 Welcome to the European Central Bank podcast bringing you insights into the world of economics and central banking. My name is Michael Steen and in this first episode we'll be taking a look at innovation and payments, cryptocurrencies, blockchain and the latest plans to create a global digital currency with Facebook's Libra. There's certainly a lot of interest around innovation and payments and so-called cryptocurrencies in particular have captured the imagination of many. The best-known one, Bitcoin, has been a trending topic over the last few years and the same can be said for blockchain which is the technology underlying most cryptocurrencies which has many potential uses from securing business transactions to voting systems and even music streaming systems. More recently media headlines have featured Facebook's plans to create its own global digital currency and the accompanying financial infrastructure known as Libra. So what is happening in digital payments and currencies and what is the role that the central bank plays? My first guest today is ECB executive board member Benoit Curray. He's been working closely on these topics as the chair of the G7 working group on stable coins. Benoit, hi let's start by taking a step back and think about what we're talking about. We're talking about digital money but what actually is money itself? The way an economist would answer your question is pointing out that money has three functions. A function has a unit of account that is you order a beer and the beer typically would be like three euros and that's a unit of account. But it's also a means of payment that is you're actually going to pay for the beer handing out the three euros and it's also a store value that is you will keep yours in case you want to be a tomorrow. Three functions and these three functions don't have to go all together and they can be performed by public money as well as private money or anything can be used for that purpose actually. So kids would use marbles or football cards as unit of account and even a store value and that's fine. Now the point is if you want to use it across a society widespread use of money and widespread trust in money, mutual trust in money in a group requires some political agreement, political understanding which is why now money is a public undertaking and is supported by laws, constitutions and is managed by central banks. So local use of money can be private. Public use of money across a society, across an economy nowadays is public underpin by laws and managed by independent institutions called central banks. And so that's to make sure that we will agree on what is this, that this is money. Exactly and because you want to trust money that will be given to you by people you don't know. That's the point. Anything is possible within a small group but when it's people you don't know then you need the rule of law to underpin confidence trust in the in the currency and that's why we have monetary law. That's why the role and mandate of the European Central Bank for instance is enshrined in a treaty which has been voted by the European people. Now that already gets into this field of the money we have today right now some of it the money in my bank account which is at the end of the day maybe just a number isn't physical is already virtual. So now we shift into this digital money area. What's changing there? What is new there? Why would you need to have if we already have money that's effectively virtual why is there that will this talk about cryptocurrencies and digital money? So what's new with the technology and you mentioned the blockchain which is the underlying technology for many of these cryptocurrencies. So I would say that the main driver for the use of cryptocurrencies has been convenience that is cost and speed. That is many cases and in particular for cross-border payments that is payments from one country to another they've proven cheaper and faster than existing means of payments based on existing currencies and that's something which is good which is useful and that should be kept used and protected. Now another driver of cryptocurrencies has been financial inclusion when you're posted in a foreign country you want to send the money back home to your family that's called a remittance and existing systems to transfer money has proven very expensive for these communities. So potentially these new technologies can also help support financial inclusion. So there's those two aspects but on the first one making it cheaper and so on that's that's because you're taking lots of players out of it because there's not a chain of banks in between the two transactions. It's partly so partly so because it's more direct it's these intermediated but it's also because the technology is better and less costly. So there seem to be huge opportunities there's a bit of skepticism as well and there's some risks and just before we go on I think we have a quick clip we can play of ECB president Mario Draghi who summed up some of these concerns at a press conference earlier in the summer. And these concerns if I can list them for you are concerns about cyber security AML money laundering terrorism financing use of these currencies for criminal purposes all this is linked also to the anonymity how would this how would this work at the same time concerns about privacy I mentioned cyber risk tax evasion monetary policy transmission financial stability and the global payment system how would this change the global payment system. So all these concerns are substantial they need to be addressed before the before the regulators can have a can have can look at this with genuine interest and positive interest. So Benoit we heard there from from president Draghi on some of the risks and can you talk a little bit more about the role that you see for central banks and global regulators in tackling these concerns and of course particularly your work that you've been doing at the G7. Well that was well summarized by president Draghi. On the one hand we don't want to stifle innovation so we want to look at what's good what's useful what's new what's cheaper what's faster in these new technologies so that they can benefit the public at large and that's something we're very positive about on the other hand we want to make sure that these new means of payments are safe meaning they should be safe for their users in terms in particular in terms of preserving the value of any money that's invested in these new means of payments. So we want to make sure that stable coins are stable and it really depends on on the integrity of how exactly the currency is or the coin is backed by assets or currency and we're looking into it so we want to make sure that they're really stable. First thing and second we want to make sure that they're safe for a society and they're safe for the economy meaning we want to make sure that they're not used for criminal purposes that the money laundering and financing terrorism dimension of it it is extremely important because we know from experience that new technologies are being used by criminals and are being used by terrorists so that's really a key priority for finance ministers and regulators across the world and we also want to make sure that they are not going to create financial instability and we want to make sure that they are not going to harm monetary sovereignty. Is that also then a concern in terms of who's behind it so is that I mean this private public kind of debate I mean if you take the Facebook example that's obviously a private company with backed by other private companies is there a reason that this should either fundamentally be a public sector or a private sector or is there a... In principle no I would say if it's properly regulated there are many examples of public goods that are provided by private companies and it's fine but you need good regulation and you need a lot of control by the government so that might end up being provided by private companies but under a very tight public control. All the conclusions might be that the hurdles are so high that we don't want the currencies to be run by private companies and I don't know that entirely depends on the answers that will be provided to our questions. And then the regulation is important that it's international because of course you don't want there to be some jurisdictions where there's a much lower level of regulation and then they end up going there. Absolutely because we're talking of technologies which spread across borders. We're talking of in many cases of technologies being provided by companies which are already global with a global basis of customers and we are talking of technologies where the main business case is about cross-border payments so it's by essence a global issue and we need consistency in the way these will be envisaged, approached and regulated which is why the G7 and now also the Financial Stability Board in Basel are looking into it. The governor of the Bank of England Mark Carney was at this year's Jackson Hole Economic Symposium and he gave a speech where he made what sounded like a radical proposal and he was talking about a global digital currency that's actually issued by a network of central banks like the Bank of England and ECB. He talked about this so-called synthetic hegemonic currency which sounds very impressive. What are your thoughts on this? Now the answers, the responses to cryptocurrencies and to stablecoins are not necessarily about issuing our own digital currencies. We might end up doing it but another response on our side is about improving the existing payment systems so that the needs that are evidenced by the whole discussion in the first place that is the demand for cheaper payments, the demand for faster payments can be met by traditional payment systems. So the whole discussion is a useful wake-up call for the central banking community and it makes us understand that we've got to be faster and we've got to step up upgrading of our payment systems. So the ECB has been doing it. We have a fast payment system tips, 24-7 payment systems which works very well. There might be other initiatives that we could take to make it more accessible in particular for cross-border payments. So the main gap I would see or the next frontier in terms of central banking activities would be to find efficient ways to connect our fast payment systems so that they can be used by citizens to transfer their expenses, to send money back home, to send money across borders so that cryptocurrencies will be less needed in the first place. Benoist, thank you very much and good luck with the work at the G7. Thank you for your interest. So having looked at the bigger picture surrounding these new payment innovations, we'd now like to go into a little bit more detail with our next guest, Maria Teresa Chimanti, ECB Market Infrastructure Expert. She's one of the ECB's leading experts on cryptocurrency and has recently co-authored research on what we call the crypto asset phenomenon. Maria Teresa, Bitcoin is actually one of the most searched for terms on our website. There's clearly a lot of hype about it, but we at the ECB actually refer to Bitcoin as a crypto asset rather than a cryptocurrency. Can you tell us why? Indeed, we think that terms like cryptocurrency are a misnomer. Instead, the ECB refers to Bitcoin and the likes as crypto assets. In the euro area, crypto assets are neither legally established as currencies, euro being the single currency of the euro area, nor are they legal tender. Also, currency are issued by trusted authorities. We demand to preserve the currency's stability. There is no such a framework in place for crypto assets. They've got this, they've also got this huge volatility, don't they, including that's one of the problems with Bitcoin. But I think there's another difference, which is also that what's backing the currency, right? Yeah, in our May 2019 report, we have pinned down the crypto asset phenomenon to the absence of an underlying claim or liability against an issuer. In other words, the value of crypto assets is imbeccable by anything or by anyone. Unsurprisingly, the valuation of crypto assets is very difficult and may be also subject to speculation. Therefore, the users of crypto assets are up against potentially very large losses in adverse market conditions. Also, if a crypto exchange or a custodian wallet provider is hacked or goes belly up, the customer's holdings will not be protected by the equivalent arrangements of a deposit guarantee scheme. As a matter of fact, the European Supervisory Authorities have issued many warnings to the users of crypto assets and the risks of buying crypto assets have been also touched upon by the authorities. So, that enter then at this point, Facebook, with their Libra initiative. Now, that's based on this thing that we touched on briefly with Benoit, but you can tell us a bit more about this notion of a stable coin. That's meant to address one of these weaknesses, if I understand correctly, yes? So, starting from Libra, Facebook's Libra is a whole new ballgame. Libra would be a stable coin backed by a reserve of assets and a payments infrastructure. Like crypto assets led by the coin, Libra also has an ambition to serve as a borderless currency. But this is where the similarities end with crypto assets and the differences begin. Unlike crypto assets, Libra will have a clearly identifiable issuer and a governing body, the Libra Association. The Libra Association is committed to managing the reserve assets as to preserve Libra's value over time and by doing so minimize price volatility relative to major currencies. Libra is also very different from current stable coin initiatives and arrangements. Stable coins are hardly used aside the crypto asset market. Libra, on the other hand, could go mainstream very quickly for starters. The resulting size or potential size of the Libra's network is large enough to trigger sweeping network effects on a worldwide scale. Of course. So, Facebook obviously has its huge scale here and it's an example of a stable coin. But also it's not the only kind of stable coin, right? A stable coin is not always backed by assets. Is that correct? Indeed. Stable coin is a phenomenon under development. Currently, there is no common view or a great definition of what is a stable coin. We define stable coin as digital units of value that are not a form of any specific currencies or basket of currencies and rely on a set of stabilization tools to minimize fluctuations in their price relative to a currency. Stable coins can also be further distinguished on the basis of what underpins their value. Stable coins can be backed by funds. Stable coins can be backed by traditional asset classes such as government bonds or by commodities. Stable coins can also be backed by crypto assets or they can be based exclusively on the perception on the expectations by users that their holdings will maintain a stable value. Is there more work that we're doing on this, given that it's such a new and sounds like it changing phenomenon? We are the first central bank to publish research on stable coin covering the taxonomy and the use cases. This work obviously lays the foundation for more work, especially when it comes to the analysis of the potential implication of stable coins for the payment system, as well as for the Euro system mandate and tasks. We obviously don't have all of the answers. In fact, stable coin also have a cross border dimension to them, which requires that we collaborate with other authorities around the world. And this is why the ECB works with their peers in international fora to address the most pressing questions and issues raised by stable coins. Now, a key aspect that we haven't covered in depth yet is the technology that makes these things possible. Bitcoin, Libra and other new projects have one thing in common. They're based on a technological innovation known as blockchain. We at the ECB have been studying this new technology quite carefully, particularly in what we call our innovation lab. And our next guest, Dick Bullman, leads a team at the ECB that looks into innovations and payments. So, Dick, welcome. Can you tell us a bit about what blockchain actually is? Blockchain is an infrastructure. It's a road, so to speak, and crypto assets and stable coins, they are the cars that use these roads. So if you want to move a crypto car from person A to person B, you use blockchain as a road. So this would be an explanation I would offer, but then you might ask, okay, good blockchain as a road, but what is special about the blockchain road? If you want to transfer money today from A to B, you can do that. You can pay in a shop, buy online, make an electronic transfer to a friend. This works without problems. The roads are there. But what makes blockchain interesting, I would even say fascinating to many people, is the underlying idea of having a much simpler road network. In today's world, if I want to transfer money to you, it goes via my bank, maybe an intermediary bank, it goes via payment system to your bank before you eventually get the money. So in particular, if it's a cross border transfer, if you assume your transfer, I don't know, from here to the States or to Asia in particular, you have many correspondence in between. It's a very complex arrangement. So the blockchain has this vision. The blockchain has the vision of working without intermediaries. That means you don't need to go via intermediary A, B and C. The road is direct. So today, if I transfer some money to you and we don't know each other, we both know that's going to work because we trust our banks and we know we're going through the banking system. Potentially in the future, using blockchain technology in this example, the idea is that the technology itself has that trust embedded, so we know that it's going to work even if we've never met each other. That's the vision that drives the blockchain idea. We touched a bit on regulation already with Benoit Currie. What are the things they are holding back, this change at the moment? What are the blocks at the moment to the blockchain, if you will? From the central bank perspective, we see that blockchain is relatively new technology still. Let's face this. It's in its infancy. I mean, there are still teasing troubles. I think I know a bit about this because we have at the innovation, we have at the ECB at this innovation lab, where we experiment with the technology. We here do analysis within the family of European Central Banks, within the community, where we internally analyze and experiment with this technology. We also work together with Bank of Japan. We have established a project, Stellar. In this framework, we do experiments. We ask ourselves the questions, whether a blockchain could meet efficiency and safety requirements of existing payment systems, whether it's cheaper, whether it's faster, whether it can process more transactions than our current infrastructures. From today's perspective, the answer is no, it cannot. Why not? Just because it's still too new, it needs to develop more, needs to be more efficient. Because you would not use a new technology if it could do just the same job that is currently done with the existing and with maybe more traditional technologies. So, from this perspective, we don't see that blockchain can do something better, but what we see is that there's a lot happening, that the progress in the blockchain space is really huge. So, and if this continues, I think it would just be a question of time and that blockchain may be then one day, but here, I mean, crystal ball gazing is not my thing. Of course, of course. But if I, you know, as a reader of newspapers and so on, you know, you see everything, people saying Bitcoin is terrible for the environment because it uses loads of energy, you're driving a bit of the idea that fine, but these kind of technologies can advance and at some point it will be quicker and cheaper, maybe than legacy technologies. They do, they do. It's the moment you spotted a problem, you can be assured that someone out there is already on it. You mentioned, and this is an interesting thing with the energy consumption. I said we have this innovation lab at the ECB and we recently got a call someone external, I think it was a journalist wanted to know, okay, how high is the energy consumption in our innovation lab? Because they are the concerned about use of blockchain and so on. But yes, the Bitcoin blockchain is really energy consuming because it uses a specific mechanism of finding consensus within the network on the information that is there put on the blockchain. So this makes it energy consuming, but we see that there are other ways of finding consensus and there is a plethora of possibilities and they are far less energy consuming. But people are mainly looking still surprisingly, I must say at the Bitcoin blockchain, it is slow, it cannot really, it's not really scalable, but yet maybe this applies to the first generation Bitcoin blockchain, but if you look at other blockchain or distributed ledger protocols, as we prefer to call them out there, you see that they are scalable and they are efficient and they are far less energy consuming compared to the Bitcoin blockchain. So these problems are in the process of being fixed. Okay, so it's a crucial thing for the central bank also to know about, but it sounds like it's not ready for deployment at the moment, certainly from our point of view. For us, no, it's not ready for prime time. We have to think twice before we move to a new technology and we can easily implement this in a small environment, but if we do it in an application which is really crucial for the functioning of the financial sector and risks, difficulties, problems could really trigger financial stability problems, then we need to make sure that this won't happen and this is why we need to carefully look at these technologies. And then in the wider innovation and payments area, there is already something we're offering now, right? This instant payments service, the tips that we have, which actually is using classical, if you will, technology. It's not blockchain, but it is very fast and can provide people with the ability to transfer money instantly. Tell me a little bit about that, if you could. Yes. So, tips went live in November 2018. So, we always develop our systems according to technological innovation and user needs. And you see there's a clear user need towards instant. If you want to exchange information, if you want to download music, if you want to stream a movie, everything has to happen in the blink of an eye. You want it, you get it. But of course, also the payment infrastructure has to be fit for purpose then and we have to make sure that we offer them also a service that could offer this. And in this context, we developed and implemented our tips service, the target instant payment settlement service. Yes, we can process transactions in the fraction of a second. We can also process very, it's cheap for each transaction costs only a fraction of a Euro cent. So, it's very, it's very efficient and it's very cheap and it doesn't, it doesn't rely on blockchain technology. As a bank customer though, if I want to use that, that's what is dependent on my bank using it. So, I should write to my bank and ask him, are you using tips? Yes, that's correct. Excellent. Okay, thank you, Dirk. That brings us pretty much to the end of this episode. It's clear that crypto assets and innovations and payments are a rapidly developing field. And we, these be clearly closely involved. We'll probably come back to this topic for another podcast later on. But for now, I'd like to thank Dick Bulman, Maria Teresa Chiementi and Benoit Carré for guiding us through this fascinating world of crypto assets and innovations. Do also look in the show notes for links to relevant papers and publications from the ECB on these topics. You've been listening to the European Central Bank podcast with Michael Steen. If you like what you've heard, please do subscribe wherever you got this podcast from and leave us a review. Until next time, thanks for listening.