The Breakdown - The Unexplored Risks of a US Digital Dollar

Episode Date: May 23, 2021

For this week’s “Long Reads Sunday,” NLW reads: “What If Somebody Hacks the Money Pipeline Next?” By David Z. Morris “A Central Bank Digital Currency Would Be Bad for the US” by Dante Disparte -- Earn up to 12% APY on Bitcoin, Ethereum, USD, EUR, GBP, Stablecoins & more. Get started at nexo.io -- Enjoying this content?   SUBSCRIBE to the Podcast Apple:  https://podcasts.apple.com/podcast/id1438693620?at=1000lSDb Spotify: https://open.spotify.com/show/538vuul1PuorUDwgkC8JWF?si=ddSvD-HST2e_E7wgxcjtfQ Google: https://podcasts.google.com/feed/aHR0cHM6Ly9ubHdjcnlwdG8ubGlic3luLmNvbS9yc3M=   Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW   The Breakdown is produced and distributed by CoinDesk.com

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 nexus.io and produced and distributed by CoinDes. What's going on, guys? It is Sunday, May 23rd, and that means it's time for Long Read Sunday. Today we've got a fun one. It's actually a two-parter. The first essay I'll be reading is from New CoinDesk Permac columnist and former Fortune writer David Z. Morris, it's about the colonial pipeline hack and what something like that would mean in the context of a completely digital U.S. money infrastructure. The second is from former Libra executive

Dante DeSparte, who's now at Circle, and it is about why the U.S. shouldn't emulate the Chinese model of central bank digital currencies. Let's start with David Morris' what if somebody hacks the money pipeline next. The Colonial Pipeline saga illustrates what may be a vulnerability with digital currency issued by central banks. A revealing new detail has emerged in the saga of the colonial pipeline. The key gasoline distribution link was shut down for six days following a hack, causing gas shortages across the southeast United States. According to a CNN report, though, the main target of the hack wasn't pumps or switching stations or other physical pipeline infrastructure. Instead, the hackers went after the money. Quote, the company halted operations because its billing system was compromised,

sources told CNN. The pipeline's operators, quote, were concerned they wouldn't be able to figure out how much to bill customers for the fuel they received. The colonial shutdown is just the latest in a drumbeat of examples of the rising threat of cyber attacks. Ransomware attacks are rapidly approaching crisis levels, while cyber espionage between nations also continued to accelerate. Most recently, the reportedly Russian-backed solar winds attack burrowed deep into a still unclear number of systems, with ramifications likely to last years. Despite the rising tide of hugely damaging hacks,

many nation central banks are pursuing the creation of new digital systems that would be major hacking targets, Central Bank Digital Currencies or CBDCs. The goal of these systems broadly is to allow users to directly hold central bank dollars in a digital form, rather than through an intervening bank or payments platform. Central banks already do this in the form of physical banknotes, and so creating digital cash isn't a wild stretch of their mandate. But CBDC systems, while nominally influenced by cryptocurrencies like Bitcoin, are unlikely to be based on the distributed block. blockchain technology that keeps cryptocurrency-based layers essentially hack-proof. That means the systems could become an unimaginably alluring target for hackers, with potential disruptions

even bigger than the shutdown of a crucial gasoline pipeline. The targeting of the pipeline's financial system, rather than its valves or switches, highlights the fundamentally heightened cybersecurity risk that accompanies conventional digital finance. While it's true that more and more infrastructure is digitally connected in one way or another, it's still generally a very challenging and long-term process to compromise those systems. Attacks like the Stuxnet worm, which the U.S. and Israel allegedly used to physically damage Iranian nuclear facilities take many years in state-scale resources to execute. The colonial hackers, at least for now, appear to have been a freelance criminal gang rather than state actors. Because they had more limited resources, it's little surprise that they

aim for the softer target of financial records. It's also a matter of strategy. Though it could turn out to be a misdirection, the gang said in a statement that the goal was to make money, not disrupt the pipeline. Interfering with such records is fundamentally easier than disrupting physical infrastructure, for the simple reason that for the most part, they are purely digital. Changing numbers in a computer system, or in this case just locking the files, is pretty much always more straightforward than using that same system to change the physical world. The core vulnerability of digital money is what necessitated the unwieldy but nigh impenetrable blockchain system securing Bitcoin.

Any central bank digital currency has to solve the same problem, but politics make the same solution impractical. The security of a cryptocurrency like Bitcoin is inextricable from the fact that nobody truly controls it. Most central banks, which ultimately must be responsive to governments, can't make that trade-off. But CBDCs could still introduce decentralized security by taking carefully selected pages from the crypto playbook. One might be elements of node validation, similar to the way blockchains rely on many copies of a ledger, according to J.P. Schnapper Kosteris, a lawyer who works with the Atlantic Council on CBDC Research and Consulting, at least in broad outline that would make it impossible for a Fed coin to be hit with the same kind of attack

that took down colonial system by locking up financial data housed in one central location. Similarly, one proposed two-tier CBDC design would allow various versions of a piece of software to interact according to standards established by central banks. While a fully centralized system with uniform code could be leveled by one vulnerability, a diverse code base makes cyber attacks harder to scale, increasing security. Even more crucial is the use of open-source software to build CBDCs. Releasing source code publicly along with incentives like bug bounty programs mean legions of white hat hackers can and will scrutinize it for bugs. Quote, open source systems have proven to be more enduring, more reliable, and more extensible over time, says Schnapper Kisteras. That's why much

of the internet now runs on software that was battle tested in the open source arena, such as Apache and Linux. And Bitcoin is famously open source, with a particularly arcane and bureaucratic update process that prevents unnecessary changes that might introduce security risks. But that option is largely unavailable to arguably the most influential player in CBDCs, the People's Bank of China. Its digital yuan is widely believed to be subject to major centralized surveillance and censorship, features that would likely be highlighted if its code were public. That would seriously interfere with another apparent goal of China's project,

driving greater usage of the yuan outside China. But it also means the system can't be robustly tested for security, vulnerabilities. Lack of transparency could in turn box the PVOC out of negotiating standards for international CBDC interoperability. Quote, I'm not sure if China and the U.S. will be playing at the same standard-setting bodies at the end of the day, Schnapper Kisteris says. Though things are still quite early, the U.S. Fed may be more amenable to making its system open source. The Boston Fed last year launched the CBDC Research Program with the Massachusetts Institute of Technology, and will reportedly be releasing not just its ideas but also its code in July.

That's one major reason why, though much has been made of China's first mover status on CBDCs, Schnapper Kisteris and others think that being careful will ultimately be more important than being fast. Quote, in terms of being deliberate about security choices and having an open source code base, it could in the long run be a major advantage and source of strength, Schnapper Kisteris says, because you don't want to roll out something super quick and have it be buggy. That would be a disaster. Looking for the best way to unlock your crypto's liquidity? Nexo.io is exactly what you need.

Borrow against your digital assets at just 5.9% APR, earn passive income with yields of up to 12% and swap between more than 75 market pairs with the instant nexo exchange. Try the Nexo wallet app to get the whole 360 degrees of crypto banking. Get started at nexo.io. Let's now read Dante Desparte's piece, a central bank digital currency would be bad for the U.S.

calls to catch China on digital currency downplay the promise of open financial technology, says Circle's head of global policy. There is a frenzied, if inaccessible debate taking place among think tanks, policy experts, and media outlets signaling that the U.S. Federal Reserve should launch a centrally issued digital twin of the U.S. dollar. Among the many arguments for why this is necessary is that the U.S. is losing ground to China, whose government has a national blockchain strategy, including a real-world prototype central bank digital currency. While these arguments are valid, they miss the larger point,

which is that by today's hyper-competitive digital currency and blockchain standards, the U.S. may not be a laggard at all, but rather is already winning the race for the future of money and payments. In trying to out-China-China on these important issues, we miss that the future of money and payments should be about enhancing domestic financial optionality. Upgrading payment and banking systems, enhancing interoperability and open-banking standards requires a major upgrade in the technology stack that supports value transfer and more open financial services innovation. That was exemplified by the original version of the COVID-19 relief bill, the CARES Act, which called for the creation of a digital dollar to expedite domestic

stimulus payments while trusted privately issued digital currencies were already in circulation, along with a growing and interoperable blockchain-based payment system. Legacy financial rails, such as ACH, EFT, and other interbank transfer networks have not had an update in 50. years. Blockchain-based payment systems represent the completion of a lot of unfinished work in the financial services value chain, which has left more than $1.7 billion around the world as unbanked, rather than a source of disruption or circumvention. China's fintech and mobile money titans collectively process over $67 trillion a year, that alone does not constitute a threat to the U.S. dollar as a global reserve currency. The vibrant crypto asset industry that calls the U.S. home has

been advocating for a more open global payment system for years. The true Internet of value would advance important first principles, such as privacy, trust, democratization of assets and prosperity, rather than clinging to dated and largely ineffective financial rules such as the Bank Secrecy Act. The bottom rung of economic mobility is access to low-cost payments. In a world where individuals rely on nationally issued identity, billions of people are on the financial sidelines, a source of global risk and destabilization. We need new forms of digital financial services, plus internet-native digital identification and authentication, which preserve privacy but provide assurances that financial crime compliance standards are being adhered to and modernized. The U.S. should lead the way on both changes,

promoting open internet-based financial services, while enabling new forms of inclusivity. We should aim to be a pioneer in building the internet of value for digital assets, identity, and other breakthrough innovations. The investors, entrepreneurs, and diverse teams building this new wave of platforms are increasingly calling the U.S. home, powering U.S. economic competitiveness and the post-COVID-19 recovery. COVID-19 revealed areas of pre-pandemic vulnerability, including our inability to execute financial transactions at population scale domestically and through poverty-fighting remittance corridors. We should be able to exchange value, monetize and own digital assets, as well as build internet native financial services firms with regulatory clarity. In the made-end decade of blockchain

digital currencies and crypto assets, a $2 trillion industry was born largely on public digital commons, rather than on risk-prone and costly technology implied by a government-administered CBTC, which would shift technology risk to the public sector and thereby to taxpayers. The more the U.S. embraces these financial innovations in industries of the future, the more the prospects of scaling internet-level prosperity and access become possible. The meteoric rise of the nine-year-old Coinbase, a crypto-native financial exchange, which is now the United States' most valuable exchange, bar none, is emblematic of the opportunity, Providing regulatory clarity and a national industrial policy that embraces exponential technology such as blockchain

can make all facets of our economy more resilient, future-proof, and competitive. Protecting vulnerable critical infrastructure, which is imperiled by the twin threats of climate change and single point of failure design, such as the colonial gas pipeline, which was hobbled by a ransomware attack, is a reason for blockchain-based thinking. The same holds true for the void of open banking and financial access across the country. And providing safe e-voting or authentication options that can enhance trust on the internet without divulging personal information, can it once improve national competitiveness and international standing for the U.S. The fastest way to disrupt the very financial system that has made the U.S. the economic and political envy of the world would be to succumb

to the pressures of launching a centralized digital currency, while the U.S. banking and financial system can improve how it deals with rampant cyber threats and an impossible digital transformation agenda that favors the largest banks in the country, CBDCs would disrupt the two-tiered banking system while providing uncertain outcomes for consumers and markets. The two-tiered banking system is the structure that enables household-name banks to interface directly with the country's central bank, enhancing consumer protection and regulations, while at the same time enabling central banks to convey monetary policy. The democratic promise of cryptocurrencies and digital currencies is the ability of powering internet-level prosperity and merchant acceptance. The technology equivalent

of digital legal tender while importing sound monetary policy. A free market-based movement is afoot driving fundamental, open, and compliant innovations in the movement of money and value on the internet. The digital currency and blockchain economy is building the next generation of digital financial services firms in the U.S. and around the world, creating thousands of jobs in an outsized share of market value. That the majority of asset-referenced stable coins in circulation today are pegged to the U.S. dollar speaks to how the fundamental trust in the U.S. dollar is the global

reserve currency of choice is being preserved by digital currencies, not circumvented by them. There are material risks in the issuance of a digital U.S. Federal Reserve dollar. Most value-added money in circulation today rides on private or consortium-backed rails. A U.S. CBDC would transition substantial technological and operational risk from the private sector, which is powering safe and well-regulated digital currencies and assets on public blockchains, to the public balance sheet and therefore shouldered by taxpayers. Also, privacy and censorship resistance is more likely to be protected by a vigorously competitive rules-based market than with general-purpose government-issued digital currencies.

We need a public-private balance that makes the U.S. dollar the reference asset for all manner of value-added activity. Whether enshrined on paper bills or emblazoned on coins, plastic cards, or in the case of digital dollar currencies in code, the key is to offer the full-faith and credit of the U.S. economy across a range of payment instruments and rails. Ultimately, that will be good for consumers, the economy, and global security. Dollar digital currencies that are backed one-to-one with assets preserved in the two-tier U.S. banking system, like USC, import all the safety, soundness, and values of the U.S. dollar, turbocharging it with the power of the internet. Your financial needs don't take bank holidays, and neither should your money. Back to NLW here. Listen, I'm just

going to be short about this one. I've said it before and I'll say it again. A digital dollar is coming. The CBDC era is coming. The specific shi. shape of that is TBD. And I want it to be the version that best serves our interests as citizens, not just the interest of the government's designing it. I think that the time to have that conversation is now before too many decisions have been made about how to design the thing, how to roll it out, et cetera, et cetera, et cetera. So I hope you enjoyed these pieces. I hope they gave you a different take on the U.S. digital dollar and some of the unexplored risks that might be there. And for now, I appreciate you listening. And I hope you had a great weekend. Until tomorrow,

guys, be safe and take care of each other. Peace. We're witnessing the greatest paradigm shift in finance in modern history. Join thousands of newsmakers and influencers talking the future of money at Consensus by CoinDesk, a live virtual experience of leaders, change makers, virtual reality meetups, keynotes from Ray Dalio, Gary Vaynerchuk, and much more. Get an up-close look at the boom in crypto, the surge in institutional investment in Bitcoin, the NFT mania, the breakneck innovation and decentralized finance, and the coming disruption from Central Bank, Digital Curricers. currencies. The breakdown listeners can visit events.coindex.com and use the promo code breakdown to save $25 today. Join us May 24th through May 27 for Consensus by CoinDesk,

and register today at events.coindex.com. Thanks for listening, and we'll see you there.