Crypto Money and Electronic Money in a New Financial System

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TomoChain

10 min readApr 3, 2020

In my previous writing A proposal of National Blockchain Design, I proposed a blockchain operated by a network of servers belong to government, banks, and large corps to serve common services of a country. Let’s assume such a blockchain is built, then its most practical application is the digital money — or crypto money of that nation.

This topic is not new, recently Christian Barontini and Henry Holden put together a research regarding usage of crypto money in 63 central banks around the world, and I also came across few other analyses of the same topic. All of those works mention a cautious approach from governments with little progress being done. However, they also haven’t described the detailed structure of the system, and that is what I intend to dig deeper in this article. I will also distinguish between crypto money (based on blockchain) and electronic money (which you might have in your ebanking mobile app, Paypal, or credit card), and elaborate the advantages of the new financial system built upon crypto money.

Electronic money

Let’s start with the common understanding that Money is not merely the notes in your wallet. The cash only plays a minor role in the total money supply, and certainly it does not reflect the overall monetary system. In fact, the banking system categorize Money into Narrow Money (M0, M1) and Broad Money (M2, M3, M4) covering cash and the assets can be converted easily to cash. For example, the circulating supply cash in the US was around $3,400 billion, account for around 16% of GDP (TradingEconomics, 2019). The rest of the money exists in other forms.

One of those other forms is the balance in your bank accounts. In fact, you can convert all of that into cash anytime, but people rarely do so, except for emergent situations. Let’s call this Electronic money. So those amount in your ebanking, mobile banking, credit card are different forms of Electronic Money and are managed by your bank(s).

In order to participate in the banking system of a country, your bank needs to open an account in the Central Bank (CB), and synchronize the database with CB so that CB can monitor and adjust the monetary policy accordingly. This is why CB is called the bank of the banks. In reality, it has various names in different country and region, we call it FED in the US, ECB in Europe, Bank of England, Bank of Japan, etc. The basic model is as following:

The key point is: every single amount of Electronic Money you have is managed by a certain commercial bank, and electronic money does not exist outside of these commercial banks. Your personal balance and spending information are stored and secured by that bank, and CB only monitoring the total balance of the commercial banks. CB does not know or manage or care about end-user account. Therefore, when you open your bank account, you happily enjoy — or miserably suffer — the technical ecosystem (mobile app, e-banking) of that commercial bank, depending on how much they care about technology.

Furthermore, when Money exists mainly in the form of financial balance sheets inside electronic software, money printing is done by simply adjusting the balance in virtual accounts, following procedures set by CBs and commercial banks. Certainly, in exchange for this convenience, banking system needs to follow very structured design and strict regulations.

Banking System and the fragmented infrastructure

To this day, Electronic Money management in banks has gone a long way. Each commercial bank equipped themselves with a complex, enormous and expensive core banking system, and it meets basic demands such as wire-transferring, saving, borrowing, etc. General users have the motivation to switch from cash to electronic money to enjoy those advancements. Electronic money plays an increasingly important role in the economy, while cash gradually disappears. In Sweden, circulating cash supply is equal to only 1.4% of GDP (Bloomberg, 2016).

Electronic money is evidently a big leap comparing to cash, however there are drawbacks it has not been able to solve, even till today:

1. End users rely entirely on commercial banks to manage their electronic money. There is no way they can manage their electronic money outside of the banks like how they can do with cash. Cash can be freely circulated outside of the banks, guarantee necessary autonomy, but with little flexibility: difficult to transfer, risky to keep, easy to be destroyed, burned, teared apart, etc. There have been solutions for this such as Paypal or some electronic wallets, but indeed they are only the extension of the bank accounts.

2. Each bank build their own, distinctive core banking system, leading to the asynchronization in inter-bank transactions. Currently many banks are working together to close the gap and process inter-bank transactions instantly, however the fee remains high, especially when the transfer is international.

3. Redundant derivative products in the financial system: this is the consequence of a fragmented system. Because of fragmentation, there needs to be integration and synchronization, following by additional costs and attached services such as SWIFT or inter-bank transferring.

4. There is no way the Central Bank or Government can make direct financial transactions with the citizenwithout going through commercial banks. This use case is rare, but necessary and useful in emergency situation such as pandemic aid or consumption stimulation.

Crypto Money and the never-before unification.

DLT & Blockchain 101 in 1 minute:
Distributed Ledger Technology — DLT: as its name, DLT is simply a novel way to store identical data in multiple locations, comparing to traditional centralized data storage. Blockchain is a form of DLT, with the data is arranged into blocks and the blocks are connected into a chain, hence the name blockchain. Crypto money is created and managed by blockchain or DLT technology.
It sounds simple, but there is an enormous evolution in technical design, because it requires the algorithm to create data in different locations, then consensus algorithm to synchronize data among servers, and the security mechanism to prevent attacks — while maintaining high transaction throughput. For instance, TomoChain employs Proof of Stake Voting (PoSV), Double Validation and many other mechanisms to ensure privacy, accuracy and usability with high speed.

From the perspective of being cashless in paying for bill, groceries, dinner, online shopping, etc. crypto money and electronic money are not that different. Their common ultimate goal is to eliminate cash. However, how they manage the account balance are totally distinctive. Let’s have a look at a simple blockchain designed to manage crypto money:

Highlights of the system:

1. The decentralized network is established with a network of servers owned by Central Bank, commercial banks, large financial institutions and large corporations in a country, similar to the model I proposed in the beginning of this article.

2. All the servers maintain an identical ledger and run the same consensus algorithm to guarantee the immutable data. Strong cryptography ensures that these servers cannot understand the content of the ledger although they own it.

3. The bank accounts are created using the same cryptographic algorithm of the system, however to use it the owner has to go through KYC processes by banks or any other service providers. This is how the banks can manage its users and even while all the banks can possess the ledger, they cannot possibly know the actual financial details of other banks.

In such a design, all the users have account ID created by the same algorithm (the popular algorithm now in blockchain is SHA256, which is scientifically proven to be not hackable). Then, we have the unification in bank account across the users, and across the banks. This seems to be a very simple change, but what benefits does it bring to CB, the commercial banks and the market?

Advantages of Crypto Money in comparison with the existing system

1. Inter-bank transfers are faster, cheaper: thanks to the common ledger with the same account ID system, the account balance changing is unified across the system, while still ensuring the performance of the whole platform.

Furthermore, if many countries issue their own crypto money, even if they do it in their respective blockchain, the connection is now much simpler through specialized inter-chain channels at national level. Then the cross-border money transfer reduces lots of friction and fee, opening the whole new era for cross-border commerce. Currently cross-border transfers through SWIFT have up to 5% fee ($5,000 fee for each $100,000 transfer). Meanwhile, the existing cryptocurrencies already process with much lower transaction fee, and in many cases the fee is as low as a penny.

2. Always-on network ensures 24/7 operation: the cases of next day transfer will be the past if the money is monitored by a blockchain with a well-designed consensus. The commercial banks can bypass the synchronization with Central Bank before transaction settlement, because the transactions are already verified before reaching finality. All the stock exchanges can also immediately switch from traditional T+2 (or T+1) mechanism into real-time trading mode without too much investment in technical solutions.

3. Security: just like cash, users can keep crypto money outside of commercial banks and still able to pay for bills, meals, groceries, clothes, services — meaning anonymity can be guaranteed. Today, some privacy protocols in blockchain technology such as TomoP (developed by TomoChain) goes even further than that in securing user and transaction data when needed.

4. Connect the government and the citizens: Central Bank and the government can make direct transaction with the citizens without going through the commercial banks in the emergency cases, such as raising fund, or provide helicopter money during crisis. Certainly, this goes against the benefits of the commercial banks, but it is also the motivation for these banks to issue better policies to attract capitals, following the market rules.

5. A unified financial platform can nurture fintech ecosystem: When the banking system is united in the common platform with a common crypto currency, it is the basis for the applications in insurance, payment, lending, sponsoring to bloom. More financial products in the market brings more income for the banks, and the market gains more value.

What may obstruct this evolutionary technology?

Costs and potential risks: When the banking system has reached today’s maturation and complexity, any changes in the core platform imply potential risks and enormous costs. This is also the reason why the Bank of Japan and European Central Bank, despite spending the last 5 years to research, have not moved to the Proof-of-concept phase.

Incentives for the commercial banks: as explained, the blockchain-based financial system brings lots of benefits for end users, however the incentives for commercial banks are not that obvious, while these banks are the parties have to change the most — leading to highest cost — if the new system is deployed. Therefore, their motivation to do research and development remains low.

Unready technology: although DLT and blockchain technology have been around since 2008 with the “hello world” of Bitcoin, the ecosystem is only developed robustly in some recent years. Perhaps that maturity is not yet sufficient to support a super complex financial system that we have today.

Which strategy for Crypto Money?

1. Wait and See: probably this is the most suitable strategy for the developing countries. As long as the existing system is still sufficient for the basic demands of the market to ensure economic growth, any passion for change and technology innovation is a luxurious plan. However, it is necessary to form a R&D team to keep an eye on the global trends, not to be left behind in an increasingly connected and active financial network.

2. POC: the idea of crypto money has been around for a while, and there are some pioneers went for it:

- Sweden was the first country announcing its experiment with e-Krona currency based on blockchain technology. Technical details have not been revealed, but we’ll have more information in the coming months. As mentioned, Sweden has the lowest ratio of cash over GDP circulating in the country, and that is the key supporting factor for the crypto money to get into the system.

- United States: in the end of March, the House of Representatives drafted a bill to issue one trillion dollar as crypto money on Ethereum platform, in order to transfer financial aid (helicopter money) directly to each citizen without going through commercial banks. This is the first time in the world such a proposal is discussed at the Congress level, and it opened up new discussions, which will tell the next turning point of blockchain technology once it’s settled.

Conclusion

Decentralized cryptographic money is not a new concept, in fact it was tested in the past decades with all the names we knew: Bitcoin, Ethereum, Ripple, and so on. However, to apply that concept into the traditional financial system, it’s a long way to go. All the evolution takes time, just like the first plane, the first spacecraft or the internet, the journey from paperwork to mass adoption of crypto money may take years or even decades. This is our beginning, and with each step of the way, we can draw the curtain a little more. Hope the ecosystem we are building will help blockchain technology to be discovered again, this time not by tech enthusiasts — but by the officials.