Read the success stories of crypto entrepreneurs.

Discussions are fun when we are part of a community.
Login Free Registration

Get 10 AltcoinN Points just by registering on this forums.

How Libra Changed the Design and Expectations for Other Digital Currencies

What should digital currency operators consider before creating one ?

While the discussion on stable coins and their design in the crypto community has been going on for the past couple of years, the public hearings and the huge interest around Libra are highlighting a number of issues that any digital currency will face in the real world if it has to hold up to mass adoption.
I am summarising these issues and my views on future design directions for digital currencies and their designers and sponsors.
Considering the regulatory landscape and how a digital currency might fit into existing regulation is very important, since most currencies and their designers/sponsors won’t generate the sort of hype that Libra has and no new regulation for a currency is likely to be drawn up. From a regulatory perspective, the sponsor/operator of the currency could possibly fall in three buckets — banking regulation, securities regulation, or payment systems regulation. Taking fiat deposits from public and issuing them digital currency tokens with guarantees that they can be redeemed for the same value could possibly attract banking regulations and being a bank means getting a banking license, maintaining enough capital, etc and it is territory that one perhaps should not go into. Instead, if the digital currency operator mints tokens like Libra where they take in fiat and peg it to basket of assets (which could be other currencies and securities), the currency operator could be seen as an asset/fund manager and the issue of currency tokens can be classified as a issue of securities. While Alternative Investment Funds (AIFs) are popular in all major jurisdictions among fund managers, the transfer of the currency token from one person to another would attract capital gains taxes which could be substantial and render it absolutely useless. The most appropriate regulation for digital currencies could be for currency operators/sponsors to be regulated as payment institutions/e-money operators which means they would be able to issue e-money/digital tokens against fiat deposits that they keep as deposits with public/scheduled banks. Being a payment system also means lesser capital requirements (eg, ~EUR 100k for Authorised Payment Institution in EU), standard rules on managing customers and KYC/AML, and most importantly no ambiguity on taxes for both issuing (VAT/GST for selling) the currency and redeeming (withholding tax on gains in buying back) the currency. However, it also means that the currency operator can not profit off the fiat reserve, and think about doing fancy things with it.
Currency pegs and the issue of control
If a digital currency is designed to be a fast, simple, inexpensive medium of exchange of value between people in different countries with different fiat currencies, the focus should be just on that. For example, if a user wants to transfer or convert 1 dollar into euros where the exchange rate is 0.9 dollars to a euro, and if that user has a digital currency equivalent to a euro, it should convert into 0.9 dollars. So much is well understood but if the digital currency is pegged to the dollar by requiring all fiat currencies (eg, euros, yen, pounds, rupees, etc) deposited by users to be converted and kept in a dollar reserve, it creates a problem. Such a single/basket of fiat based reserve backed pegged currency would increase the demand for the currency in which the reserve is denominated (ie, dollar in this case) and reduce the demand and suck out liquidity in terms of the originating fiat currencies (ie, euros, pounds, rupees, etc in this example). Extrapolated on a macro scale, this could possibly mean ineffective fiscal and monetary policy control by governments in countries of originating fiat currencies. Imagine the government in such a country trying to sell its treasury bonds (for lets say, funding development expenditure) at a rate which possibly returns less than the dollar pegged digital currency whose appreciation with respect to the local currency is giving a better RoI to its holders. Imagine a central bank in such a country trying to sell dollars (if it has any!) to shore up the price of its depreciating currency where the depreciation is partly due to increased demand for a digital currency pegged to a foreign currency like the dollar. Or imagine a central bank raising domestic interest rates to curb inflation but where prices of goods and services are in a digital currency pegged to a foreign currency. The prospect of potential loss of fiscal and monetary policy controls by sovereign states means that such dollar/basket pegged digital currencies would face opposition and rejection by many countries. Also, given that, it will be easier to operate a digital currency under the payments systems regulations which do not allow reserves to be created in foreign currencies or in offshore jurisdictions, a digital currency designer/sponsor/operator would need to create a currency token that is pegged to the exchange rates between any two pairs of fiat currencies and not one fiat currency, using reserves kept in all these different fiat currency jurisdictions where it operates. What this means is that if a user is transferring 1 british pound to India, the recipient in India gets INR 90 or so and what the recipient gets will not depend on the exchange rate of the INR to the USD. Governments in sovereign states are not likely to perceive such a scheme as loss of control of its monetary and fiscal policy mechanism. In such a scheme, the domestic fiat currency will simply sit as deposits in a bank within the borders of the country and won’t be sucked out from the system in exchange for dollars. Inflation and interest rate controls would also not get impacted as, for example, raising interest rates would entice people to redeem their digital currency for the domestic fiat instead of redeeming it against a (possibly appreciated) dollar.
Identity and Blockchain
Knowing who holds a digital currency and issued one into that currency’s compatible wallets is very important from a KYC/AML/CFT perspective. And every blockchain whether Ethereum or Libra would link such an identity to a public key on the blockchain and any transactions between two or more users would then be observed as value transfers between public key/addresses on the blockchain. Placing the control of the blockchain operations (eg, validator nodes in Libra) with the same organization that is also issuing the digital currency (eg, Libra) may however mean that the organization can link a user’s identity to transactions on the blockchain and therefore would raise significant privacy control issues. However, if the identity provider and the blockchain itself are controlled by different organizations (eg, Calibra as wallet provider for Libra and Ethereum Foundation for the blockchain network), this will alleviate privacy concerns. For a digital currency designer/sponsor/operator, it is perhaps better to see these — currency and blockchain- as orthogonal aspects and support as many as underlying blockchains without sacrificing the basic cost/benefit economics of operating the currency — for example, think of spending more on transaction gas prices as % of transaction value compared to service taxes and cost of doing a regular fiat exchange.
Distribution and Custody
Unlike a facebook that already has a huge reach to consumers around the world or a visa/mastercard that through their acquirers are accepted in a very large number of merchant business establishments around the world, a new digital currency will need massive consumer and merchant adoption. However, if the currency operator is a licensed payment institution/emoney operator, it not only helps with on/off ramps which has to do with collecting fiat in a bank account against digital currency being issued, and paying out fiat from a bank account against digital currency being redeemed. But this might also help with partnering issuing and acquiring organizations to scale both reach to consumers and businesses. Issuers are typical banks, travel operators, payment wallets, etc that have existing linkages with payment settlement infrastructure in a country. Issuing digital currencies in payment tools such as wallets or cards that consumers already use is easier and better than expecting them to adopt a newer payment tool. Similarly, acquiring businesses that would accept digital currencies may become less challenging by partnering existing acquirers such as banks, and payment processors that sell payment terminals and QR code readers. Therefore, having regulated on/off ramps is necessary for a new digital currency to thrive by leveraging existing distribution channels. Digital asset custody remains a challenge though as a currency issued in the form of a token (eg, ERC20) does need to be stored safely and banks and securities custodians still do not have the digital infrastructure to store tokens. Fiat accepting and custodial crypto exchanges are another option for on/off ramps and custody, but however, there are not many out there that are regulated in onshore jurisdictions.
Capital controls
Coming from a country with capital controls such as India which limits convertibility on the capital account (eg, in/out bound investments from foreign jurisdictions), I know that a country like India or perhaps China may not allow a digital currency that can cross borders without the central bank being notified of it. This can however be addressed by operating through established and regulated cross border payment institutions such as authorized dealers for foreign currency transactions or a digital currency operator taking an authorised dealer license. Similarly, although in a very different context, countries like the USA that impose sanctions quite effectively due to the fact that the dollar is used as a reserve currency and is the most preferred currency to settle cross border transactions may not at all like that a digital currency is used to settle international transactions.
With regulators and governments waking up to the opportunities and challenges crypto and digital currencies pose to existing financial systems around the world, we should expect to reach a point soon when someone launches a digital currency that checks all the essential boxes of being — non threatening to central banks and governments, widely acceptable to consumers and businesses, secure and protective of private data.
Disclosure : I am working on the design and implementation of a digital currency protocol called the Via that imbibes some of these ideas in the article. The Via is a digital currency collateralized in multiple fiat currencies that is designed to be stable and for transferring value between applications running on different blockchain platforms, hence the name Via. Please feel free to connect with me on twitter.