Blockchain path to more inclusive world By Emir Hrnjic and Nikodem Tomczak
Some 2 billion people in the world and unbanked and lack access to useful and affordable financial services. According to the World Bank, this is one of the major barriers to reducing extreme prverty and social inequality.
Yet, of these 2 billion, approximately two thirds have access to a mobile phone with internet connection. This enables access to emerging blockchain technologies, offering in turn some unique and promising solutions to create a more equal and inclusive world.
Blockchain is an open and decentralized technology that enables electronic transfer of value without intermediaries. By design it is transparent, inclusive and censorship resistant. Because it is decentralized it empowers individuals, institutions, and governments to build democratic technological solutions that are resilient and less prone to manipulation.
As a result the technology has the potential to eliminate divisions across caused by social, age, and gender gaps, erase geographical, cultural, and jurisdictional restrictions and build economic resilience. At the same time, it provides a platform for near real-time settlement of trades and retrieval of critical assets over a secure network at much lower cost than traditional financial solutions.
One of the main causes of financial exclusion is that many of the world’s poor lack proper personal identification and documented property rights. Blockchain technology can help to overcome this by storing tamperproof personal information, unlocking access to financial services while reducing the risk of fraud.
In developing countries, the ability to register and retrieve property rights should increase social mobility and improve living standards.
Meanwhile, on a global level, blockchain technologies should increase transparency and fraud detection, potentially reducing corruption and poor management of resources.
This will be of even greater importance in the era of global projects, such as the China-led One Belt One Road Initiative spanning dozens of underdeveloped countries, which demand improved coordination of economic activities. In these contexts, promoting accountability and transparency can reduce problems with trade disputes while lowering barriers to entry for parties from many different countries.
Many developing nations have near-universal access to 3G mobile networks. Coupled with high mobile phone ownership rates this offers the potential to enable many underserved people to interact with blockchain technology and boost financial participation.
Since the cost of traditional money transfer can be as high as 20 percent, bypassing the banking system significantly reduces transaction costs and allows rural people to send and receive payments at near zero cost.
An example of this is Kenya’s M-Pesa mobile payment system which has opened access to banking and financial services to anyone with a mobile phone and helped lift almost 200,000 Kenyan households out of extreme poverty.
International organizations, such as the United Nations, have already launched several networks and programmes that use blockchain to increase participation, lower transaction costs and reduce fraud. This is particularly important for over 1 billion people who lack proper identification documents, many of them refugees from war-torn countries.
For example, the World Food Program has integrated blockchain to eliminate third party fees and to improve its assistance programmes by using the technology to store refugees’ IDs. A recent smart city project in Phnom Penh saw residents issued a digital passport which includes a digital wallet function. Individuals can sign up for utilities services with their digital identities within minutes and skipping middlemen agencies. However, the impact of blockchain on financial inclusion is not without potential pitfalls.
Running the decentralized blockchain can be costly, demanding dedicated equipment and high electricity consumption to secure the network. And of course it’s important to bear in mind that technology alone does not have supernatural powers to heal the ills of modern societies. Blind belief in “solutionism” that blockchain technology offers would be a mistake. Similar prophecies were made about the internet and the idea that the ability of computers to send data between each other would magically deliver a more just and equal society.
Furthermore, a full understanding of how the technology works may be necessary to build up a true trust-based relationship.
While the technology may allow us to minimize trust in people and intermediaries, trust in the technology itself needs to be built through education. This clearly presents an obstacle to financial inclusion as underprivileged communities usually also have the largest educational gaps.
Finally, if blockchain is to become a vehicle for financial inclusion, there must be internationally agreed regulations. Specifically, regulatory safeguards for a smooth transition would have to be established in order to minimise risk of a sudden disruption to current financial networks.
Blockchain is a foundational technology that could potentially redefine economic systems and lead us to a more equal and financially inclusive world while mitigating risks and lowering transactional cost. At the same time its transparent and tamperproof characteristics can improve public oversight and strengthen economic resilience while increasing citizens’ confidence in the distribution of public resources. However, the full social impact of the technology will depend on its adoption rate; and that – to a large extent – will depend on our ability to bridge existing educational gaps.
PBOC Keeps Faith in Digital Currency By Emir Hrnjic and Nikodem Tomczak
Deputy director of the People’s Bank of China’s (PBOC) payments division, Mu Changchun, recently announced that the issuance of China’s central bank digital currency (CBDC) is imminent. China’s CBDC will partially replace cash in circulation which will likely help forecasting targets for money supply and enable access to real-time data regarding money demand. This, in turn, would help PBOC to effectively tighten control over the monetary policy with the objective, according to Mr. Mu, to “protect [China’s] monetary sovereignty and legal currency status.”
China’s CBDC would partially rely on a distributed ledger technology (DLT) and will be primarily designed to handle large transaction volumes expected in a country with the world largest population. In fact, PBOC believes that the DLT would not be able to support a volume of simultaneous transactions such as the volume on Singles’ Day – the largest online shopping day in the world.
In a proposed two-tier system, the central bank will create the digital currency and financial institutions such as Alibaba, Tencent, UnionPay and four largest state-owned banks will be involved in its distribution to country's 1.4 billion citizens. Eventually, the new digital yuan will be made available to customers outside China. Alibaba owns the Post.
The distributed ledger technology is heavily researched by most of the world’s central banks. A study by the Cambridge Centre for Alternative Finance predicts that more than a third of these organisations would have active DLT applications within 10 years.
The emergence of cryptocurrencies and the underlying DLT have opened up new possibilities for the secure digital transfer of money. The typical features of cryptocurrencies – the public ledger, immutability, and its decentralised nature – are hard to be incorporated into centralised banking.
A central bank digital currency powered by DLT would nonetheless support faster, auditable, and more transparent interbank settlement systems.
However, not all countries support the introduction of a CBDC. Australia, New Zealand and South Korea have raised concerns about its effect on the stability of the financial system. In their argument against CBDC, they cited risks associated with “credit, liquidity and legal management” and “significant implications for the [central] bank's financial stability mandate.”
Indeed, introduction of CBDCs available directly to the public could lead to unintended consequences during economically uncertain times. For instance, credit contraction could be exacerbated by commercial bank customers transferring their funds to a more secure and risk-free CBDC, starving the commercial banks of access to deposits. This, in turn, would lead to a large contraction of consumer credit, harming the real economy.
The mainland's digital currency, however, will not be available directly to the public and will not compete with commercial bank deposits. It will be used by the PBOC and commercial banks for settlement of transactions. This may increase transparency of the Chinese banking system and create more stability.
Reuters reported that the mainland's digital currency would “strike a balance between allowing anonymous payments and preventing money-laundering.” In fact, tracing digital currency transactions on an effectively centralised ledger should be simple and effortless. Hence, a China’s digital currency will enable the central bank to track money laundering, terrorism financing, and other illegal activities.
On the other hand, this represents another potential drawback of a China’s digital currency as it will give a central bank the power to observe and control individuals’ finances and transactions, including those happening on China’s successful mobile payments applications.
Nonetheless, the Bank of England’s study concluded that CBDC issuance “could permanently raise GDP by as much as three percent… [and] could substantially improve the central bank’s ability to stabilise the business cycle.”
As DLT and regulations mature, central banks may need to implement digital currencies or risk losing relevance in the global economy. Commercial banks have to react to successful CBDCs too, and plan to replace deposits with other sources of funds.
Central banks need to bear in mind that, in the transition to the central bank issued digital currencies, they must not lose sight of their primary role – maintaining trust in money.
Decentralized Finance in a Centralized World By Emir Hrnjic and Nikodem Tomczak
The growth of global financial markets has created enormous wealth, especially benefitting a few players who are closely connected to the world’s main financial centres.
The centralized nature of the industry has enabled these powerful intermediaries to position themselves in the middle of the system and thus extract rents from other participants.
This oligopolistic structure has stifled competition and decreased efficiency, while increasing the cost of financial services.
Reflecting on this, Vitalik Buterin, one of the leading crypto gurus and co-founder of Ethereum, recently stated that moving money between accounts using banks is “insanely inefficient” and “international payments… [are] even worse.”
The rapid development of blockchain technologies, however, combined with the spread of low–cost mobile internet access is disrupting this model. Together they are opening the way to exciting innovations and the emergence of the Decentralized Finance movement.
Known as DeFi this rapidly growing movement aims to revolutionize existing financial services by creating decentralized applications on top of peer–to–peer networks, such as Bitcoin, that operate without intermediaries.
One of its main objectives is disintermediation and disempowerment of rent–extracting middlemen by enabling direct peer-to-peer transactions.
LOW TRANSACTION COST
In 2015 Jamie Dimon, CEO of JPMorgan Chase, predicted that “Silicon Valley start-ups were coming to eat Wall Street’s lunch.” DeFi could be the manifestation of his prophecy.
After blockchain developers struggled to design a killer application, DeFi looks poised to transform the finance sector by automating payments and loans.
For example, Bitcoin enables peer–to–peer payments at very low transaction cost and very refined price granularity. A case in point is the recent purchase of an art piece for U$0.00000004143 which was transferred almost instantaneously using a payments network built on top of Bitcoin. To put this amount in perspective, consider that one billion of these pieces would cost just U$41.43.
This shows DeFi’s potential for improving facilitation of micropayments, microloans, and opening up new monetization strategies used in pay–per–use subscription, gaming and online advertising.
With DeFi, transaction costs typically do not scale with transaction amounts, allowing for transfers of tens of millions of dollars for less than a dollar - a rate unthinkable in the current centralized financial systems with numerous intermediaries.
In addition, transactions can also be finalized much more quickly than traditional financial institutions allow.
On the lending side, even though peer–to–peer crypto lending applications are in the nascent stage, their popularity has been growing at a rapid pace.
DeFi lending taps into the blockchains’ ability to settle transactions using smart contracts instead of an intermediary, significantly reducing counterparty risk and cost. At the same time, typical annual percentage rates are lower than those available from traditional lenders.
Moreover, since no credit checks are performed on some platforms, DeFi–enabled lending has the potential to reach many more people – especially in developing markets.
BUILDING ON BITCOIN
The impact of DeFi on financial services then is potentially vast.
DeFi benefits from the disruptive spirit that has driven innovation in Bitcoin, helping to build strong relationships between people and financial service providers.
Bitcoin, for example, has enabled the electronic transfer of value without middlemen. The trust element of Bitcoin is gained through open access to its public ledger, which does not depend on an intermediary to protect and secure its records which are instead guarded by cryptography.
As a result, DeFi, just like Bitcoin, is less prone to manipulation and, hence, more resistant to censorship.
Openness and public access to the ledger implies improved transparency and inclusiveness – two principal factors that strengthen and democratize financial relationships between individuals, corporations, and government organizations.
DeFi can simplify access to financial products regardless of where people live or how wealthy they are, opening up the potential to contribute to finance at every level of society.
Furthermore, open–source code of the underlying technology and permissive copyright licenses encourage continuous innovation.
For example, smart contracts – pieces of code that reside on the blockchain and enable decentralized financial applications – automatically execute essential tasks.
This predictability reduces the cost of doing business, while transparent recording of transactions and auditable contract code decrease the likelihood of disputes.
There are however certain trade-offs associated with building decentralized applications on top of public blockchains, among them low transaction processing rates and the high cost of maintaining a secure ledger.
Currently, there are relatively few crypto custody services which are important for those investors who are not technologically savvy enough to directly use DeFi applications.
Furthermore, the notoriously poor user experience in the blockchain space urgently needs attention. Better product design and user-friendly apps would go a long way towards building wider adoption.
Then there are specific issues related to different applications. For example, whilst many crypto investors have raved about crypto–lending leader MakerDAO, some borrowers have been shocked by its sudden spike in interest rates – from an annual rate of 0.5 percent to almost 20 percent.
Finally, as with all revolutionary technologies, regulatory uncertainty has haunted blockchain technologies since their inception. Conflicting messages from regulatory bodies regarding licensing requirements for exchanges will continue to slow down DeFi adoption.
Overall DeFi is a novel and promising development that has a potential to transform the current financial systems by overtaking rent–extracting intermediaries and, thus, reducing costs of services.
More specifically, it appears that DeFi is poised to impact payments and lending, while posing a serious competitive threat to traditional finance firms.
DeFi undoubtedly has huge potential in improving financial inclusion. However, its technical complexity and many moving, interacting parts require careful assessment.
Whilst the promised benefits are substantial, a treacherous path toward widespread adoption lies ahead.
Challenges ahead for Facebook’s Libra Emir Hrnjic and Nikodem Tomczak
Facebook’s recently unveiled digital currency, Libra, has drawn much excitement over its potentially transformative impact.
Facebook’s 2.5 billion users around the world and the firm’s extensive experience in developing user-friendly apps undoubtedly provides Libra with a huge head start. Users will be able to use Libra to purchase goods, transfer money, as well as for in-app purchases on the Facebook Marketplace, WhatsApp, Instagram, and other affiliated platforms.
This gives Facebook an unrivalled ready market through which to accelerate Libra’s early adoption.
One crypto insider tweeted that Facebook’s announcement would “go down in history as THE catalyst that propelled digital assets… (including bitcoin) to mass global consumer adoption.”
Yet despite all the breathless excitement, achieving Facebook’s high ambitions for Libra will not be without challenges. Critics have warned that Libra will effectively be Facebook’s private currency and financial regulators have been cautious at best in their response to the news.
The Financial Times proclaimed that Libra was “nothing more than a brazen attempt to override national monetary sovereignty by creating a global-scale Federal Reserve equivalent.”
So is Libra really the game changer some have suggested? Here are three main challenges Facebook’s new cryptocurrency needs to overcome.
Libra will be pseudonymous like Bitcoin. All transaction data will only be available to and tracked by the members of the consortium who have access to its network. Facebook says it will not be available to the public.
The social network’s business model centres on collecting droves of personal data that allows advertisers to accurately target their marketing efforts. However, following some major data privacy scandals – think Cambridge Analytica as just one example – the firm has been under huge pressure from regulators to be more stringent about how this data is used.
Facebook faces an uphill task of convincing the public that Libra will be serious about data protection. Since Facebook’s official position is “there is no expectation of privacy” with Facebook data, it is not clear whether that culture will be reflected in Libra’s policies in the future.
Additionally, while Facebook’s wallet, Calibra, may not share its user data with Facebook, there is nothing preventing this or other apps built on the Libra Blockchain from having access to Facebook’s data. In fact, it would be very advantageous for these apps to tap into Facebook data for credit scoring and advertising purposes, for example.
Indeed, access to Facebook’s personal data trove and its potential misuse or manipulation is what many regulators fear.
While cryptocurrencies have a great potential, they have a very bad reputation due to widespread scams, frauds, and hacks that have cost investors billions of dollars. As regulators are trying to protect average consumers, their scepticism toward Libra is justified.
Anticipating regulators’ reluctance, Facebook discussed the launch of its cryptocurrency with central banks, including the US Federal Reserve and the Bank of England. Mark Zuckerberg reportedly met with the Governor of Bank of England, Mark Carney.
After the currency was announced, while Mr Carney publicly stated that the Bank would have “an open mind” about Libra, he also called for “strict regulations” if it takes off. What these might be remains to be seen.
In the US meanwhile, Congresswoman Maxine Waters, chair of the House Financial Services Committee, requested a moratorium on the development of Libra, comparing it to “starting a bank without going through any [regulatory] steps.” She also announced that Congress would hold a hearing on Libra.
And in France Finance Minister Bruno Le Maire said that “it is out of question [that Libra will] become a sovereign currency,” citing concerns about privacy, money laundering, and terrorism financing.
DISTRIBUTED BUT CENTRALIZED
Economist and former US presidential advisor Nouriel Roubini, a famous crypto sceptic, stated bluntly that “[Libra] has nothing to do with blockchain [since it is] fully private, controlled, centralized, verified and authorized by a small number of permissioned nodes.”
Indeed, Libra is centralized and controlled by traditional financial intermediaries such as PayPal, Visa, and Mastercard. Tech giants including Uber, Lyft, and eBay have also invested at least U$10 million each to join the Libra Association. As of now, there are 28 founding members, with plans to expand to 100 members by the Libra Blockchain launch next year. These founders will act as “nodes” to continuously verify and add transactions to the Libra ledger.
While the transacting parties in Bitcoin and other decentralized cryptocurrencies do not need to trust each other, financial participants will have to trust Libra and the validating node operators. Indeed, trusting financial institutions proved disastrous to many customers prior to the financial crisis of 2007-2008. Moreover, blockchain purists denounce Libra for going against decentralization and trust-less nature in favour of centralized consensus protocols.
While cryptocurrencies aim to eliminate powerful intermediaries, Libra’s concept puts intermediaries back in the middle of the system enabling them to make excessive profits and capture valuable data.
At its development conference in May this year, Mark Zuckerberg said one of Facebook’s key development areas was to “make it as easy to send money to someone as it is to send a photo.” He identified payments and private commerce as “one of the areas we're really excited about.”
In fact, Facebook seems eager to build on its vast social media user base to dominate financial services. A parallel could be the case of Alibaba’s Alipay in China.
In order to reach that goal, Facebook will have to overcome significant hurdles. Whilst investors seem excited and optimistic about Libra – as evidenced by the five per cent increase in Facebook’s share price – it faces an arduous task ahead.
Business Times The Transformative Nature of Blockchain–Based Smart Contracts
By Emir Hrnjic and Nikodem Tomczak June 4, 2019
As well as providing the backbone of cryptocurrencies such as Bitcoin and Ether, the emergence of blockchain technology has enabled a range of other lesser–known technological advances.
One such development is the emergence of so-called smart contracts – an application some advocates believe could prove to be even more transformative.
On the surface smart contracts work like traditional contracts, outlining the terms of an agreement between two or more parties. The “smart” element supposedly comes from the cryptographic code that verifies, executes and enforces the terms of the agreement.
The value of smart contracts lies in the ability to automate the execution of a range of tasks when predefined conditions are met. As smart contracts are typically self-verifying, self-executing and self-enforcing, they do not require an intermediary or a central authority to regulate the contract’s execution. With no need for a middleman, the predictable nature of the code that underpins them drastically reduces the cost of doing business.
In addition, the code of smart contracts can be easily audited by all parties involved whilst the blockchain provides a tamper–proof record of every transaction executed.
Yet, regardless of how conceptually powerful smart contracts may be, it could also be argued that they are neither “smart” nor “contracts.”
Indeed, they are only as reliable as the code describing them and the blockchain that secures them against manipulation. While simple agreements could be automated, more sophisticated contracts are more likely to require human judgment or off-blockchain resolution of disputes.
The immutable nature of blockchain technology is typically celebrated for its positive implications, but this same feature also has the potential to cause adverse effects and increased risk. For example, the computer code that underpins them is susceptible to human error as much as a written contract.
Furthermore, just because the smart contracts are enforceable on the level of computer code, it does not necessarily mean that they are legally binding agreements.
In fact, it is highly debatable whether the nature of the code describing contract provisions constitutes legally enforceable obligations unless some of the provisions are moved outside of the blockchain. In other words, it is unclear whether transacting parties need real-world legal agreements in addition to smart contracts on blockchain.
In an effort to clarify this and attract businesses and investors, the US state of Arizona and several other states have recently passed bills recognising the legal effect of smart contracts in conducting electronic transactions, helping to pave the way for their wider acceptance as standard business practice.
The applications of smart contracts range from simple data storage to complex accountancy, finance, and governance frameworks. They have served as the basis for development of decentralized applications enabling the initiation, funding, and servicing of loans. And, for better or worse, they have enabled the creation of a range of crypto-tokens, serving as the backbone of initial coin offerings (ICOs).
Going forward, smart contracts are poised to transform the finance sector by automating loans, insurance, and payments, drastically reducing overhead costs and increasing efficiency. Transparent recording of transactions and auditable contract code reduce the likelihood of disputes and hence accelerate financial transactions involved.
However, we have also seen that vulnerabilities in smart contracts can lead to major losses of funds.
In one infamous example in 2016, a hack exploited weakness of smart contracts underpinning The DAO, a blockchain-enabled venture capital fund, causing a loss of 3.6 million Ether (the equivalent of roughly US$50 million at the time).
The funds were ultimately recovered as developers opted to reset Ethereum’s codebase. However, this came at a major reputational cost, since Ethereum’s blockchain history was rewritten, casting into question the supposed decentralization and immutability of the platform.
Despite this, smart contracts continue to find new applications. The recording and publishing industries, for example, are beginning to use smart contracts to enforce copyright and tackle piracy and plagiarism, thus preventing potential multimillion-dollar losses.
So, whilst blockchain-based smart contracts are relatively new, their rapid rise and breadth of application shows a degree of confidence in their future.
Indeed, their transformative effect could mean that smart contracts may become an entire industry in itself, underpinning a new decentralized finance sector.
However, for smart contracts to achieve wider adoption, the industry will have to overcome some key hurdles. One of the main shortcomings is concerns about the fragile state of cybersecurity, as potential adopters worried about possible loss of funds may choose to stay on the sidelines and wait for improved solutions.
Likewise, unscrupulous developers remain a danger to the industry, despite regulators around the world increasing the scrutiny and prosecution of illegal practices. Unclear legal ramifications, meanwhile, increase the uncertainty and risk to potential adopters.
In the meantime, blockchain developers will have to work hard to close the vulnerabilities in code, lawyers must fully understand and prepare for the legal repercussions, and entrepreneurs should figure out what role smart contracts can play in defining the future of their business.
South China Morning Post Blockchain can be a catalyst for a more inclusive world By Emir Hrnjic and Nikodem Tomczak May 18, 2019
A lack of financial inclusion is a significant cause of social inequality in the world. The World Bank considers access to useful and affordable financial products key to reducing extreme poverty and the Group of 20 economies recently committed to efforts aimed at advancing financial inclusion worldwide.
But while 2 billion people in the world are unbanked and lack access to financial services, two-thirds of them have access to a mobile phone with internet connection. This enables access to blockchain technologies, which may in turn provide some unique and promising solutions to creating a more inclusive world.
Blockchain is an open and decentralised technology that enables electronic transfers of value without intermediaries and is, by design, transparent, inclusive and censorship-resistant.
In fact, blockchain has the potential to eliminate traditional divisions across societies, age and gender, whilst also erasing geographical, cultural and jurisdictional restrictions and strengthening economic resilience.
A lack of proper personal identification and documented property rights remains one of the main reasons for financial exclusion.
However, blockchain technology can overcome this by holding tamper-proof information about individuals, thus unlocking access to financial services. Furthermore, the ability to register and retrieve property rights in developing countries should increase social mobility and improve living standards.
On a global level, blockchain technologies should increase transparency and fraud detection, while reducing corruption and poor management of resources in developing economies.
This will be of even greater importance in the era of global projects such as the China-led Belt and Road Initiative that spans dozens of underdeveloped countries. Such projects demand improved coordination of economic activities.
In these contexts, promoting accountability and transparency can reduce problems with trade disputes while lowering barriers to entry for parties from many different countries.
Many developing nations have near-universal access to 3G mobile networks. Coupled with high mobile phone ownership rates, this offers the potential to enable many people to interact with blockchain technology and boost financial participation.
Since the cost of traditional money transfers can be as high as 20 per cent, bypassing the banking system significantly reduces transaction costs.
An example of this is Kenya’s M-Pesa mobile payment system, which has opened access to banking and financial services to anyone with a mobile phone.
This access to mobile money has had a profound impact, helping to lift almost 200,000 Kenyan households out of extreme poverty.
However, the impact of blockchain on financial inclusion is not without potential pitfalls.
Running the decentralised blockchain can be very costly, demanding resources, such as dedicated equipment and high electricity consumption to secure the network.
Furthermore, a full understanding of how the technology works may be necessary to build up a true trust-based relationship, which can be built through education. However, this presents an obstacle to financial inclusion as underprivileged and underserved communities usually experience the largest educational gaps. Finally, if blockchain is to become a vehicle for financial inclusion, there is a need for internationally agreed regulations.
The Business Times Centralised money in a decentralised world
By Emir Hrnjic and Nikodem Tomczak May 2, 2019 AT the Singapore Fintech Festival in November last year, Christine Lagarde, managing director of the International Monetary Fund (IMF), called on the world's central banks to consider issuing digital currencies.
Although no central bank has yet done so, many - including those in Sweden, Canada and China, as well as the European Central Bank and the Bank for International Settlements (BIS) - have been carefully studying and experimenting with different distributed ledger technologies (DLT).
According to a recent study by the Cambridge Centre for Alternative Finance, a fifth of central banks will soon be using DLT and more than a third will have active applications within a decade.
IMPACT OF DISTRIBUTED LEDGER TECHNOLOGIES
Traditionally, central banks control the supply of money, administer interbank payment systems, maintain public confidence in the value of national currencies and generally support a nation's economic stability.
Recently, however, the emergence of cryptocurrencies and the underlying DLT have opened up new possibilities for the secure digital transfer of money while other financial innovations are facilitating the establishment of cashless societies.
Bitcoin, the highest profile of the new cryptocurrencies, appeared poised to compete with national currencies and effectively created trust-minimised banking. However, its extreme volatility and low transaction processing capacity have cast doubts on the notion that cryptocurrencies can become a workable medium of exchange.
This leads to the question: can any of the features of cryptocurrencies - such as the public ledger, immutability, and its decentralised nature - be incorporated into centralised banking? If they can, what would be the benefits and costs of a central bank digital currency (CBDC)?
No universal definition of a CBDC exists, but were such a currency to launch, it is generally agreed that it would be a direct liability of the central bank and should result in wider accessibility to central bank money.
In this context, DLT could support faster, auditable, and in general more transparent interbank settlement systems, while avoiding issues like single point of failure and decreased settlement costs.
A leading advocate for incorporating cryptocurrencies into the central banking system has been Dong He, deputy director of the International Monetary Fund's Monetary and Capital Markets Department. He recently suggested that central banks should adopt some of the concepts from cryptocurrencies to maintain demand for central bank money.
Attitudes from the banks themselves have been somewhat mixed. South Korea's Central Bank, for example, openly opposed issuing a CBDC saying that whilst such a currency could significantly transform the banking system, there are risks associated with "credit, liquidity and legal management" and market stability.
Likewise Australia and New Zealand have both ruled out pursuing a central bank digital currency citing low demand and "significant implications for the bank's financial stability mandate".
A research study by the Bank of England in 2016 examined the risks and benefits of a CBDC and concluded that a properly designed CBDC may actually "strengthen the transmission of monetary policy changes to the real economy" and would not harm the private banking sector. However, the study also warned that any mismanagement of transition from physical to digital cash could pose a major threat to the financial stability.
The main challenges for the introduction of a CBDC stem from potential credit contraction and possible abuse of power.
The head of Germany's Bundesbank, Jens Weidmann, argued that when the economic situation becomes uncertain, existing commercial bank customers would decide to keep their money in the form of a CBDC, since it would be essentially risk-free and more secure than in commercial banks.
This may pose a problem for commercial banks as they would partially lose access to deposits, automatically leading to a sudden and severe contraction of consumer credit harming the real economy.
Alternatively, banks would have to rely on more expensive and risky funds such as issuing securities, which would increase the rates on consumer credits. Either of these scenarios - credit contraction or more expensive credit lines - would risk economic recession or, in extreme cases, the possibility of a bank run.
Another potential drawback of a CBDC is giving a central bank power to observe and control individuals' finances. This would likely raise eyebrows among many proponents of personal freedom.
Furthermore, an effectively centralised ledger could give rise to a corrupt or monopolistic intermediary - the exact issue that cryptocurrencies developers have tried to avoid.
Despite many potential challenges, the Bank of England's study concluded that CBDC issuance "could permanently raise GDP by as much as three per cent . . . could substantially improve the central bank's ability to stabilise the business cycle".
As suitable secure DLTs emerge and countries adopt proper regulatory frameworks, central banks will have to consider issuing their own digital currencies or risk losing relevance in the global market.
Likewise, commercial banks will need to replace deposits with other sources of funding, likely disrupting the current fractional reserve banking system as well.
Any transition from the current system to the new decentralised world of central banks would have to happen without undermining the very primary role of central banks - maintaining trust in money.
The Straits Times How Initial Coin Offerings Can Reinvent Themselves
By Emir Hrnjic and Nikodem Tomczak January 27, 2019
In late May Singapore regulators clamped down on Initial Coin Offerings (ICOs), ordering one issuer to stop the offering of its digital tokens and eight exchanges to cease trading these tokens.
Although the Monetary Authority of Singapore did not publicly name the issuer involved, it said the move was to halt the issuing of digital tokens that resembled securities or futures contracts, but which did not follow the legal procedures required of regular securities and futures.
This has caused some observers to wonder about the future of this innovative fund-raising method in what had become the largest ICO market in Asia.
In 2017 start-ups raised roughly US$5 billion worldwide through ICOs, surpassing traditional venture capital funding and transforming the early stage fund raising landscape. Yet in the same period roughly half of the attempted ICOs failed to get off the ground.
Many blockchain companies have focused solely on developing the technology, hoping that the tech alone will drive market adoption. However, as it became clear that a sizeable majority of ICO companies either could not deliver on their promises or simply never had any intention of doing so, disgruntled investors have led calls for stronger regulations.
To meet these demands and reduce the risk of fraud and failure, how can ICOs reinvent themselves to win investor confidence?
The long history of finance theory and practice provides useful hints. For example, securitization, loan procurement, and staged financing have been successfully used for public and private companies for decades.
Can these well-established methods serve as prototypes in blockchain environment? What are the pros and cons of these security designs? Finally, can they be modified and adapted to blockchain companies?
The answer is simpler than it seems.
Based on the concept of securitization of assets, profits, or revenues generated by blockchain companies, the Security Token Offering method represents a regulated ICO that strictly complies with finance laws. The benefits are improved efficiency, liquidity, and transparency, and often include certain features such as proxy voting.
Since any investment including real estate, stocks, bonds, commodities, and even infrastructure projects can be securitized (or tokenized), the market value for tokenized securities could potentially reach hundreds of trillions of dollars.
While securitization provides investors with more assurance, as securities have clearly defined intrinsic value and the company is required to disclose investment risk, newly issued tokens require an underwriter as well as compliance with laws and legal requirements.
Another innovative way to raise funds for blockchain companies is through Initial Loan Procurement – a method that allows blockchain start-ups to enter loan agreements with creditors through smart contracts.
Just like in a typical loan agreement, the issuer has a legal obligation to return investor funds plus pre-determined interest over the maturity of the loan.
Unlike other methods, they are typically more tax efficient and compliant than ICOs and token holders become creditors since they lend money to a company.
It has other advantages in that it is regulatory compliant and the loans are not subject to tax. Further, the immutability of blockchain technology provides confidence to creditors.
Well-known in venture capital playbook, staged financing method consists of two different phases: the fundraising phase, where the start-ups raise funds; and the fund disbursement phase, in which the funds are released to entrepreneurs after reaching predetermined milestones.
Similarly, its blockchain counterpart – Decentralized Autonomous ICO (DAICO) – serves to mitigate some of the shortcomings of standard ICOs by enabling investors to influence how the ICO funds are spent. It does this by including provisions that the ICO company would have to reach agreed targets before accessing portions of raised funds. In cases where it does not, investors would be able to vote on a refund.
By giving investors control over the funds, this approach limits the possibility of a scam and ensures that the project developers sustain both their motivation and accountability. Finally, just like staged financing, DAICO alleviates risks for investors.
With many ICO start-ups failing to deliver on their promises, the crypto community is focusing its attention on how to eliminate fraud, comply with regulations and boost investor confidence.
At the same time, the growing interest of institutional investors in ICOs is fuelling demand for better regulations and improved governance.
This increased scrutiny is pushing potential ICO issuers to strengthen their technical development teams with legal, finance and business professionals.
The likely consequence is further development and adoption of improved methods of raising capital for blockchain start-ups such as ICO versions of securitization, loan procurement, and staged financing.
While these methods are still in their infancy and examples of start-ups choosing these alternatives are limited, innovations like these represent the future of fund raising for blockchain start-ups.
For investors, keeping abreast and informed of these rapidly evolving models will be the key to success.
South China Morning Post How Small Firms Reap Benefits from Blockchain Switch
By Emir Hrnjic and Nikodem Tomczak January 19, 2019 A recent research study conducted by the World Economic Forum and Bain & Company estimated that blockchain technology could boost global trade by US$ 1 trillion, much of it benefitting small and medium-sized enterprises (SMEs). With this in mind, blockchain offers great potential for China’s SMEs, which account for over 90 percent of market entities there and generate over 90 percent of the country’s GDP. These SMEs can use blockchain to simplify internal processes, and in the long run, grow their businesses.
Blockchains are designed to enable transactions without the need for an intermediary or for transacting parties to trust each other. The public nature of many blockchains also offers greater levels of transparency.
Immutability of data on the blockchain also provides finality for transactions and a fully auditable record for regulators, helping to prevent fraud, mitigate risk, and decrease accounting costs. For retailers, provenance and supply chain auditability increases transparency and boosts consumer confidence.
Among many notable blockchain-enabled uses for SMEs, most significant is the enabling of fast, efficient, and low-cost solutions for interbank transactions.
In traditional financial systems, many intermediaries exploit their position to charge inflated transaction fees, even if they provide meaningful service and reduce transaction risk. Moreover, traditional international bank transfers can take days, whereas transfers on blockchain take minutes.
Blockchain also dramatically simplifies cross-border payments allowing SMEs to easily collaborate and pay partners and employees residing in different countries. Blockchain-based payments are also especially cost-efficient for transfer of so-called micropayments – a key consideration for businesses relying on such transfers, such as emerging subscription-based services and microloans.
Another important feature of blockchain for SMEs is the ability to develop and apply smart contracts. These are blockchain versions of traditional contracts with transparent and guaranteed execution. Funds sent to the smart contract are locked and are only automatically released once until all the required conditions to finalize a transaction are fulfilled.
As companies are built on contracts, smart contracts can be used to expedite, secure, and automate business operations. At the same time, they cut operational and transactional costs by removing intermediaries such as lawyers, bankers and auditors.
For SMEs, smart contracts can speed up payments and reduce cash flow problems as they are executed as soon as the predefined conditions are met. Furthermore, smart contracts allow for interaction of multiple parties ensuring transparency and increasing trust and security.
Examples of potential smart contracts for SMEs include creating and enforcing contracts with merchants and customers, handling invoicing and transfer of assets.
Implementing blockchain technologies for SME owners that have never had any experience with this technology can be a daunting task. Until recently, the only option was hiring expensive blockchain developers to provide in-house solutions.
However, with more software companies providing affordable and practical blockchain implementations, the prospects for SMEs integrating blockchain technology into their business processes is becoming a reality.
The range of potential applications of blockchain technology offer vast scope for exploration that could reward first movers. For SMEs the most promising applications include supply chains, proof of provenance, digital identity verification, and safe distributed data storage. SMEs that are currently using or offering these with any other technology should seriously consider migration to blockchain-based solutions.
The blockchain is about much more than bitcoin or other cryptocurrencies. Among many applications, it offers fast, efficient, and cost-effective solutions, helps in preventing fraud, reduces costs and automates business operations. This opens the way for SMEs to compete with much larger players on a more level playing field.
The Straits Times Mind the Blockchain Knowledge Gap By Emir Hrnjic and Nikodem Tomczak October 7, 2018
In recent years, new technologies disrupted the finance sector’s status quo and created a wealth of opportunities worldwide. In Singapore alone, in 2016 – 2017, the fintech industry created 2,000 jobs, and thus, met the target of Singapore’s Financial Services Industry Transformation Map.
Within the fintech arena, blockchain technologies led a surge in demand for skilled manpower especially in software development. Blockchain turned into the fastest growing job skill while salaries for blockchain-related jobs jumped above those for software developers in non-blockchain companies.
One of the drivers of the increased demand is the large amount of money raised via Initial Coin Offerings (ICOs) – an innovative method for early stage financing. A typical blockchain company spends a large portion of its ICO war chest on hiring new talent to deliver on the promises made during the ICO.
In response to a surge in labour demand, a brain migration from related industries, such as software development, increased the labour supply. Additionally, the global labour market has been experiencing talent flight into early adopting nations where blockchain companies are thriving in part due to mild or non-existent crypto-related regulations. Nevertheless, a gap in labour supply-demand remains.
HOW TO PREPARE?
So how does one prepare for the possible disruptions in the labour market that technologies such as blockchain are causing?
One important aspect is that this new technology is a combination of a multitude of diverse fields like many other currently emerging technologies. Blockchain uniquely amalgamates cryptography, computer science, economics and finance. Although one does not need to have an in-depth education and knowledge in all these fields to start a career in blockchain, a firm grasp of all the important concepts as well as an understanding of how they fit together is highly desirable.
Adding to the complexity, the path to a career in blockchain is hindered by the lack of proper certification programmes. Top finance companies such as JPMorgan Chase, Citigroup, and NASDAQ recently advertised multiple positions related to blockchain that require accreditation, though, it is not entirely clear what would constitute a proper certification. One can’t currently have a formal education in blockchain as arguably no official standards exist yet.
WHO SHOULD FILL THE GAP?
So, if blockchain skills are in high demand, who should fill the gap?
The Institute of Banking & Finance (IBF) seems like a natural authority to initiate the standards, since IBF has a mandate to establish competency standards in Singapore’s financial sector.
On a country level, the Monetary Authority of Singapore (MAS) typically takes a hands-on approach in talent development. MAS supports bringing in international talent for transfer of knowledge as well as building a local pipeline of IT talent for the financial services sector. Finally, MAS works with key financial institutions to help their staff get retrained for new jobs.
At the university level, blockchain is an integral component in education such as the Executive Masters for Investments and Risk Portfolio Management (EMIR) at the National University of Singapore (NUS) Business School. Globally, major universities such as Stanford, Princeton, and MIT have also developed blockchain-related courses as part of their finance, computer science or law curricula.
But self-learning appears to hold the most appeal. In a fast-paced field such as blockchain, where new technology solutions appear almost every week, traditional learning resources like books become outdated quickly.
In fact, abundant blockchain knowledge resides in white papers, blogs, public Slack or Telegram channels, online tutorials, or code repositories such as GitHub. Learning by doing, immersing oneself in the technology, networking with diverse people from company founders to cryptoenthusiasts by attending multitude of workshops and social events, and perhaps, ultimately contributing to the code base may be the best approach.
Combining self-learning with formal university courses may offer a means to build a learning culture suitable for this new technology. Competitions for students are hands-on and exciting. At a recent Bank of China-sponsored competition with the NUS Business School, students from 12 countries were invited along with xxx Singapore teams to propose blockchain innovations, culminating in a hackathon to develop the corresponding app architecture. Such competitions give students opportunities to be part of a “live” blockchain case, experience blockchain at work, and learn as they analyse the case for solutions. Such competitions can also be extended to practitioners to motivate them to learn more about blockchain.
Experience is, indeed, the best teacher, and being at the forefront of the research and development is always gratifying in the long term and may clearly differentiate anyone from their peers in the job marketplace.
In the short to medium term, a plethora of jobs await suitable candidates. Acquiring blockchain knowledge may eventually lead to a well-paid and satisfying job in technology and finance start-ups, as well as established companies.
Self-motivation, keeping pace with the rapidly changing technology landscape and careful planning for a blockchain career can be very fruitful in the nascent field with numerous job opportunities.