by Jamie Holmes
On July 20, 2016, the Economic Affairs Committee of the House of Lords held a hearing to educate themselves on the potential benefits and risks of using blockchain technology and the effect it may have on the economy. The lively discussion raised some interesting points and questions; while shedding light on recent research on a central bank issued digital currency, it also explored the disruptive impact of distributed ledger technologies and allowed the politicians an opportunity to ask questions. When probed about the viability of the emerging fintech sector Ben Broadbent, Deputy Governor of the Bank of England, said,
“…the bursting of the ‘tech bubble’ didn’t do too much damage economically. The projects were mostly funded with equity not debt, similar to this sector. It is not credit…but equity that is funding a lot of this.”
His comments potentially signal a bright future for blockchain innovations in the UK. Below we will explore the three main themes from this recent hearing.
What will a central bank digital currency look like?
The committee seemed most interested in discussing a recent research paper by the Bank of England, entitled the “Macroeconomics of central bank issued digital currencies.” The main finding of this research was that if the central bank issued 30 percent of the Gross Domestic Product (GDP) as digital currency, the GDP would rise by around 3.0 percent. This is not surprising given the lackluster growth in economic activity in the U.K. recently.
“It is a very interesting piece of work,” said Broadbent. “It rests on the idea that seignorage would go up and would bring a more efficient means of taxation. Another kind of effect is the Q.E. [Quantitative Easing] effect, where increasing the balance sheet of the central bank reduces the interest rate and thereby stimulates economic activity. That’s something we have done, with our Q.E. program at around 20 percent of GDP.”
Broadbent stressed the that a central bank issued digital currency would overhaul the banking sector.
A central bank issued digital currency would have significant consequences for what the banking sector will look like — so we have to ask ourselves this question: what do we want it to look like?
It is encouraging to see the government debate with Broadbent on the topic of fractional reserve banking as cryptocurrencies and Bitcoin seem to have forced central banks to think about this issue a bit more. Bitcoin is a full-reserve system; someone cannot lend out 1 Bitcoin unless they hold at least 1 Bitcoin. However, with fiat currencies, it is a fractional reserve system. A bank can lend multiple amounts of what they hold in reserve. By looking at the issue of a national, digital currency, it is interesting to examine the question, does a full-reserve or fractional-reserve system work better? And it is a promising sign that politicians are asking this question too. However, there are no easy answers. Broadbent noted that this is a question that has challenged economists for centuries.
Perhaps the most important indirect effect of introducing a central bank issued digital currency is that it would revolutionize empirical research in economics. According to Professor Michael Mainelli, from the Gresham College, “For the first time, the quantity of money and the velocity of money can be observed and measured accurately and can bring economics away from astrology and closer to astronomy.” Under the current system, central banks create money but so do lenders in the financial sectors; when they extend credit, this is added onto the existing money supply, making it difficult to precisely measure these variables.
Disruption to existing industries
As the U.K. economy is mainly dependent on financial services, committee members probed for an indication of the extent to which existing industries may be disrupted by distributed ledger technologies. When pressed for confirmation of the $16 billion-a-year figure that blockchain technology could save banks, from research by Santander, Broadbent replied, “We are at the start of things… Who knows? But that figure compared to the GDP of a developing country is very small and I would hope the cost savings are bigger than that.”
He also highlighted the cost advantages of blockchain-based systems saying, “A clear advantage with a lot of this technology is that there is a single standards and a single platform; therefore, we get increasing returns to scale.”
According to Mainelli, the disruption will be most impactful for the economic and power structures of central, third-parties.
Normally, under a central third party their position allows them to hold onto all the data, they will eventually abuse this position and make money out of it somehow. Society often struggles with this…
When asked, “What stands in the way of rapid rollout of this technology?”, he replied, “Collaboration. Banks currently do not need to share information.” He also alluded to the flexibility of this technology, “There are a variety of things you can build with new ledgers. There are a lot of design choices here. Setting rules on the blockchain: this is where we need industry collaboration…” and gave insurance as a further example to the committee.
Mainelli told the committee that blockchain will will have disruptive effects on a host of industries, mentioning electricity, shipping, insurance, health, media and any industry formed by some sort of central third-party. In insurance, contract disputes take up a large proportion of costs for the Ministry of Justice and Mainelli suggested that distributed ledgers can save billions per year in a very short time. He emphasized the binding of contracts is what is ground-breaking about this new technology. A vast sum of money is wasted on lawyers and legal fees just determining the conditions present at the time the contract was forged.
Not only will the financial sector undergo a major upheaval but so will the government. Lord Spens emphasized that the government can become much more efficient across a number of departments. For example, a trial by the Department of Work and Pensions to use a virtual currency to distribute benefits payments, named “GovCoin,” has shown a significant reduction in administration costs. This virtual currency program could be adopted nationwide to reduce waste and increase the efficiency of the public sector.
Lord Keer raised the point that the Estonian government had adopted blockchains and brought up the issue of whether that example demonstrates that distributed ledger technology is proven to work and whether the U.K. government could learn some lessons. Mainelli highlighted that it has effectively replaced the bank identity system and seems to have been a great success. He then went onto state his case for adopting this technology, noting two areas where the U.K. will reap huge benefits.
Firstly, adopting a blockchain identity system like Estonia’s will reduce the large costs associated with Know-Your-Customer and Anti-Money Laundering as this will become obsolete with such a system, as well as administration costs of collecting and maintaining records.
Secondly, distributed ledgers will allow a better handling of data of immigrants and the ability to verify people’s identities without the risk of the integrity of the data being compromised.
Concerns raised, fears put to rest
Fears and concerns raised by the committee members ranged from a slide into a Big Brother state, to new incumbents forming monopolies in disrupted industries and hidden activity in the economy facilitated by a national, digital Pound Sterling.
Fear of a larger “informal economy”
Concerns from the committee were raised about entities escaping supervision of the state and regulators, making reference to Bitcoin, the virtual currency that is pseudonymous and has allowed people to maneuver outside of the traditional financial system. Broadbent replied by saying, “Of course, we would want to monitor this… but this technology doesn’t necessarily mean it will lead to more ‘hidden’ activity…”
Fear of monopolies
Lord Keer expressed concern about monopolies, suggesting that as companies compete to use the technology, a single winner could emerge. He referred to the industries that Mainelli mentioned as being exposed to disruption, probing whether blockchain technology would allow companies to establish position in their respective markets with a high degree of pricing power. Mainelli stated that “I am fully assured that we wouldn’t wind up creating a large monopoly.”
Fear of a Big Brother state
Discussion over whether you could track someone’s spending habits using GovCoin and find out what they were spending their money on raised alarm about whether this technology would lead to some sort of “Big Brother” state. After hearing about all the potential advantages, the committee questioned if this was even ethical. However, Dr. Catherine Mulligan, researcher on cryptocurrencies at the Imperial College London, agreed that while that it could be used to turn Britain into a Big Brother state, she also said that “it could be designed differently” in order to avoid such an outcome. She also posed a thoughtful question after discussion about whether or not people should be allowed to spend benefits on whatever they want.
With this technology, the challenge for us is to think about what sort of economy is it that we want?
Blockchain’s future bright in the U.K.
As government plays catch-up to this new technology we could well see the UK utilize the blockchain similar to how Estonia has used it. What was interesting from the hearing was that the committee was especially interested in how the issuance of digital currency could improve the rate of economic growth. This could be a real driver toward favoring implementation of this revolutionary innovation within the U.K. government in the the post-Brexit fallout.
By increasing the efficiency of tax collection and benefits distribution, blockchain technology could provide a basis for the government to reform itself and conduct a leaner operation. But it will also force the government to confront deep, ethical questions such as, “What kind of economy and financial sector do Britons want to achieve?”