TFT recently had the pleasure of entering the surreal world of theoretical economics with the Bank of England’s Head of Future Technology William Lovell. The following is an abridged version of Mr Lowell presentation entitled, ‘Bank of England, Payments and Fintech, What Next?’ Buckle up, things are about to get a little strange…
“Central Bank money has super powers. It’s the thing we use to pay interest rates. So when an interest rate is set, that’s actually paid on reserved Central Bank money. And it’s also the thing that we use to settle payments between banks, or basically remove risk from the banking system. When money is paid to a bank, the client of that bank call the bank, doesn’t have to worry about the stability of the bank is receiving that
funds through, because they know it’s settled at Central Bank. And we use Central Bank money to do this.
Now, you might be saying to yourself, why is this important for blockchain?
It’s one simple reason. If blockchain platforms are going to scale, up to the sort of size where significant volumes of business are being done across them, they will start to build significant financial risks. As we start to see a lot of settlement, it could be of commodity transactions, it could be trade finance, it could be retail, it could be all sorts of things. We’ll have a little look of what those kinds of things are. But if that grows to any sort of scale, the money has to settle and you create risk. So we will bring Central Bank money to that, on to the blockchain, so that we can take that risk out.
If blockchain platforms are going to scale, up to the sort of size where significant volumes of business are being done across them, they will start to build significant financial risks.
How we do that?
Our story starts in 2015. First of all, we were starting to do some real research in traditional currencies. Daunting to say, if we took something like Bitcoin, could you do a fair back version of traditional currency? It was quite theoretical economics. At the same time, in another room nearby, we were realising that the central part of the payments infrastructure had been designed in the 1990’s, for the economy of the 1990’s.
With globalisation in particular and challenger banks, there were lots of reasons to start thinking about those things differently. And we brought these two things together, and that’s why I’ve called it digital currencies meets payment systems. You can think of it as a bunch of theoretically communists sitting down with a bunch of sort of gnarly payments guys and going, “Hang on a second. This is two different ways to think about the same thing”. And this is what we realised. We realised that traditional currency and a Central Bank payment system are basically the same thing. But in different forms, and that we needed to pursue both to understand more about it.
Could a Central Bank digital currency replace all of the payment systems?
“Trading coconuts on treasure island”
Now, the reason for this name is that, as we started to do this work quite a lot of people were taking an interest in it. There was quite a lot of buzz in the press about what we were doing about digital currencies. We wanted to be super, super clear that what we were doing was experimenting with the technology to find out what it could do and how we might use it. We didn’t want anyone to misinterpret that as a kind of clandestine introduction of a digital currency so we created a new currency, it’s called the “Coconut”, and we had a Central Bank that we called “Treasure Island”. So that, anybody that heard about it would know that this is people experimenting with the technology, trying to understand the economics, and not a sort of a product that was about to hit the streets.
We wanted to be super, super clear that what we were doing was experimenting with the technology to find out what it could do and how we might use it
We set-up an Ethereum blockchain, and we used it to create a Central Bank style payment system. So, we were able to settle money between the different banks on our network, we were able to pay interest on reserves, and do those Central Bank things, and we set that up. We were able to show that when a Central Bank node was taken offline (in the demonstrations we did it literally by pulling the plug on it) the payment system would continue. That was the moment that light bulbs went on in people’s heads and they were like, “Right, okay. We understand now what this technology can bring… it extinguishes some risks”. For example, particularly around resilience, but it brings some other questions that we need to think about; about who’s in control of this. When you pull the plug on the Central Bank bit, at least a few people shift uncomfortably in their seats. It’s like, “Okay I get this, but what happens next?”.
We created a new currency, it’s called the “Coconut”, and we had a Central Bank that we called “Treasure Island”
We learned that you can run a Central Bank system theoretically on a blockchain and that there’s some real resilience in security games. But we also found that there was some significant, privacy and finality problems to solve. By finality, I mean making sure you know when the title of the asset has changed. Which, when you’re working at consensus mechanism is a slightly more difficult thing to do. We concluded that the next generation of the UK real-time growth settlement system actually won’t be built on a blockchain.
We didn’t feel that the distribution benefits were strong enough to outweigh the problems we would need to solve. But what we did identify was, we absolutely have to be able to be what we called, “Blockchain compatible”.
We didn’t feel that the distribution benefits were strong enough to outweigh the problems we would need to solve.
The other thing that we really learned about it were the opportunities to use cryptographic proof in ways that we haven’t done before. (i.e. the opportunities to be able to prove when a payment instruction is received and that it comes from where you think it does and is initiated by the people you think it is). [Cryptography] does much more than merely secure the payment system, it creates a kind of proof of payment.
One of the really big advantages of blockchain-type technology is that it actually helps the whole concept of the transaction to live on. What we realised was that we really wanted to provide something that allowed people to synchronise the movement of an asset, from one place to another, with the movement of payment in the opposite direction. Delivery versus payment.
Now I know that exists in some securities markets but there are lots and lots of other places where it doesn’t exist but it could. The property market, for example. Actually having something where the title of the property can change, and the money moves in a synchronised fashion. That would make the process much faster, it would make it much more efficient, and it would take a lot of risk out. We’re speaking to the UK Land Registry about this but we haven’t got as far as a plan to implement yet. We’re working out how it might work though. Don’t look out for it being rolled out next year, but this is the kind of thing that we’re looking to do.
We’re trying to work out how we can make sure that, as those problems are solved in the market, we are able to bring Central Bank money to it so that we’re not imposing interface standards that people can’t work with. This is why we’re very interested in standards work…
To summarise, the next generation of Sterling is not going to built on a blockchain. That’s really because, Central Bank money is an asset; a centralised asset, and we didn’t see the benefits of actually distributing it over the costs of the problems that we would need to solve. But as you can see, hopefully from my walk through of the different use cases, we expect we will be able to support and integrate with blockchain platforms. We will actually be able to make integrating with payments, particularly in the high value space, more straightforward and preserve data better. We think there are real opportunities for blockchains to reduce friction, to increase transparency, and trust and reduce risk.”