The technology of money

Technology is a force akin to nature. And just like nature, technology evolves. Money is a form of technology. A technology to keep account and facilitate exchange.

We have seen the evolution of monetary technology through the ages: from clunky gold coins, to paper notes onto electronically chipped credit cards and mobile wallets. However, coins and Apple Pay are only means of payment.

Whilst the means of payment have evolved, underlying payment rails have remained analogue. Recent technological developments are transforming the underlying infrastructure of money.

What is money

The underlying technology of money is the ledger. Ledgers are a record system that keep account of transactions and balances.

In modern finance, the use of ledgers for facilitating the movement of money traces back to the Medici family. In the 15th century, the Medici family popularised a record keeping system called double entry bookkeeping. Double entry bookkeeping enabled money to move across the globe by using two ledgers: one for credits and one for debits. By balancing these ledgers, financiers were able to track money and thus have confidence in handing out loans and facilitating payments across borders.

In 2008 double entry accounting had a challenger for the first time: the blockchain. Blockchain is the underlying technology of cryptocurrencies like bitcoin. Blockchains are cryptographic ledgers. Bitcoin's blockchain, similar to Medici's ledgers, holds an account of transactions and of who owns what. But there are three key differences.

Firstly, instead of relying on two ledgers, blockchain uses many ledgers (held in “nodes” i.e. computers). Secondly, instead of being verified by a financier; blockchain entries are verified by a protocol. Finally, historic ledgers have relied on human trust whilst blockchain based ledgers place trust in technology.

Blockchain and the internet

To better understand the move from double-entry to many-entry bookkeeping, a rough analogy can be drawn.

The move from traditional financial accounting to blockchain based distributed ledger accounting is akin to the move from the postal network to the internet. In finance, the way money moves has changed; in communication, the way messages move has changed.

Three parallels can be drawn between blockchain and the internet.

Firstly, both blockchain and the internet rely on protocols: an example of a blockchain protocol is Bitcoin which facilitates transactions between different wallet addresses; the key internet protocol is TCP (Transmission Control Protocol) which facilitates communication between different IPs.  

Secondly, both blockchain and the internet removed the need for intermediaries: blockchain lets you send money without banks; the internet lets you send messages without the post office.

Finally, the internet and blockchain have both brought similar benefits. Traditional mailing services are much slower and more expensive than electronic mailing services. And transactions on blockchains are much faster and often cheaper than traditional banking rails. Most importantly, by cutting out intermediaries both blockchain and the internet enabled decentralization.

Decentralized networks are a breeding ground of disruptive innovation

Whilst the comparison between the internet and blockchain holds some weight – it may be overegged.

Prior to internet protocols speeding up communication, there also existed the telegraph and the telephone. Similarly, banks have evolved: they have used communication channels like SWIFT and other infrastructure to enable faster monetary movement. However, the key distinction between previous innovations and the innovations of the internet / blockchain is the use of open network protocols.

Both the internet and blockchain are open networks that allow anyone to participate. And this is arguably the greatest benefit. Often termed “decentralization”; the notion that there is no single entity in control and that organization is driven by participation.

On the internet, a series of hosts and servers are used to send messages between different computers – without a single one having full control. Similarly, blockchain networks have mining nodes and full nodes who are all engaged in verifying transactions – without a single one having full control.

Dee Hock, the founder of VISA, explains the value of such decentralization “in healthy living systems control is distributed and change occurs continually…. evolution effortlessly tossed off countless varieties of complex organizations— rain forests, marine systems, weather systems, immune systems— with seeming ease… something about the nature of complex connectivity that allows spontaneous order to arise, and when it does, characteristics emerge that cannot be explained by knowledge of the parts.”

Accordingly, the decentralization these new technologies offered have given rise to continuous and unpredictable innovations: the internet has given birth to countless new models of human communication whilst blockchains have produced countless financial innovations: Automated Market Makers, Perpetual Swaps, Stablecoins, Oracles etc.

New Financial Structures

TCP/IP transformed the communication infrastructure of modern society. Similarly, blockchain is changing modern financial infrastructure.

The aforementioned blockchain innovations are termed Decentralized Finance (DeFi). DeFi is a nascent industry that has spawned trillions in value across open network protocols. However, outside of facilitating speculation, it has been argued that DeFi innovation has little real-world application. This is changing.

Central Banks across the globe are investigating the launch of digital currencies (CBDCs) utilising distributed ledger technology for the base layer of money. Whilst Central Bank adoption of blockchain technology is telling; it is less significant than adoption by private entities. The real transformative application of blockchain will come from private markets. As Larry Fink, the CEO of BlackRock, portends: tokenization will be the next generation for markets with stocks, bonds and fiat currencies represented on blockchains via “tokens".

Tokenization of finance

By representing an asset as a token, the asset becomes fluid by virtue of blockchain infrastructure. With current payment infastrucure, money moves around the world via banking communication systems such as SWIFT. These monetary channels require a settlement: i.e. confirming of the transaction by correspondent banks. This settlement process usually takes about 2 days. In contrast, blockchain protocols can provide instant settlement. Central Banks have run successful test pilots whereby instead of relying on a consortium of banks to move money, the currency is represented as a token on a blockchain and is then able to move instantly. Instant settlement via blockchain protocols bring signifigant benefits to areas such as remittances and treasury management.

Major banking institutions are involved in tokenizing many other real world assets such as bonds, securities and fund instruments. Citi predict that USD 5 Trillion worth of securities will be tokenized by 2030, the European Investment Bank have deployed digital bonds and JP Morgan have launched tokenized fund initiatives – evidencing the present and growing value of DeFi technologies.

The winds against progress (regulations)

Whilst blockchain technology has received the approval of both the highest echelons of government monetarists as well as titans of the private sector. Significant headwinds remain.

These include technical issues: e.g. scalability issues on public blockchain networks, low quality user interfaces and susceptibility to hacks and other exploits. More importantly, legal issues: without regulatory clarity, many institutions are estopped from meaningful engaging with this new monetary technology.

Whilst regulatory efforts are afoot, many of these are hostile to public blockchains.

For example, the UK’s recent FCA guidance gives approval to Fund Tokenization on permissioned, private blockchains but fails to clarify routes of interoperability with public blockchains. In addition, the EU recently released MiCA a set of regulatory guidelines that guide cryptocurrency operators. However, the legislation places limits on stablecoin transactions that are not pegged to the Euro. This portion of MiCA reveals a wider concern that lies at the root of ongoing regulatory headwinds: the rise of public blockchains risk the monetary sovereignty of fiat currencies.

The stated reason for regulations are transparency and investor protection. Public blockchains are completely transparent with all transactions being public; moreover, market manipulation and loss of funds occurs frequently in the traditional stock market.

Since public blockchains allow for anti-money laundering enforcement and degrees of investor protection; it is likely that the true reasoning behind regulatory concern is the entrenchment of the status quo. Whilst public blockchains enable greater innovation and have, undeniably, greater impact; regulators are unlikely to relinquish monetary sovereignty.

Conclusion

Technology is a force akin to nature. And money is a form of technology. In nature, evolution is an unstoppable force and though the environment may try to resist, eventually the best technology will succeed.

In previous years, blockchain technology has been outright banned by regulators and ridiculed by established institutions. However, persistent innovation on the bedrock of sound technology has proven that public blockchains are here to stay. Accordingly, large institutions are now building on public blockchain infrastructure and regulators are being forced to accommodate digital assets at risk of being outcompeted by more lax jurisdictions.

The legal system is likely to entrench permissioned blockchains where regulators are able to retain a degree of control. Nonetheless, it is in open networks where the greatest innovation occurs. Accordingly, regulators must ensure that tokenization frameworks facilitate communication with public blockchains to remain aligned with the evolution of money.