The future of money
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Bitcoin and cryptocurrencies from a systemic perspective rather than a technical perspective. Banking will be redefined.
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The future of money
- 4. EXAMPLE - STONE MONEY OF YAP Early money transfer on the island of Yap Eventually islanders decided not to move stones around… …and instead keept verbal track of who owned what share of each stone… …even a stone that sank to the bottom of the sea remained currency in circulation
- 6. INNOVATION D – TURNING CREDIT INTO MONEY Assets Liabilities 1) Diversification 1st loss 2nd loss 3rd loss 4th loss 3) Structuring 2) Collateralization 4) Maturity transformation Long term Short term Voila! Feels just like money. BANK
- 7. NEW LOANS MAKE MORE MONEY Assets Liabilities House buyer´s bank New mortgage loan New deposit House seller´s bank Assets Liabilities Reserves DepositsReserves Deposits
- 8. NEW LOANS MAKE MORE MONEY Assets Liabilities House buyer´s bank Mortgage loan House seller´s bank Assets Liabilities Transferred reserves New deposit Reserves Deposits Reserves Deposits
- 9. 0 500 000 1 000 000 1 500 000 2 000 000 2 500 000 3 000 000 1998 1998 1999 2000 2001 2002 2003 2003 2004 2005 2006 2007 2008 2008 2009 2010 2011 2012 2013 2013 2014 2015 2016 SEKm"CREDIT MONEY” IS THE MOST COMMON MONEY On demand deposits from non-bank public Coins and notes in circulation SWEDISH MONEY SUPPLY “Actual money” is decreasing at the same time as ”credit money” is increasing Money supply
- 11. Isolated ledger A Isolated ledger B Email Money Money Time = instant Cost = 0% Time = days Cost = Up to 8% PAYER RECEIVER “CREDIT MONEY” HAS ITS CHALLENGES Bank Assets Liabilities Loans Deposits Illiquid TRANSACTION COSTSINSTABILITY + = RISKUnstable
- 12. ENTER DIGITAL MONEY - BITCOIN • Decentralized digital currency • Not backed by any government or organization • Instantaneous peer-to-peer transactions • No need for trusted third party • No counter party risk • Cryptographic security • Low cost banking for everybody everywhere • Inflation proof • Based solely on the consensus that it has value
- 13. Distributed ledger – same copy in every node • The receiver now can spend that amount • Transaction cost = virtually zero • Time = ~10 minutes PAYER RECEIVER Receiver’s public key/adress HOW BITCOIN WORKS Long version: 1. New transactions are broadcast to all nodes. 2. Each node collects new transactions into a block. 3. Each node works on finding a difficult proof-of-work for its block. 4. When a node finds a proof-of-work, it broadcasts the block to all nodes. 5. Nodes accept the block only if all transactions in it are valid and not already spent. 6. Nodes express their acceptance of the block by working on creating the next block in the 7. chain, using the hash of the accepted block as the previous hash 8. https://bitcoin.org/bitcoin.pdf
- 14. GLOBAL AND INSTANT REACH • Protesters in Kiev held signs for the television cameras asking for money in 2014 • Thousands around the world pointed their cellphone cameras at the on-screen video and made donations with literally three clicks • The transactions were communicated in 20 seconds and confirmed within ten minutes at a cost of a fraction of a cent per dollar • Transactions were anonymous: the government could not monitor them, and the recipients did not know whom to thank. - Boston Consulting Group – Thinking Outside the Blocks December 1, 2016 UKRAINIAN EXAMPLE
- 15. CONSENSUS FORMING THERE IS VALUE IN BITCOIN # OF WALLETS IN USEMARKET CAPITALIZATION Source: Bitcoinity.org Source: Blockchain.info 0 2 000 000 000 4 000 000 000 6 000 000 000 8 000 000 000 10 000 000 000 12 000 000 000 14 000 000 000 2012-01-02 2013-01-02 2014-01-02 2015-01-02 2016-01-02 USD 0 2 000 000 4 000 000 6 000 000 8 000 000 10 000 000 12 000 000 03/0… 06/0… 08/0… 09/1… 10/0… 13/0… 15/0… 16/1… 17/0… 20/0… 22/0… 23/1… 24/0… 26/0… 28/0… 29/1… 30/0… 03/0… 04/0… 05/1… 06/0… 10/0… 11/0… 12/1… 13/0… 17/0… 18/0… 19/1… 20/0… 23/0… 24/0… Number of Bitcoin wallets in use
- 16. GROWING FROM A SMALL BASE # TRANSACTIONS PER MONTHBITCOIN ACCEPTANCE 0 1 000 000 2 000 000 3 000 000 4 000 000 5 000 000 6 000 000 7 000 000 8 000 000 9 000 000 2011 2012 2013 2014 2015 Source: Coinmap.org Source: Bitcoinity.org For live transaction data: https://blockchain.info
- 20. WHAT IS THE BIG DEAL? • Global payments could become instant, available to anyone with a smartphone and very cheap regardless if transactions are cross border • The new global payment network would not involve incumbent infrastructure from institutions such as VISA, Mastercard, American Express, or banks • Former depositors can hold large quantities of electronic money without having to expose themselves to counterparty risk or worry about physical storage • The Bitcoin network has not been down since its inception in 2009 • A full scale adoption of digital money could be very disruptive for banks as they still make large part of their living on facilitating transactions* • The 2nd, and perhaps most disruptive change, would be a disappearing demand for transaction accounts from households and corporations * Payment fees make up 40% of global banks’ total revenue according to McKinsey report “Global Payments 2015: A Healthy Industry Confronts Disruption”
- 21. BANKS ARE VERY DEPENDENT ON DEPOSITS Capital > 1 Year funding Deposits from households and SMEs Other deposits Derivatives Source: Liquidatum and Riksbanken 10 20 30 40 50 60 Almost 40% of European banks’ assets are funded by deposits Funding of European banks’ assets, %
- 22. IF DEPOSITS MORPH INTO DIGITAL CASH • Banks would have to offer higher rates to convince the public to lend them money • Higher funding costs would likely depress profitability of the banking sector • Lower bank sector profitability could affect credit ratings which would put upward pressure on wholesale funding costs as well • Higher bank funding costs means increased cost of credit for banks’ borrowers • Higher borrowing costs could impact asset prices like residential and commercial real estate, equities, bonds, commodities, infrastructure etc. • Banks ability to “create money” would be materially impacted and as such central banks’ ability to conduct monetary policy through the banking system will be too • Ironically, banks could help make the problem worse as digital cash could become a more attractive asset to keep as liquidity reserve instead of today’s central bank deposits, government bonds and other banks’ covered bonds. Today’s issuers of instruments that are held as liquid assets i.e. governments and mortgage institutions, could see funding costs go up for this reason too.* • In the end, we would probably end up with a safer banking system, with less maturity transformation and higher quality liquidity reserves – the transition could be somewhat uncomfortable though - for banks’ shareholders, holders of impacted assets and highly indebted borrowers that are dependent on the perseverance of low cost of credit * 15% of total assets, of banks under Basel Committee supervision, are so called ”high quality liquid assets” according to speech by Basel Committee Chairman Stefan Ingves 2 December 2016
- 25. DISCLAIMER This material focuses on the potential of digital money. It does not focus on risks. As such here follows a few notes for nuance and disclosure • Although the author owns some cryptocurrency, this material does not constitute advise to anyone to invest in bitcoins or other cryptocurrencies • Bitcoin is a young technology and it takes relatively deep knowledge for individuals to handle digital currency in a secure way. There is no way to retrieve lost bitcoins when a private key is lost or stolen. • The price of cryptocurrency, in particular cryptocurrency that is not Bitcoin, has been very volatile. • Most institutions like exchanges, custodians etc in the cryptocurrency space are less mature and far less regulated than blue chip institutions. As such there have been examples of both poor governance and fraud causing customers financial harm. • When it comes to Bitcoin in particularly a disproportionately large share of trading and confirmation of transactions take place in China which makes the global network somewhat vulnerable to Chinese government’s stance on cryptocurrencies. • Tax and legal treatment of digital currencies differ significantly between jurisdictions. Also, in some parts of the world, typically in jurisdictions with unstable state backed monetary regimes, there are examples of when governments have taken outright hostile positions on digital currency.
- 26. APPENDIX
- 27. WHAT IS A BLOCKCHAIN – BITCOIN EXAMPLE 1) Chain of signed transactions Source: Inspired by Bitcoin and cryptocurrency technologies, 2016 Signed by Private Keycreator CreateCoin (unique CoinID) Signed by Private Keycreator Pay to Public KeyAlice: H( ) Signed by Private KeyAlice Pay to Public KeyBob: H( ) Signed by Private KeyBob Pay to Public KeyCharlie: H( ) 2) Arranged into blocks prev: H( ) transID: 71 transactions prev: H( ) transID: 72 transactions prev: H( ) transID: 73 transactions 3) Confirmed by distributed consensus network
- 29. BLOCKCHAIN AS UNIVERSAL LEDGER Bitcoin & other crypto- currencies “Blockchain” Create digital money by creating new assets Create digital money by digitizing existing assets No institutions Financial market participants Bitcoin innovation ALTERNATIVE USES OF BLOCKCHAIN TECHNOLOGY Source: Erik Olofsson of chain.com