runwaysale, Raru and Appliance Online. Additionally, all merchants on the payfast.co.za platform (30 000 websites), accept Bitcoin.

Ethereum differs slightly from Bitcoin, with more focus on technical blockchain development. It is an open source platform used to build decentralised applications. Examples of Ethereum applications include self-executing smart contracts and native tokens. A number of interesting developments on the Ethereum blockchain are emerging. WeiFund, a crowdfunding solution, operates similarly to conventional crowdfunding platforms such as GoFundMe and Kickstarter. However, instead of using fiat currency, WeiFund raises funds using the Ether cryptocurrency. Users can contribute and manage crowdfunding campaigns with the use of smart contracts to turn donations into complex agreements.

http://media.coindesk.com/uploads/2014/02/Litecoin-logo.png

Litecoin was created by Charles Lee, a former engineer at Google, with the intention of becoming the second most valuable cryptocurrency. When it was written, it was the second biggest cryptocurrency by market capitalization, but has since fallen to the 6th largest as it has yet to see much more investment. Litecoin is similar to the Bitcoin. The main difference is that it takes an average of two and a half minutes to generate a block, contrast to an average of ten minutes that Bitcoin takes to generate a block. This means that Litecoin can confirm transactions at a faster speed than Bitcoin. However, it is important to note that transactions occur instantly, whilst confirmation of transactions occur as the blockchain propagates.

https://pbs.twimg.com/profile_images/473825289630257152/PzHu2yli.png

Monero is attempting to take on Bitcoin by providing greater transaction anonymity. Bitcoin is known for supporting anonymous transactions; however, each transaction has a sender, receiver and amount recorded on the blockchain. Each wallet has an address which can be traced back to the owner through IP addresses and service providers. To combat this, Monero makes use of a ring signature to provide for more privacy.

Ripple’s digital currency XRP is similar to Bitcoin as they are both digital currencies that can be mined and sent from peer-to-peer without an intermediary. Ripple is used as a currency agnostic value exchange. It is a real-time gross settlement system enabling real-time global payments anywhere in the world. The advantage of this is that it can be in any form of currency (Dollars, Yen, Euros, etc.). Ripple enables secure, instant and inexpensive global financial transactions and may assist Bitcoin in accessing the rest of the financial world.

There are over 700 different cryptocurrencies currently in issue which opens up a broad investment base. Hopefully some of these points spark your interest to delve deeper into each cryptocurrency’s ambition and that the summary above has given you a starting point for further research.

by Matthew Shaw

The Evolution of Money – Part 2

The emergence of crypto instruments has allowed digital monetary value to be held without the need for a trusted intermediary for the first time in history. Crypto currencies – the most common type of crypto instrument today – such as Bitcoin, Ether, and many others demonstrate this fact.

(This is a continuation of my earlier blog: The Evolution of Money – Part 1)

The emergence of crypto instruments has allowed digital monetary value to be held without the need for a trusted intermediary for the first time in history. Crypto currencies – the most common type of crypto instrument today – such as Bitcoin, Ether, and many others demonstrate this fact. Anyone who owns crypto currency has a unique private key (akin to a password) that allows the owner (and only the owner) to mathematically “unlock” or spend the value at an associated public address (akin to an account number). The ledger that records the amount of crypto currency at any particular public address is maintained by a network of computers (called nodes) that run a consensus algorithm to ensure that they are all synchronised.

The ingenuity of this network of nodes working together to validate transactions (and reject any double-spending) is that the multitude of nodes ensures that there is no dependence on any single one to ensure the integrity of the ledger. This is a powerful concept – the way to remove a trusted intermediary is not to get rid of the intermediary, but to increase the number of intermediaries that are maintaining the same ledger so that trust in any particular intermediary is no longer needed. Dependence on any single intermediary reduces as the network grows, and indeed the term “intermediary” starts to become inappropriate and even inaccurate.

To understand the financial world’s fascination with crypto currency and blockchain, we have to examine the nature of money. The traditional textbook definition of money refers to its three major functions in society: a means of exchange; a unit of account; and a store of value. Interrogating this further, however, it becomes apparent that all three functions relate to the concept of money representing value. After all, why accept money as a means of exchange for something else of value unless one believes the money has at least the value of what it was traded for? And a unit of account that measures the value of other products needs to possess value itself, otherwise it would be abandoned as a unit of account (as we have seen in any economy that has witnessed hyperinflation). So if the functions of money boil down to the value it possesses, what determines the value of money?

Six characteristics determine how effectively money performs the functions mentioned above and in turn determine its value. These characteristics are:

  1. Durability – if money is meant to store value and does not last long itself, it cannot function as a very good store of value;
  2. Portability – to facilitate trade, money needs to be very portable, and costs associated with transferring it from one party to another diminish its function as money;
  3. Fungibility – a unit of money should be exactly the same as any other unit, otherwise time and energy would be consumed in comparing tokens rather than promoting trade;
  4. Divisibility – the smallest unit of money must be worth less than every other tradable asset, otherwise another token of money would need to be used to trade something worth less than the smallest unit of money;
  5. Scarcity – the oversupply of any commodity brings its value down, and in the extreme case, where something is overly abundant, it cannot be used to trade for other scarce resources; and
  6. Acceptability – money is accepted because the recipient believes it will be accepted by others when he/she wants to spend it. Without the belief that money will be accepted by others in the future, it would cease to be money.

Crypto currency is a better performing form of money (versus physical cash and digital money) in two significant ways: (1) It is more durable (it’s backed up by many more servers across institutions than traditional digital money that is backed up only by the servers of an individual bank); and (2) it is more portable (as it is more seamless to move money on a single decentralised ledger than across different centralised ledgers). Money is supposed to be the most frictionless asset in society, and crypto currency is the most frictionless form of money to date.

The Evolution of Money – Part 3 coming soon!

by Farzam Ehsani

 

 

 

 

 

 

 

The Evolution of Money – Part 1:

Any monetary value in our society exists in one of two ways: bearer instruments or registered instruments. A bearer instrument is an asset that is assumed to be owned by the holder of the instrument for which no transaction record is kept.

CRYPTO INSTRUMENTS – THE NEW MONETARY INSTRUMENT

Any monetary value in our society exists in one of two ways: bearer instruments or registered instruments.  A bearer instrument is an asset that is assumed to be owned by the holder of the instrument for which no transaction record is kept.  An example is physical cash.  You do not need to prove to anyone that the physical cash in your wallet is yours.  You have it and so you are the presumed owner.  Society keeps no record of who previously had the $20 dollar bill that now sits in your wallet.  Registered instruments, on the other hand, are assets whose ownership is determined by referencing a ledger managed by a trusted institution (e.g., properties at the Deeds Office, bonds and equities at the Central Securities Depository, or digital money in a bank account).  While all assets can be categorised as either bearer or registered instruments, assets can also be categorised as either physical or digital assets.  Overlaying asset form (i.e., physical vs. digital) onto instrument type (i.e., bearer vs. registered) helps us understand the evolution of monetary instruments in our society.

farzam-pic
Figure 1: The evolution of monetary instruments in society

 

Physical bearer instruments were the first monetary instruments of humanity (e.g., animal hides, shells, salt, etc.), but communities came to realise that such forms of monetary value had their limitations.  Land, for example, would be a disastrous bearer instrument.  If you left your land to hunt, and came back to find someone else standing on your land claiming it as theirs, one of two outcomes could result:  The loss of the land to the new “owner”; or violence to resolve the dispute.  Furthermore, there would be an incentive to remain on your land to maintain ownership and avoid any potential disputes.  None of these outcomes is conducive to an advancing civilisation.  So as communities came together, physical registered instruments emerged where the community collectively agreed on a trusted intermediary to keep the record of ownership (the source of truth) of a particular asset and update it on the community’s behalf.

As computers became more widely adopted, many of these physical registered instruments migrated from physical to digital registers.  The birth of digital registers also gave rise to digital registered instruments – instruments that have no physical form, and are defined purely by an entry onto a digital register (e.g., a government bond or money in a bank account).  Physical forms of value are easy to understand in this framework.  Digital instruments are less intuitive.

A purely digital bearer instrument (e.g., a digital coin) cannot function as a monetary instrument due to the double-spending problem.  Think of a photograph on your smartphone.  Sending this photograph to someone else does not delete it from your phone – you retain a copy.  This poses a problem for anything digital that is meant to represent value.  What is critically important in any monetary system is that when someone spends their money, they no longer have it.  The ability to copy and paste the digital coin ID mentioned above ad infinitum – the ability to double-spend it – reduces its scarcity and ultimately debases its value.  To avoid double-spending of digital monetary instruments, society has established trusted institutions (such as banks, deeds offices, CSDs) that ensure that when someone receives digital value, someone else must by definition no longer have it.  This is a fundamental principle of our double-entry accounting system where every debit must be equal to a corresponding credit.

In summary, three types of monetary instruments have been described:

  • Physical bearer instrument;
  • Physical registered instrument; and
  • Digital registered instrument.

These three instrument types were the only ones available to humanity until 2009.  That year, Satoshi Nakamoto’s seminal paper “Bitcoin: a peer-to-peer electronic cash system” combined advances in computer science, cryptography and game theory to develop what has now become known as blockchain technology.  This technology has allowed the emergence of a fourth type of monetary instrument:

  • Crypto instrument

The crypto instrument is a digital hybrid instrument with characteristics of both bearer and registered instruments.  It’s like a bearer instrument because the holder of a digital private key is the presumed owner of the value it controls, and a registered instrument because that value is recorded on a ledger (albeit a distributed one).  The presence of both bearer and registered instrument characteristics are necessary for the existence of a crypto instrument.  All assets issued onto a blockchain are crypto instruments.

The Evolution of Money – Part 2 coming soon!

by Farzam Ehsani

Why cash is here to stay

Many assume that physical cash is on its way out of our financial system. You’d be forgiven for thinking this, given current advances in technology, widespread adoption of mobile phones, higher inclusion of people into the ranks of the “banked” and the broader FinTech revolution taking place. However, deeper reflection leads to a different conclusion…

Many assume that physical cash is on its way out of our financial system.  You’d be forgiven for thinking this, given current advances in technology, widespread adoption of mobile phones, higher inclusion of people into the ranks of the “banked” and the broader FinTech revolution taking place.  However, deeper reflection leads to a different conclusion:  As long as dire poverty exists in any society, cash cannot be done away with.

cash-is-here-to-stay
Image credit: seemoreandmore.tumblr.com

Let me explain.

Any monetary value in our society is allocated to individuals in two ways – bearer instruments or registered instruments.  A bearer instrument is something that is assumed to be owned by the holder of the instrument.  An example is physical cash.  You don’t need to prove to anyone that the cash in your wallet is yours.  You have it and so you’re the presumed owner.  Registered instruments, however, are assets whose ownership is determined by referencing a database managed by a trusted institution (think houses at the Deeds Office or your digital money that is in your bank account).

Now let’s compare cash (a bearer instrument) with the digital money in your bank account (a registered instrument).  Even assuming zero bank fees, to access the money in your bank account incurs costs.  You either need to have a device with internet access (costly) or you need to travel to your bank branch (also costly) to access or spend the money in your bank account.  Physical cash on the other hand incurs no costs to be spent or accepted.

It is socially untenable for a government to require its poorest citizen to incur costs in order to accept value in the form of its currency.  As such, it follows that cash will remain in our society as long as the “access cost” to digital money is not insignificant to the poorest member of our society.  And of course, this assumes that fiat currency (i.e. government-issued currency) will last longer than it takes us as a society to eradicate extreme poverty! (More on this another time.)

by Farzam Ehsani

Kenya’s mobile money story: the runaway success of M-Pesa

Development finance and corporate banks alike have long wrestled with the issue of banking the unbanked in the developing world, which would encourage broad-based socio-economic development on the one hand, as well as greater product distribution for the private sector banking institutions.

http://martinpasquier.com/wp-content/uploads/2013/11/Mpesa-agent-shack-kenya-afrikoin-mobile-money-martin-pasquier-emerging-markets-innovation.jpg
Image credit: http://martinpasquier.com

Development finance and corporate banks alike have long wrestled with the issue of banking the unbanked in the developing world, which would encourage broad-based socio-economic development on the one hand, as well as greater product distribution for the private sector banking institutions.

However, bringing greater financial inclusion to the bottom of the pyramid no longer means universal branch bank account ownership. Nowhere is this more evident than in Africa, particularly in one of the continent’s emerging fintech hubs, Kenya.

http://asmarterplanet.com/blog/2011/04/kenya-leapfrogs-the-rest-of-the-world-with-its-mobile-money-services.html
Image credit: http://asmarterplanet.com

In 2006, before M-Pesa was launched, 25% of Kenyans had access to banking products. By 2014, this figure had jumped to 68%. Almost half of these users do not have a formal bank account, indeed, formal banking sector inclusion in Kenya remains as low as 23%. However, the M-Pesa platform performs the essential financial transactions:  deposit and withdraw money, transfer money to other M-Pesa users and non-users, pay bills and purchase airtime. M-Pesa agents are as ubiquitous as pavement airtime kiosks, whose owners have been duly trained and are incentivised by clipping a commission per M-Pesa transaction. This is the kind of distribution network that most ATM-driven banks can only dream about.

This context is not unique to Kenya. Small wonder then that Sub-Saharan Africa is a global leader in the use of mobile money technology. On average 16% of the adult population actively uses a mobile money product in the region; the global average is 2%. Of the 18 countries in the world that have more mobile money accounts than bank accounts, only one, Paraguay, is not in Africa.

The significance of M-Pesa and the mobile money products like it is the potential it holds for retail financial access in the developing world and the money to be made in doing so. As the trail-blazer in this innovation space, Safaricom now generates a reported 10% of its revenue through providing a transactional banking platform for that segment of the population conventional financial institutions did not consider worth it to bank.

[Reprinted with permission from Observer Research Foundation].

by Lucy Corkin

 

Read the full story originally published by Observer Research Foundation website here.

 

The Observer Research Foundation is India’s leading policy think-tank seeking to lead and aid policy thinking towards building a strong and prosperous India in a fair and equitable world. ORF has the mandate to conduct in-depth research, provide inclusive platforms and invest in tomorrow’s thought leaders today.

lucy-corkin-rmb1-cropped2Lucy Corkin is Business Manager at RMB Africa, having joined RMB as a Class Of in 2012. She has a PhD in International Relations from SOAS, University of London, and has picked up a couple of languages along the way, including French, Portuguese and Mandarin Chinese. She is a regular contributor for the Observer Research Foundation where she gets to share her thoughts on goings on in Africa, the world of banking, and anything else that grabs her attention.