Cryptocurrencies: separating misconception from potential
Cryptocurrency is such a nebulous term and it creates a lot of confusion from the underlying potential of the technology that powers it. There is a wide spectrum of the field of cryptocurrencies between bitcoin and initial coin offerings, and the innovation that is happening with stable coins such as Circle's USD Coin that are backed 1:1 by US dollars.
Although technically they each use blockchain-based foundations as their underlying technology, they are quite different in their application. The innovation that was inspired by bitcoin will reshape the global financial infrastructure; it can be just hard to distinguish how it will emerge and, for some, to separate misconceptions from the potential.
Stable coins such as USDC are a bit different than bitcoin. They are effectively cryptocurrencies whose value is pegged to an asset, much like the Bermuda dollar is pegged to the US dollar. US dollar-pegged stable coins particularly have a lot of potential.
The best way to think about stable coins backed by dollars are as open-banking application programming interfaces, or APIs, that will drastically reshape our global financial infrastructure. It's a bit of a perspective shift, but it is essential to be able to understand the direction of the industry itself. We are on the verge of a substantial shift in terms of global access to financial services as a result.
The question is, what role does Bermuda want to play in the development of this new financial infrastructure?
In a recent medium post, David Marcus, the principal behind Facebook's Libra association, outlined core reasons why the social-networking service is looking to build a payment system on top of blockchain rather than existing technology. He outlines primarily the limitations of existing technology, the siloed nature of existing banking systems and the challenges and costs associated with moving money globally as core motivations.
Marcus identifies the challenges associated with existing technology networks as being closed and not well connected. As an example, he highlights the separation and lack of interoperability between regional payment networks such as ACH, interbank networks such as Swift, central bank networks and more. It is difficult, complex and expensive to transfer money between these disparate systems.
He then outlines the challenges associated with siloed banking infrastructure and provides a great analogy. Present-day money transfers are like if you could only reasonably send e-mails to other accounts within the same provider.
That would be like being able to easily send e-mails to only an @gmail.com address if you also had an @gmail.com address. Conversely, to send to an @outlook.com address would take days, be very complex and costly.
Thankfully, e-mail doesn't work that way. In the world of e-mail, the introduction of open standards such as SMTP have drastically changed the notion of communications such that messaging like e-mail has become instantaneous, cheap and interoperable between different providers. The same needs to happen for money and assets generally.
Marcus makes a key point that “building on top of existing rails and across disconnected payment networks won't reduce cost, open up the market to more innovation, nor lower the barrier of access to modern financial services as much as building a new infrastructure”.
We need to develop new global standards to drive the potential of interoperable financial services of the future.
While the jury is still out on whether Libra will be a credible source of that infrastructure and standardisation, the key takeaway is recognising that when you look beyond the hype and hysteria of cryptocurrencies, you can see that the core building blocks of standardisation that will drive a new form of financial infrastructure are being put in place.
The development of cryptocurrencies is bringing considerable standardisation, global interest and development resources.
Take for example, the foundational ERC20 standard that is at the root of many of the fiat-backed stable coins that have been launched to date. It is a very simple interface introduced on the Ethereum blockchain. While far from perfect and in some ways very rudimentary for some of the use cases that have evolved on top of it, it set a strong foundation that has been copied across various blockchain platforms and has garnered substantial adoption.
At its core, the ERC20 standard established core specifications around how to transfer a balance from one blockchain address to another, regardless of the application or user interface employed. The nature of blockchains being open-shared networks makes it like an open standard.
You can think of this like the core standard behind e-mail that allows you to send e-mails to @gmail.com or @outlook.com without having to worry about them being completely different e-mail platforms hosted by entirely separate companies.
For the financial world, this is the equivalent of being able to readily and easily transfer a balance between bank accounts around the world as easily as you can today within the same bank, if not even easier.
Furthermore, with the addition of the money itself being programmable, it becomes possible to customise the rules and conditions, which govern those transfers and which unlock a wealth of opportunity and potential for innovation.
There is a growing realisation globally that digital currencies are the future and need to be taken seriously. Recently, Benoît Coeuré, a member of the executive board of the European Central Bank, described Libra as a “wake-up call for central banks and policymakers”, adding that stable coins could address key deficiencies in the present architecture of the financial system while highlighting the need to properly manage the compliance and financial stability risks.
He highlighted the need for new approaches to regulate these new products, as it can be difficult to fit these new concepts into traditional regulatory boxes.
Many jurisdictions are exploring the notion of launching forms of central bank-issued digital currencies such as the Eastern Caribbean Central Bank and its pilot project announced a few months ago, the Marshall Islands' intent to launch their own Central Bank Digital Currency or the rumblings of the Chinese Government to do the same.
Two US congressmen recently asked the Federal Reserve to consider issuing a digital version of the US dollar highlighting the growing interest globally. The question is, are CBDCs the right path forward?
The International Monetary Fund recently highlighted via its blog that “the world of fiat money is in flux, and innovation will transform the landscape of banking and money”.
The IMF highlights the risks of Central Bank Digital Currencies as costly and risky, which would push central banks into the unfamiliar territory of brand management, app development, technology selection and direct customer interactions.
It has begun supporting the notion of giving stable-coin providers access to central bank reserves as a potential blueprint for the digital cash of tomorrow, a “synthetic central bank digital currency”, which would allow for a public-private partnership between central banks and private-sector issuers.
The principal feature being that private-sector issuers could be provided direct access to central bank reserves.
This would allow central banks to focus on their core function of providing trust and efficiency, while leaving private-sector issuers of stable coins to do what they do best; that being to innovate and interact with customers under appropriate supervision and oversight of regulators.
The big unknown is how the industry will unfold. Stable coins such as Circle's USDC certainly have the head start. It recently celebrated its first anniversary as having become the second-largest stable coin globally behind the more controversial Tether stable coin, which is not backed 1:1 by US dollars.
USDC and others like it show no signs of slowing their growth, particularly as people look to shift away from Tether because of lack of trust, and as the ecosystem around one-for-one, fiat-backed stable coins develops.
Are stable coins issued in the private sector the future? It's possible.
It is hard to be absolutely certain how the innovation will play out. However, it is easy to conclude that there is a growing global chorus of recognition that disruption of our traditional monetary systems is a given and that there is an opportunity to play a role in shaping it.
The challenge facing global regulators and policymakers is how to chart the right course to shape a future that adequately manages the risks while providing the most access to the opportunity that this new financial infrastructure will unlock.
A key question for Bermuda is whether we want to play a role in participating in this path of discovery. We have a significant advantage in that we have a mature, well-respected financial services regulator that has a history of 30-plus years of applying a progressive, principled approach to managing risk.
This enabled us to craft a new and clear regulatory framework around managing key risk in this space, such as cybersecurity, custody and compliance, and set a foundation upon which considerable innovation can occur and further policies can be enacted.
So, assuming we want to embrace innovation and take a solid shot at expanding our international business pillar beyond insurance towards other forms of financial services, we have an opportunity.
The opportunity exists particularly when it comes to the development of the ecosystem that will be built on top of these open standards and infrastructure.
The question is, what steps can we take to leverage our strengths in managing risk while taking a progressive approach to embrace and empower the industry to grow?
What steps would clearly establish Bermuda as an attractive centre of innovation, identifying us as a lighthouse to guide the rest of the world on a path to embracing this innovation?
What steps appropriately balance the need to carefully manage the risk of disrupting our hard-earned reputation?
We certainly didn't manage to become the offshore risk capital of the world with US and European Union equivalency in insurance without understanding how to take calculated risks and chart a reasonable course.
The first step towards charting a new course is recognising that the discussion and debate need to move beyond the bitcoin and cryptocurrency bubble, and the strong desires of some to prove that fintech has no merit.
The national discussion needs to shift to how we create the right environment to drive the kind of innovation and opportunity that matches our brand, regardless of the hype and hysteria around the technology used to achieve it.
• Denis Pitcher is a Bermudian tech entrepreneur with an interest in exploring the potential of blockchain and distributed ledger technologies for Bermuda. He is a fintech consultant to the Bermuda Government's fintech Business Unit as well as a tech cofounder and chief architect of resQwest.com, a global tourism technology solutions provider. He can be reached at firstname.lastname@example.org