Cryptocurrencies Exist Because Of Alternative Demand
Central bankers are feeling the heat of Facebook’s Libra digital currency project — but beyond an existential threat to central bank seigniorage, cryptocurrencies are raising the fundamental question of what money is, to begin with.
Tom Hargraves adjusted his spectacles nervously as he looked over his shoulder. The 40-year-old actuary at a large investment bank had no reason to believe that anyone was actually following him, but he couldn’t be too careful.
As he walked down the hallway of the Grand Hyatt in downtown Manhattan, Hargraves was notably distinct for being unremarkable. Most would have dismissed him as just another bespectacled Wall Street money man.
To the trained eye, however, Hargraves reeked of wealth.
Clad in a US$10,000 bespoke Loro Piana suit and a discreet white gold Rolex Cosmograph Daytona, Hargraves had done well for himself in the world of finance.
Tonight, however, the thing on Hargraves’s mind was not money, but honey.
Despite being (allegedly) happily married to his high school sweetheart for over fifteen years and despite having professed to want nothing more out of his life of wedded bliss, Hargraves had long felt something missing.
Mother to their two beautiful daughters, Dorothy was a soul mate and life partner to Hargraves and while he felt that he couldn’t reasonably ask for more, there was still that area of his life which he needed to be filled.
And so despite all the outward trappings of a perfect life and marriage, every so often, Hargraves would find himself in high-end hotel rooms with US$1,000 an hour escorts who would indulge his every lurid sexual fantasy, everything that his wife would not indulge him with.
On more than one occasion he had sought to get help for his sexual addictions. But therapists did little to douse the flames burning between his loins, because as Hargraves soon surmised when a need became so insatiable that it bordered on obsession, the best thing to do was to seek out the means to fill that need.
Whether one agrees with it or not, that services, such as those used by Hargraves continue to exist and in some cases thrive, speak more to the existence of needs than the proliferation of moral indifference.
Because where there is a need, life will find a way.
When You Have A Hammer Everything Looks Like A Nail
Which is why when it comes to cryptocurrencies, despite the fact that many critics have panned it as a solution in search of a problem, the reality is that the “solution” would never have developed if there wasn’t a genuine need to redefine our relationship with money.
There wouldn’t be a “need” if governments and businesses had not created the fertile ground for cryptocurrencies to foment.
And while it is true that in their current state of art, cryptocurrencies have yet to live up to the hopes of being a unit of account, a store of value and a means of exchange, when the possibility that a (pseudo) cryptocurrency such as Facebook’s Libra demonstrated the possibility of performing all three roles, central banks suddenly sat up and took note.
Because whilst Bitcoin and its brethren pose no immediate threat to the seigniorage that nation-states enjoy, Facebook’s Libra did.
So it comes as no surprise then, that on the back of regulatory pressure and little incentive to support Facebook’s ambitious Libra cryptocurrency, self-preservation took hold of a number of key backers of the social media giant’s foray into finance, including Visa, Mastercard, Stripe, and PayPal.
To be sure, it was doubtful if the likes of payment services giants Visa and Mastercard were ever genuinely on board with Libra, to begin with — there are strong economic incentives for Visa, Mastercard, Stripe, and PayPal to maintain the status quo — it props up their fee structures and entrenches legacy earnings in the lucrative payments ecosystem — something that Libra would have unwound.
And wooing regulators to bless Libra has been no cakewalk either, having done nothing more than to spook central bankers at the IMF’s recent annual meeting held in Washington, a whole month ahead of Halloween.
But Facebook founder and CEO Mark Zuckerberg have been telling scary stories to central bankers well before Halloween.
As far back as June, whilst announcing the launch of Libra, Zuckerberg already hinted to U.S. policymakers that they were well behind in a race that they had not even known they had signed up for.
A story that has finally gotten central bankers running scared — if they do not have a hard think about whether to make their own digital currencies, someone else will.
Two years ago Stefan Ingves, governor of Sweden’s central bank, started looking into an e-krona to be created and run by the Riksbank.
And what was viewed with no more than bemusement by Ingves’ equivalents in other central banks, has since resulted in the same central bankers seeking out serious conversations with their Swedish counterpart about central bank-issued digital currencies, ever since Facebook announced its pursuit of Libra.
Lael Brainard, a governor at the Federal Reserve who has run a working group on digital payments since 2016, told the Financial Times last week,
“Libra heightened the urgency and sharpened the focus of senior policymakers on this work.”
Speaking to the Financial Times, Tobias Adrian of the IMF suggests,
“It could be that this is taking over the majority of transactions. At that point policymakers fear losing control if private companies win the digital money race.”
Four months after the Libra proposal first made headlines, cryptocurrencies, which had till then been placed on the backburner by Congress, were suddenly viewed as an existential threat to central banks and their ability to manage a country’s monetary policy.
In the corridors of power in Washington, in front of the media and behind closed doors, talk of Libra suddenly dominated.
Whereas Bitcoin and other cryptocurrencies could have been laid (almost permanently) in the “to-do” tray of policymakers on Capitol Hill, Libra was a clear and present danger.
And central bankers do not generally move this quickly unless they are rushing to put out a fire — the last time they moved so swiftly was in the wake of the Great Financial Crisis.
Clear & Present Danger
Unlike Bitcoin, Libra is the stuff of central bankers’ nightmares for two primary reasons — the first is scale.
Bitcoin may be widely traded (debatable), but it has no ready ecosystem to support its widespread use as a unit of account, a store of value and a medium of exchange — whereas Facebook does.
Given the 2.7 billion users on Facebook’s combined platforms, the social media giant, which already has the power to influence elections, could quite rapidly roll out Libra and a payment system that has the potential to be used by one in every three human beings on the planet.
Facebook’s user base alone makes it the largest country in the world and while it owns no land, one could argue that it owns something far more important — digital real estate and the power to influence.
The second conundrum that Libra presents to central bankers is that it represents a direct assault on monetary sovereignty.
Simon Potter, a fellow at the Peterson Institute who used to run the markets desk at the New York Federal Reserve notes,
“(Libra) was a shock to central banks. I think Facebook hadn’t thought through carefully how important control of currency is for governments and central banks.”
Because while digital payment apps such as Swish in Sweden and Alipay and WeChat Pay in China are ubiquitous, they still move deposits among existing commercial banks with digital payments a direct representation of actual fiat currency issued by the central bank.
Libra, on the other hand, is an entirely different animal altogether.
Backed by a reserve of bank deposits and sovereign debt from different countries, the components, and constituents of the assets that back Libra are determined by a private consortium.
Essentially, whoever runs and owns Libra would be running the world’s largest private central bank and ergo, it’s most powerful.
Against this backdrop, the Federal Reserve, arguably the world’s most powerful central bank was given cause for concern because Libra has the potential to interfere with the ability of central banks to provide liquidity when markets are under pressure.
Under situations of the financial crisis, the efficacy of central bank bailouts could be dramatically undermined if investors, fearful of continued loose monetary policy pour into Libra.
And then there’s the dollar.
Don’t Forget The Dollar
Despite only accounting for 4.27% of the world’s population, as much as 60% of all U.S. bills are traded overseas.
With many companies and households, especially those in countries with particularly sketchy and revolution-prone governments, holding dollars as a foreign hard currency reserve as well as a physical store of value, the ability to replace such reserves for a rainy day with a readily convertible, digitally accessible and freely transferable privately run cryptocurrency such as Libra may simply be too tempting to pass up.
The consequence of which would be that central banks and by extension governments, would have far less bite when trying to enforce sanctions.
Because the majority of global commerce is conducted in dollars and routed through New York, U.S. sanctions can cause significant economic pain for other countries — not so if Libra becomes used in its stead.
And it’s not just sanctioned which could lose their sting — the ability of central banks to tweak monetary policy — how much cash flows into the system — could be severely weakened as well.
One Hand Tied
The IMF’s Tobias Adrian notes,
“It could be that (Libra) is taking over the majority of transactions. At that point the central bank is losing control of monetary policy.”
Some central banks are stepping up their efforts to create publicly run digital currencies, as a way to allow technology firms to innovate without giving up state control and in this regard, China has been one of the first few countries to throw its hat in the ring.
But the U.S. Federal Reserve has no plans to follow suit and perhaps with good reason.
Managing Director of the Monetary Authority of Singapore, Ravi Menon, in a recent interview with the Business Times, remarked that there was no compelling reason for central banks to issue digital currencies.
Menon commented that if central banks started issuing their own digital currencies, people would end up holding a large part of their wealth as a direct liability of the central bank,
“Do we want that? How would the credit transmission mechanism work if most of our savings are in central bank digital currencies?”
“Today we keep a tiny amount of cash with us and the rest of it is placed with the banks.”
“The banks lend that money to finance economic growth.”
“If most of our money were to be held with the central bank, then the credit allocation function falls on central banks.”
“Central banks are not equipped to do that.”
Let’s not forget that not too long ago, the U.S. government crossed what was at the time considered a “moral hazard” by bailing out Wall Street in the wake of the Great Financial Crisis.
If the bulk of money in the financial system is held by the central bank, it would be the central bank to decide who gets loans and for what reason.
During the Great Financial Crisis, then U.S. Treasury Secretary Henry Paulson was extremely reluctant to bail out investment banks Bear Stearns and Lehman Brothers because the U.S. government was not typically in the business of rescuing private companies which had gone bust — that is the very essence of the free market economy — limited government intervention.
But when it became evident that the financial system as a whole was under threat without government assistance by way of a bailout, Paulson was forced to act — creating what he termed a “moral hazard” — because how does a government decide who gets saved without accusations of corruption or cronyism?
How is a central banker to be perceived as acting without fear or favor?
Just because many of the banks that got bailed out in the Great Financial Crisis had leaders who were ex-classmates or colleagues of the Treasury Secretary, did that necessarily mean that he had expressed favoritism towards them?
Even if he hadn’t, the perception and criticism could be reasonably made.
Which is why as Singapore’s Menon notes, central banks are not structured to make these sorts of decisions with that level of intimacy with the market— which is where commercial banks come in — they create a layer between the government and private individuals and businesses — but they also create more friction and concentrate commercial and financial power in the hands of a select few.
Not My Battle
And while most central bankers are trained to argue about macroeconomics, Libra has provoked a fight over monetary theory — the central question of what money is.
Central bankers are ill-equipped to tame this beast.
The IMF’s Adrian notes,
“The central bank is losing control of monetary policy.”
“This is dealing with the plumbing.”
“And most people don’t deal with the plumbing.”
Until now, the absence of discussion of what the nature of money is, as well as its function in society has left the field wide open to Facebook and cryptocurrencies to raise the level of discourse in this regard.
But the advent of Libra has put a bee in central bankers’ bonnets.
Beatrice Weder di Mauro, president of the Center for Economic Policy and Research said at a UBS panel last Thursday that Libra has been one of the catalysts to make central banks think “much more actively” about their own involvement with digital currencies.
di Mauro notes that the attitude among central bankers is shifting from just “regulating it and saying, ‘no, we don’t like this’” to a far more proactive approach towards whether central banks should be actively looking to rejig their monetary systems or the nature of currency altogether.
Which brings us back to the concept of “need.”
To be sure, no one is arguing that in their current state of the art, cryptocurrencies provide some sort of silver bullet for all of our issues with regards to currency and the monetary system.
But the expression of cryptocurrencies, their persistence in existence is rooted in the genuine “need” for change of the current status quo because:
- There are increasingly fewer options for reliable stores of value and the rise of gold is evidence of that.
- In a globalized world, with e-commerce and global purchases, consumers are paying far more in terms of “friction” costs when there ought to be a seamless and cheap way to transfer value.
- Investment opportunities and banking options remain painfully in the hands of the privileged few, while billions across the world remain stuck in a poverty trap that while not deliberately designed by the current monetary system, is an idiosyncrasy of that system.
Against this backdrop, cryptocurrencies and Libra have risen to challenge that status quo because they reflect a genuine need — not in and of themselves, but a need to review the current monetary and financial system — and to begin the discussion about what purpose a currency is intended to serve.
Because as inequality across the globe continues to rise, the discussion should shift towards increasing access to economic opportunity to defuse the inevitable tension that inequality creates and perhaps in that sense, we “need” cryptocurrencies to fuel the level of that debate.