BITCOIN AND OTHER DIGITAL CURRENCIES

Digital Currency Set To Go Official

Central banks around the world are seeing the value in investing in technologies creating back-up digital currencies to facilitate interbank transactions, but not without challenges

The future of money is digital.

By Atique Naqvi

For the financial conscious around the world, Bitcoin comes up in the discussion every now and then. As the digital currency crossed the US$8,000 threshold, the cryptocurrency ride is as exciting as ever.

Before talking about the future, let me turn a few pages from my own history. In 2009, I wanted to buy Bitcoin for fun. For about US$30, I was getting 5,000 Bitcoins. One of my friends at work said I was wasting my money, and he very convincingly prevailed. Now, one Bitcoin is worth US$8,000, and I would be rich by US$40 million. Damn it!

Though Bitcoin is the most popular digital currency due to its widespread acceptance and usage, there are other options too, such as Litecoin, Ethereum, Zcash, Dash, Ripple, and Monero.

As of November 20, 2017, one Bitcoin was worth US$8,240, Litecoin (LTC, $72.50), Ethereum (ETH, $369.49), Zcash (ZEC, $306.18), Dash ($478.56), Ripple (XRP, $0.240) and Monero (XMR, $139.35).

The Monetary Authority of Singapore has sanctioned a study on cryptocurrencies, and the business-friendly country is all set to launch a digital version of its Singapore dollar (one Singapore dollar would get you US$0.736).

Global consulting firm Accenture joined hands with the Monetary Authority of Singapore (MAS) and The Association of Banks in Singapore (ABS) to publish a report that illustrates how blockchain technology could significantly improve the kinds of payment systems that currently enable banks around the world to transfer trillions of dollars per day to each other and help them manage their financial liquidity.

The report is based on the results of a successful prototype involving nearly a dozen major banks and three leading blockchain technology platforms that were tested in parallel. The test confirmed that real-time gross settlement (RTGS) functionalities such as gridlock resolution and a liquidity-saving mechanism on a decentralized system work. Real-time gross settlements are large-value interbank payments of cash or securities that require immediate settlement. Crucially, the test proved, perhaps for the first time, that blockchain-based designs can also effectively preserve privacy in such transactions.

According to the report, a blockchain-based system could also help mitigate interbank payment risks by increasing system resiliency through the removal of a single point of failure and providing cryptographic security, immutability, and real-time processing.

The joint study is based on the outcomes of Phase 2 of Project Ubin, which was managed and delivered by Accenture. The 13-week project was led by MAS and ABS, with participation from 11 financial institutions. It explored the use of blockchain technology for specific RTGS functions, including the feasibility of decentralizing liquidity saving mechanisms, while maintaining privacy in banking transactions.

Accenture leveraged the blockchain capabilities of the Accenture Liquid Studio in Singapore to develop three prototypes by three workstreams on three different blockchain platforms: Corda, Hyperledger Fabric and Quorum. The prototypes successfully demonstrate that key RTGS functions, such as fund transfer, queueing mechanisms and gridlock resolution can be achieved through a variety of techniques and solution designs.

The report indicates that a blockchain-based RTGS system would reduce the costs and resources of day-to-day operations and eliminate the risk of the central bank becoming a single-point-of-failure in a systemic disturbance.

In a 2010 study, the World Bank described large-value central bank payment systems as typically “the most significant component of the national payments system”.

The Bank of England said on an average day their system settles around £500 billion between banks (almost a third of the UK’s annual GDP).  They called it “the beating heart” of the UK payment system. By allowing banks to settle high-value transactions between each other, electronically, in real time, RTGS eliminated settlement risk on the largest payments flows – the ones most likely to threaten financial stability by bringing down the system if they failed.

Like Singapore’s MAS, Bank of England has been moving forward aggressively with DLT. They projected savings of tens of billions by using blockchain technology for settlements.

The European Central Bank and Bank of Japan also analyzed DLT’s potential and cited promise, but they’ve taken a conservative path. In their 23-page joint analysis in September they said DLT “could meet the performance needs of large-value settlement systems” and “has the potential to strengthen resilience and reliability.”

Explaining how central bank digital currencies will work, German consulting firm Roland Berger says a central bank digital currency as full digitization of the bearer instrument avoids issues present in different "settlement coins". Just as cash is transacted between two parties, when the value is transacted with a central bank digital currency, the bearer instrument changes possession directly in real time. As with a cash transaction, this implies there is no need for any reconciliation or clearing between the parties transacting.

“Ideally, a central bank digital currency should mimic banknotes and coins in all respects, meaning once a consumer has converted money held in an account or as physical cash into a central bank digital currency, it could be used anywhere as payment without the intermediation of a bank or any other facilitating organization. The digital money will be kept in a digital wallet or electronic cash box system similar to how banknotes and coins are held in the physical world.”

However, there are challenges in government-backed central banks taking the digital currency route. Roland Berger says the central banks need to adopt a new mindset and build capabilities and structures that allow them to collaborate with innovative so ware providers and understand current and future technologies, which are evolving and changing at a high speed.

“If not properly transitioned from the current economic model, a central bank digital currency has the potential to disrupt the entire financial ecosystem, which is built on fractional reserve banking.

“Our current model of commercial banking is built upon the assumption that depositors are not in need of immediate liquidity. This enables custodians of deposits, commercial banks, to hold a fraction, usually between 10 and 40 percent, and issue new loans with the remaining amount. The money multiplier, as it is commonly known, enables these commercial banks to create new money in the form of debt.

“Once a central bank digital currency is issued by a central bank, users will no longer have the need for secure storage within the vaults or books of commercial banks, as value can now be securely stored using digital cryptographic means. This will likely result in greater "M0" or central bank cash in circulation, as users have no need to risk storing it in a consumer checking account.

Also, the annual interest rate on a checking account will not be enough to stop a bank rush, as users exchange value in checking accounts for a central bank digital currency to be stored directly in their digital wallets. Continuing to use a traditional consumer checking account will mean greater cost and inconvenience, as well as the necessity to trust a bank, says Roland Berger.

Despite the challenges, central bank digital currency is a hot topic among central bankers. A World Economic Forum research paper revealed that more than 90 central banks are engaged in discussions worldwide about the potential issuance of a central bank digital currency.

With the positive sentiment around the currency of the future, the value of independent crypto-currencies will keep on rising, and very soon Bitcoin will cross the US$10,000 threshold. Investors should also look at the other credible digital currencies, and see what is the best investment for them depending on their needs.

Euro, dollar, Yen, anybody?