EMIR HRNJIC
  • Home
  • OPINION PIECES
  • Media
  • Case Studies
  • Publications
  • Exec Ed
  • Teaching
  • Presentations
  • Events
  • Block'N'White Consulting

Digital Currency Can Impact Monetary Policy (as published in Business Times on May 14, 2020)

5/23/2020

0 Comments

 
By Emir Hrnjic

The People’s Bank of China (PBOC) has reportedly begun a pilot test of the digital yuan in April, thus, becoming the first major economy to introduce a central bank digital currency (CBDC). The experimental trials started in three cities, including Shenzhen, Suzhou, and Chengdu, as well as in the Xiong’an New Area and digital yuan became part of the monetary system.

Together with President Xi Jinping’s recent appeal for greater urgency in the development of blockchain, the pilot launch of digital yuan epitomizes China’s ambition to become the digital currency leader. Moreover, state-media outlet China Daily claimed that “[China’s] digital currency provides a functional alternative to the dollar settlement system.”

While China was the only major economy that made a daring step toward a major milestone, governments and central banks around the world have been experimenting with blockchain and digital currencies for years. The early versions of the US stimulus bill included the development of a digital US dollar, while The European Central Bank recently released a working paper analyzing merits of its potential digital currency.

Indeed, as central bankers around the world are increasingly showing interest in blockchain technologies and the global adoption of digital currencies continue, they could eventually challenge and partially replace fiat currencies, thus, creating significant monetary policy implications. 

In agreement, a recent report of G7 working group on as a subset of digital currencies known as stablecoins stated that “stablecoins that reach global scale could pose challenges and risks to monetary policy.”

THE IMPACT OF CENTRAL BANK DIGITAL CURRENCIES

CBDC would likely help monetary policy targeting money supply and enable access to real-time data regarding money demand. It would also likely be a direct liability of the central bank, while blockchain-based interbank settlement systems would be faster, auditable, and more transparent.

In general, central banks influence monetary policy by changing the short-term interest rate. Additionally, monetary authorities reduce long-term interest rates by buying long-term government bonds. This process, also known as quantitative easing, increases the money supply.

CBDC could help with targeting of money supply since citizens would have direct access to the central bank’s base money. It would also enable governments’ access to real-time data on money demand.

Indeed, a recent research study by the Bank of England concluded that a central bank digital currency might “strengthen the transmission of monetary policy changes to the real economy.” 

Bitcoin supporters glorify its fixed issuance schedule with no discretionary influence of central banks or any other institution. They often present past evidence of central banks in several countries abusing their discretionary power and printing money for the benefit of various interest groups. 

In the case of CBDC, the central bank’s commitment problem could be potentially solved by using smart contracts to predetermine the issuance rate of the currency when predefined conditions are met.

However, the pre-determined currency issuance implies that money supply would by default ignore future market factors and, hence, the future quantity of money would not be able to respond to future market conditions.

THE IMPACT OF PRIVATE CRYPTOCURRENCIES

When Facebook and its partners in Libra Association announced the development of cryptocurrency with a potential user base of 2.4 billion active users last June, the possibility of a private cryptocurrency replacing sovereign currency became a reality.

At the Congress Hearing organized a few weeks later, Facebook’s executive David Marcus stated that The Libra Association has “no intention of competing with any sovereign currencies or entering the monetary policy arena.” However, if Libra becomes a widely adopted private currency as its founders hope, it will inevitably have monetary policy implications regardless of the founders’ intentions.  

Libra will be fully backed by the basket of currencies comprising the US dollar, euro, Japanese yen, pound sterling, and Singapore dollar, and, thus, it will effectively follow the monetary policies of the five central banks that issue these currencies. As regulators around the world expressed concerns that Libra could interfere with their national currencies and monetary policies, Libra was recently redesigned, and a new White Paper describes single-currency stablecoins separate from the Libra coin.

Notwithstanding these changes, Libra could eventually partially replace some sovereign currencies, especially in countries with high inflation and unstable banking system. According to BIS’ report, private cryptocurrencies backed by tech giants could “rapidly establish a dominant position in global finance and pose a potential threat to competition, stability and social welfare.” 

Furthermore, the potential dominance of Libra or any other private cryptocurrency in a specific country would severely undermine the effects of monetary policy of that country and jeopardize its economy. If citizens start using cryptocurrency rather than local currency, weak demand would cause local currency’s depreciation. As inflation of local currency increases, it will affect even non-adopters of the cryptocurrency.

In this respect, the effect of cryptocurrencies would be analogous to the dollarization – the impact of the US dollar on local currencies in some developing countries. For example, demand for local currencies in countries such as Zimbabwe or Cambodia is affected by lack of trust in the currency and, thus, locals use the US dollar as a medium of exchange. This currency substitution causes local monetary authorities to lose a set of monetary policy tools that can affect macroeconomic outcomes.

On the other hand, libertarians and free market devotees claim that competition from private currencies may impose market discipline on central banks, which should improve the quality of sovereign money. Currency competition, they argue, can reduce inflation and prevent the central bank’s manipulation of interest rates.

Moreover, monetary policy typically affects the real economy via central banks’ short-term interest rate, which has an impact on the bank funding cost and, thus, bank lending rates. This monetary policy pass-through is limited by the relatively strong market power that banks have over depositors. In layman’s terms, deposit rates are not very responsive to policy rate changes. 

However, an improved blockchain-based payment system would likely increase competition and, as a result, competitive pressures on depository system would increase the responsiveness of deposit rates to policy rates.

As global adoption of cryptocurrencies continues to accelerate, policy makers expect that they will challenge and even partially replace fiat currencies in future. Central banks’ digital currencies are likely to strengthen the transmission of monetary policy and help monetary policy targeting money supply.

Dominant private cryptocurrencies, on the other hand, would severely undermine the effect of monetary policy. Furthermore, they could also lead to diminishing relevance of some sovereign currencies, the loss of their value, and high inflation. 

0 Comments

Prospect of Cryptocurrencies in Islamic Finance (as published in the Jakarta Post on February 24, 2020)

2/24/2020

0 Comments

 
Prospect of Cryptocurrencies in Islamic Finance
By Emir Hrnjic and Nikodem Tomczak

In May of this year a mosque in London announced it would begin to accept donations in cryptocurrency form.

Although many were skeptical, the mosque received four times more donations in cryptocurrency during the month of Ramadan than in traditional cash.

Even before the mosque’s experiment, debate has been raging about the permissibility of cryptocurrencies under Islamic law as religious scholars deliberate the issue of sharia compliance. 

Some religious scholars in Egypt, Turkey, and India for example have directly opposed the use of cryptocurrencies citing various issues such as their use in illegal activities, widespread speculation and price volatility. Others, however, have declared bitcoin sharia compliant, paving the way for Islamic institutions to start accepting cryptocurrencies. 

Considering that the worldwide Islamic finance market recently surpassed U$2 trillion, the issue of sharia compliance has huge economic significance. Muslims make up almost a quarter of the world’s population and Muslim countries account for approximately 10 percent of global GDP. 

To comply with sharia, financial products should avoid interest, speculation, and excessive uncertainty. They should also be ethical and underlying contracts should be transparent, whilst Islamic financial instruments should be backed by real economic activity or a physical asset. 

Against these benchmarks, concerns have been raised about widespread speculation and the extreme price volatility of cryptocurrencies. Furthermore the majority of cryptocurrencies have no underlying economic activity or physical asset. 

However, taken to an extreme, strict interpretations of Islamic finance disapprove even of traditional fiat currencies – especially so after the gold standard was abandoned in 1971 and money lost its “real” value. 

As a solution, some have argued for the creation of Islamic gold dinar and Islamic silver dirham currencies, backed by gold and silver, saying that such a system would alleviate several problems of modern economies such as inflation and recurring financial crises.

Whilst the ambiguity about sharia compliance has kept many devout Muslims on the sidelines, companies across the Islamic world have started incorporating blockchain and cryptocurrencies into their business models. 

Among ASEAN countries, Malaysian government formed partnership with Hong Kong’s iSunOne which specializes in digital banking services to develop the blockchain–based Islamic financial network and to establish a blockchain–based Islamic bank. 

In Indonesia, Blossom Finance offers Smart Sukuk Tokens which represent an ownership in the sukuk used in funding microfinance projects. The platform is able to reduce the cost of sukuk issuance by automating much of the legal, accounting, and payment cost.

Meanwhile in the Middle East, a crypto token for money transfers received sharia certification from an advisory agency licensed by the Bahrain’s central bank, while Saudi Arabia’s monetary authority signed a partnership with blockchain firm Ripple to use the company’s platform for cross-border payment settlements. In April, Saudi British Bank (SABB) launched an instant cross-border transfer service based on Ripple’s blockchain technology.

One crypto solution that seems tailor-made for sharia compliance is stablecoin – a cryptocurrency backed by a stable commodity such as gold or silver. 

Since the concepts of the Islamic gold dinar and Islamic silver dirham represent ideals of Islamic finance, a stablecoin backed by gold or silver provides an opportunity for an emergence of a “digital Islamic gold dinar” or “digital Islamic silver dirham.” 

The market value of a stablecoin theoretically equals the value of its underlying collateral deposited in a crypto company’s bank account. Hence, a stablecoin should have a stable value regardless of the ups and downs of the rest of the crypto market. This should avoid excessive volatility fueled by speculation and market manipulation, although of course gold and silver are not completely immune from these.

Recently, a stablecoin issued by a Swiss firm and backed by a basket of eight fiat currencies and gold received sharia certification from a leading consultancy and audit firm in Bahrain. 

However, a concern for collateralized coins is that they require intermediaries including the token issuer guaranteeing redeemability of the stablecoin and the banks safekeeping of the collateral. In this case credibility of an authenticator of the commodity held in reserves would be an issue. Furthermore, the presence of intermediaries renders such schemes effectively centralized, and as a result subject to a single point of failure.

Along with their impact on Islamic finance, truly resilient stablecoins would profoundly impact the cryptocurrency world in various ways. For example, enabling crypto-based loans with significantly reduced volatility risk would make a large impact on lending and borrowing markets. Moreover, stablecoins could be used for payments, remittances, salaries and many other purposes.

If stablecoins prove resilient, they will unlock the blockchain potential to its fullest with the potential to even rival bitcoin as they become a truly global medium of exchange. 

Islamic investors and entrepreneurs are increasingly aware of the seemingly endless opportunities. 

While the debate over the permissibility of cryptocurrencies is still ongoing among Muslim scholars, governments must decide whether to back cryptocurrencies or risk being ostracized from the new economies. 

Furthermore, central banks in Muslim countries should embrace opportunities offered by the growing importance of cryptocurrencies. 

In that spirit, development of stablecoins backed by gold or silver will revitalize a “digital Islamic gold dinar” or “digital Islamic silver dirham” providing a tailor-made solution for sharia compliant cryptocurrencies. 

Marrying the cryptocurrencies with key principles of Islamic finance may finally bring the needed stability and scale to Islamic finance. 
0 Comments

Beware of Risks in Blockchain–Based Smart Contracts (as published in South China Morning Post on November 16, 2019)

11/16/2019

0 Comments

 
Beware of Risks in Blockchain–Based Smart Contracts
By Emir Hrnjic and Nikodem Tomczak
 
Among the many technological advances enabled by blockchain technology, such as the emergence of cryptocurrencies, smart contracts have attracted significant attention due to their potential transformative power in business and finance.
 
Digital contracts, much like traditional contracts, outline the terms of an agreement between two or more parties but the terms are in the form of computer code residing and executed on a blockchain. The “smart” aspect of these contracts comes supposedly from their ability to automatically enforce and execute the contract provisions on the blockchain when preset conditions are met.
 
The self-verifying, self-executing and self-enforcing nature of smart contracts removes the need for any central authority or intermediaries for the contract execution, drastically reducing the cost of doing business.
 
Transacting parties can easily audit the smart contract code, while the blockchain technology theoretically provides a tamper–proof record of the contract code and of every transaction executed by that code, minimizing risk and greatly improving transparency and accountability.
 
However, these contracts are arguably neither “smart” nor “contracts.”
 
The code describing the contract provisions is not necessarily legally binding.
 
For its obligations to be legally enforceable the transacting parties may also need real-world legal agreements to facilitate the resolution of potential disputes that would arise from human-made errors in the smart contract code.
 
Appropriate legislation needs to be passed to recognize the legal effect of smart contracts when conducting electronic business transactions. To this end, many jurisdictions have recently passed relevant bills recognizing the legal effects of smart contracts, helping to pave the way for their wider acceptance.
 
Smart contracts have widely proliferated on different blockchain platforms and currently underpin the emerging decentralized finance sector that facilitates funding and servicing of loans, digital securities trading, as well as initial coin offerings.
 
Furthermore, they are poised to transform businesses by drastically cutting overhead costs, increasing efficiency by automating many business tasks, and accelerating financial transactions by reducing the likelihood of disputes.
 
However, smart contracts are relatively new, and to achieve wider adoption, some key hurdles need to be overcome.
 
Since a smart contract is as good as the underlying computer code, vulnerabilities and hacking that would result in loss of funds are major concerns that may force potential adopters to stay on the sidelines.
 
In one infamous example of smart contract vulnerability, a weakness in the smart contracts code underpinning a blockchain-enabled venture capital fund, caused a loss of 3.6 million Ether (the equivalent of roughly US$50 million at the time) in 2016.
 
The recovery of the funds came at a major reputational cost to the blockchain security and governance.
 
Despite regulatory efforts around the world, unscrupulous developers remain a danger to the industry, while the legal uncertainties of conducting business on blockchain platforms across different jurisdiction significantly increase the risk.
 
Before smart contracts achieve wider adoption, the code vulnerabilities and the legal frameworks need to be properly addressed. In the meantime, entrepreneurs should figure out what role smart contracts can play in defining the future of their business and factor in the risks involved.
0 Comments

Blockchain path to more inclusive world (as published in Jakarta Post on October 4, 2019)

11/7/2019

0 Comments

 

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.

0 Comments

PBOC Keeps Faith in Digital Currency (as published in South China Morning Post on September 21, 2019)

9/21/2019

0 Comments

 
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.
0 Comments

Decentralised Finance in a centralised world (as published in Business Times on July 25, 2019)

7/29/2019

0 Comments

 
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. 

GROWING PAINS

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.

0 Comments

Challenges ahead for Facebook’s Libra (as published in The Business  Times on July 4, 2019)

7/4/2019

0 Comments

 
The Business Times

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.
 
DATA PRIVACY
 
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.
 
REGULATORY PUSHBACK
 
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.

0 Comments

The Transformative Nature of ​Blockchain–Based Smart Contracts (as published in Business Times on June 4, 2019)

6/4/2019

0 Comments

 
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.
 


0 Comments

Blockchain can be catalyst for a more inclusive world (as published in South China Morning Post on May 18, 2019)

5/18/2019

0 Comments

 
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. 
0 Comments

Centralised money in a decentralised world (as published in The Business Times on May 2, 2019)

5/3/2019

0 Comments

 
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".

MAIN CHALLENGES

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.
0 Comments
<<Previous
Forward>>
    Picture
    Picture
    Picture
    Picture
    Picture
    Picture
    Picture
Powered by Create your own unique website with customizable templates.
  • Home
  • OPINION PIECES
  • Media
  • Case Studies
  • Publications
  • Exec Ed
  • Teaching
  • Presentations
  • Events
  • Block'N'White Consulting