New digital currencies will have a profound impact on our concept of money, the financial system and the economy, says a top regulatory lawyer.
“It’s possible for something to be money without having anything to do with governments”
“No matter what you think of bitcoin, it’s an absolutely valid demonstration that it’s possible for something to be money without having anything to do with states or governments,” says Simon Gleeson, a partner at law firm Clifford Chance.
Gleeson is one of the world’s leading experts in the regulation of financial services and banking. He was speaking to New Money Review editor Paul Amery in the latest episode of our podcast, ‘the future of money in thirty minutes’.
Gleeson’s views put him at odds with the UK’s financial authorities, who last week sought to debunk any claim that bitcoin could be regarded as money.
Digital tokens like bitcoin “fail to meet the tests of money (reliable store of value, wide acceptance and a unit of account) and are not legally recognised currencies,” the Financial Conduct Authority said in a consultation paper released last week.
Private money is not new
During the podcast, Gleeson reminds listeners that the idea of non-state-issued currency is not new.
“We’ve had privately issued money in the UK for a very long time,” Gleeson says.
“Today we have the Bristol pound, for example. And in the 18th century it was very common for factory owners to issue their own micro-currencies, which circulated within their own town or region. It was those micro-currencies that gave rise to bills of exchange and cheques.”
Distinguishing money from deposit takers
“You don’t need money to have an economy or capitalism”
Gleeson goes on to distinguish between the money we deposit at banks—which are legal claims against deposit-taking institutions—and the actual pounds or euros we use for keeping tally. From the point of view of the law, these units are entirely imaginary, he says.
“We administer imaginary counters in our heads. They are no more than points. We are just keeping score,” Gleeson says.
He comes to a surprising conclusion.
“In theory we could get rid of the entire commercial banking sector and replace it with a large book-keeping exercise. At that point you’d have got rid of money altogether. Weirdly, you don’t need money to have an economy or capitalism.”
Banks face massive disruption
The advent of new digital money and new payment service providers (PSPs) signals an existential crisis for the banks, says Gleeson.
“Managing a bank is about to become a lot harder”
“Banks have three core functions: providing payment services, taking credit risk and managing the mismatch in liquidity between their deposits and loans. Today those functions are provided by a single entity. But there’s no reason why they should all be in one place. The direction of travel is fragmentation,” he says in the podcast.
There’s one immediate problem for the banks, Gleeson says.
“If PSPs interpose themselves between banks and their customers, they are likely to cream off the profits from the banking system. That presents a systemic risk,” he says.
He also says that, however hard they try, it will be difficult for banks to reinvent themselves in a way that addresses the growing competition from newcomers.
“If you’re an incumbent in an industry that’s being heavily disrupted, finding a path through is really hard. Managing a big bank is about to become a hell of a lot harder.”
Structural changes and risks
Elaborating on the types of risk created by these structural changes, Gleeson uses the example of China, where new payment firms have recently risen to a position of great economic power.
There’s a fundamental change in the deposit base of commercial banks as a result, he says, which presents a challenge for those tasked with maintaining the stability of the financial system.
“The Chinese authorities have been worrying about the speed of growth of payment service providers. From the perspective of the commercial banks, enormous amounts of money that were previously sticky, long-term, low-cost retail deposits have now become relatively mobile short-term, high-cost commercial deposits coming in from the PSPs.”
How to resolve Facebook’s Libra
Gleeson talks about one of the biggest outstanding legal questions regarding new digital currencies, taking Facebook’s new Libra project as an example.
“How would you resolve something like Libra? They don’t have a central bank behind them. In an emergency, no-one can make new Libras, in the same way as central banks can create new dollars, euros or pounds.”
Money’s privileged status
By comparison with other forms of property, money has always had a privileged legal status. Will this extend to bitcoin and other digital currencies? It depends on how the courts treat these new digital tokens, says Gleeson.
But in theory, he says, there’s nothing preventing bitcoin acquiring the status of currency—a key legal attribute of money.
“Even though in theory you can trace bitcoins, if the law says that bitcoin is money, then the law will not allow you to trace it.”
Gleeson explains why money’s ‘liability exemption’ first came into place.
“The legal argument here is that if you had to look into the provenance of every banknote before accepting it, that would do massively more aggregate damage than being able to spot stolen or laundered money,” he says.
Avoiding a Soviet monetary system
“The central bank would end up as the primary allocator of credit”
Gleeson explains why policymakers will have to tread very carefully when introducing new central bank digital currencies (CBDC).
“Central bank digital currencies have practical advantages,” Gleeson says. “They would be a handy thing to have around from the point of view of the efficiency of payments.”
But if we’re not careful, we could end up with a Soviet-type economic system, Gleeson says.
“If you had a broadly accessible CBDC circulating in competition with private digital money, it’s very hard to see why anyone would want to hold the latter. The vast majority of deposits would end up with the central bank. And the central bank would then end up as the primary allocator of credit in the economy.”
Opening up the payments infrastructure
Gleeson discusses recent initiatives by the Bank of England to open up its payments infrastructure.
“There are two important parts to Mark Carney’s statement,” says Gleeson, referring to a recent speech by the Bank of England governor.
“One is that he is going to allow PSPs to access the UK’s real-time gross settlement (RTGS) system, the core of the sterling payments system. The other is that he is going to allow PSPs to have accounts directly with the central bank. A PSP with that access can effectively by-pass the whole of the commercial banking system.”
Inefficiencies in payments
“Making payments across borders is very slow and very expensive”
Gleeson explains why the law has up to now prevented the creation of a single, seamless global payment system—and why Facebook’s Libra initiative is focusing on cross-border payments.
“The trouble with existing payment systems when you try to use them across borders is that you run into legal problems regarding things like settlement finality. For a lot of the world, making payments across borders is very slow and very expensive.”
Expect banks to fight back
“The banks will not just fold their tent and steal away”
Financial technology firms expecting banks just to give up in the face of mounting competition should have a rethink, though, says Gleeson.
“If payments start to be seriously disrupted, the banks will not just fold their tent and steal away. They will fight back.”
In any case, current innovations in payments will have to coexist with earlier technologies, Gleeson says.
“Coins have been around for 2,500 years. Banknotes have been around for a couple of hundred years. Apple Pay has been around for three or four years. But I can walk into the newsagent in the morning and use any one of these to buy a newspaper. Payment developments don’t displace each other, they tend to coexist.”
Challenges for the law
The advent of new digital currencies poses major questions for the law, says Gleeson. He lists some of them.
“The kinds of questions lawyers will be trying to answer will be: ‘If I owe you sterling and you owe me Libra or bitcoin, can I set off and how do I have to treat these claims? What’s the value of the claim for Libra and can I have judgment in Libra or do I have to have judgment for a value of sterling and, if so, what is that?’ The points where the old and the new rub against each other are where we’re going to see the real challenges for legal development.”
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