You might have read the headlines. “Sweden could be the first economy to introduce its own cryptocurrency” (Business Insider) or “Sweden’s Very Own Bitcoin” (Bloomberg). But why would a country issue a cryptocurrency, their “own Bitcoin”, when the major selling argument of such a currency is that it is decentralized and not controlled by an authority? The confusion is understandable, especially since the Riksbank (the Swedish central bank) made a number of references to cryptocurrency in their first report, a little more than a year ago. Media is to blame for much of this confusion though because of their usual tendency to create click-bait headlines using the most recent buzzwords.
The truth is that what the Riksbank is trying to achieve has little in common with Bitcoin. This should have been clear from the beginning but the fact that the words cryptocurrency and bitcoin is now completely absent from the second report, published recently, indicates that the Riksbank has learned something during the past year. Or perhaps they simply tried to gain some more exposure by riding the blockchain hype of 2017.
But let’s have a look at what problems the e-krona is actually meant to solve. The core of it is actually explained in the very first sentence, in the foreword of their first report:
Recent years’ technological developments and the changes we can see in the payment patterns of the general public are opening up a number of questions concerning payments in the future and how best to take advantage of modern technology. Today, cash is used to an ever-decreasing extent in Sweden, which has led us within the world of central banking to start considering whether a digital complement to cash that is guaranteed by the state is needed so that we will be able to promote a safe and efficient payment system in the future too.
Now, first of all, Sweden is quite unique in the way that cash usage is decreasing very rapidly:
This has of course been noticed by the Riksbank and they feel that this impacts their ability to do their job. Let’s see what the Riksbank has interpreted their job to be:
The Riksbank is Sweden’s central bank. We ensure that money retains its value and that payments can be made safely and efficiently. We also issue banknotes and coins.
So, let’s focus on payments first. The Riksbank want to ensure “that payments can be made safely and efficiently” and they think that their possibility to do so might decrease if cash is no longer used. Why? Because all payments will be made through payment systems owned by private actors. Access to cash will be limited in a world where hardly anyone uses it.
So why do they see a possible problem with the payment systems of private actors? Part of this has to do with the fact that the payment infrastructure in Sweden is very consolidated. A large majority of invoices in Sweden are paid to a “Bankgiro number”. Bankgirot is a company owned by seven Swedish banks, the four largest banks in Sweden control 97.7% of the stock in Bankgirot.
In the past few years, a way to transfer money instantly between individuals in Sweden, known as Swish, has become very popular. Money is sent by using an app and entering the phone number of the receiver. Regardless of which banks the sender and receiver use the money shows up instantly in their bank account. And there is no need to create a new account, you just connect your phone number to your existing checking account. This way of payment is also increasingly being used for commerce and is now the quickest and easiest way to pay for a train, bus or subway ticket in Sweden.
OK, so who owns Swish? You guessed it, it is a company owned by the largest banks in Sweden and it relies on infrastructure owned and created by above mentioned Bankgirot. So, while it is a great service to consumers, and part of the reason that cash usage is decreasing so rapidly, it puts more power in the hands of the banks and we get a kind of oligopoly situation. The Riksbank is worried that if these payment systems fail there is no alternative available anymore (and Swish has by the way experienced quite a lot of downtime due to technical issues).
Access to central bank money
When you use the banks’ payments systems you also use the banks’ money. It is important to understand the difference between “central bank money”, such as notes and coins, and “bank money”, such as the number in your bank account. Central bank money is issued by the central bank while bank money is issued by the banks. The public only have access to central bank money in form of notes and coins while the banks actually have access to a digital version, through accounts at the central bank.
The Riksbank think that it is important that the public have access to central bank money because it is (in their view) “risk free”. Now, even central bank money is of course not risk free, which is obvious in countries like Venezuela, but as long as you view the state as something more stable than private banks there is at least less risk in central bank money. Since bank money is a claim on a bank, a promise to give you central bank money on demand, there is additional risk involved.
The digital bank run
The fact that bank money carries an additional risk to the customer means that banks always have to be prepared for a possible bank run. When confidence in a bank declines and people sense that the bank might not be able to pay them back people run to the bank to get their money first, before the bank is empty. This knowledge should in theory keep the bank from playing it too risky, they have to maintain the public’s trust that they are able to pay back.
In a world where cash no longer exists there is no longer a way for customers to “get their money out”. The only thing they could do is to transfer it to another bank (or buy something that is not money). But what if there is a real crisis and the customer doesn’t trust any of the banks? If the money can’t leave the bank system, banks have a huge advantage and may play an even riskier game.
Enter digital central bank money.
With an e-krona there is again a way for the public to get their money out of the bank system, this time digitally, which makes a bank run even scarier for the banks as it can happen a lot quicker. This restores the balance and moves some of the power back from banks to the customers and the central bank.
Value-based vs account-based
The Riksbank make a distinction between an account-based and a value-based e-krona where the former is money held in an account at the central bank while the latter is more similar to cash and can be held “locally”. This may sound like a fundamental difference but they are more similar than they appear at first. In the words of Riksbanken:
Both types of e‐krona assume that there is an underlying register so that it is possible to record transactions and safeguard who is the rightful owner of the digital krona. This means that digital transactions with e‐krona will be traceable.
This seems to be a realization that the Riksbank have made since their first report in 2017, that there has to be a register and that transactions will be traceable even in the value-based case. There is still a lot of confusion here both about what is desired and what is technically possible. In the second report, the only way that they see non-traceable transactions taking place is by allowing prepaid cards that are handed from person to person.
It should be noted that digital cash in the way that is implied in above (a prepaid card that changes owner) doesn’t really work securely as it doesn’t solve the double-spending problem (how can we make sure that the card isn’t copied?). You might argue that such systems of prepaid cards actually already exists and this is true, but it introduces an element of trust and it usually requires recipients of transactions to be online. It is also hard to see how they would implement a 250 euro limit and still maintain anonymity. What keeps someone from splitting a 2,500 euro payment into 10 anonymous payments of 250 euro each?
The closest solution to digital and offline cash is David Chaum’s eCash invented in 1990 where transactions are anonymous and where double spending is not completely prevented but can be detected and traced to an individual after it happened. This solution assumes that an individual has an account from which the digital cash is withdrawn so we see that the account-based and the value-based solutions actually go hand in hand.
The great thing about the e-krona project is the intention to give the public access to digital central bank money. This is especially important now that usage of cash is rapidly decreasing. The bad news is that there is no reason for privacy advocates to open the champagne. In their second report the Riksbank made it clearer that even the value-based system will be traceable and even if they do intend to make smaller payments anonymous it is hard too see how they will achieve this technically. Be prepared to see this requirement being scrapped altogether.
The Riksbank also seem to overestimate their power in several areas. One criticism of the declining usage of cash is that older people have a harder time making payments and they seem to think that they can solve this problem too, by creating an app that everyone can understand:
For instance, one possibility would be a mobile phone app with a picture of a banknote that is moved by means of a swiping motion on the screen to a payee, to visualise the payment
This reads exactly like someone eager to innovate but who is actually stuck in old paradigms. There is no reason to think that the Riksbank would be better than the private sector at creating a good user experience. Another question is whether it is even possible for the Riksbank to make a system that is secure, something that has been argued against by e.g. Alexander Bottema (video in Swedish).
Anyhow, the project has now proposed that the Riksbank initiate a pilot program to develop one or more possible technical solutions for an e‐krona concept. It will be interesting to see what conclusions they reach after this stage but we will likely have to wait another year for such a report.