The Future of Money and the Payment System published a lecture held by Agustín Carstens, General Manager of the Bank for International Settlements at Princeton University, Princeton, New Jersey, USA, on December 5, 2019.

We publish the main highlights of the speech:

Theoretically speaking, money is a social convention, hence anything could serve as money provided that everyone buys in. But this definition is not enough to predict how a particular version of money will perform in the payment system.

The institutional details matter when it comes to how durable and how efficient any economic arrangement can be.

Three developments have propelled money and the payment system to the top of the policy agenda in the last few years, raising questions about their basic architecture: 1) the rise and subsequent fall of Bitcoin (BTC) and altcoins; 2) the entry of big tech firms into financial services; 3) the intense debates concerning Libra and other stablecoins.

Authorities and central banks realize they need to address the issues related to technological innovation and its impact on money and payments in a far more proactive way.

Policymakers need to harness the best technology that is grounded on a solid foundation.

The monetary system is founded on trust in the currency, which is something only the central banks can provide, but they need to embrace innovation.

At the same time, their traditional functions are tailor-made for the many innovations on the horizon, including central bank digital currencies (CBDCs).

Making the distinction between token-based money and account-based money: the tokens themselves may be intrinsically worthless, but people accept them as payment in the expectation that everyone else will accept them too, while account-based money uses an intermediary.

Nowadays, anyone with a bank account holds currency in digital form, but the architecture of account-based money remains the same for hundreds of years.

One notable aspect of Bitcoin was that it harked back to the earlier, token-based definition of money, one that does not rely on intermediaries such as banks.

The particular given formulation of the consensus mechanism fails two basic tests: scalability and finality of payments.

This is where the central bank comes into its own, playing four key roles, with the modern payment system being comprised of two tiers where the central bank serves as the banker to commercial banks – thus underpinning the public’s trust in money.

In case of BTC, if a sufficiently large group of bookkeepers collude to rewrite the history of the distributed ledger, payments that were made far in the past could be made null and void.

Throughout history, private moneys have come and gone, the critical issue being how the value of a particular form of money is underpinned.

As long as the foundation of trust provided by central banks is in place, many forms of monetary arrangements can be built on top, using any number of different technologies.

Technological advances have opened the door to a more fundamental shift away from conventional account-based money, but the technology by itself does not confer a stable value on CBDCs.

What ensures their stability is that only CBDCs are redeemable in central bank money and are supported by the central bank public goods.

CBDCs can be classified into wholesale CBDCs and retail CBDCs.

For wholesale payments, settlement liquidity is particularly important. Account-based CBDCs used by regulated financial institutions have long existed in the form of conventional central bank deposits held by commercial banks.

The introduction of retail CBDCs would represent a complete sea-change by opening up new possibilities, though they also raise a host of questions and issues.

Arguably, the most effective way to improve the retail payment system is to build out the current account based, two-tier system to accommodate faster payments. This would be based on a level playing field with room for both traditional banks and innovative non-bank payment service providers (PSPs).

Innovators include emerging economies and others who are unhampered by legacy technologies or resistance from vested interests. Central bank public goods need to move with the times, but the technology is secondary to the underlying economics.

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