Crypto's Biggest Challenge: Permissioned Digital Currencies

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In a pattern similar to the five stages of grief, cryptocurrencies appear to be going through the ‘five stages of acceptance’ in mainstream society. First there was pure ignorance; then dismissal; followed swiftly by skepticism; then limited or restrictive toleration; and finally (we hope) acceptance.

While few pundits (unless you’re FT Alphaville) would be so brazen as to dismiss crypto out of hand – Jamie Dimon’s likening of Bitcoin as “a fraud” has not aged well – most mainstream figures see themselves as healthy skeptics.

Just this week, the IMF Managing Director Kristalina Georgieva said that although they had been assessing the benefits of cryptocurrencies, including financial inclusion, they had also said it could “be abused for illegal purposes” and that there were “issues with sovereignty that need to be well understood and addressed.”

But as last week’s bust of ‘welcome to video’, one of the largest pedophile rings in history shows, cryptocurrencies operating on public ledgers are far from a criminal’s best friend. In fact, they can actually go some way to identifying and correcting illicit behavior that had previously been undetectable when hard cash was the only option.

It feels that the asset-class may be about to enter the next stage of acceptance: limited or restrictive toleration, including mainstream entities – governments and private companies -beginning to trial and test the technology as well as devise their own permissioned iterations that leverage blockchain technology but nonetheless give them suzerainty over who can and can’t use it.

Nothing better summarizes this stage more than this term: digital currencies.

Digital currencies ≠ permissionless

Prima facie there is little difference between cryptocurrencies and digital currencies: they are both designed as stores of value working on some form of distributed ledger technology that can facilitate fast and seamless payments both domestically and across borders.

In February, US investment bank JPMorgan unveiled JPMCoin, a permissioned settlements solution using USD-backed tokens; Facebook announced Libra in June, which it claimed would allow everyone with a Facebook account to send and receive value; the People’s Bank of China (PBOC) revealed in August that it has also been working on its own state-backed digital currency, slated for release in the next few months.

But cryptocurrencies and the new proposed digital currencies are not the same thing. They are different in one crucial way: digital currencies are permissioned, whereas cryptocurrencies, the likes of Bitcoin (BTC) and Ether (ETH), are permissionless –  they are freely available for anyone to use without censure.

JPMorgan has full control of JPMCoin. At the time of writing, it can only be used by JPMorgan itself as a means to transfer value across borders on behalf of its clients. That’s it.

With Libra, American politicians have already raised concerns about whether Facebook and the rest of the Libra Association will guarantee users financial privacy and whether large for-profit companies will have the power to censure transactions not to their liking.

Facebook’s Founder and CEO, Mark Zuckerberg, appeared before Congress this week, with a clear message that his company would not participate in the Libra payments mechanism if it did not secure U.S. approval.

As Binance researchers also highlighted, the new Chinese digital currency will probably enhance state surveillance with authorities having access to the entire financial history of more than 1.3bn people.

For a country with a dubious human rights record, it raises fundamental questions on who really benefits from this new digital currency. Could citizens be excluded from their accounts as punishment for dissenting against the state?

In defense of crypto

Although the developmental phase has been far more chaotic, cryptocurrencies in their purest form provide what the IMF recognized as the main advantage of digital assets: permissionless financial inclusion.

A coin exists at a price determined by the free market, for anyone anywhere to use as they see fit. Being built on a public ledger means most cryptocurrencies cannot be used for illicit activities. Like the ‘welcome to video’ case, authorities can identify and track criminal activity.

However, while it would be difficult to see the Uighur minority or Tibetan independence advocates having unrestricted access to China’s digital currency, there is no one entity with the ultimate authority to arbitrarily exclude certain types of people from using a cryptocurrency.

The rise of digital currency initiatives has not altogether been a bad thing. Indeed, it has helped change attitudes surrounding cryptocurrencies from hyped-up Ponzi schemes to a new asset-class with a set of unique characteristics – and the potential to change significant parts of the existing financial system.

Libra, in particular, has made central banks around the world begin to seriously consider digital currencies. As one FT journalist put it: “if [central bankers] do not have a hard think about whether to make their own digital monies, someone else will.”

A fundamental shift is underway: “The American government…has had the view that we do not have to compete for things that are governmental”, explained US Congressman Patrick McHenry on last week’s Unchained Podcast.

Whether that’s the value of the USD or the regulatory regime, “…we have to change our mindset, we have to compete against other regimes around the globe and we have to compete with private sector innovation”, he said.

The meeting of two worlds

Digital currencies are the synthesis of two very different paradigms, a blend of some of the aspects of decentralization including borderless payments, with overarching centralized control.

Governments and multinationals are beginning to tolerate distributed ledger technology, but only if it’s on their terms: which means permissioned blockchains. They see the advantages and will countenance adoption, but they are unwilling to shift away from their initial position.

In the long-term, that will be untenable.

In the meantime, the industry runs the risk of accepting digital currencies on their terms. To use an old Devonian term, it would be akin to taking the pastry and throwing away the meat.

International payments may become seamless, but unless they are fully-permissionless they will do little to encourage the higher good of greater financial inclusion.

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