Why Crypto Will Disrupt Central Banks Into Treating Citizens More Like Customers

As you probably know, “disruption” has become something of a buzzword in the business world recently.

So it was interesting to see a couple of stories about how disruption actually works and some implications it might have in the broader economy:

• A great podcast from Andreesen Horowitz on how fintech startups compete with established banks and insurance companies.
• A report from the World Economic Forum on the actual steps central banks are taking to use distributed ledger tech in their operations.

Here are the facts about where we are, according to the stories:

Startup fintech companies don’t want all banking and insurance clients. They want the most profitable ones.

In finance — especially insurance, which is essentially just a numbers game — the best customers (the ones who rarely make claims) subsidize the worst customers (the ones who make claims).

Startup fintech companies can use this message to poach profitable customers by, for example, creating a “community” of good drivers who pay lower car insurance premiums. New data analytics capabilities can verify their good driving behavior.

To compete, the incumbent financial companies basically need to be more specific about creating differentiated brands and messaging for the various sub-groups of their overall customer base.

That might mean competing with startups with one “exclusive” brand but and subsidizing it with another brand that is “inclusive,” i.e. accepting categories of clients the startups don’t want.

Very interesting… especially when you consider how today’s biggest incumbent financial players — central banks — are responding to competition from crypto projects.

Central banks are experimenting with pegcoins / stablecoins or variations thereof.

To be honest, we think the the term stablecoin isn’t perfect. What we’re talking about here is that the value of the cryptocurrency is pegged to something else, like a fiat currency.

Obviously, fiat currencies aren’t that stable. Sure, they might be relatively stable compared to crypto but it depends on the fiat and the cryptocurrency.

So the term fiatcoin is better. Or how about pegcoin? In case it is pegged to something other than fiat.

But… it is good marketing. Stability is what users want here at the end of the day. We’ll get to that later.

No matter what you call it, central banks are experimenting with the idea.

And that makes sense.

Consider that some of the more commonly known stablecoins are backed by some fiat currency held by a private party. Gemini dollars, for example, are backed by dollars held by the Gemini Trust.

In a way, therefore, you might consider someone like the Gemini Trust just a middleman. The American Federal Reserve (which happens to be a private institution too, by the way, despite the name!) could simply back a crypto coin with its own dollars — i.e. the digital ones and zeroes it calls dollars!

Maybe that’s ultimately where we’re headed.

Now let’s go into more detail about the “competition” between fiat and crypto.

Crypto is competing with fiat by “cherry picking” users.

As we’ve written about before, we don’t think fiat or crypto are in head-to-head, direct competition with each other.

It’s similar to how the fintech startups compete with bigger incumbents. It is not a battle for all the customers. Just a few specific types of customers.

Similarly, good cryptocurrencies are used and will be used for narrow use cases. We don’t believe they will be a total replacement for fiat currencies.

Everyone always talks about paying for coffee in Starbucks with crypto as some sort of crypto adoption holy grail. It could happen — but more likely you will be paying for a specific type of fair trade coffee (or something else related to coffee even more narrowly defined) with crypto first.

Central banks haven’t quite wrapped their head around this kind of competition — especially at the “retail” level.

Historically speaking, government-issued currencies are a relatively recent phenomenon.

Beforehand, people used a currencies from whatever source best fit their needs. Obviously, times were different and there weren’t so many options available. But you could think of this as something like “retail currency competition” in that the average buyer or seller could / had to choose how they wanted to pay.

Today, in many countries you can also choose which currency you want to pay in. If a bank card terminal recognizes that your card is denominated in a foreign currency, for example, it might ask you which currency you’d like to pay in.

But that’s at the payment processor level. A very interesting space with lots of cutthroat competition with startups like Revolut and Curve.

But when it comes to “retail” currency choices in one country vs another, things have been quite “gentlemanly” in our opinion. You don’t see, for example, the Bank of England actively competing with the German Bundesbank to get Germans to pay for their groceries in British Pounds.

At the national, “wholesale” level things are a little less gentlemanly. The petrodollar as a diabolically genius example here. Institutions also trade bonds denominated in different currencies etc. and things are rather more competitive.

But then along comes crypto. Bitcoin, the first cryptocurrency as we know it, was created as a retail alternative to fiat currencies. It wasn’t designed to be part of the fiat status quo. There is no governmental backing behind it, and anyone can choose to buy or sell with it without any involvement of any government anywhere.

And central bankers haven’t quite wrapped their heads around the whole thing. But they’re getting there.

We think this competition will push central banks to become more transparent about the stability they are “selling to their customers.”

There’s an interesting video from the International Monetary Fund’s managing director about how crypto is shaking things up and that “stability is necessary.”

Apart from our crypto-style suspicion of mainstream NGO financial institutions (check out Confessions of an Economic Hitman to learn more), we think her story needs work.

It should be less about “stability and the status quo is important because we said so” and more about “offering citizens the more stable options that only a world government can provide. Different choices to accomplish different goals with something for everyone, etc.”

Incumbent financial institutions use stories like that to compete with fintech startups. And it’s true — stability is in fact a good thing. For example, most people would probably agree that the US dollar is a more conservative investment than Bitcoin. At least in the short run.

Bitcoin has only been around for 10 years or so, and has seen dramatic price swings. The US dollar has been around for much longer. There’s been inflation, but at the same time there is huge momentum — created ethically or not — behind the US dollar as a store of value.

So we believe that central banks are going to use their own crypto (i.e. pegcoins / stablecoins) to promote stability as a competitive advantage.

That means being more transparent about where that stability actually comes from.

Believe it or not, how the American Federal Reserve gets audited is a point of political contention.

It all seems silly compared to the transparent nature of blockchains and cryptocurrency, doesn’t it?

Ultimately, we think “customers” are going to be the big winners here. They will have more ways to make better, more informed choices about their finances.

Central banks are going to be forced to compete for customers as crypto projects cherry pick them for niche use cases. These customers will need a story and the central banks are going to have tell it!

That story might simply be about patriotism. Think about how American producers often label their products as “Proudly Made in America,” for example. It could be that we start seeing slogans like “Pay Proudly in Dollars” (or FedCoins!) in the next few years.

We hope, though, that those stories will be more about transparency and giving people solid economic reasons to believe in a state-backed currency vs a stateless currency like Bitcoin or BlockStamp BST.

Right now, the stateless currencies are definitely winning the war for transparency — at least with regards to algorithms that are set to control inflation. Hopefully they will drag central banks along for the ride!