With mainstream investment products increasingly finding a second home on the blockchain, it’s a good time to ask what role central banks would play if everything they have learned while policing double-entry bookkeeping over the last 350 years becomes irrelevant.
The techno-anarchist vision behind cryptocurrencies like Bitcoin was to free the financial wellbeing of individuals from the clutches of large custodial institutions — and the monetary mandarins supervising them. That utopia never materialized, but the embrace of the underlying technology by traditional banks and asset managers has taken off.
There’s plenty of appetite for it. Now that apps like Robinhood have made investing super easy, Millennials and Gen Z refuse to accept that private banks will hawk unlisted unicorns to their wealthy parents, but not to the actual users of the products and services of these new-age startups. Why should lumpiness of private equity or private credit get in the way of mass access?
Democratizing finance by fractionalizing it was a lofty aspiration even a few years ago; it’s becoming a reality now. Just last week, Franklin Templeton launched Singapore’s first retail tokenized fund. The product is basically a mirror of an existing money-market instrument. But it will exist in the crypto space, allowing individuals to access it for as little as $20.
Alternative assets now have their tokenized versions, too. KKR & Co.’s Health Care Strategic Growth Fund debuted on blockchain three years ago.
Money has gone the same way as assets. Tether Holdings Ltd.’s market-leading coin USDT is well known to those who use the 1:1 representation of the dollar to buy crypto. Banks, meanwhile, are jumping into the $200 billion-plus stablecoin market to explore other use cases: Standard Chartered Plc plans to offer a Hong Kong dollar digital clone. Rival HSBC Holdings Plc has tokenized gold. Bank deposits may be up next.
This is a new terrain for central banks. Historically, money and securities have been tied to accounts, their movement and ownership recorded according to Italian mathematician Luca Pacioli’s 1494 treatise on double-entry bookkeeping. Central banking, which emerged in Sweden 350 years ago, put the monetary authority’s ledger at the top of the system, helping to stabilize it. Paper accounts eventually gave way to electronic entries, but the basics of traditional finance remained broadly intact — until now.
Unlike central banking, distributed ledgers are a decentralizing force. Using the technology, it’s possible to create digital tokens that represent legal claims just like money and securities, but they aren’t tied to accounts; they belong to whoever has the cryptographic key. The coins can be programmed using self-executing software code, or “smart contracts,” removing the need for multiple layers of intermediaries.
Want to move some pension savings into a new fund? The back-and-forth of faxes and emails — between asset managers, distributors, fund administrators, trustees, and registrars — gets compressed when all the data needed by the software is on the blockchain. What used to take a week can be done in two days. Selling one currency to buy another in cross-border commerce is instantaneous.
But what happens if tokens end up replacing all money and securities? Will central banks still be able to run monetary policy? When manias, panics and crashes hit, can they restore calm by their usual practices — paying interest on bank reserves; temporarily creating or absorbing liquidity; or permanently loosening and tightening financial conditions through outright purchases and sales of securities? The Bank for International Settlements and the New York Federal Reserve’s innovation center joined hands to explore just those questions.
Theirs was no thought experiment. The researchers put together the central-banking toolkit on the blockchain. The good news is that the prototype works — in both routine situations and periods of stress. That isn’t all. Project Pine also took a first stab at exploring if smart contracts could make implementation of monetary policy more nimble, efficient, and effective. They perhaps can, but not if central banks are just another participant in the money market. “They might also require privileged access to institutional data and higher standards of privacy and security,” the researchers noted in their report last week.
In fact, when the central bank performs the functions of an “oracle,” an outside source whose data is trusted by everyone else in a decentralized network, resources don’t have to be wasted on seeking consensus from participants. (For instance, it’s just more practical for intermediaries to let the central bank be the sole timekeeper in interest calculations.)
Project Pine assumes a scenario where all of today’s money and assets have been tokenized. The transition to that stage, if it does ever occur, may be long and messy. In the interim, as the use of tokens increases, demand for bank reserves could become volatile and hard to predict. It will be interesting to see how monetary authorities handle the coexistence of money and tokens.
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