Making Sense of Crypto Ravi Menon
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Bibliographic details
- Authors: RAVI MENON
- Published: September 1, 2022
Overview and central message
- Central banks and regulators cannot afford to wait for clarity on how crypto-related innovations will shape the future of money and finance.
- Innovations include digital assets, cryptocurrencies, stablecoins, and central bank digital currencies (CBDCs).
- Some innovations already pose risks that must be understood and addressed; others present potential benefits worth harnessing.
- Frameworks developed by central banks and regulators need to evolve continually as technologies, business models, and market practices change.
- The Monetary Authority of Singapore (MAS) aims to develop an innovative and responsible digital asset ecosystem by examining various crypto innovations individually, taking into account their specific risks and potential uses.
Digital assets: features, use cases, and Singapore initiatives
- Definition:
- A digital asset is anything of value whose ownership is represented in a digital or computerized form; it could be a financial asset, a real asset, or something intangible.
- Three distinct features of the digital asset ecosystem:
- Tokenization: using software programs to convert ownership rights over an asset into a digital token that can be stored, sold, or used as collateral.
- A distributed ledger, or blockchain: an immutable computerized record of the ownership and transfer of ownership of a token.
- Cryptography: advanced encryption techniques to ensure that transactions in these tokens are secure.
- Promising use cases in financial services:
- Cross-border trade and settlement.
- Trade finance.
- Pre- and post-trade capital market activities.
- Reported efficiency gains using distributed ledger technologies:
- Cross-border payments and settlements: reductions in settlement time from two-to-three days to less than 10 minutes and in transactions costs from 6 percent of transfer value to less than 1 percent.
- Trade finance: reductions in processing time for letters of credit from five to 10 days to less than 24 hours.
- Capital markets: reducing the time to clear and settle securities transactions from two days to less than 30 minutes.
- Singapore pilots and initiatives:
- United Overseas Bank Ltd. piloted issuance of a S$600 million digital bond on Marketnode’s servicing platform that facilitates a seamless workflow through smart contracts.
- Marketnode is a joint venture between the Singapore Exchange and the investment firm Temasek.
- MAS launched Project Guardian to explore digital asset applications in wholesale funding markets. Led by DBS Bank, JP Morgan, and Marketnode, the first pilot involves creating a liquidity pool comprising tokenized bonds and deposits locked in smart contracts to enable seamless secured borrowing and lending.
- OCBC Bank partnered with the digital exchange MetaVerse Green Exchange to develop green financing products using tokenized carbon credits to ensure provenance and reduce double-counting.
Cryptocurrencies: assessment and regulatory stance
- Private cryptocurrencies (e.g., Bitcoin) are assessed as failing as money:
- Perform poorly as a medium of exchange, store of value, and unit of account.
- Many widely traded cryptocurrencies are utility tokens that have become speculative assets with prices divorced from underlying economic value on the blockchain.
- Extreme price volatility rules them out as viable tokenized currency or investment asset.
- Illicit activity and cybercrime concerns:
- Use of e-wallet addresses or pseudonyms facilitates illicit transactions, including money laundering.
- Cryptocurrencies have helped to fuel ransomware.
- MAS actions:
- Consistently warned the public of hazards of trading in cryptocurrencies.
- Implemented measures to make it harder for individuals to access cryptocurrencies, including banning advertisement or promotion of cryptocurrencies to the general public.
- Plans to impose further restrictions on retail access to cryptocurrencies.
Stablecoins: potential and regulatory priorities
- Definition and promise:
- Stablecoins are tokens whose value is tied to another asset—usually fiat currencies—and seek to combine stability and tokenization to be used as payment instruments on distributed ledgers.
- Some technology firms have integrated stablecoins into payment services; Visa and Mastercard allow transactions to be settled using USD Coin.
- Regulatory focus to ensure stability:
- Stability depends on the quality of the reserve assets backing the coins, not merely on being pegged to a fiat currency.
- Key supervisory concerns: liquidity, credit, and market risks of reserve assets; auditability of reserves; ability to redeem stablecoins at par.
- Risks and systemic considerations:
- Collateralization by financial assets ties stablecoins more closely to the broader financial system than unbacked cryptocurrencies.
- Under liquidity stress, a stablecoin issuer could be forced into a fire sale of reserve assets with potential repercussions for the financial system.
- While contagion risk is small at this point, appropriate regulatory levers are being considered if the risk becomes significant.
- The Financial Stability Board (FSB) and international standard-setting bodies continue to update guidance.
- MAS will soon issue proposals to regulate stablecoins in Singapore.
Wholesale CBDCs: rationale and cross-border potential
- Definition:
- A CBDC is a direct liability and payment instrument of a central bank. Wholesale CBDCs are restricted to use by financial intermediaries and are akin to balances commercial banks now place with a central bank.
- Rationale and benefits:
- Strong case for wholesale CBDCs, especially in cross-border payments and settlements.
- Current cross-border payments are slow, expensive, and opaque; payments often route through multiple banks and settlement is not instant.
- Directly linking instant payment systems across countries achieves real-time payments at lower cost, but settlement remains an issue.
- Wholesale CBDCs on a distributed ledger have potential to achieve atomic settlement—the exchange of two linked assets in real-time.
- International collaboration:
- Bank for International Settlements Innovation Hub Project Dunbar explores a common multi-CBDC platform to enable atomic settlement across multiple countries; partnership includes the MAS, Reserve Bank of Australia, Bank Negara Malaysia, and South African Reserve Bank.
Retail CBDCs: assessment and alternatives
- Nature and contested case:
- Retail CBDCs are digital cash issued by a central bank to the general public; their unique attribute is being a liability of the central bank.
- Three commonly cited arguments for retail CBDCs and MAS responses:
- Preserve direct access to public money in a digital economy:
- MAS view: differences between liabilities of central banks and commercial banks are generally of little practical concern to most individuals. Trust in money safety and central bank backstops may reduce the need for direct access.
- Constraint on monopoly power in retail payments:
- Alternatives include opening up retail payment systems to more participants (including non-banks), capping interchange fees, and setting minimum standards for speed, access, and interoperability—balanced against the risk of discouraging new entrants.
- Greater privacy and control over personal information and transactions:
- Alternatives include regulatory or legislative enhancements to protect user privacy and data governance.
- MAS position for Singapore:
- The case for a retail CBDC in Singapore is not compelling for now given well-functioning payment systems and broad financial inclusion.
- Retail electronic payment systems are fast, efficient, and cost nothing; a residual amount of cash remains in circulation and is unlikely to disappear.
- MAS is building a technology infrastructure that would permit issuance of retail CBDCs should conditions change.
Future state scenarios and policy guidance
- Uncertainty acknowledged:
- It would be foolhardy to be definitive about how innovations will pan out; central banks and regulators must monitor trends and adapt policies and strategies accordingly.
- Plausible future outlined:
- The digital asset ecosystem could become a permanent feature co-existing with today’s intermediary-based system.
- Traditional fiat currencies likely to continue to dominate.
- Securely backed private stablecoins and wholesale CBDCs could play an important role in cross-border payment and settlement.
- Retail CBDCs may emerge as a small component of the monetary base—similar to the role played by cash today.
Source: Making Sense of Crypto, Ravi Menon, F&D Magazine, September 2022.