The case for a blockchain reserve currency
Blockchain is a technology
One interpretation for the origins of blockchain is to see it as a solution to the problem that too much of our economy requires trusting someone arbitrarily placed in their role by appointment and that such dependence is unnecessary and often undesirable. In its purest form, blockchain as a technology can be stateless and anonymous. This might be useful to some, but the lack of recourse for any damage that may arise in the commerce across such a stateless and anonymous environment makes it poorly suited to the expectations of modern-day citizens.
So, a decade goes by and we see these citizens of States seek to interact with the many blockchain enabled ecosystems that are created. This gives rise to statute, regulation and in some cases prohibition. The desire to gain value from and to add value to the nominally stateless Blockchain ecosystems gradually grounds these ecosystems into the States that permit their citizens, natural or corporate, to serve and be served by the blockchain implementations. The result is a hybrid disequilibrium where even the best of breed BitCoin is challenged by the old guard – challenged as to its worth, its value, and even its purpose.
This is odd considering that money in the United States (and most everywhere else) has since the mid-1970s been based on nothing more than paper agreements and convention. The definition of a fiat currency is that its value does not derive from any real-world commodity. Only from our collective trust in the government and its actors in the financial system do we find confidence in the dollar or Euro or Yuan and from that the trading of goods and services for the swipe of a card, display of a QR code or progressively less often the handing over of some paper that is difficult to counterfeit.
Much of the economic pain experienced in the last 300 years has occurred as countries have sought to deal with the supply of their currency, its value in terms of the currency of their trading partners and how that interacted with the real economy. This ongoing experiment has demonstrated that money works better when not connected to anything in the real world. So, a medium of exchange and/or store of value issued by a non-State proponent in such a fashion so as to build the same trust (or potentially more trust) than that afforded the ‘money’ issued by nation States is potentially just as legitimate. Thanks to our unknown benefactor(s) under the pseudonym Satoshi Nakamoto, a technology now exists to do just that.
Money is an on-going experiment
Irrespective of the legitimacy of any currency, the old issues remain. How is the supply governed and how does it respond to demand, how is it convertible and how does it relate to other currencies via the conversion? It is generally forgotten that an unintended consequence of the Bretton-Woods system was to disassociate the currency exchange rates from local currency conversion rates of gold. Nonsensical in today’s global economy, but back in the 1960s gold could be multiple times the value it had domestically in one country vis-à-vis another. This curiosity was so normal as to be part of the plot in the ‘Goldfinger’ James Bond movie of 1964.
An outcome from seeking to safeguard citizens of States as they trade in and with blockchain-based securities is that they are no longer stateless and rarely anonymous. This begs the question as to whether or not the enormous resources required to facilitate trust via proof-of-work tests that often do not eliminate the risk of 51% attacks is helping or hindering the adoption and utility of the ecosystem they are serving. The point being that if actually utilising a blockchain currency means to ground it in a jurisdiction and to be identifiable then why burden it with costly consensus mechanisms designed to enable anonymity and statelessness?
The answer is naturally use-case specific. However, any reserve non-state issued currency will become linked to multiple jurisdictions and require trust from those who use it and most importantly trust from those who do not. This trust can be built by a non-state proponent and it can establish operational integrity via an economy for its infrastructure that enables its consensus mechanism, but how might such an ecosystem start? One way it probably doesn’t start is via establishing a constraint on the potential supply of the currency. If a core purpose is as a medium of exchange then it needs to be able to limitlessly respond to the demand (noting that whether it does or not is another matter).
Rarity in a currency is undesirable. The mispricing of money in terms of gold prior to the Bretton-Woods era restricted the supply of money and brought about price deflation and arguably extended and worsened the Great Depression. Rarity in specific notes and coins when associated with replaced legal tender or the legal tender of fallen States is simply the conversion of the prior currency into a collectible and a store of value. It is clear that some blockchain implementations are framed with their tokens akin to rare notes and coins rather than as a present-day currency.
Conversely, limitlessness is worse. The events in Venezuela provide a recent reminder of the disastrous social impact that decoupling the supply of money has from the real economy. The associated deflation of the value of the currency vis-à-vis every other currency defeats one of its primary roles as a short-to-medium term store of value. The result more often than not is a complete breakdown in trust in the currency and more broadly the State that issues it.
The issuance, governance, and maintenance of the utility of a currency are a challenge that many nation States accept is beyond their capacity. In response, many countries adopt a foreign currency as their legal tender. We also have nation States whose citizens do not sufficiently trust their government and elect to adopt a foreign State’s currency as their day-to-day default in spite of what their government declares as the official legal tender. It is useful to remember that the US Dollar itself had its own growing pains with the Spanish Real as legal tender until 1857, a period of damaging currency deflation due to the money printing that financed the Civil War, and many other shocks before the ‘greenback’ became what we see today. Moreover, its role as the world’s reserve currency arose not only from the strength of the government of the United States but as an unintended outcome of its structural trade surpluses and discoveries of gold in the lower-48 resulting in the United States holding the majority of the world’s gold reserves in 1944.
At the dawn of the 21st Century there are signs that the role of the US dollar is not what it once was and that other currencies are being utilised as true reserve currencies both for nation States themselves and for commercial trade. It is arguable that the structural change to trade deficits since the dollar became a fiat currency and the more recent acceptance that gold reserves as a percentage of currency reserves are not the measure of currencies’ strength removes the initial basis for the appointment of the US dollar to its role as reserve at the Bretton-Woods conference.
In a post-US dollar reserve currency world, why not a non-nation State issued currency? It is clear that fostering a non-nation State issued reserve currency will present significant challenges but given that much of the social pain caused by the governance of currencies has been a self-inflicted outcome of the politics of nation-States, a non-nation State issued currency might very well be the best option.
The first step to stability is commercial
One option taken to date has been to develop ‘StableCoins’ that for various reasons are expected to, and often do, price themselves in accordance with a State issued fiat currency. The liquidity and ease for blockchain to blockchain exchange relative to blockchain to fiat exchange and the various jurisdictional interpretations of these events particularly in respect of liabilities for duties and taxes means there is a specific use-case utility for such ‘StableCoins’. Yet, notwithstanding potential episodes for regulatory overreach that may occur as blockchain technology is integrated into the economy, this is most likely a transient utility. That is, in the longer-term exchange to and from fiat or blockchain ‘currency’ should have similar friction and domicile liability.
The long-term use case for the current form of ‘StableCoins’ then becomes unclear. Most achieve their relative stability to the fiat currency constructively from market expectation rather than from a strict mechanism of the market or design of the Coin itself. It is comforting that an issuer of a StableCoin may have reserves backing the initial issuance of the tokens, yet as the designs of most (perhaps all?) are that the tokens are like securities, they trade between market participants and not with the reserve holder. This may look the same as how State issued currencies operate but it is not.
Broadly speaking nation-States as the taxing authorities, provider of services, employer, the buyer of products and services and lender-of-last-resort represent 30-50% of the economies in which their State issued currency is the legal tender. This real-economy role, its scale and use of the legal-tender for its commerce grounds the currency in day-to-day life and creates a stakeholding link between the trade in and with the currency and the backing the State provides the currency via regulation and reserves. Today’s ‘StableCoins’ are not similarly supported by their issuer and while the nodes and economics supporting the trust architecture of the public blockchain implementation might engender trust for the transactions so as to eliminate dealing with third parties such as banks, it does not support the value of those tokens in any other currency, fiat or blockchain.
This is not a new problem. The creation of the only new post-Bretton-Woods reserve currency involved debate, regulation, and intervention to ensure its value would be stable. Today the Euro’s value is not questioned, yet for as much as a decade after its introduction there remained uncertainty as to how it’s supra-national nature would work and whether or not all the participating nations would be able to remain as issuing members. In hindsight, as a currency, this grand goal of a European Union issued fiat currency is a success while simultaneously being a cautionary tale for any who might seek to follow.
A non-State issued reserve currency won’t have the extensive supporting mechanisms and regulatory support that established the Euro. Instead, it will need to solve the problem the same way nation-States resolved it in the first place, with a form of gold-specie mechanism. That is, the trust we take for granted today for the value of State issued currency was be built from a history where any citizen could claim a specific amount of a real-world good from the issuer of the money. In the 19th century, the only potential goods for this exchange that actually built trust were gold or silver. Today, while that same exchange might be quaint, it would seem reasonable that an exchange for a reserve fiat currency should suffice.
It is clear that the first step to stability then is that the design of the non-State issued currency is that the issuer is bound, can transparently demonstrate capacity and capability to settle and there is a low-friction mechanism to actually settle all the currency issued in one or more nominated fiat or blockchain currencies or commodities. Materially, this is a commercial design feature not a technological one.
Trust from within is not enough
There is a surprising level of trust in the blockchain community. Millions of people participate in an internet-based ‘wild-west’ where events occur daily where tokens are stolen, private keys are lost forever, much-valued privacy is not kept and commercial failures occur without any avenue of recourse for the affected. It is quite possible the present level of trust devotees hold for their favoured blockchain ‘Coin’ represents an on-going but not everlasting honeymoon period.
Either way, this trust is from within. Non-users of blockchain while most often simply ignorant of the entire ecosystem are otherwise weary and untrusting. This might not matter except some of those lacking in trust for blockchain implementations include regulators and authorities with whom a non-State issuer of a proposed reserve currency must engage with.
The first step as defined above means the issuer is a market-maker. The issuer while establishing a stateless currency will not itself be stateless in order to facilitate this role. Therefore, to enable the trust required of those not using the currency the issuer will need to conform to the norms of State-issuers including facilitating and supporting measures and processes for the restriction and monitoring of the use of the currency in money laundering and terror finance, managing privacy and so on. What this means for the blockchain implementation for such a currency is that it cannot be a public implementation at launch.
So far, all public implementations introduce risks arising from the capacity of actors that are not stakeholders in the issued security or ‘Coin’ to interfere with its function, operation and value. This capacity is largest when the currency is young, and supply and volume are relatively small – precisely the same time that the building of trust is most important. In many cases, the core token or an ancillary token for the implementation has a small number of ‘whale’ holders that have no other stakeholding role than the disproportionate holding itself. They may benevolently operate like a ‘central bank’ and facilitate market behaviour that gives rise to stability but the role is adopted, rarely part of the design and not a binding obligation with the market and its participants.
In short, the current form of public implementations undermine the use-case of a reserve currency, particularly during the period it gains trust and confirms its stability. In the same manner that today’s fiats worked in parallel with other legal tenders and how the Euro was an accounting currency for two years before it was legal tender, a non-State issued blockchain based reserve currency will need time to develop and must then start as a private implementation.
The supply chestnut
The instability of State-issued currencies even when they were ‘specie’ backed with gold or silver must be avoided for a prospective non-State issued reserve currency. The absence of a nation-State politic to have a motivation other than the stability for the currency is a very good start. The absence of an interdependency with a national economy and its terms-of-trade is also very helpful. This last point is also a weakness as this lack of interdependence means there is no prima-facie real-world link.
One might promote this doesn’t matter. Existing blockchain ‘Coins’ generally don’t. Their supply is either in response to purchase orders for the ‘Coin’ or an algorithmic mechanism typically linked to activity within the implementation’s ecosystem. The former should facilitate value stability during positive demand cycles while the latter creates value appreciation under the same market forces. Market participants may dislike but will be aware, that what may appreciate can depreciate. So far so good for the algorithmic supply model.
Experience shows that intermittent falls in value for even the highest volume ‘StableCoins’ can occur and some of these value-jitters have not been from an absence of demand but often purely from negative sentiment. What then the impact from an actual and structural absence of demand? None (or perhaps very, very few) have binding arrangements from their issuer to utilise the ‘backing’ of the ‘Coin’ however audited and verified. So how does supply reduce to maintain value? It would appear that it doesn’t and as such the value won’t have an economic reason to be stable.
The first step above addresses this in principle, but the challenge for reserve status is that while supply may have a mechanism to respond, the absence of a real-world link means that there is no external justification for any market liquidity. Most ‘StableCoins’, when placed under pressure, will either break away from any concept of stability or become completely illiquid. A market-maker will ensure settlement so as to facilitate the liquidity for any sell order, but this is not the promotion of liquidity. In the extreme, the approach purely facilitates the complete withdrawal of the currency from the market altogether.
Back to the ‘specie’ currencies in the 19th century and we see a parallel. The basing of the value of the currency to a mostly immutable and verifiable good in gold worked well for trust except when the supply and demand for gold as a commodity changed unexpectedly, as it did after the Californian’ and Australian’ gold rushes. A gold-specie currency today would have to respond to the effects the on-going mining and consumption of gold creates in the value of gold in fiat currencies. A gold-specie currency would have appreciated to three times its value at the start of the century in US dollar terms. Great for a long-term store of value, but not so good as a medium of exchange particularly as the appreciation was not orderly.
The point to pay attention to however is that it was only the unexpected changes in supply that mattered. That is, the general existence for the mining and consumption of gold didn’t materially impact value. In the absence of any new sources of supply, the mining activity self-balanced to demand of a growing economy given that the gold had a fixed value in the legal tender. Therefore, newly mined gold vis-à-vis growth in money supply more or less matched economic growth. This is an oversimplification as new uses for gold had its own effects. Nevertheless, as long as the cross-border movement of gold was regulated and those regulations were enforced, the money supply was tightly linked to economic growth.
A 150 years later and we don’t have such a commodity and while a fiat currency may represent a practical specie for building trust and stability in value, even if that fiat aligns well with the economy of the issuing nation-State, that isn’t very useful for a non-State issued currency not linked to that economy via economic participation. What then is the option for a real-world link that will enable an external justification for liquidity? If not a commodity and not a fiat, then it will need to be a non-financial intangible that is identifiable and defined in all the jurisdictions that are expected to use the currency as a reserve.
Conveniently there is just such a unit of value. Based on global agreements binding most nation-States the Greenhouse Gas Protocol has established an independently verifiable intangible with a constrained but limitless potential supply, the Carbon Credit. Carbon Credits have many of the attributes of gold in the 19th century. There are various sources for the ‘mining’ for supply, there are jurisdictional controls and regulation regarding the acceptance and use of Carbon Credits from difference sources, effective embargos on cross-border trade for local regulatory application and a broader market for consumption or in the vernacular of Carbon Credits, surrender.
The similarity also extends to greatly differing prices between one jurisdiction and another. In the extreme, Carbon Credits acceptable to Sweden cost around US$125 while Ukraine’s is under a dollar. This occurs as each nation-State resolves for their own domestic economic reasons appropriate pricing to achieve their policy goals. Carbon Credits as a product of the Greenhouse Gas Protocol’s efforts are an innovation of this century and with their youth, they have had all the same challenges befalling blockchain – imbalances in supply and demand along with regulatory uncertainty causing volatile pricing for some markets, high profile fraud, and weaknesses in oversight and enforcement.
Just as blockchain’s current weaknesses as a non-State issued reserve currency are addressed with the ‘first step’ commercial design noted above, Carbon Credits can similarly be commoditised for non-regulated trade. The purpose here is not primarily to address weaknesses in the carbon trading market, but the existence of an economically-linked intangible commodity in the Carbon Credit means that it can satisfy the real-world link and promote the necessary liquidity to prevent an absence of demand to cascade into market failure as is the risk for existing ‘StableCoins’.
We already have blockchain implementations that seek to be “StableCredits” as it were, representing Carbon Credits in one market or another. Does this mean these implementations have accidentally stumbled upon the pathway to a new global reserve currency? In short, no. The design for the blockchain emerging in this discussion does mean that the token is linked to the Carbon Credit, but this link is not to digitize the Credit (notwithstanding that it does), it is to establish a mechanism of real-world economic linkage to frame supply of the token as the unit of the currency.
It appears that we now have a workable second step to stability. The non-State issuer needs to secure sources of supply of its specie, being Carbon Credits as proposed here. This enables a mechanism to facilitate and justify the expansion of supply in a manner that does not undermine or inflate the value of the currency.
The issuer can’t compete
A fundamental weakness of current blockchain implementations is the existence of ‘whale’ holders which generally include stakeholders of the issuer. The lack of a formal binding role for these market participants means that it is unclear how they may behave. No matter how they do behave, for some market participants, their actions will be competitive.
The basis for the trust that is placed in the issuer of a currency is that they and their stakeholders are not competitors or profit takers in the market the currency enables. Imagine if the Bank of England was to seek to purposely and strategically make a profit from its regulatory role and its dealing in the Pound? It is true that the Bank’s role in monetary policy means that at times a profit is taken, as are losses. The market, however, trusts that the United Kingdom’s central bank does not act in the market in a manner to achieve this outcome.
The disproportionate influence central banks or a ‘whale’ holder of tokens have in the market facilitated by the issued currency means that the motive of these market makers is paramount to the trust sought within the broader community to legitimise the currency in the economy. The trust of the Bank of England comes from its history of performance, the trust of other central banks for the world reserve currencies is much the same. The acceptance of the Euro’s central bank took a period of time. The acceptance of the Yuan’s central bank appears to await more history as to its behaviour and potentially a demonstration of action that is independent of the nation-State issuer of the currency.
The success of fiat currencies between nation-State issuers and the establishment of a portfolio of reserve currencies for trade and inter-jurisdictional settlement is not just from the expectation that the associated central banks of these currencies are independent but that they have no self-interest. The public statements and reports of the central banks are the record of account for this lack of self-interest with some appearing to essentially apologise when they make a ‘profit’ from their actions. It does not matter that the motivation for this may be mostly about their domestic banking system, the result is that reserve currencies are not the ‘toys’ of their issuer.
An issuer with a political purpose is sufficient to call into question the currency they issue. How might a non-State issuer as primary stakeholder not simultaneously undermine the purpose of the currency through its own self-interest? Quite simply, by not having a self-interest.
Self-interest is not a given. Certainly, any company, trust or investment scheme has self-interested stakeholders and in the event that any of these types of entities were to be an issuer of a currency, the issuer would have a self-interest. It may be practical to structure a co-operative or partnership so as to make the emergent self-interest be held by the currency holders of the currency issued. This might succeed in separating the governance of the issuance of the currency from the ‘whale’ holders, it may be possible within the blockchain implementation to facilitate some form of internal control from the holders to the management, but it far from clear how such purposely private mechanisms would satisfy the required transparency to non-users of the currency noted earlier.
At least one structure does exist to satisfy this requirement. Several jurisdictions have developed robust oversight and transparency for entities that exist solely for a purpose and that have no beneficial owners to whom the entity can gain a self-interest. They have various names, but in much of the English-speaking world, they are called charities. Not all jurisdictions are equal in their success of governing charities, but implemented correctly, a charity can operate in a manner so as to be independent, transparent, subject to oversight and have no self-interest.
Pricing is not about pegging
A currency gains a value from its acceptance in the exchange for goods. To begin with, there is no guide as to this exchange and as such new currencies, like the US dollar until the mid-1800s, operate in parallel with other legal tenders whose value was already established in the minds of the citizens. A mature fiat currency however actually defines the value of things and other currencies. In 1820 it would not have been unusual to have asked how much is the dollar was worth expecting an answer in gold. Progressively over time the currency as the primary medium of exchange, particularly in respect of ‘pricing’ the value of labour, earns the value attached to it within people’s daily lives.
A challenge for a non-State issued currency is that there is no domicile jurisdiction from within which the currency can build a concept for its value. Notwithstanding embargos, a non-State issued currency will always operate in parallel with the local legal tender(s). This observation appears to justify the current protagonists for blockchain ‘StableCoins’ to be setting or ‘pegging’ of their ‘currency’ with a fiat or basket of fiat currencies. Surely what is good enough for the US dollar must be good enough for these upstarts. However, ‘StableCoins’ do not benefit from the commitment reserve currencies gain from the central bank issuer to maintain a value for the currency vis-à-vis any other currency or commodity and they lack a time value reference. What then is the impact of the on-going commitment for the pegging of these ‘StableCoins’? Technically, it relegates the ‘StableCoin’ to something more akin to a blockchain frequent flyer program than a currency.
A global product and service marketplace facilitated by a frequent flyer points medium of exchange still has a utility. It is likely to represent a highly valuable pursuit for the stakeholders of the issuer, but it is not a pathway to an alternative reserve currency. For a non-State issued currency to succeed, the value must function independently of the monetary policies of fiat currencies and as such must eventually have a floating rate of exchange to any fiat currency.
Not a single step process
It should be obvious that simply launching a currency guided by the discussion above is not going to ensure the newly issued currency the destiny of reserve status.
Launching a blockchain ‘coin’, stable or otherwise, as an intended reserve currency is to set oneself up for failure. In the absence of any regulatory domain for the issuer to be protected, the competition and diverse interests of the market actors, current and future, will mean that it will not be able to survive its own infancy. Instead, the true contender for a Blockchain Reserve Currency [BRC] is one following in the path taken by the Euro. That is, a ‘coin’ implemented from the demise of others that have established their own place.
The features for the design introduced above are not reflected by any current blockchain implementation and as such the first step is to develop the ‘coins’ that will in time legitimise the BRC. In terms of the history of the currencies that formed the Euro, these ‘coins’ as they are issued equate to the early issuance of their national currencies post World War II. In the same manner, their value is based on a commodity reference – at that time gold, in this case, Carbon Credits. Local economic factors then bringing about the pricing and eventually unequal values for exchange between them (in terms of the specie unit).
The first step then is the issue of StableCoins with the design features noted above initially priced in reference fiat currencies. They must be supported for settlement at that reference rate and as there is no relationship between the monetary policy within the blockchain implementation and the policy driving the fiat currency, the reference rate should adjust in keeping with the domestic inflation of that currency. Moreover, at least at the initial stages, as there is no inter-implementation trade to link their respective monetary environments there is no justification nor stability mechanism to support the settlement of inter-StableCoin direct exchange.
Carbon StableCoin [CSA][CSD][CSP][CSE][CSY] as the first step
The problem and key steps to a solution are, to a greater or lesser extent, defined. Now to introduce an offering, the Carbon StableCoin.
Climate Change Equity https://www.climatechangeequity.org/, an Australian charity just celebrating its 10th anniversary, has developed an institutionally supported offering where the supply of the Coin occurs from developing and controlling ‘mines’ of Carbon Credits where the generated Carbon Credits are issued to Members of the charity in proportion with their stakeholding.
The ‘mines’ are real-world projects that are commercially profitable and that earn carbon credits in the course of their business. The stake is the payment of the membership fee which itself is money-back guaranteed for the provision of the Carbon Credits and capital guaranteed to be returned at the end of the membership where this option is part of the membership.
The key innovation is the market making of the settlement of the carbon credits as issued in the ‘coin’ with a floor price in the associated fiat currency. The effect of this is to facilitate a commercial return in the fiat via the Membership and simultaneously build a supply of a non-State issued blockchain implementation that is both a medium of exchange and a store of value. It just might be the first step to a Blockchain reserve currency.
In the first instance there are five such ‘StableCoins’:
[CSA] Carbon StableCoin Australian Dollars (see the associated Membership Prospectus https://docs.wixstatic.com/ugd/9f35af_8fc9c9afe2984a5ea2eb3ad8bc8efe59.pdf);
[CSD] Carbon StableCoin United States Dollars (see the associated Membership Prospectus https://docs.wixstatic.com/ugd/9f35af_0d7bf422ee41401c8b73591f41c9d00b.pdf);
[CSP] Carbon StableCoin Great British Pounds (see the associated Membership Prospectus https://docs.wixstatic.com/ugd/9f35af_5502250e61e740178a7454172d35e59b.pdf);
[CSE] Carbon StableCoin Euro (see the associated Membership Prospectus https://docs.wixstatic.com/ugd/9f35af_bca5c3a87d354133b7a2628063ba5f83.pdf);
[CSY] Carbon StableCoin Chinese Yuan (see the associated Membership Prospectus https://docs.wixstatic.com/ugd/9f35af_0207f832a74940e59a5a38053a5a90a9.pdf).
The return offered via the Membership is the same for each Membership in each respective fiat. The difference is the value in the fiat at issue and the associated inflator to respond to the fiat’s domestic inflation rate. This being:
[CSA] AUD$40 per ‘Coin’ indexed at the Australian Consumer Price Index;
[CSD] USD$25 per ‘Coin’ indexed at the United States Consumer Price Index;
[CSP] GBP£20 per ‘Coin’ indexed at the United Kingdom Consumer Price Index;
[CSE] EUR€40 per ‘Coin’ indexed at the European Union Consumer Price Index;
[CSY] CNY¥88 per ‘Coin’ indexed at the Chinese Consumer Price Index.
The first part of creating a potential non-State issued reserve currency is commercial, not technological. This offer is designed to meet the criteria to develop the necessary stability.
A Whitepaper on the implementation specifics will follow.