The Breakdown - Are Central Bank Coins the End of Financial Privacy?

Episode Date: October 6, 2020

Today on the Brief: Markets gain as Pres. Trump’s condition stabilizes SEC Chairman Clayton sees future where all stocks are tokenized Uniswap had more volume than Coinbase in September  Our main discussion: central bank coins and financial privacy.  The EU recently released a new research paper on a possible digital euro. Like many other official central bank reports, it assumes there is no possibility of an anonymous digital bank currency. NLW dissects arguments from people including JP Koning and CoinCenter’s Jerry Brito on why this shouldn’t be true. 

While the technology may be interesting, while there may be relevant enabling efficiencies that come from central bank currencies, you have to kind of view them if you're in the crypto space as first and foremost surveillance money, because I think that's what they are. I hope I'm wrong, but I fear that I'm not. Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by Crypto.com. XO.io, an elliptic, and produced and distributed by CoinDesk. What's going on, guys? It is Monday, October 5th, and today we're discussing whether central bank coins mean the end of financial privacy. First up, however, let's do the brief. First on the brief today, a quick market update. Things were getting a little turbulent at the end of last week, given that the normal election issues and volatility therein were greatly

exacerbated when Donald Trump, President of the United States, came down with COVID-19. This morning, the Wall Street Journal says that stocks rise on signs of muted political risk, and the original subheading included both Trump's health condition as well as a growing Biden lead, although the second part has now been removed from that subheader. Regardless of the argument, the S&P 500 rose 1%, the NASDAQ rose 1.4%, and the Dowell rose 0.9%. Now, even though that Biden part might have been removed from the subheader, the main body of the article does reinforce the idea of a contested election being a factor in market volatility. In other words, the more it looks clear that one candidate is going to win, whichever one

it is, the more markets settle down. That said, there's also an interesting new narrative that markets are starting to wonder about the real downside to a Democrat win, where there may be corporate tax increases, which obviously the market doesn't like, but that may be offset somewhat by positive stimulus implications. Next up on the brief today, tokenize stocks. Jay Clayton, the head of the SEC, was part of a webinar with the Chamber of Digital Commerce, and in it he said that, just like all stock trading is today electronic, it could be that one day all stocks themselves become tokenized. He said that the SEC's door is, quote, wide open to, to someone that can, in his words, tokenize the ETF product in a way that adds efficiency.

Pomp actually covered this this morning in his Pomp letter and wrote this. Here's my favorite prediction about how this is all going to unfold. I believe the SEC is eventually going to mandate every company in traditional exchange to tokenize the securities that are traded in the market. This would allow regulators to become proactive in their security law enforcement and would save them enormous amounts of time, money, and energy. Basically, in Pomp's argument, he's effectively arguing that in the future, the law itself will be written into the code in a way that specific actions are stopped from occurring before they even happen.

Now, folks like Pomp are absolutely convinced that in the future, all stocks will be tokenized, and really that all financial instruments will be tokenized, and this conversation with the head of the SEC is one more piece of evidence in favor of that argument. Third and finally on the brief today, the ongoing battle between Dex's and centralized exchanges. Uniswap is the leading decentralized exchange by volume. It saw 15.4 billion in trading volume in September's overall record 23.5 billion in trading volume across all decentralized exchanges. In this same month, Coinbase reported 13.6 billion in monthly volume, which, for those who can do math, is lower than 15.4 billion. Maybe an even more interesting number, though, is the decentralized

exchange to centralized exchange volume ratio. In September, it was 13.9%, and that's up from 6.06% in August. Now, I think that one important takeaway from this, I don't believe that it means that Normies are all of a sudden dexing. I think it just means that more of the enfranchised crypto users are shifting their behavior to the things and opportunities offered by these decentralized exchanges. Still, it shows just how significant this growth is. From a basically infinitesimal percentage up to nearly 15% in a few months is a pretty big deal. But with that, let's shift to our main discussion about financial privacy and central bank digital currencies. So let's do a little bit of frame setting first. Central bank digital currencies have been

on the radar for some time. China, for example, has been researching the idea since as they claim 2014. Over the last few years, however, we've seen a couple of key inflection points. A first inflection point had to do with the rise of stable coins. Tether, of course, became an important part of the crypto ecosystem as early as 2017 and 2018, but by late 2018, there was the beginning of what has been a veritable Cambrian explosion of stable coins. Those create a framework, a mental model, and a technological template for central bank. digital currencies, given that most of them are representations of some specific fiat. For sure, the stable coin launched that got the most notice, though, and was the most

significant inflection point on this journey, was the introduction of Libra in the middle of 2019. This was, as I have said before, a total starting gun for other nations. All of a sudden, stable coins weren't just some cute digital representation of a fiat currency. Part of the reason for that was that Libra originally had this concept of a basket. The Libra was not going to be pegged to a single currency. It was going to be backed by a basket of currencies that had weights. The idea was to increase stability, but nations, particularly the United States, saw this as a direct threat to, in many ways, their monetary sovereignty.

That feeling was accentuated by the fact that Facebook wasn't just any other private company. It was a private company with a two billion-strong user base built in. It wasn't hard for nations to start to connect the dots and see that this could become a very big issue very quickly. China was the first to respond to Libra in short order. Within days, a former member of the People's Bank of China said that China really needed to get out ahead. And within weeks, there were announcements of the DeSep Project, the digital currency and electronic payments protocol. When China took this seriously, the rest of the world took it seriously as well. And I think it was really interesting.

You can go back and watch Libra Hearing 1 with David Marcus. Was not primarily about China. It was really a referendum on Facebook's previous and unresolved injustices, as many congressmen and women and senators would have it. Libra Hearing 2, however, a few months later, was very much about China. That was the one where Mark Zuckerberg testified. and it was very clear that if we don't do this, China's going to get way ahead of you was the central argument by that time.

So Libra was, for many nations, an important moment to start really taking this much more seriously. A third inflection point, however, came this year in the midst of the COVID-19 crisis. As governments tried to figure out what their stimulus package was going to be, it became clear very quickly that distribution and rapid distribution were major issues. In one draft of a stimulus bill from the House Democrats, a digital dollar was actually included, a Fed account, basically, which would have had Americans hold a direct account with the Federal Reserve, which they could automatically put money into. So where are we now?

The conversation has grown significantly. John Kiff is an IMF senior financial sector expert and keeps a running tally of where retail central bank digital currencies are being explored. I'm going to quickly breeze through the list just to you get a sense of how frequently this is happening. So this is where central banks have explored or are exploring issuing retail CBDCs. Australia, Brazil, Canada, Chile, Denmark, Ecuador, Finland, Ghana, Hong Kong, Iceland, India, Indonesia, Israel, Jamaica, Japan, Korea, Malaysia, Mauritius, Morocco, New Zealand, Norway, Russia, Switzerland, Thailand, Trinidad, and Tobago, Tunisia, Turkey, United Kingdom, United States. So these are all places that are researching. Now here are the jurisdictions where central banks are

in advanced stages of retail CBD exploration. Bahamas, with a pilot underway in a full launch this month. China, which has a pilot launched. The Eastern Caribbean, which has a Q4 pilot launch for this year. South Africa. Sweden, which has a proof of concept started. Ukraine, which has a pilot completed. In Uruguay, which has a pilot completed. What's more, you can see almost every day or certainly every week, there's some news on CoinDesk or the Block about a new jurisdiction getting deeper into the CBDC waters. This episode is brought to you by Crypto.com, the Crypto super app that lets you buy, earn, and spend crypto all in one place and earn up to 8.5% per year on your Bitcoin. Download the Crypto.com app now to see the interest rates you could be earning on BTC and more

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Central bank currencies could be hugely convenient for governments. Think automated taxation, for example. So when I say micro, I mean the relationship between the government and an individual citizen, there are a lot of benefits for central bank digital currencies. Then there are, of course, macro issues. A recent People's Bank of China publication made it close. that the goal for China is to combat the dominance of the USD as the global reserve currency. And back here at home for the biggest digital dollar advocates like Chris Giancarlo, the former CFTC chair, this macro issue and keeping the state of the US dollar in the world is a key part of their battle. But what about the other player in the global reserve race?

Easily the second most used settlement currency in the world after USD is the euro. Just this month, the European Central Bank published a report introducing a digital euro. I'm going to read briefly the intro letter from ECB head Christine Lagarde just to give you a flavor for this report. A key part of the Euro system's mission is to provide citizens with riskless money for their payments. The Euro system has been providing Eurobank notes for nearly two decades. While cash is still the dominant means of payment, new technologies and the increasing demand for immediacy from consumers are changing the way European citizens pay. This is evident in the expanding role of fast electronic payments. To ensure that consumers continue to have unfettered access to central bank money in a way

that meets their needs in the digital age, the ECB's governing council decided to advance work on the possible issuance of a digital euro, an electronic form of central bank money accessible to all citizens and firms. A digital euro would be introduced alongside cash, it would not replace it. A digital euro would create synergies with private payment solutions, contribute to a more innovative, competitive, and resilient European payment system. By serving as a unifying force in Europe's digital economies, a digital Europe would also be an emblem of the ongoing process of European integration. It is too early to commit to a specific design of a digital euro, but it is clear that any type of design must fulfill a number of principles and requirements

identified in this report, including accessibility, robustness, safety, efficiency, and privacy, while complying with relevant legislation. Looking ahead, we need to be ready to introduce a digital euro shall the need arise. For now, we maintain the options open as to whether and when this should happen. Our role is to secure trust in money. This means making sure the euro is fit for the digital age. So the key question actually does have to do with the design, however, and that's what we're exploring here. John Kiff again, when sharing this article or this report with his readers, put it this way. He said the European Central Bank's recent report exploring the idea of issuing a retail central bank digital currency claims that, quote, regulations do not allow anonymity in electronic payments,

and the digital euro must in principle comply with such regulations. In fact, the fifth EU anti-money laundering directive, AML5, exempts issuers of e-money slash prepaid cards from collecting consumer information if user holdings do not exceed euro 50, euro 150 for non-rechargeable stored value cards. Why did the EU build an anonymity exemption into payments law, but now chooses to avoid exploring it in potential CBDC designs. John Paul Coning puts the question more precisely. He writes, will the ECB's new euros for all be relatively open and anonymous like cash, or will they require ID and permission like a bank account? He references that same quote as Kiff, saying, while anonymity is currently the case for banknotes and coins, regulations do not allow

anonymity in electronic payments, and the digital euro must in principle comply with such regulations. He then goes on to say, however, but I'm pretty sure the report is wrong on this. The 5th EU anti-money laundering directive exempts issuers from collecting customer information as long as fixed monetary thresholds aren't exceeded. So if the ECB believes that it must comply with existing regulation for electronic payments, then surely a digital euro falls under e-money law and thus can have some anonymity. Keep the line above in mind if the ECB believes that it must comply with existing regulations, for electronic payments, because as we'll see, that question of which existing regulation

the ECB has to comply with is really, really key. But JP goes on to ask, why would we care about anonymity in the first place? One of the major reasons, and certainly the one that's chief on the minds of the ECB, is the financial inclusion case. The most disadvantaged parts of society are those people who are most likely to lack ID. These are the people who are most likely to be impacted by a shift to an entirely digital payments paradigm. Think about, for example, homeless people no longer being allowed to use cash. J.P makes the point that the ECB is contradicting itself here. The report says that the decline in cash could exacerbate financial exclusion for the unbanked and for vulnerable parts of society, forcing the central bank to intervene. Why then wouldn't they

use the built-in permissions for exactly this type of issue? Of course, another case for this sort of anonymity is the general civil liberties case. This is certainly the one that many of you Bitcoiners who are listening right now are most likely to respond to on a visceral level, the idea that people have a right to transactional privacy with their money. Right now, cash affords this, but in a world where we have only central bank cash, there's no cash at all. CoinCenter has spoken about this extensively. It's one of their key issues. And speaking of CoinCenter, let's come to their director, Jerry Brito's writing on this exact issue. As I mentioned before, Koning makes the point that the ECB believes that it must comply with existing regulation

for electronic payments. But why can't it be regulated like banknotes? Brito wrote about this a couple weeks ago responding to a speech from the Fed Cleveland President Loretta Mester. He wrote, where most people responded to the part of that speech where it seemed like the Federal Reserve was saying that they had been looking at a digital dollar longer and more deeply than we knew, where Brito's attention was caught was this quote. The experience with pandemic emergency payments has brought forward an idea that was already gaining increased attention at central banks around the world, that is, Central Bank digital currency. Legislation has proposed that each American have an account at the Fed in which

digital dollars could be deposited as liabilities of the Federal Reserve banks, which could be used for emergency payments. Other proposals would create a new payments instrument, digital cash, which would be just like the physical currency issued by central banks today, but in a digital form and potentially without the anonymity of physical currency. And that last line is key, and I'm going to read an extensive selection from Brito here. Central banks and related authorities are increasingly publishing papers explaining what the design of a CBDC might look like. In itemizing the various design choices available, they explain that any design will be constrained by the necessity to, quote, comply with AML law. However, no such constraint exists in reality,

and the various central bank papers that bring this up do not cite any specific law or regulation. It seems to be a tick on the part of paper authors who seem to be assuming that there must be such a law and are thus artificially limiting their design choices. He then points to examples of this from central banks from England, Canada, and the Fed itself, and says, again, it makes no sense to say that a CBDC, which, after all, does not yet exist, must be designed to comply with AML obligations for the simple reason that no such obligations have yet been promulgated for CBDC. Laws governing CBDC have not yet been passed by legislatures because CBDC does not yet exist. While the Bank of England and Bank of Canada simply assert without any

citation that a CBDC will certainly be subject to AML regulation, the Fed acknowledges it is making an assumption about what it thinks will likely be the law in the future, not what the law is today. In both cases, central banks are substituting their judgment for the legislatures, which has not yet to create on the matter, and are limiting their design options as a result, which is unwarranted. Until Congress says otherwise, anonymous CBDC should be on the table. What's funny about the Fed's assumption that, quote, it is extremely unlikely that any central bank would embrace a fully anonymous instrument is that today there are $1.95 trillion worth of fully anonymous Federal Reserve notes in circulation. Fed officials routinely tout their commitment

to meet the demand for cash, and it has shown no interest in eliminating cash. So it's not like their involvement in supplying, quote, fully anonymous payments instruments is reluctant. There is no reason why Congress could not choose to opt for digital dollars that are as anonymous as physical notes. And indeed, there are good reasons why doing so is in the national interest not to mention consistent with American values, such as liberty, privacy, and autonomy. The Fed should not presume to know what Congress and the people will want and should consider all options including anonymous bearer digital currency. So the point that Jerry Brito is making is that there's no reason a priori that digital cash couldn't be just as anonymous as regular cash,

other than the fact that when it comes to law enforcement, the government hates cash. They hate how anonymous it is. It is a relic of an era where governments had less power to surveil citizens, and it's unlikely to me that governments are going to voluntarily allow that sort of anonymity ever again. Part of why I think there is such momentum around central bank digital currencies is that they solve the problem of anonymity of cash for central banks, for governments. I would love to be proven wrong, but it feels to me we're entering a world of more, not less, surveillance, and governments are going to perceive the need to be able to surveil more, not less, as a fundamental competitive need for their own performance.

Perhaps we will get to a place where an administration sees it to be the opposite, but it's very hard for me to imagine that from where we are, especially with how politically pleasing arguments are that currency X, if anonymous, would just be used for money laundering or sex trafficking, or pick your crime. Basically, right now in the U.S., I don't think there's a natural ally for privacy in government, and that means it's unlikely that privacy will be preserved in the long term. So while the technology may be interesting, while there may be relevant enabling efficiencies that come from central bank currencies, you have to kind of view them if you're in the crypto space as first and foremost surveillance money, because I think that's what they are.

I hope I'm wrong, but I fear that I'm not. Anyways, guys, thanks for listening. I appreciate it. And until tomorrow, be safe and take care of each other. Peace.