A History of Money & The Role of Central Banks in an Age of Digital Assets

2018 has been a whirlwind year for distributed ledger technology and we’ve seen significant developments across the entire technology stack (categorised well by Fabric Ventures recent “The State of the Token Market”): underlying protocols (blockchains), trading infrastructure (exchanges, custody, compliance), technical infrastructure (governance, privacy, scalability), data management (identity, oracles), and decentralised applications. A lot has been going on — some legitimate and building the infrastructure for a new financial system (or at the very least enhancing the existing one) and others riding the wave of overpriced Initial Coin Offerings (seeing less of this now due to the downturn in the market).

At firstminute capital (a $100m London-based seed fund backed by 30 unicorn founders), our thesis has been clear — back ambitious entrepreneurs building the platforms which underpin blockchain technology and cryptocurrencies. The infrastructure these companies are developing will, in our opinion, enable mass-market consumers and corporates to access a new financial system with its roots in Satoshi Nakamoto’s 2009 white paper, “Bitcoin: A Peer-to-Peer Electronic Cash System” (timed to perfection following the Global Financial Crisis). Many of the platforms in the traditional fintech space have been built out over the last 5 years (Revolut, Monzo, N26) and we’ve seen a horizontal unbundling of financial services (see great CBInsights graphic here) followed by a re-bundling via features and products being rolled out to users. This, however, is still up for grabs in the blockchain space, which is why investing in the space is so exciting.

To date, we have made 5 investments in blockchain and look forward to finding more founders to partner with:

  • Argent: London-based decentralised banking protocol (just launched their Ethereum smart wallet focused on seedless recovery — available to download on the App Store and Google Play for IoS and Android)
  • Quanterium: London-based dark pool institutional trading platform (also backed by two crypto hedge funds)
  • Templum: NYC-based tokenized asset offering platform (just successfully concluded a digital security offering for St. Regis Aspen Resort)
  • Luther: London-based enterprise blockchain for insurance claims settlement
  • Stealth: Warsaw-based fiat to crypto on-ramp protocol (watch this space — building a new payments system for crypto)

As 2018 draws to a close, the bear market for crypto has settled in and regulation of the space remains unclear. For example, the recent “Cryptoassets Taskforce” report (published in October) called for a blanket ban on derivative products related to underlying cryptoassets. Granted it did have positive things to say around the underlying technology associated with blockchain. More to come here in Q4 2018 and Q1 2019 as they announce further guidance on what activities fall within the current regulatory perimeter, exchange tokens and communication around tax treatment of crypto assets.

There has, however, been one silver-lining in 2018. Central Banks have vocalised potential support (or at least openness) for a Central Bank Digital Currency. As a result, we wanted to share some thoughts around how we are viewing the future of currency and payments in the context of the history of money (difficult to understand digital assets without reviewing how we got here in the first place). A lot of these thoughts draw on Niall Ferguson’s “The Ascent of Money” and David Graeber’s “Debt: the first 5,000 years”. Cameron McLain (Hummingbird Ventures) “A Brief History of Blockchain: An Investor’s Perspective” is also well worth a read.

Barter: We can trace the exchange of goods and services for other goods and services to the Phoenicians (food, weapons and spices). In fact, this payments system never really ended and we saw evidence of this in the 1930s Depression in the US.

Example of Bartering in the Great Depression in 1933

Coins: Due to the inconvenience of trading goods, shifts were made to use metal coins as a medium of exchange. First evidence of this was in China back in 1,000BC, and we continued to use coins in Europe until the 17th Century, fuelled by the colonial conquests which brought back huge supplies of precious metals — remember the Spanish Conquistadores?

Francisco Pizarro meeting the Inca leaders in the 16th Century

Bills of exchange: This was a promissory note between a buyer and seller that could be used to settle transactions via the first Commercial Banks. These were written up across national currencies (in Europe and beyond) and paved the way for the first foreign exchange markets to be born.

The Medicis rose to prominence in the 15th Century

Rise of Gold, Notes and the Banks: Some of the key actors here were the Bank of Amsterdam (1609), the Bank of France (1671), and the Bank of England (1694). These were established to facilitate trade, war and fix government finances (debt). This was the first sign of true fiat money as notes were backed by gold held in reserve. They were large institutions that acted as a lender of last resort and ensured settlement between transacting parties. Beginning life as private institutions, we eventually evolved to a system of local and national Commercial Banks and Central Banks.

The Bank of England

Gold Standard to Fiat: With the world wars of the 21st century, the Gold standard became a major bulwark to governments being able to stimulate economic growth. The end came in 1931 in the UK and 1933 in the US — fully removed by Nixon in the 1970s. Fiat currency (Bank Notes) were now legal tender and could no longer be redeemed for gold. Instead the legal tender was backed by Central Banks and their reserves. This has been a great economic stimulus for the global economy, enabling Central Banks and governments to print money and lend it out to governments and Commercial Banks, all in the name of driving economic growth. Here we had the birth of credit (unless you’re David Graeber and believe credit came first!)

Franklin D. Roosevelt taking the US off the Gold Standard in 1933

Electronic Money: Only a small portion of money in the financial system is actually printed by Central Banks. The majority is created through lending/credit — our deposits with Commercial Banks are just numbers on a screen that are constantly being debited and credited. We then had the rise of mobile payments and then Fintech wallets such as Venmo, Revolut and Monzo.

Nikolay Storonsky (Revolut), Valentin Stalf (N26), Tom Blomfield (Monzo)

Virtual Currency: These are the cryptocurrencies we have all learnt to love or hate (Bitcoin, Ethereum etc.) and which rose to prominence following Satoshi’s white paper. These are technically not currencies as they are not considered a medium of exchange, store of value or unit of account. Great overview from Mark Carney in his speech on the “Future of Money”. We are moving forward here as stablecoins have been developed to solve these issues. Two examples are Tether (fiat collateralized) and MakerDao (crypto collateralized). Some good pieces on stablecoins on Andreesen Horowitz’s “Crypto Canon”.

Satoshi Nakamoto’s white paper published in October 2008

Central Bank Digital Currency: This is the compromise it looks like we are ending up with and is a solution that sits between electronic-money and traditional cryptocurrencies. In this world there is no more cash printed by Central Banks and digital money is issued directly by the Central Banks (rather than via Commercial Banks). Consumers in this scenario would either:

  1. Hold an account directly with a Central Bank (in the same way that wholesale institutions do now) who ensure immediate settlement or;
  2. Hold wallets with banks who control the customer experience (whilst settlement continues to be facilitated by Central Banks in the background).

Payments between individuals (aka physical transfer of tokens between two parties via a consumer wallet) could then be centralised or decentralised — in any case this process would be overseen by Central Banks. Great overview in the IMF’s recent report, “Casting Light on Central Bank Digital Currencies”.

Taking a step back, you may wonder why a Central Bank Digital Currency is any different to electronic-money. This is a great question and is still being debated but below I have offered up some thoughts (drawing heavily on other work including Christine Lagarde’s recent statements at the Singapore Tech Festival) on why digital currency would improve the current situation:

  1. More financial inclusion: our current financial infrastructure only serves those who provide economic benefits to private sector institutions (huge swathes of poor and rural communities have to function outside the system);
  2. Better consumer experience: no more intermediaries to charge exorbitant fees and long settlement time;
  3. Monetary Policy flexibility: interest rates could go below zero (currently constrained by cash) and helicopter money could be introduced which could see Central Banks issuing currencies directly to consumers to stimulate economic growth in times of need — cash for citizens! Sounds exciting.

To keep this balanced, there are two key issues that need to be worked out:

  1. Privacy versus financial integrity: there obviously needs to be a trade-off here to prevent bad actors exploiting the system (money laundering would be a key problem);
  2. Run on the banks: as we’ve mentioned in this scenario Commercial Banks kind of lose their relevance for retail customers — why would I hold an account with a Commercial Bank if I can go straight to the Central Banks to hold custody of my assets and settle my transactions. It’s cheaper and quicker! This could be solved by Central Banks lending out retail digital asset deposits to Commercial Banks (ensuring they can still lend) or even out-sourcing the wallet experience to the Commercial Banks and Central Banks just stepping in for settlement.

All in all, there are a number of issues to be worked out but the future looks bright for payments and distributed ledger technology. Already there are numerous companies doing great things in the space, building the underlying infrastructure for a new financial system. I hope government, Central Banks and regulators embrace the opportunity to change the way we think about money. Fiat currency is not the end of the history of money and digital assets are here to stay.

If you are building in blockchain, crypto, or fintech, we’d love to hear from you as we want to find people building the infrastructure of the future.