Thursday, September 23, 2021

Central Bank Digital Currency

Central bank digital currency: the future starts today, a speech by Benoît Cœuré, Head of the Innovation Hub at the Bank for International Settlements identifies a number of problems that central banks face:
Big techs are expanding their footprint in retail payments. Stablecoins are knocking on the door, seeking regulatory approval. Decentralised finance (DeFi) platforms are challenging traditional financial intermediation. They all come with different regulatory questions, which need fast and consistent answers.

Banks are worried about the implications of CBDCs for customer deposits. Central banks are mindful of these concerns and are working on answers. They see banks as part of future CBDC systems. But make no mistake: global stablecoins, DeFi platforms and big tech firms will challenge banks' models regardless.

Stablecoins may develop as closed ecosystems or "walled gardens", creating fragmentation. With DeFi protocols, any concerns about the assets underlying stablecoins could see contagion spread through a system. And the growing footprint of big techs in finance raises market power and privacy issues, and challenges current regulatory approaches.
Below the fold I discuss the idea of CBDCs

Cœuré sets out three goals for a CBDC:
We have to ask ourselves why consumers would want a CBDC and what would they want it to do? The recent European Central Bank (ECB) public consultation showed that they value privacy, security and broad usability. In order to meet consumers' expectations, CBDCs need to be made to work most conveniently. Payment data must be protected. Digital functions that are not available with cash can be developed, such as programmability or viable micro-payments.

Then CBDCs should meet public policy objectives. Central banks exist to safeguard monetary and financial stability for the public good. CBDCs are a tool to pursue this through enhancing safety and neutrality in digital payments, financial inclusion and access, innovation and openness. Important questions remain. How can CBDC systems interoperate, and should offshore use be discouraged?

Technology opens up design choices. System design will be complex. It involves a hands-on operational and oversight role for central banks and public-private partnerships to develop the core features of the CBDC instrument and its underlying system. These features are: ease of use, low cost, convertibility, instant settlement, continuous availability and a high degree of security, resilience, flexibility and safety. Complex trade-offs will be addressed by central banks including how to balance scale, speed and open access with security; and how to balance offline functionality with complexity and security.
The central bank that is arguably furthest along in developing a CBDC is the People's Bank of China (PBoC). Claire Jones, in Ant split says more about money than Ma, points out that their goals for a CBDC are different:
That the CCP wants access to data on people’s spending habits is not exactly a shock. Indeed, as we have long argued ... the crackdown on Ant is less about muzzling Jack Ma than it is about maintaining control over money as we transition to an almost entirely digital system of payments and settlements, and credit creation.

The attack on Ant is but one of spike of a multipronged plan to maintain Beijing’s near monopoly not only in the creation of currency, but the provision of credit and the clearing of the entire economy. That plan includes a crypto ban and the launch a central bank digital currency, the design of which will create a centralised ledger granting the People’s Bank of China access to each and every single transaction done using it.
Jones concludes:
We don’t have all the answers. But the ideal is to aspire to a system that relies on trust, not on data or surveillance to manage people. It also needs to find a way to keep the corrupting forces within centralised systems in check — tools that allow anyone to opt out at a moment’s notice could be one option for doing so. Yet technological advances are going in the opposite direction, focussing on ever more gated and complex systems, that are powered by personal data, foregoing concerns over privacy in the process. The only alternatives, meanwhile, are focused on energy-intensive bureaucratic systems such as blockchain.

If that continues, then systems that truly empower and protect individuals will never exist. And we should, eventually, prepare for versions of what we’ve seen today in China the world over.
But with total knowledge and total control comes total responsibility, as JP Konig points out in Are Central Bankers Ready for Payments Theater?. Konig imagines the scene:
It’s 2026, and Federal Reserve Chair Jerome Powell has just sat down in front of the U.S. Senate Banking Committee. Powell has spent the last few days preparing to be grilled by lawmakers about why the Fed recently raised interest rates.

But the questioning quickly takes a different tack.

“Why is FedSend being used by dangerous white supremacists for funding?” asks Sen. Elizabeth Warren of Massachusetts. She’s referring to the Fed’s central bank digital currency, FedSend, unveiled in 2024. “What sorts of controls do you have in place to prevent this?”

The next question comes from Sen. Mike Crapo of Idaho., who wants to know why FedSend is being used as a payment method on porn websites hosting BDSM and underage porn.

Another senator asks: “FedSend has become the most popular means of payment for fraudsters running tech support and IRS scams. How do you plan to protect seniors?”
Senators can't ask these questions about physical cash. They can ask these questions of banks and credit card companies, requiring them to obey KYC/AML (Know Your Customer/Anti Money-Laundering) laws. But these are private actors, the central bank is the government.
After a CBDC has been built, it will have to be governed. The central bank will have to write out its terms of service, or TOS – a payments constitution that describes who can use it and how.

This TOS will become ground zero for all sorts of political disputes. Are central bankers like Jerome Powell ready to enter the messy politics of governing a retail payments system?
It decides to go with a very simple TOS, something like: “FedSend cannot be used for illegal activities,” and that’s it. Even this bare-bones payments constitution will open the Fed to attack. Fed officials will now have to arbitrate the line between legal and illegal, and that’s much trickier than it sounds.
In the past, the tasks of enforcing the rules, determining in detail what the rules were, mediating disputes about the rules and about individual transactions were delegated to payment processors, the banks and credit card companies. So when things went right, they paid the cost of these functions. And when things went wrong, they paid the legal and PR price. Konig uses this example:
OnlyFans’s recent ban of explicit porn (which was rescinded after a few days) illustrates how divisive payments governance can be. We still don’t know why OnlyFans decided to hack off one of its own legs, but it may have had something to do with the rules of the underlying payments systems on which the site relies. The media fallout was a huge PR disaster for all involved, including Mastercard. If FedSend was part of the picture, it, too, would have been dragged into the controversy.
Konig poses a choice for the central bank. It can brand the mechanism as a Central Bank Digital Currency, taking on the roles and responsibilities of current payment processors. Or it can delegate these roles, as at present, to non-governmental entities such as banks and credit card processors. He writes:
But at this point FedSend would be like all of the other Fed products that are offered wholly through banking intermediaries, like FedACH or FedWire. The banks repackage them, or white label them, as they see fit and set the price.

At which point the Fed has become just another dumb pipe, one with no control over the final product. It’s not really a CBDC anymore. It’s just another bank product. What’s the point?
The point would be that the central bank would own a database of all transactions. That's clearly what the PBoC wants. But owning that database, and thus having the power to refuse or delete transactions, would in practice mean accepting the responsibilites the central bank tried to delegate. Konig thinks this is a choice, but in a democratic society I don't think it is.


David. said...

The BIS "innovation hub" has produced yet another proof-of-concept:

"A prototype of multiple Central Bank Digital Currencies (mCBDCs) developed by the Bank for International Settlements Innovation Hub and four central banks demonstrated the potential of using digital currencies and distributed ledger technology (DLT) for delivering real-time, cheaper and safer cross-border payments and settlements.

The mBridge project is a cooperation between the BIS Innovation Hub Hong Kong Centre, the Hong Kong Monetary Authority; the Bank of Thailand; the Digital Currency Institute of the People's Bank of China; and the Central Bank of the United Arab Emirates."

David. said...

Ax Sharma provides everything you need to know about Decentralized Finance (DeFi) in the ROTFLMAO Crypto platform mistakenly gives $90M to users, asks for refund:

"In a major blunder, cryptocurrency platform Compound accidentally paid out $90 million among its users.

Shortly after the mistake, the platform's founder began asking users to return the money—or else they would be reported to IRS, and possibly doxxed, threatened the founder."

Give us our money back or we'll make you obey the tax laws!

Immutability for the win!

David. said...

Gotta love the cascading screwups at Compound:

"There are a few proposals to fix the bug, but Compound’s governance model is such that any changes to the protocol require a multiday voting window, and Gupta said it takes another week for the successful proposal to be executed."

Rate-limiting bug fixes!

“No user funds are or were at risk so it’s not that big of a deal,” said Gupta. “Everyone kinda got diluted but didn’t lose anything directly.”

So that's OK then.

"0.5 comp tokens are being added roughly every 15 seconds,"

Cryptocurrency fixes the big problem with fiat, inflation!

David. said...

Simon Sharwood points to a welcome outbreak of realism in Hong Kong's central bank sees seven big issues to solve before a central bank digital currency can fly:

"The Hong Kong Monetary Authority (HKMA) has issued a technical perspective paper on central bank digital currencies (CBDCs), suggesting two viable designs but also finding seven issues that need to be nailed down before it would be comfortable implementing the "e-HKD".

The paper [PDF] explores "potential architectures and design options that could be applied to the construction of the infrastructure for distributing e-HKD".
But the document is ultimately inconclusive because even with all of the above considerations, the HKMA found seven deeper issues it thinks must be resolved before a CBDC can be implemented."

David. said...

The most amazing thing about the Compound fiasco is this:

"There are a few proposals to fix the bug, but Compound’s governance model is such that any changes to the protocol require a multiday voting window, and Gupta said it takes another week for the successful proposal to be executed."

They were so confident in their programming skills that they never even considered that an exploit was possible. They built a system where, if an exploit was ever discovered, the bad guys would have ~10 days to work with before it could be fixed.

Engineering is all about asking "what could possibly go wrong?" but these cowboys are so dazzled by the $$$$$ that they never ask it.

David. said...

Zeke Faux's Anyone Seen Tether’s Billions? is a long-ish read and an excellent overview of the history of Tether. He saw:

"a document showing a detailed account of Tether Holdings’ reserves. It said they include billions of dollars of short-term loans to large Chinese companies—something money-market funds avoid. And that was before one of the country’s largest property developers, China Evergrande Group, started to collapse. I also learned that Tether had lent billions of dollars more to other crypto companies, with Bitcoin as collateral. One of them is Celsius Network Ltd., a giant quasi-bank for cryptocurrency investors, its founder Alex Mashinsky told me."

This is a version of the magic "money" pump" I wrote about in Stablecoins.

David. said...

CryptoCat reports that Bitfinex paid a colossal $23M fee to send $100K of USDT:

"Crypto exchange Bitfinex completed a highly consequential transaction on Sept. 27 when sending $100,000 of the stablecoin Tether (USDT) to the layer-2 subsidiary platform DeversiFi. For reasons unknown, the exchange paid 7,676 ETH, equivalent to $23.7 million, marking quite possibly the largest gas fee ever recorded on the Ethereum blockchain.
To put the enormity of this fee into context, consider the fact that the average transaction fee on the Ethereum blockchain currently stands at 0.013 ETH, or $39.96. In addition to this, two weeks ago, $2 billion of BTC was transferred between unknown wallets for an infinitesimal fee of $0.78."

David. said...

In US Department of Justice creates cryptocurrency enforcement unit, Kim Lyons reports on another turn of the screw:

"The US Department of Justice has created a team to investigate cryptocurrency-related crime. The National Cryptocurrency Enforcement Team (NCET) will handle investigations of “crimes committed by virtual currency exchanges, mixing and tumbling services, and money laundering infrastructure actors,” the agency said in a news release. Mixing and tumbling services can obscure the source of a cryptocurrency transaction, by mixing it with other funds.

Cryptocurrency is “used in a wide variety of criminal activity,” including ransomware demand payments, money laundering, and for the illegal sales of drugs, weapons, and malware, the agency noted."

David. said...

People who get insanely rich in a speculative bubble get enormous lobbying power to prevent the bubble bursting. Regulators Racing Toward First Major Rules on Cryptocurrency by Eric Lipton, Ephrat Livni and Jeanna Smialek reports on one instance:

"The regulatory push has generated a wave of lobbying by cryptocurrency executives. They have lined up in recent weeks in a series of virtual and in-person meetings with banking and financial regulators, seeking to shape the new rules while largely acknowledging that some form of federal oversight is now inevitable."

David. said...

White House Weighs Wide-Ranging Push for Crypto Oversight by Jennifer Epstein and Benjamin Bain signals more turns of the screw to come:

"Financial regulators appointed by Biden are taking an increasingly hawkish tone about the burgeoning crypto market as they seek to step up oversight of the asset class. Regulators have expressed concerns about the lack of investor protections and possible risks to financial stability as the market has ballooned to more than $2 trillion.

National security agencies across the administration are also grappling with high-profile cases of digital currencies playing a role in ransomware attacks like the Colonial Pipeline episode earlier this year."

David. said...

Emily Graffeo's DeFi Protocol Cream Finance Loses $130 Million in Latest Crypto Hack reports that:

"DeFi protocol Cream Finance suffered yet another hack this year after an exploit stole at least $130 million in what could be one of the largest thefts in decentralized finance.

The attack on the Ethereum-based lending protocol was first reported by The Block Crypto, which cited a tweet by PeckShield Inc. highlighting a large flash-loan transaction that carried out the theft.

The burgeoning DeFi landscape has drawn in billions of dollars in investor funds, but it has been a frequent target by hackers, with many using flash loans -- a type of uncollateralized lending -- as a way to exploit poorly protected protocols.

Cream was involved in similar attacks that stole nearly $38 million in February and almost $19 million in August, according to The Block. Meanwhile, a hacker stole $600 million worth of crypto tokens from the PolyNetwork protocol in August in what is considered to be the largest DeFi hack ever."

David. said...

Louis Ashworth's The reasonable case against CBDCs is well worth reading:

"Let’s say it explicitly: it’s completely reasonable — sensible, even — to be concerned about CBDCs.

There are two overwhelming reasons for this:

— people should always be hesitant about potentially giving up rights to their government, even if they trust their government.
— even if people currently trust their government, they should operate on the basis that they may not always trust their government."

Ashworth's annotations and rebuttals of the Bank of England's PR for "Britcoin" are on point.