Tokens—smart digital claims on assets—are going to completely remake financial markets, predicts author and technologist David Birch. Meanwhile, China’s state-backed digital currency experiment could accelerate a global power shift from the US to Asia, he says.
In a new essay called ‘the Digital Currency Revolution’, published by London’s Centre for the Study of Financial Innovation (CSFI), Birch says he expects trading activity to migrate over time from traditional financial markets to tokens.
Tokenisation could make intermediaries like stock exchanges, banks, clearing firms, and custodians redundant, says Birch.
Instead, he says, we will all exchange hundreds or thousands of bearer digital assets between ourselves in bilateral deals.
Bearer assets are those where possession of the asset allows you to dispose of it. Cash, or bearer bonds, are examples of bearer assets.
In the existing system, most financial assets, like shares and bonds, are registered in the name of users. A series of intermediaries keeps the books of record.
While this future, token-based financial market may sound far-fetched to anyone used to the current system, says Birch, what he calls ‘our personal machine-learning AI supercomputer robo-advisors’—otherwise known as mobile phones—will do the hard work for us.
In future, our mobiles will calculate exchange rates and convert one digital asset into another as well as storing our token holdings in digital wallets.
In his essay, Birch gives an example of how tokenised finance will differ from the current system.
“A start-up launches, and instead of issuing equity, it issues ‘money’ that is redeemable against future services. So, for example, a distributed file storage start-up might offer money in the form of megabyte days that are redeemable five years from now.”
“In the early days, this ‘money’ would trade at a significant discount to take account of the risks inherent in the venture. But once the file system is up and running, then the value of the money should rise.”
Displacing intermediaries and improving oversight
Birch says a digital token-based finance market has several major advantages over the current system, starting with cost.
“The cost of trading tokens will be a fraction of the cost of trading stocks and bonds, which is why liquidity will seep out of existing markets and into these new and more efficient structures,” he says.
“One might imagine a new version of London’s Alternative Investment Market, where start-ups launch but, instead of issuing money, they create claims on their future in the form of tokens.”
“The cost of trading tokens will be a fraction of the cost of trading stocks and bonds”
In future, we are all likely to hold a combination of asset-based private tokens and public fiat currency-backed tokens, says Birch, predicting an ‘explosion’ of token issuance.
Governments could also reap benefits from issuing money in digital token form, says Birch, citing research from the Bank of England.
“Central bank digital currency (CBDC) issuance of 30 percent of GDP, against government bonds, could permanently raise GDP by as much as 3 percent, due to reductions in real interest rates, distortionary taxes, and monetary transaction costs,” the Bank said in a 2016 working paper.
Birch says tokenisation will also improve the oversight of economic activity by shifting monitoring from operating with a lag towards operating in near-real time.
“The technological architecture means continuous verification and validation instead of periodic auditing long after the trades and exchanges have taken place,” he says.
China threatens US financial hegemony
Birch notes the intensifying competition amongst superpowers in the area of money, arguing that China’s long-awaited digital currency could enable it to operate worldwide as a competitor to the US dollar.
“The principal threat to the dollar comes not from Facebook but China”
China’s digital currency, says Birch, is likely to use a two-tier architecture, with commercial banks having accounts at the central bank and buying digital currency directly from it. Individuals and businesses will then open digital wallets provided by commercial banks or other private companies (like China’s payment giants, Alipay and Tencent, which runs WeChat).
If China’s central bank can ensure that same digital currency held in different apps is freely exchangeable, “it will be on the way to one of the world’s most efficient electronic payment infrastructures,” says Birch.
In turn, if China decides to internationalise its digital currency’s usage, it poses a direct threat to the US’s control over the global financial system, says Birch.
“The principal threat to the role of the dollar as prime currency comes not from Facebook but from China,” says Birch.
“If the Alipay and WeChat wallets become widely used by a couple of billion people…they will pretty soon shift to the digital renminbi if it does indeed offer speed, convenience and person-to-person transfers.”
“A trader in Africa may soon find it more convenient to order goods from a Chinese partner via WeChat and settle via Alipay. And if he or she can settle instantly with a Chinese digital currency, then they will soon find themselves accepting the same in payment.”
Digital tally sticks
Birch also expects a boom in payments using money issued by small communities, whether geographically based or virtual. Community-based tokenised currencies could then be used to pay for relevant local goods or to support local public services.
“Tokens that implement the values of communities may come to dominate the transactional space”
“Tokens that implement the values of communities (and, because they are ‘smart’, can enforce them) may come to dominate the transactional space (think of the Islamic e-Dinar and the London Groat),” says Birch.
Tokens, for example those run on the ethereum blockchain, can embed executable programmes, leading some observers to call tokens ‘smart’ or ‘programmable’ money.
The communities issuing tokens could also be nation states, says Birch, who notes that Estonia is already thinking of issuing tokens rather than government debt.
The money raised in such an Estonian token offering could be used for a fund jointly managed by the government and outside private companies, says Birch, allowing investments in new technologies for the public sector, as well providing venture capital for Estonian companies.
Estonian tokens could also be used a payment method for public and private services both within the country and globally, says Birch.
Back to tax
Ironically, such an innovation—government-issued tokens replacing bonds and cash—would take us back in history to the time when tally sticks were used to pay taxes.
“Money is something that you can pay your taxes with,” says Birch.
“Money is something that you can pay your taxes with”
“If Estonia were to go ahead by merging its currency and bonds into a single, liquid, circulating digital asset, then we will have gone full circle back to the days when government tally sticks were circulating in England.”
Tally sticks, usually made of hazelwood, were marked with a system of notches and then split lengthwise. English King Henry I introduced a tally stick system in around 1100, accepting only such sticks for the payment of taxes.
Tally sticks became tradeable in a secondary market, leading the word ‘stock’ to be used more broadly as meaning a financial claim on another person.
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