Making room for digital currency within the two-tier monetary system


Here’s a good question: Can digital currency (DC) thrive within the two tier monetary system that banks use around the world? After all, the current system has stood the test of time and is used by everyone. Tearing it up and trying to replace it with, say, cryptocurrency doesn’t make sense. How do you fulfill DC’s promises without throwing the baby out with the bathwater?

Earlier this year, Citi published an article titled “The Regulated Internet of Value” (the “Citi Paper”). In it, Tony McLaughlin, Head of Emerging Payments and Business Development at Citi’s Treasury and Trade Solutions, argues for a resolution of the ongoing showdown between supporters of stablecoins and those who favor central bank digital currency. (CBDC) with a third option: the creation of a Regulated Liabilities Network (RLN). As McLaughlin (2021: 2) explains: “The money of tomorrow must be global, so we can envision a constellation of interoperable regulated accountability networks, each based on national currencies and overseen by local regulators. “

McLaughlin is right about that. If tokenization is truly the best way to store and transfer digital value, as Citi Paper suggests, it’s important for the regulated financial industry to take a unified approach to avoid fragmentation and promote functionality. And perhaps, more importantly, to prevent transactions from migrating to the unregulated sector and putting our current system on the back burner.

According to Citi Paper, pursuing tokenization in parallel would allow central banks to expand beyond CBDC projects and include tokenization of all regulated liabilities. McLaughlin believes this would “overcome a potential downside, namely the disintermediation of private regulated entities.” He suggests (2021: 9) that this broader focus on regulated responsibilities “brings the benefits of tokenization without the negative consequences. It upgrades regulated currency, which today only exists in account form. “

What McLaughlin doesn’t like, however, is that systems like this are already operational in the pilot phase with banks around the world.

Several central banks (think China and the Bahamas) have made great strides towards issuing digital currency on their own. Others have realized the value of adopting alternative means to deliver the benefits of tokenization without actually issuing digital currency to residents. After all, if a central bank can avoid opening a Pandora’s Box while still offering the benefits of the CBDC, such as 24/7 access to banking services and fast, cheap and easy cross-border payments. , she will have truly located the holy grail. Emerging digital currency models make this possible – and are closer to bringing an RLN to life than McLaughlin might suspect.

The Citi paper rightly notes (2021: 2) that maintaining a stable economic environment with sound monetary policies requires a secure digital currency that must be: “(a) regulated, (b) redeemable at face value on request, (c) denominated in national currency currency units and, (d) an unambiguous legal claim on the regulated issuer.

Unlike cryptocurrencies such as Bitcoin, regulated liabilities include central bank money, commercial bank money, and electronic money, as they are all on the balance sheet of the relevant regulated financial institution. An RLN would also allow stablecoins to be incorporated into the current financial system as regulated liabilities. By design, the transfer of money in a network of regulated liabilities will be in favor of the verified legal persons, thus reducing the risk of financial crimes, and would be carried out through the transfer of tokens. These transfers are made through entries in a private book kept by the bank, and not through bearer instruments. Consider the following definitions from Citi Paper:

• A token in a central bank wallet is a liability of the central bank

• A token in a commercial bank wallet is a liability of the commercial bank

• A token in an electronic money wallet is a responsibility of the electronic money issuer.

“The legal significance of the token is given by its location in the wallet in which it resides. When a token is at rest in a portfolio controlled by an institution, it then appears on that institution’s balance sheet as a liability in favor of the token holder. In contrast, Bitcoin payments are made in the digital form of a bearer instrument.

Today, emerging digital currency models have harnessed the power of blockchain technology to express token liabilities on the same shared ledger. This shared ledger represents the best of both worlds, creating a digital currency that is “always on”, instant and programmable, with global reach, but regulated by a strong banking system.

This is because a shared ledger system allows both central bank money and commercial bank money to be tokenized. In addition, it allows transactions to be settled instantly as the banks in the system transact using tokenized central bank balances on shared ledgers. The platform would support several regulated liabilities. To meet data sovereignty, there would be one ledger for each currency and it would host multiple types of liabilities for that currency. Banks can have positions on more than one register. The ability for a bank to debit a position on one ledger and credit the balance to another ledger allows cross-border payments.

And the best part? Everything fits perfectly into the two-tier monetary system.

The Citi Paper is a critical contribution to the payments literature, providing the first public articulation of how an RLN can address the very real challenges of integrating digital currency into our current financial framework. Yet while McLaughlin says creating such a network may seem like a ‘pipe dream’, at M10 Networks we are already on track to bring the vision of central banks and commercial banks around the world to life.


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