Charles Silverman, former head of Financial Technology Corporate Banking, and currently head of AML/BSA Risk Management Oversight, Wholesale Banking describes how a centralized distributed ledger could revolutionize how governments, banks, and citizens.
Read ArticleMoney. It’s come a long way in the last millennium, evolving from crude systems of barter, through a heyday of unregulated coins and currency, to government-issued fiat money, and into the modern age with sleek electronic transactions. In the U.S., we’ve consolidated from more than 10,000 different banknotes in 1860, issued by individual banks, to a single, trusted U.S. dollar, managed for more than 100 years through the Federal Reserve network.1
Despite all these advancements, the systems that financial institutions use to track and record the movement of money are far from cutting-edge. Distributed ledger technology, along with a government-issued digital currency, has the potential to change that by establishing a platform that’s fast, safe, and transparent.
Removing friction from the global monetary system
Digital currencies exist today — Bitcoin or Ether, for example. However, these “cryptocurrencies” operate independently from the established monetary system. That makes them impractical for many transactions, and prone to volatility.
A government-backed digital currency, on the other hand, would replicate a paperless version of the current U.S. dollar. This fiat currency would hold value in the same way as a quarter or $10 bill, and be subject to the same government regulations as the current supply of cash and coin. It would also be different than today’s “electronic” or “digitized” currency, which is really just a bank’s record of stored money; the record itself is not legal tender.
The technology that powers digital currencies, a distributed ledger system known as blockchain, holds tremendous promise if used as a centralized platform for a digital currency. It could create a streamlined payment system where any person or entity could move funds instantly — from one internet protocol (I.P.) address to another — without the need for an intermediary.
Taking that friction out of the system could generate tremendous efficiencies, which in turn could eliminate many of the costs and settlement delays associated with today’s payment mechanisms. Clearing houses, which form the backbone of the current money movement system, cease to exist in a fully digital environment. Financial services firms — including credit card providers, banks, and credit unions — would no longer expend resources or collect fees for simply moving funds and recording transactions; instead, their business models would pivot to user experience, customer service, core offerings such as loans and mortgages, and innovative new services.
Of course, the timeline for a digital currency is a long tail transition. Just as coins and paper currency have co-existed for hundreds of years, so would a digital, fiat currency exist side-by-side with today’s traditional forms of money. Depending on the technology in place and public demand, the switch to a fully digital environment could take decades — or longer.
Increasing speed and transparency in financial transactions
A government-backed digital currency could offer numerous benefits for businesses and consumers.
- Confidence. Transactions using a digital currency would preserve the same value as their cash and coin counterparts, giving buyers and sellers security and peace of mind. Digital currency, with its distributed ledger record held by the U.S. government, could remove concerns and potential losses due to counterfeiting.
- Speed. Even with faster payments, which can move funds between bank accounts in just seconds, recording the final settlement of those transactions can take up to three days — and longer for cross-border payments. By replacing today’s legacy systems and clearing houses with a centralized distributed ledger, moving money and recording each transaction could occur instantly.
- Transparency. It’s relatively easy to move physical currency outside the financial system; it’s why criminals seek out those briefcases of unmarked bills in the movies, and why banks demand verification for cash deposits over $10,000. A digital currency could make financial crimes such as money laundering and tax evasion far more difficult. Generating a permanent electronic record of every transaction — and one that’s held by the U.S. government — could make enforcing fraud and cybercrime legislation practical and effective.
- Savings. All parties in a digital currency transaction stand to save money. By eliminating intermediaries, consumers and businesses could avoid the fees charged by providers to execute transactions. Going completely digital could help banks and governments reduce the resources needed to identify and mitigate many financial crimes, which today account for billions of dollars annually.
A centralized digital currency isn’t entirely without risks. In the wrong hands, rogue governments could operate outside the law, potentially circumventing international sanctions. Electronic record-keeping also triggers privacy concerns for some. The existing banking system would need a makeover of their technology platforms to accommodate a new form of money. These and other challenges would need to be addressed before a digital launch.
Adopting a centralized digital currency isn’t imminent and would take time. But, neither is it the stuff of futuristic science fiction. World economists have innovation on their agendas, with governments, banks, and businesses excited to see what’s next.
1. Visual Capitalist, “A Tale of Two Banking Sectors: Canada vs. U.S.,” May 16, 2018