Consequences of the Crisis, Part I: Digital Cash Becomes a Political Issue

This is the first of three posts exploring blockchain applications that I believe will see accelerated adoption due to the ongoing crisis. None will arrive fast enough to impact the pandemic, but all will be in consideration for dealing with the aftermath. Crises have a way of changing society’s priorities.

One of the more underrated news items of not that long ago was New York City joining San Francisco in banning cashless business. It revealed the blow back against one of the most commonly held beliefs in finance and tech, that all payments will eventually be digital and handled by an ecosystem of for-profit banks, card rails and Fintechs.

The first problem with that thesis is that it doesn’t account for tens of millions of people who exist outside of the banking system and would therefore be locked out of a cashless economy. The second problem is that it assumes society would be fine paying an effective tax on every single transaction in the form of fees.

Both issues were thrust into the spotlight when Libra was announced. Although many disagreed with Facebook's solution, few disagreed with the stated problem: fees on payments are usually borne by the least privileged among us, including migrants, the poor, gig economy workers and small businesses. The controversy over Libra's proposed solution created an explosion of interest in so called central bank digital currencies, or CBDCs.

Central banks are already important in payments, both via the banknotes (aka cash) they issue and due to the national payment infrastructure (check clearing, RTGS) they operate. Notably, these systems are either free or operated at cost — unlike corporate digital payment solutions, whose fees create economic distortions, such as delis with minimums for card purchases and gas stations that charge more for credit. There are also non-financial costs to private payment solutions, such as privacy and mass data collection.

A tokenized cash equivalent (aka stablecoin) such as Libra is a partial solution. Although still privately issued, stablecoins have a different business and data model, which is why they are often designed as loss leaders. No stablecoin provider will ever be as profitable as PayPal, and that’s the point.

A general purpose CBDC goes as a step further, because unlike with a stablecoin, users don’t have to worry about the adequacy of the reserve. If the Fed were to issue a tokenized dollar on some blockchain and declare it legal tender, then it would be as valuable as a physical dollar bill. Fees would be minimal if any, so the entire economy would get an effective tax break.

The covid crisis has exposed our current system’s inability to get money where it’s needed quickly. Digitally native companies have offered to help, but there are thorny questions of how. Would these companies be willing to waive the fees and data collection that are core to their business model? If not, would society be OK with some percentage of the stimulus money flowing not to those who desperately need every penny, but to Silicon Valley companies? The answer, according to some in congress, is absolutely not, so they proposed an alternative.

Found in earlier drafts of the stimulus bill (but taken out before passage), that solution called for commercial banks to operate so-called “narrow banks” that would process stimulus payments at a loss, and for the Fed to open up its balance sheet and payment system to the general public — also known as a retail CBDC. One solution would be a money loser for commercial banks while the other would greatly disrupt the payments industry.

My thinking on this subject has evolved since I first proposed the disruptive potential of stablecoins a few years ago. My core thesis can be found here, and is summarized as “stablecoins will do to payments what Skype did to pay-per minute phone calls.” I’m now expanding that thesis to include a political imperative. The crisis requires countless injections of cash by the government, and the notion that mega financial firms or billionaire tech bros should profit as a result is distasteful. I have nothing against private companies earning a profit, but now there is a technology that affords society the same outcome for free.

The congressional digital dollar proposal has nothing to do with blockchain, and most central banks looking into CBDCs are as open to using traditional account-based solutions as they are to tokens. But the former just isn’t as good. A distributed ledger is more resilient than a non-distributed one. An immutable ledger is preferable to an editable one. Private-key based transactions are more secure than identity-based ones. Programmable money is superior to non-programmable money. Both account-based and tokenized CBDC solutions use ledgers, but blockchain is better ledger technology.

As the economic fallout from the current crisis unfolds, the need for better, faster and cheaper payments will become a hot-button issue. That will drive a lot of innovation, but those hoping to extend the old way of doing things will now encounter political push back. If digital payments are viewed as a public good, then stablecoins win out.

The opinions expressed here are strictly my own and not that of any client, employer or associate.