The future monetary system

Summary

The speaker discusses the current challenges facing the crypto ecosystem, highlighting its instability and unsuitability as a basis for a monetary system. The talk emphasizes the fragmentation of cryptocurrencies and the reliance on stablecoins, which ultimately depend on central bank money. The speaker contrasts crypto with central bank money, advocating for a future monetary system rooted in central bank trust, with innovations like CBDCs enhancing financial stability. The conclusion stresses the importance of central banks in shaping the future monetary system beyond the turmoil in the crypto world.

Takeaways

• 📉 The crypto market is experiencing significant turmoil with many cryptocurrencies losing over 90% of their value compared to their peaks.
• 🏦 The strain on the crypto ecosystem, including shadow banks, raises concerns about financial stability and the urgent need for policy responses.
• 🔍 Despite the immediate challenges, there's a need to focus on the structural flaws in crypto that make it unsuitable as a foundational monetary system.
• 🔑 The prevalence of stablecoins indicates crypto's reliance on traditional currencies, highlighting the need for a stable unit of account provided by central banks.
• 🌐 The extreme fragmentation of the crypto market, with over 10,000 coins, contradicts the concept of money as a unified medium of exchange.
• 💡 Crypto's decentralized nature leads to high transaction costs and congestion, which are counterproductive to its widespread adoption as a currency.
• 📈 The success of crypto is highly dependent on rising coin prices and new buyer inflows, which is not sustainable for a stable monetary system.
• 🌳 The future monetary system should be rooted in central bank money, with a robust ecosystem of services provided by the private sector.
• 💼 Central banks are uniquely positioned to lead the future monetary system, providing the unit of account and ensuring payment finality through their balance sheets.
• 🏦 The introduction of Central Bank Digital Currencies (CBDCs) could offer programmability, tokenization, and other advanced features while maintaining the trust in central bank money.
• 🌐 Multi-CBDC platforms have the potential to create a richer ecosystem, facilitating transactions across different currencies on a shared DLT platform.

Q & A

What is the current state of the crypto universe according to the script?

The crypto universe is in turmoil, with the ecosystem of crypto coins and shadow crypto banks showing considerable strain. Prices of many cryptocoins have crashed, with some lesser-known coins falling by 90% or more relative to their peaks last year.

What is the role of stable coins in the crypto ecosystem?

Stable coins are cryptocurrencies designed to maintain a stable value relative to traditional currencies, such as the US dollar. They indicate the pervasive need for crypto to rely on the credibility of central bank money, serving as a sign of the search for a nominal anchor.

Why are stable coins often far from stable as mentioned in the script?

The script refers to the example of the Terra stable coin, which was the third largest and collapsed significantly over a few days in May, illustrating that despite their aim for stability, stable coins can be volatile.

What does the prevalence of stable coins indicate about the crypto system?

The prevalence of stable coins shows that if central bank money did not exist, it would need to be invented, highlighting the inherent need for a stable unit of account in the economy.

How does the script describe the fragmentation of the crypto universe?

The script describes the fragmentation as a result of the proliferation of over 10,000 crypto coins, which contradicts the expectation that a suitable currency would lead to a coalescence around one cryptocoin.

What is the role of validators in the crypto system?

Validators in the crypto system can be miners, large holders of coins, or 'whales' in a proof-of-stake system. They play a crucial role in the consensus-based settlement process of cryptocurrencies.

Why does the script mention congestion as a feature of crypto systems?

Congestion in crypto systems leads to high transaction costs and rents for insiders, functioning like a toll road. It creates an opportunity for new entrants but also sustains the system by ensuring that tolls are paid.

How does the script relate the concept of network effects to money and crypto?

The script explains that money benefits from network effects where greater use leads to greater acceptance. In contrast, crypto illustrates a case of fragmentation and high costs, which is the opposite of the 'more the merrier' property of money.

What is the vision for the future monetary system as described in the script?

The vision for the future monetary system is the fusion of enhanced technical capabilities around the core of trust provided by central bank money. Central banks are positioned to provide the core, with a rich ecosystem of services provided by the private sector.

What are the potential benefits of using wholesale CBDCs (Central Bank Digital Currencies) with distributed ledger technology?

Wholesale CBDCs with distributed ledger technology could incorporate additional functionality such as programmability, atomic settlement, composability, and tokenization, while maintaining privacy and enhancing the结算 of transactions.

How does the script differentiate between retail CBDCs and retail fast payment systems?

The main difference is that retail CBDCs are a direct claim on the central bank, while a fast payment system gives users access to the liabilities of payment service providers. Both aim to enhance financial inclusion and lower the cost of payments.

What is the significance of multi-CBDC platforms mentioned in the script?

Multi-CBDC platforms bring together CBDCs from several central banks, transacting on the same platform, governed by DLT, and represent an important component of the future monetary system, fostering richer ecosystems with diverse private sector service providers.

Outlines

00:00

📉 Crypto Turmoil and Structural Flaws

The script addresses the current turmoil in the crypto market, noting the significant strain on the ecosystem due to leverage and maturity mismatch. It highlights the crash in cryptocoin prices, with many experiencing a 90% or greater drop from their peaks. The speaker emphasizes the urgent need to address the risks crypto poses to financial stability, while also considering the deeper structural issues that make crypto unsuitable as a monetary system. The prevalence of stablecoins is discussed as an indicator of crypto's reliance on traditional currency, and the instability of these coins is underscored. The fragmentation of the crypto market, with over 10,000 coins, is presented as evidence of crypto's inability to serve as a unified medium of exchange, contrary to the benefits of network effects seen in traditional money.

05:03

🚧 Crypto's Congestion and Validator Economics

This paragraph delves into the economic model underpinning crypto, particularly the role of validators such as miners or large coin holders, and how they benefit from network congestion. The speaker explains that congestion is not a bug but a feature in crypto, akin to a toll road, generating high rents for insiders. The chart presented illustrates the relationship between user fees and transaction volume on the Ethereum blockchain. The paragraph also discusses the challenges of balancing capacity and security in the crypto space, and how the fragmentation and high fees of Ethereum led to the rise of alternative blockchains, such as Terra, before its collapse.

10:05

🌳 The Future Monetary System: Central Bank Digital Currencies (CBDCs)

The speaker outlines a vision for the future monetary system, centered around the trust provided by central bank money and enhanced by technological capabilities. The metaphor of a tree is used, with the central bank and its money forming the solid trunk, supporting a vibrant ecosystem of private sector services. The components of this system include central bank money (M0), commercial banks, non-bank payment service providers, and the potential for wholesale CBDCs using distributed ledger technology (DLT). The paragraph discusses how finality in permissionless DLT platforms can be achieved using real names and cryptographic techniques like zero-knowledge proofs, and the potential for additional functionalities such as programmability and tokenization.

15:07

🏢 Retail CBDCs and Financial Inclusion

The script explores the potential of retail CBDCs and fast payment systems to enhance financial inclusion and lower the cost of payments. It highlights the similarities between retail CBDCs and fast payment systems, such as their reliance on open architecture and APIs for interoperability and effective competition. The success of Brazil's Pix instant payment system is cited as an example, showing how it rapidly gained widespread adoption and significantly reduced payment costs for merchants. The paragraph also touches on the potential of tokenized deposits and conditional payments in a permissionless DLT system.

20:09

🌐 Multi-CBDC Platforms and the Future of Monetary Systems

The final paragraph discusses the concept of multi-CBDC platforms, which bring together CBDCs from several central banks on a single DLT platform. The BIS Innovation Hub's trials of such platforms are mentioned, along with the potential for these arrangements to support a rich ecosystem of services provided by the private sector. The speaker concludes by emphasizing the importance of central banks looking beyond the current crypto turmoil to focus on the long-term goals of the future monetary system, which should anticipate future developments rather than just reacting to past ones.

Keywords

💡Crypto Universe

The 'crypto universe' refers to the entire ecosystem of cryptocurrencies, including various digital coins and the platforms that facilitate their use. In the video, it is described as being in turmoil, indicating the current instability and volatility in the cryptocurrency market. The script discusses the strain on this ecosystem due to factors like crashing prices and runs on 'shadow crypto banks,' which are non-regulated entities that operate similarly to traditional banks within the crypto space.

💡Stable Coins

Stable coins are a type of cryptocurrency designed to minimize price volatility by pegging their value to a stable asset, often a fiat currency like the US dollar. The script points out that despite their name, stable coins are not always stable, as evidenced by the collapse of the Terra stable coin. They also highlight the dependency of the crypto ecosystem on traditional currency for credibility, showing the inherent need for a stable unit of account in the financial system.

💡Decentralization

Decentralization in the context of the video refers to the distribution of authority and verification processes across a network, rather than being centralized in a single entity. This concept is fundamental to how cryptocurrencies operate, with validators such as miners or large coin holders reaching consensus on transactions. However, the script argues that decentralization can lead to fragmentation and high costs due to the need to reward validators, which can result in congestion and high transaction fees.

💡Network Effects

Network effects describe a phenomenon where the value of a product or service increases with the number of people using it. In the video, it is mentioned that money benefits from network effects because its acceptance is based on the expectation that others will also accept it. The script contrasts this with the fragmentation seen in the crypto space, where instead of a single dominant cryptocurrency emerging, there are thousands competing, which goes against the network effect principle.

💡Congestion

In the video, 'congestion' refers to the overcrowding of transactions on a blockchain network, leading to increased transaction fees and costs for users. The script uses the example of the Ethereum blockchain to illustrate how high user fees can result from network congestion, which in turn can create opportunities for new entrants with higher capacity but potentially lower security standards.

💡Validators

Validators in the context of cryptocurrencies are individuals or entities responsible for confirming transactions and adding them to the blockchain. The script mentions that validators can include miners in proof-of-work systems like Bitcoin or large coin holders in proof-of-stake systems. The need to reward validators contributes to the fragmentation and high costs within the crypto ecosystem.

💡Central Bank Digital Currencies (CBDCs)

CBDCs are digital forms of a country's currency issued by its central bank. The video discusses the potential of CBDCs, both wholesale and retail, to enhance financial inclusion and provide a more efficient means of payment. The script contrasts CBDCs with cryptocurrencies, suggesting that CBDCs can offer the benefits of digital currencies while being backed by the trust and stability of central banks.

💡Distributed Ledger Technology (DLT)

DLT is the technology behind blockchain, allowing for a decentralized and distributed database that records transactions across multiple computers. The video mentions the potential of DLT to support additional functionality in CBDCs, such as programmability and tokenization, while maintaining privacy and preventing double-spending.

💡Financial Inclusion

Financial inclusion refers to the extent to which individuals and businesses have access to useful and affordable financial products and services. The script discusses how retail CBDCs or fast payment systems can enhance financial inclusion by providing instant payment options, reducing costs, and making financial services more accessible to a broader population.

💡Multi-CBDC Platforms

Multi-CBDC platforms are systems that allow for transactions involving CBDCs from multiple central banks on the same platform. The video describes these platforms as part of the future monetary system's 'canopy,' suggesting that they can support richer ecosystems with diverse private sector service providers and foster innovation in cross-border transactions.

💡Finality of Payments

The 'finality of payments' refers to the point at which a payment is irrevocably settled. In the video, it is mentioned as a fundamental role of central banks, which can ensure the finality of payments by using their balance sheets. This concept is crucial for maintaining trust in the financial system and is contrasted with the volatility and uncertainty seen in the crypto space.

Highlights

The crypto universe is currently in turmoil with prices of cryptocoins crashing and highlighting risks to financial stability.

Crypto's deeper structural flaws make it unsuitable as a basis for a monetary system.

Stable coins, aiming to maintain a stable value relative to traditional currencies, show the pervasive need for crypto to rely on central bank money's credibility.

The prevalence of stable coins indicates a search for a nominal anchor, yet they have been far from stable.

Crypto's fragmentation with over 10,000 coins shows it is not suitable as money due to its inability to serve a coordination role.

Decentralization in crypto leads to validator-based settlement, causing fragmentation and high transaction costs.

Congestion in crypto platforms, like Ethereum, leads to high user fees and rents for insiders, contrary to the benefits of network effects in traditional money.

The collapse of the Terra blockchain illustrates the instability of crypto platforms and the risks they pose.

Crypto works primarily when coin prices are rising and new buyers are entering the market, but it unravels when speculative inflows dry up.

Central banks are uniquely positioned to provide the core of the future monetary system, building on their issuance of central bank money.

The future monetary system is envisioned as a tree with a solid trunk of central bank money supporting a rich ecosystem of services.

Wholesale CBDCs could incorporate additional functionality, such as programmability and conditional payments, using cryptographic techniques for privacy.

Multi-CBDC platforms bring together CBDCs from several central banks on the same platform, governed by DLT, offering diverse ecosystems.

Retail CBDCs and fast payment systems can dramatically lower the cost of payments and enhance financial inclusion, as seen in Brazil's PIX system.

The canopy of the forest metaphor represents the integration of multiple monetary components, including multi-CBDC platforms, in the future system.

Central banks are on a journey to fulfill the vision of the future monetary system, focusing on long-term goals beyond the crypto turmoil.

Transcripts

thank you augustine um and and welcome

everyone um as augustine noted the the

crypto universe uh is in turmoil right

now uh the ecosystem of crypto coins and

shadow crypto banks that add layers of

leverage and maturity mismatch through

the system

um are showing considerable strain

um and as i was say noted the prices of

cryptocoins have crashed they are you

know many of the lesser-known coins

have seen their prices fall by 90 or

more

relative to their peaks

last year

now crashing prices and runs on shadow

cryptobanks highlight the risks to

financial stability

and clearly addressing these risks

is indeed an urgent policy challenge

but while we address these urgent

challenges we should not lose sight of

the deeper structural flaws in crypto

that make it unsuitable as the basis of

a monetary system

and we need to keep

the longer term structural issues on our

dashboard

as we think about the future monetary

system

now what are these deeper structural

flaws of crypto as money

as i was noted the first clue lies in

the role played by stable coins

stable coins as you know are

cryptocurrencies that aim to maintain a

stable value relative to traditional

currencies such as the us dollar

but

the prevalence of stable coins show uh

the pervasive need of crypto to

piggyback

on the credibility of central bank money

it is a sign

if you like of the search for a nominal

anchor

and yet um as we've seen stable coins

are often far from stable

the market value of the terror stable

coin which had been the third largest

collapsed over a few days in may

crypto started by turning its back on

central bank money

but it has quickly rediscovered the need

for a stable unit of account

which is best provided by by real money

issued by the central bank

so if you like the prevalence of stable

coins

shows that if central bank money did not

exist

it would need to be invented

the same goes for money's role as a

medium of exchange

money is a social convention we accept

money

because we expect others to accept money

in the future

and money is the perfect example of the

benefits of network effects

which entails this virtuous circle

of greater use

and greater acceptance

but crypto doesn't work like that

what is striking is that there has been

a proliferation of crypto coins

the result has been the extreme

fragmentation of the crypto universe

if crypto were suitable as money we

would have expected

uh one cryptocoin around which everyone

coalesced

instead we have a severe form of

fragmentation

of the crypto universe with over 10 000

crypto coins

jostling for a place in the limelight

and gone is any pretence

that crypto money can serve a

coordination role

now the reason

for the fragmentation

of the

crypto universe is that crypto runs

under the banner

of decentralization

where settlement is done through

consensus

formed by validators

now who are these validators the

validators can be miners

as in bitcoin or large holders of coins

or so-called whales

as in a proof-of-stake system

the fragmentation of crypto arises from

the need to channel rents to validators

and other insiders

and one way that rewards are kept high

is through congestion

when the crypto platform is used

intensively by users

transactions costs

and hence rents to insiders

uh tend to skyrocket

and this particular chart shows the

relationship between

the user fees on the vertical axis

and the number of transactions on the

horizontal axis for the ethereum

blockchain

so

if you like unlike money which rests on

the virtuous circle of greater

acceptance and greater use

crypto generates instead high costs

high rents to insiders and congestion

they open a gap for new entrants

with often higher capacity

but they often also cut corners and

security

in fact

finding the right capacity

at the outset is like balancing on a

knife edge

and let me explain that

as i've as i've explained congestion if

you like is a feature uh not a bug of

crypto

it's like a toll road

collecting tolls from users

but too much capacity

means that no one pays the tolls

which means that the system cannot be

sustained

in fact the the picture on the right

hand side um is uh from the time of the

so-called bitcoin

block size wars uh some of you may may

recall that

where there was a proposal to increase

the block size of bitcoin to

gather more transactions into one block

um but then but that was uh that didn't

really catch on

the the right hand uh

um image comes from someone who is

advocating for the status quo saying

look you know this is what you're

proposing

and to really drive home the point on

congestion

uh let's look at the proliferation of

different blockchains

in the decentralized finance or d5

sector

as recently as late 2020

most d5 applications ran on the ethereum

blockchain

and that's shown in the

size of the blue bar there

and this is to say most of the

collateral that was posted

in the d5 sector was posted on

the

ethereum blockchain

but over time

coming into

2021 other blockchains exploited the gap

created by congestion and the high fees

that i showed you in the previous slide

and by early may this year

ethereum here in blue

only had about half of the collateral in

the d5 sector

meanwhile

the terror blockchain shown here in red

was growing very rapidly and grabbing

market share

however as we know all this came to an

abrupt halt when the terror platform

collapsed

so with this levers

money and its network effects should

give rise to the property of the more

the merrier

so the more money meets general

acceptance the more it will be used

instead crypto illustrates the opposite

dictum it's a case of the more

the sorrier

and the fact that crypto is so prone to

fragmentation

makes it unsuitable as a basis for the

monetary system and that's what we

conclude in the chapter

what's also becoming clear in the

turmoil right now is that crypto only

really works when coin prices are going

up

and there are inflows of new buyers of

coins

and this particular chart shows a number

of new d5 addresses

shown by the bars

actually follows the price action of the

crypto coin itself which is the black

line just as the annual change

and as we've seen in the last few weeks

when speculative inflows

actually dry up the market can quickly

unravel

now when we look back

the rise of crypto over the last several

years has been a remarkable spectacle

it highlights the place of technology in

the popular imagination

and its galvanizing role in debates on

the shape of things to come

so in this respect

crypto offers a tantalizing glimpse of

newer arrangements

and technical features

but as we um argue in the chapter

everything that can be done with crypto

can be done also with central bank money

well except perhaps for money laundering

and ransomware attacks

but that's uh

that's with good reason

so as agustin showed the vision our

vision for the future monetary system as

laid out in chapter three

is the fusion of enhanced technical

capabilities

around the core of the trust

provided by central bank money

and central banks are uniquely

positioned

to provide the core of the future

monetary system

after all they issue central bank money

which serves as a unit of account in the

economy

and from the basic promise that's

embodied in the unit of account

all other promises in the economy follow

and of course the second fundamental

role of the central bank building on the

first is to ensure the finality of

payments

by using its balance sheet

so the metaphor that we use for the

future monetary system is that of a tree

it's solid trunk is the central bank and

central bank money

and the tree supports a rich and vibrant

ecosystem of services

provided by private sector institutions

and arrangements

in this tree the ecosystem is rooted

in the settlement on the central bank

balance sheet and this is the metaphor

uh that uh

that really comes in everything is

rooted in the settlement

on on the central bank's balance sheet

now what are the components of this

monetary system

as the foundation we have central bank

money or m0

which supports the monetary system

but building on central bank money are

the commercial banks and non-bank

payment service providers or psps

who take on the customer facing

activities

and within this structure we can

envisage a superior representation of

central bank money

available to banks and non-bank psps

through wholesale cbdc's

if these wholesale cbdc's operate with

distributed ledger technology or dlt

they could incorporate additional

functionality

these functionalities are fully

compatible

with the requirement of using real names

rather than hiding behind private keys

as is the case in crypto

so

how is finality attained in

permissionless dlt platforms

using real names

and the mechanics can be explained

through

a simple analogy

of passing on a physical banknote

the recipient of a physical bank note

here it's person d at the end of this

chain

wants to be assured that the note is

genuine

and not counterfeit

in a cvdc platform this can be done by

proving

the source

the origin or the provenance of the

money

now in the case of crypto

the provenance is proved by publicly

posting

the full history of all transactions

with all the uh the private keys all

listed

of course when real names are used um

such public posting would violate

privacy

and would be unsuitable as a payment

system no one else needs to know

where i buy my groceries

in the case of dlt systems using central

bank money this is where cryptographic

techniques

such as zero knowledge proofs come in

and cryptographic techniques allow the

payer to prove that the money was

obtained from valid past transactions

without revealing

the full history of who paid what to

whom

and depending on the detailed

implementation of such a system we may

also need a notary

to prevent the the same digital token

being spent twice

and needless to say the central bank

would be a a very natural choice for for

this kind of role

now whatever the specific implementation

is chosen

decentralization and new capabilities

can be achieved with all the benefits

that come from central bank money

and new capabilities may include for

instance programmability

or the ability to make payments

conditional on specific criteria being

met

this can

this can allow for instance for atomic

settlement whereby two legs of a

transaction that are inseparable

are executed together or not at all

another capability is composability or

the capacity to combine several

operations into one

and the image as you see here is that of

money legos that combine

different operations into one block

the third capability is tokenization

or the creation of a digital

representation of money or other assets

to be traded on the dlt platform itself

this could allow banks to offer

tokenized deposits

which could be used for conditional

payments

so how would this work

the

classical notion of settlement through

the book entries of intermediaries can

find new expression

on these dlt platforms

where tokens are transferred in

settlement rather than

through book entries

so in this respect the economics remain

the same

but the technological medium

progresses

in this way wholesale cbdc's could

support the settlement of the purchase

of assets for instance

so here for for example the buyer of a

house

may wish to make a large payment

but

a large payment to the seller of the

house

but conditional on the title of the

house being transferred

now from the seller's perspective the

seller wants to ensure that the title is

transferred only on condition

that the money is received

and the buyer and seller

may do this with a tokenized deposit in

a permissionless dlt system

together with

a token that represents the house itself

in the background the wholesale cbdc

helps this transaction to settle

and those

movements all occur

in one bundle

so far i have described wholesale

applications

in parallel with wholesale solutions

financial inclusion can be greatly

enhanced in the retail domain

through either retail cbdc's

or through retail fast payment systems

both of which will allow for instant

payments by households and businesses

now as we discuss in some detail in the

chapter

retail cbdc's and retail fast payment

systems

actually bear a very strong family

resemblance

both rely on an open architecture

together with application programming

interfaces or apis

that ensure the interoperability ensure

the interoperability of services

provided by banks and non-bank psps

and interoperability

ensures effective competition that

lowers costs

the main difference between retail

cbdc's and retail fast payment systems

is that cbdc's are a direct claim on the

central bank

whereas

a fast payment system only gives users

access to the liabilities of the payment

service providers

retail cbdc's and fast payment systems

can drive can sometimes drive dramatic

progress in lowering the cost of

payments

and enhancing financial inclusion

for example

this is a case for brazil in brazil the

picks instant payment system

was adopted by two-thirds of the adult

population

in just over a year after its launch

and in terms of use as you see here in

the in the green line

pix transactions

have now surpassed credit and debit card

transactions by volume

for merchants accepting fixed payments

costs only 22 basis points

again here shown in the tiny green bar

there

and this is just one tenth

of the cost of accepting credit card

payments for merchants

and

additional work which you can read about

in the chapter uh by various central

banks show that retail cbdc's

hold similar promise as these retail

fast payment systems

particularly if they're designed with

interoperability

and financial inclusion as the key goals

now we started with a tree as the

organizing metaphor

but when we zoom out we get to the

canopy of the forest

where the tree branches meet

and the canopy

actually embodies an important

additional component

of the future monetary system

in the form of so-called

multi-cbdc platforms

and such arrangements bring together

cbdc's from several central banks

all transacting on the same platform

now these arrangements involve more than

one central bank and here and and

therefore more than one currency

and this is

why such arrangements are typically

governed

as dlt platforms

so this is a view of the canopy from

above

and the bis innovation hub has

coordinated trials of several multi-cbdc

platforms

and in a new report that was published

at the same time as the annual economic

report

it draws initial lessons on the design

and implementation of these multi-cbdc

platforms

the early trials opened the prospect of

examining

the

open the prospect of examining richer

ecosystems

with a diverse range of private sector

service providers

of course

the full extent of possible innovations

is difficult to foresee

but one thing is for sure

all of them

will be supported by the tree

firmly rooted in the ultimate settlement

on the central bank's balance sheet

so

let me conclude

central banks as guardians of the

monastery system are embarked on a long

journey

in fulfilling the vision of the future

monetary system

and here the objective is to put in

place the arrangements that anticipate

future developments

rather than merely to react to past

developments

so while the crypto universe is gripped

by turmoil and attracting all the

headlines

uh it is incumbent on us in the central

bank community

to look beyond the headlines

and to think about these longer-term

goals

thank you very much