Former US financial executive: Libra may never make progress, let us look forward to the central bank digital currency

Original Source: China Financial Forty Forum (https://mp.weixin.qq.com/s/s_rP2VCAmPlmBS4of56LYA)

It has been five months since Facebook released the Libra project white paper, and the regulatory agency’s negative attitude seems to have become more and more determined. Whether it's a hearing in the United States or a large conference of international organizations, we can hear the voices of governments from all over the world.

“Libra may never be able to make any progress in the face of heavy resistance and opposition.” At the inaugural Bund Financial Summit held recently, Timothy Ma, a senior fellow at the Kennedy School of Government at Harvard University and former chairman of the US Commodity Futures Trading Commission Timothy MASSAD said.

The first is due to the conflict between Libra's vision and reality, followed by concerns from the regulatory level. Libra may make money laundering and tax evasion easier for criminals, a common problem that global regulators worry about. In addition, emerging market countries are concerned that if Libra succeeds, it will lead to “backdoor dollarization”, but in fact, even in the United States, Libra is not supported by regulators.

“I rarely see President Trump, Federal Reserve Chairman Powell, and Democratic Congressman Maxine Waters, who is in charge of the chairmanship of the House Financial Services Committee, agree on anything. However, after hearing the Libra proposal, They quickly objected to Libra’s proposal, or at least expressed concern,” Massard said.

Although Libra may never be able to land, this proposal is still valuable for future directions. In particular, Libra has prompted central banks to accelerate the exploration of sovereign digital currencies. Massad revealed that the Fed is still continuing to analyze the potential benefits and costs of the central bank's digital currency, but is now more concerned with the popularity of real-time payments.

Massad believes that the widespread use of the central bank's digital currency can reduce transaction costs, thereby increasing the level of financial inclusion, but it may also have some negative effects. But despite the challenges, the central bank's digital currency is still worth looking forward to.

The Future of Digital Assets and Money

Text | Timothy MASSAD

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Timothy Massad speaks at the first Bund Financial Summit

I am very grateful to the Shanghai New Financial Research Institute and the China Financial Forty Forum for inviting me to participate in this wonderful summit. I am honored to be here, especially with so many outstanding guests. What is the future of money? In my speech today, I will introduce the current development of digital assets, especially the “Libra” digital currency plan proposed by Facebook, and discuss the development prospects of the central bank's digital currency.

What does Bitcoin bring to us?

Ten years ago, when the global financial crisis was in full swing, Nakamoto launched Bitcoin. The white paper published in the introduction of Bitcoin looks at the future of Bitcoin from a radical perspective and believes it will bring about tremendous changes in the financial system. In this white paper, the problem is pointed out that “the fate of the entire monetary system” must be maintained by a bank-like “trusted aggregator”.

To solve this problem, we can build a different solution from the existing financial system: using a new technology, trading in an irreversible way, and recording it in a distributed, decentralized bookkeeping system, the system Known as the "blockchain," anyone connected to the Internet can access and verify it. With this technology, we can create a "peer-to-peer system that reduces dependence on central intermediaries."

But at least for now, this idea has not yet become a reality. Bitcoin and other digital assets have not reduced our reliance on large financial intermediaries and have failed to generate important peer-to-peer payment systems. These new assets have not yet passed the triple test faced by traditional currencies: payment methods, unit of account, and means of value storage. Its transactions are mainly for speculation.

There are many reasons for this. First, the price of Bitcoin fluctuates greatly and is not suitable as an alternative currency. Second, Bitcoin transactions are irreversible. Most people are actually more willing to use a system that corrects errors. For example, if you are not satisfied with the goods you receive, you may want a refund. Third, Bitcoin can handle too few transactions, far from meeting the needs of today's global economy: Bitcoin can handle seven to ten transactions per second, while Visa can handle 25,000 or more. More transactions. In addition, although the consensus-based "Proof of Work" verification method used by Bitcoin is theoretically decentralized, its mining operations are actually very concentrated and energy efficiency is very low.

In fact, it is ironic that the cryptocurrency not only does not reduce the dependence on intermediaries, but instead triggers a new type of intermediary: cryptocurrency exchanges. Although smaller, the accountability mechanisms of these cryptocurrency exchanges are weaker than those of large banks in the vortex center of the financial crisis. They are largely unregulated. During my tenure as chairman of the US Commodity Futures Trading Commission, we announced in 2014 that the cryptocurrency is a commodity, but we have no jurisdiction over the transaction of cryptocurrency on the cash market trading platform. There is still a very serious gap in the relevant regulatory framework.

These crypto exchanges also do not follow the standards that traditional securities and financial derivatives market intermediaries need to follow. Therefore, the protection of investors is very weak, fraud and conflicts of interest are common, and system failures and hacking are numerous. In fact, a recent supporter of cryptocurrency said in a statement by the Securities and Exchange Commission that 95% of the transactions reported by 81 exchanges were falsified.

These exchanges are also accompanied by a broader range of social risks as they are used for money laundering and illegal payment activities, such as funding for ransomware, terrorist activities or black market transactions. In addition, although cyberattacks against the financial market infrastructure are currently one of the main culprits affecting the stability of the financial system, these new financial intermediaries are not subject to the regulation of current cybersecurity, and these subsequent unpredictable consequences will be given to finance. Other links in the system cause collateral damage.

However, although bitcoin and existing cryptocurrencies may not see much value in addition to being a speculative tool, I believe that innovation at this stage has taken us to a whole new stage , which may prove that digital assets and distribution The great value of the ledger technology is either verified.

Developed countries are experimenting with interesting innovations, such as the development of licensed blockchain systems to perform transaction settlement and clearing in a more efficient manner and to track them throughout their lifecycle. These have been applied in the trading of securities, derivatives and other assets in the US and other regions, as well as in the Lukangtong stock system. These systems can provide more timely information to regulators.

For example, clearing houses – central counterparties (CCPs) – have a very important place in the global financial system. If a licensed distributed ledger system is used to record futures trading, regulators can monitor futures trading positions in real time to more effectively monitor risks from CCPs. The distributed ledger system can also track stock borrowings or repo transactions, so that we can minimize the risk of re-collateralizing securities. The lengthy re-collateralization chain not only leads to uncertainty in ownership, but also if these vital markets are not functioning effectively, it will also lead to huge financial stability risks.

In addition, less developed countries may also use distributed ledger technology to build more efficient financial market infrastructure, many of which have been mentioned today.

Why do regulators don't like Libra?

In this environment, how should we review the Libra currency proposal proposed by Facebook? Will it push virtual currency to a new stage and bring higher value? Or is it a betrayal of Nakamoto's vision – digital currency is still managed and managed by the most powerful technology companies in the world?

For three reasons, we need to explore this issue. First of all, because Facebook is huge, we need to carefully consider its proposal. Facebook has more than 2 billion users, so whether you support this proposal or not, it will have a huge impact.

Secondly, Facebook's goal is very ambitious, claiming to provide services for people without bank accounts, but this statement may be just a superficial word, and its real intention may be to collect data . Despite this, there are still billions of people living outside the financial system. Although Facebook's plan can't meet the needs of these people, it makes people pay more attention to the needs of such people.

Third, the proposal for the future may be more important than the content itself, which may include how to implement sovereign digital currency faster.

Facebook's proposal proposes to create a digital token as a global currency and a payment method. In addition, it can be constructed in a way that enables digital identification. The token will be in the form of a stable currency, that is, it is a digital asset collateralized with the stated underlying asset, and its underlying asset consists of a basket of five currency cash and its equivalent. Because of the stable currency structure, Libra's volatility should be much lower than Bitcoin. Therefore, the possibility that it is generally accepted as a payment method should be greater.

Libra will be a licensed-based system. Only licensed companies can issue Libra, or Libra can be exchanged for legal tender, the so-called “squatting mechanism”. Libra will be managed by an association that includes Facebook and many other financial institutions. Facebook claims that it will transform Libra into a decentralized, non-permitted system for the next five years, but it is unclear how this can be achieved.

Facebook said the proposal is intended to serve 1.7 billion people without a bank account worldwide. This goal sounds quite pleasing, but is it feasible? How can I get the initial Libra without a bank account? Will the cost of getting Libra exceed the user's ability to withstand it? Facebook or any of its current partners do not have a network of shops or other physical stores that allow non-bank accounts to pay for Libra through cash. Even if Facebook can solve this problem, it must be persuaded that merchants who regularly trade with people without bank accounts accept Libra payments. Will a landlord without a bank account accept payment using Libra? Will the open-air food market or small grocery store welcome customers to pay with Libra? Moreover, governments in developing countries may be resistant to Libra's risk of weakening its sovereign currency. In addition, Libra did not propose other services that might be more attractive to people without bank accounts, such as microfinance.

For those with a bank account, it is more convenient for funds to enter and exit the Libra system. But at the same time, they also have many other alternative payment methods, such as credit cards, debit cards, checking accounts, and existing mobile payment services.

Even if Facebook can build its own payment infrastructure, as recent JP Morgan Chase research shows, people without bank accounts account for only a small percentage of the global economy and payment activities. In addition, B2B payments in the payment sector still account for the largest share. The Libra designer's goal is not to compete in this area, because the field needs to have a network similar to Fedwire (the Fed's system for transferring large payments) that can support high turnover transactions, thus meeting the liquidity requirements of the day – that is, overdraft Loans or short-term credits, etc.

Ultimately, Libra's appeal to customers as a payment system depends on whether the transaction costs of acquiring and using Libra are low enough compared to alternative systems, and whether their network and additional benefits are large enough.

Libra is often compared to successful mobile payment systems such as Alipay and WeChat. But the difference is also obvious: Alipay's payment business is based on a widely used e-commerce network, while Facebook is more similar to WeChat, and its payment service based on social media platform may exist. Bigger obstacles.

Alipay and WeChat pay a very creative design approach, and the cost of user funds in and out of the system is very low. In addition, the two systems also provide a large number of online benefits that encourage people to keep their money in the system. These benefits include discounts on goods, promotions, and the provision of affiliated financial services, such as paying interest and providing loans like banks. These systems use clever ways to provide money market funds in cases where the relevant regulations prohibit direct interest payments.

Regulators are generally negative about Libra's proposal overall. The size of Facebook and its horrendous record of privacy protection have, to a certain extent, led to distrust and resentment by regulators. However, the reasons for regulators' negative attitude towards Libra go far beyond this.

In the United States, I rarely see President Trump, Federal Reserve Chairman Powell, and Democratic Congressman Maxine Waters, who is in charge of the chairmanship of the House Financial Services Committee, agree on anything. However, after hearing the Libra proposal, they quickly objected to Libra's proposal, or at least expressed concern. In the summer of 2018, President Powell said that the Fed's regulatory field barely involved or focused on cryptocurrencies, but the emergence of Libra changed his attitude. Chairman Waters drafted "Let Large Technology Companies Stay away from the Money Act," and if the bill is passed, the Libra proposal will be directly banned. Of course, the program itself is too large to cover, so it may not be supported, but it also reflects Libra's difficult situation under the opposition of the regulator.

A series of issues that regulators are worried about, including how to prevent Libra from being used by criminals to achieve money laundering. The central bank institutions have very consistent calibers on this issue.

Regulators can also consider Libra's regulation from many different perspectives: Given the value of the underlying asset, is it a collective investment fund or an exchange-traded fund? For Libra Reserve, should it be regulated like a bank? Should we limit the way these assets are invested?

In addition, there are financial stability issues, such as deposits in Libra that are not covered by deposit insurance. In addition, tax authorities may think that every Libra transaction needs to be taxed because the underlying value of a basket of assets will change, which will greatly diminish Libra's appeal.

I also realize that outside the United States, some people worry that if Libra succeeds, it will lead to “backdoor dollarization” – or that the Western legal currency may have an excessive impact in the global monetary system, thus causing Negative effects.

The challenges facing the central bank's digital currency

Libra may never be able to make any progress in the face of heavy resistance and opposition. However, the direction of this proposal for the future may be more important than the content itself.

First, the proposal may raise concerns about the modernization of digital asset law . This is definitely a good thing.

Second, the proposal may raise concerns about the increasingly blurred boundaries between technology companies and financial services . This applies not only to digital assets, but also to how we view financial technology as a whole.

In today's society, fintech startups can design technology-enabled platforms or services, develop customer relationships, capture customer data, and then contract with regulated institutions to provide regulated products. However, should such financial technology companies also be regulated? If a cloud computing service provider provides core IT services to a number of banks with systemic impacts around the world, is this cloud service provider subject to financial market regulation? Is it at least necessary to meet regulatory requirements for network security and privacy protection? This reflects a common phenomenon: financial market innovation in the United States is often driven by the private sector rather than by the government; innovation is often born on the edge of the regulatory radius. Regulation tends to be lagging behind, as is the case in digital assets and financial technology.

Finally, the Libra proposal sparked more and more attention to the central bank's digital currency (CBDC). Many countries are currently exploring the central bank's digital currency, including China. In fact, Libra is said to have prompted the Chinese central bank to accelerate its digital currency development plan. The Fed is still continuing to analyze the potential benefits and costs of the central bank's digital currency, but is now more concerned with the popularity of real-time payments.

The reasons for exploring the central bank's digital currency include the following aspects: First, the public is increasingly reluctant to use cash, second, the use of digital currency will increase payment efficiency, and third, further expand the coverage of financial inclusion.

Central bank digital currencies can be broadly divided into two categories: wholesale and retail. The wholesale central bank digital currency is only available to a few large financial institutions, such as banks in the national clearing and settlement system. The issuance of wholesale digital currency can promote interbank payments; but it is likely that most people will not be in economic life. Trading methods have a significant impact.

Conversely, the retail central bank digital currency can target all individuals and businesses. In the specific implementation process, a “value” method may be used to store the currency in the mobile phone application or the physical card; or an account may be used to establish a uniform for each person or enterprise in a unified account book. Account. Regardless of the system, the central bank's digital currency traceability is stronger than cash. After all, the system will record transactions digitally, but there may be problems in privacy protection that cannot be ignored. In addition, there is one difference between the account-based system and the value-based system: the former can pay interest for the central bank's digital currency, and may change the central bank's consideration of monetary policy.

The widespread use of central bank digital currencies can reduce the basic transaction costs and thus the extent of financial inclusion.

However, the central bank's digital currency may also have some negative effects. Depends on its specific characteristics . For example, the central bank's digital currency may reduce bank deposits, which will have a major impact on the bank's financing model, and even have a negative impact on the credit creation process and the speed of money circulation – after all, private banks create more credit than the Fed. It is true that after the adoption of the central bank's digital currency, banks can make corresponding adjustments, but what happens in the face of financial pressure? The widespread use of the central bank's digital currency may increase the risk of depositors divesting from the banking system, which in turn will lead to greater financial stability risks – depositors may quickly convert deposits into central bank digital currencies to achieve asset preservation (a flight to Safety). The central bank's digital currency has also raised privacy concerns, and it has also made it even more vulnerable to cyber attacks.

The above questions are very challenging. What is going on in the future is still inconclusive. Anyway, I look forward to seeing some form of central bank digital currency coming out in the near future.

I want to end my speech with an anecdote: Marco Polo came to China in the 13th century, when he saw the banknotes for the first time in his life and was amazed. He called it alchemy because the banknotes at the time were made of bark. To this day, some people have compared the digitalization of finance to the new alchemy, and the changes it brings are exciting.