They say a banking licence is a licence to print money. Most people when they hear this assume this refers to how much profit banks make, but the truth is the expression comes from an older time, when banks where literally allowed to print bank notes.
These bank notes where a convenient way of walking around with stored value, they existed along side a few other systems at various times, and it’s worth briefly talking about each of them.
Firstly, there was coin. Coins had intrinsic value, literally the metal they were made of. You could take a coin from Spain to a merchant in Venice and he’d accept it, not because he could exchange it at a money changer, but because you could simply melt it down and get the value out of it. Coins had a disadvantage though, the value you could carry scaled more or less linearly with the weight. (gold and silver being step changes in value/gram).
Along side coins there was another system, a peer to peer money system called Tally Sticks. People would literally split a wooden stick in half, and then when they wanted to record a new debt between 2 individuals they’d hold the sticks back together, and make a new mark.
Tally sticks were convenient for 1:1 transactions, and if you held a tally stick that said say, you were owed £100 by a farmer down the road, you could probably sell that to another farmer, or banker for £98 or £99.
Peer to Peer money has existed at other times as well, various communities have created their own, like the Brixton Pound or the Ithica Hours, and in the 60’s in Ireland people would use cheques, written to their local pub as a form of currency during the frequent multi month long bank strikes.
Within a country though, by far the most convenient system of value was the Bank Note. Accepted universally, valid for the payment of all goods, services, debts and taxes, and usually backed by the government even in the event of the issuing bank failing.
Banks traditionally earned money by a system called Net Interest Margin. What they would do, is take deposits, and pay the depositor a small amount of interest, and lend those deposits out to borrowers for a larger amount of interest. The difference, less their costs including the loans that go bad is how they made their money.
Banks can also lend money back to the government, by giving it to the Bank of England, and earn some interest on that. The Bank of England can pay back the banks, by either creating new money (inflation), or by collecting tax. When it works right, the whole system is nicely balanced.
Banks therefore, used to like issuing bank notes, because rather than having to sign up a customer, and create an entry in their ledger (presumably giving the customer a deposit book), they simply took the gold, and handed the customer an anonymous, but hard to duplicate piece of paper promising to pay the bearer the sum of £10. They would then loan the £10 back to the government and earn some interest.
Block chain technology is rapidly maturing to a state where both the coin type money, the tally stick type of money and the “bank note” type money can be represented and processed.
The original blockchain, Bitcoin, was like coin. The value of a single Bitcoin comes from it’s intrinsic properties. Satoshi explained it best when he said this:
As a thought experiment, imagine there was a base metal as scarce as gold but with the following properties:
- boring grey in colour
- not a good conductor of electricity
- not particularly strong, but not ductile or easily malleable either
- not useful for any practical or ornamental purpose
and one special, magical property:- can be transported over a communications channel
If it somehow acquired any value at all for whatever reason, then anyone wanting to transfer wealth over a long distance could buy some, transmit it, and have the recipient sell it.
Coin is great, especially for low value purchases where the buyer and seller are in the same place. There’s a big downside to using coin, especially coin that can be teleported instantly.
One of the best preventions to fraud is to physically be close a person who wants to sell you something, and hand them the coin, while they hand you the goods. Without the threat of violence all sorts scams become possible where the buyer sends the (bit)coin, but the seller never sends the goods.
This will limit Bitcoin ultimately to being used only for purchases where physically meeting the seller is undesirable (drug deals) or where the two parties trust each other just enough to know they won’t get scammed immediately, but don’t want to just accept a vague promise of future payment (IOUs or Tally Sticks).
Much has been written about the Ethereum blockchain, about how it has smart contracts that can talk to each other. These contracts enable a kind of Internet of Agreements. Anyone can create peer to peer contracts that allow for tokens representing some value to be exchanged for something else.
The Ethereum network also has it’s own kind of cash. It’s called Eth, and it’s intrinsic value is: That it can do all the things Bitcoin can do, and it’s also guaranteed to be in-demand as it’s used to pay for the running of the network. Its value is not pegged to anything though, and not enough things are priced in ETH to stabilise the price, so it fluctuates wildly in the winds of supply and demand.
The last piece of the puzzle then is for the Ethereum network to have “Bank Notes”. These would be just like the bank notes of old, issued by a Bank, that does so in order to lend the money back to the Government, and denominated in the currency of the land.
Ideally any licensed bank would accept bank notes issued by any other bank, and could chose to use them to settle debts to the issuing bank, or have some way of exercising them, perhaps by sending them to the Bank of England, causing the BoE to credit their reserve account, and debit the issuing bank.
To the user, the experience would look like this. They open their bank app on their phone, click the withdraw button and some money from their account is converted into, say Royal Bank of Scotland Ethereum Pounds Sterling (RBS-EPS), or Monzo Ethereum Pounds Sterling (M-EPS).
In some ways this would be like walking around with an ATM in your pocket. Super convenient!.
These EPSs feel like they live on your phone, but are really a special type of contract (ERC223) that lives on the blockchain.
They have all the normal properties of cash, they’re reasonably anonymous, they’re pegged to the currency that goods are priced in. They can also be sent from the phone, to other people as easily as a Whatsapp message, they can be used to buy things in person, using Apple Pay or Android Pay, and they can be used to pay for things online, but with a one huge advantage.
When you currently buy things online, you’re giving the merchant your credit number with only the vague hope that they will bill you only for what you’ve agreed, and never again. You’re also hoping they don’t store that number, and hoping that if they do, that number doesn’t get hacked out and leaked.
Using an Ethereum Pound to pay for things is like using cash, once you’ve sent the correct amount to the merchant, you never need to worry about them taking liberties with your wallet again.
This utopia of an idea has been tried before. Many payment startups have fallen by the way-side, unable to overcome the inertia of customer ambivalence.
Notable exceptions exist for direct instant peer-to-peer payments. Things like Venmo and PayPal in the U.S. or Monzo P2P in the UK. These have succeeded because they removed they need for one party to be a “merchant” and the other a “customer”. They simply made it possible to exchange value conveniently and had a nice user experience.
Part II: why tokenized GBP will work from the first pound to the billionth.
