Part 4 - Perspectives on Banking - The Evolution of Digital Programmable Currencies and Related.

So, Money has been evolving for centuries. ?Money used to be represented on clay pots and slates, cowrie shells and Whales Teeth, we started using coins, they turned out to be heavy, difficult to transport and prone to debasement (clipping, shaving, diluting etc).? Depository receipts were an innovation, pieces of paper representing value (for example gold) in a vault, other pieces of paper that represented things like commodities and goods that were going to arrive any day now depending upon the wind and the pirates. ?Once a reputation and trust (now there’s a concept!) were established, we recognised we could issue more notes than the gold in the vault, this would enable economic development and productivity, would increase the flow of trade, wealth would be created, and people would have better lives. ?We started creating money as we know it today. ?Well, generally speaking, and with some hugely significant exceptions, crises and negative societal developments, this central bank monetary policy led fractional banking, fiat currency approach has worked over the past centuries. ?It has continued to evolve, it’s not that long ago since currencies were literally backed by gold, the first credit card was only introduced about 70 years ago! Securitisation (good and bad types!) although around in various nascent forms for a long time, has only become a fundamental part of the financial landscape in the last 50 years. ?The word “credit” comes from the Latin “credo”, “I believe”, it reflects the concept that the model of Central Bank and Commercial Bank money that we work with only has an intrinsic value because we believe in it, we trust in it, we know that if we go to buy a cup of coffee with some dollars that the coffee maker will be willing to sell us the coffee in exchange for the physical or digital money. ?Now, in fairness, that dollar or euro or yen money is backed through a reasonably complex relationship between Central banks and National Governments by tax receipts and Government borrowing, (beyond the scope of this piece and this is where the disbelievers and ardent evangelists for a different way of doing things can legitimately ask difficult questions!). But monetary policy transmission works and enables the economy, and many people don’t realise or forget, that central banks no longer try to control money supply, they control the price of that money into the market. ?They are completely concerned with inflation, and the management of inflation to around 2%, that depreciation of currency by a tantalising annual amount to just make you go out and spend some money, buy things now, in order to keep the economy turning over, getting that balance between consumption, investment and saving.? ?Simple as that! ??Of course, it’s not simple, like every complex subject, monetary policy brings challenges, things keep getting more expensive (inflation!), young people can’t afford to buy houses, workers in many sectors feel they are not able to keep up with “the (rising) cost of living”. ?In some, particularly challenged economies, the monetary policy doesn’t work (or never did!), and the country/region enters into a dollarization phase, where the country loses control of its management of the economy, and it is essentially outsourced to the USA through the substitution of the USD in the economy. ?So, what’s next, and how does money (and therefore banking) evolve after digitization and web 2.0, in the era of social media, real time gratification and web 3.0?

Web 3.0 is all about decentralization, user sovereignty, reducing intermediaries, ownership of your data, consent, “trust in code” rather than trust in people and getting rid of legacy processes or ways of doing things. ?Countries like Argentina or Zimbabwe, or even Greece, are exhausted by Monetary policy experience over decades. ?People ask is there a better way, they have to believe (credo!) in something in terms of a unit of account, a store of value and a medium of exchange if you are going to engage in the modern world. ?The GFC created the concept and realisation of programmable digital currencies, exemplified by the King of cryptocurrencies, Bitcoin. ?Many critics point to a complete lack of intrinsic value for Bitcoin and the family of cryptocurrencies. ?It’s created “out of thin air”, yep…but so are dollars and euros. ?The best way I can describe Bitcoin is that it is a combination of currency (money) features/functionality with payment features/rails, it basically combines the two. ?In my view buying bitcoin is buying equity in a payment system and currency combined, (just for clarity I am not advocating you go out and buy Bitcoin). ?Governments and Regulators have struggled to define it, is it a currency, a commodity, neither? ??It can be confusing to the average person who just wants to be enabled in their daily lives. ?In the same way most of us do not understand how the internet works, (TCP/IP etc) or even how a car works, it doesn’t mean we don’t use a car or the internet. ?Similarly, Bitcoin and other cryptocurrencies (of which there are 9,000!) are coming in from the cold, gaining some maturity. ?Initially Bitcoin was only for computer geeks, then it was only for criminals, then it was only for very specific use cases, then it was only for small “failed” countries, now it seems to be for the biggest and savviest fund management organisations in the world (i.e., Bitcoin ETF’s). ?Bitcoin and many other cryptocurrencies, (most obviously Ethereum) and their descendants are in my view “here to stay”, have functional real use and value. ?Of course, many cryptocurrencies and projects will fail, and similar to the maturity curve of nation states and businesses, there have been, are and will be bad actors and fraudsters who infiltrate the system. ?But the power of programmable digital currencies is shining through, and they have a place in the modern financial tool kit.? The use of cryptocurrencies, stablecoins, Central Bank Digital Currencies (CBDC’s), some decentralized finance functionality (only some!) is a world of growth and development that will surely have significant effects on “how we do things around here” in the decades to come. ?From international trade finance and payments to carbon credits and securities issuance, from investment property fund management transactions to how we think about “cash” and “bank deposits”, are all areas being disrupted.

Blockchain 1.0, 2.0, 3.0 and 4.0.

Blockchain has evolved; there have been 4 distinct step changes/evolutions, Blockchain 1.0 was all about the introduction and deployment of the “King of Crypto’s” Bitcoin, and the foundational work of Satoshi Nakamoto, who brought together a number of concepts around cryptography and “e-cash” to implement the Bitcoin core platform, and the “cash for the internet-internet of money” was created.? Of course, he was “standing on the shoulders of giants”, leveraging off the work of X Y and Z. Blockchain 2.0 introduced the ability to build applications on the blockchain, and is represented by the original of the species the Ethereum platform and its native cryptocurrency Ether. Ethereum was followed with a plethora of other open-source software protocols that enable smart contract development/deployment in a decentralized blockchain environment. ?Smart Contracts are autonomous self-managing computer programmes that execute automatically on the basis of predefined (legal/contractual) clauses between parties. ?The code automatically executes based upon “an if/then” protocol.? Ethereum allows the deployment of permanent and immutable decentralized applications on it, with which users can interact. Decentralized finance (Defi) applications provide financial instruments that do not directly rely on financial intermediaries like brokerages, exchanges or banks. ?This facilitates borrowing against cryptocurrency holdings or lending them out for interest. The Defi market is very immature however, and has thus far, very limited use cases, and although often described as opening up finance for people who have in the past been financially disadvantaged or excluded, seems to me to carry huge risks of rehypothecation and the circular counter-intuitive issue (when it comes to talking about “financial inclusion”) of needing collateral to post in the first place if a user wishes to engage in a defi application.? Ethereum also allows users to create and exchange various forms of fungible and Non-fungible tokens, these tokens are digital representations of either digital or Real World Assets (RWA’s), and therefore enables the movement, settlement, trading, storing of value in a way not possible before. Tokenization of assets seems to be one of the monster use cases that is likely to propel Blockchain as a foundational software for the 21st century.? By Blockchain 2.0 it is fair to say that Blockchain had revolutionized peer-to-peer information exchange by combining cryptographic principles with decentralization, immutability and transparency. ?Blockchain’s fundamental feature being a distributed ledger where each record or block is secured and bound to its successive blocks through hash functions thus resulting in a chain of blocks, the bigger the chain, the more secure the structure. Blockchain 3.0 saw the scaling of Decentralized Apps, (dApps), digital programmes that run on a Blockchain network of computers instead of a single computer and thus are beyond the purview of any central authority. ?Blockchain 3.0 is described as being built on the foundations of FFM, an acronym for Fast, Feeless and “Minerless”, so you get the idea, “bigger, better, faster, more!” ?(“Minerless” referring to the evolution of blockchains from Proof of Work (extremely energy intensive, e.g. Bitcoin) to Proof of Stake, Authority and a plethora of other protocols that are deemed to be secure but far more energy efficient (up to 99% less energy use!). ?Blockchain 4.0 heralded in the use and scaling of Tokenization, fungible, non-fungible, real world assets (RWA) etc, as well as more interoperability between blockchains, greater functionality and connection with AI and IoT. ?So, we have now come to a place where Blockchain can and is deployed in a plethora of industries and current and/or future use cases from carbon credits to e-voting, from securities trading to real estate investment.

So, Blockchain enables every transaction, interaction and exchange to be recorded on a decentralized ledger, something that is visible by all but alterable by none. ?It could be regarded as an open book, whose pages turn in real time, under the watchful eye of everyone in the room. In fairness, that’s transparent!

There are three core pillars which underpin this technological revolution, decentralized networks, immutable ledgers and smart contracts.

Firstly, decentralized networks distribute power away from single entities, ensuring no one organization or person can monopolize control or information. This dispersal not only democratizes access but also ensures transparency in that actions must be verified by multiple nodes, not just a central server. This is the key, we are moving away from central server to many hundreds, thousands, or millions of servers/nodes. ?Think of it as a community garden, where everyone must agree on what’s planted and where-nothing grows without consensus. Next immutable ledgers serve as the unalterable books of digital interactions. ?Once something is recorded on a blockchain ledger, it is infeasible to change it, appending is order of the day. ?This permanence ensures that every transaction is traceable and transparent, providing a clear audit trail from start to finish. ?It’s like etching records in stone, visible to anyone who passes by.

Finally, Smart Contracts automate transactions based on agreed upon rules embedded in code, executed without bias or manipulation. ?These aren’t just contracts in the traditional sense but self-executing agreements that operate transparently on the blockchain. ?Imagine a vending machine that not only dispenses snacks, but also self-audits, orders refills, and manages its finances publicly - smart contracts do this at a complex scale for financial agreements, property exchanges and much more. ?Together these three pillars construct a foundation robust enough to support a new era of transparent, fair and accessible digital interactions making some opaque systems of the past obsolete.