The case for national digital currencies, not Bitcoin
Bitcoin is now accepted as legal tender in El Salvador. Many believe all countries should do the same, and that the time is right for Bitcoin to take over the world as a global digital currency.
Decentralization is not a good idea for a currency
The core tenet of most cryptocurrencies is decentralization, the idea that no single entity or individual should have absolute control over it. Instead it's protected by the fact that controlling 51% of the network is hard when lots of diverse entities are involved. The push for decentralization in cryptocurrencies is the root of most of its problems.
- For the 51% protection to work you need a large network of independent server operators
- To get that you need to give them some incentive to host their servers
- It's natural then, to give them some of the new currency in return
- But the currency is worth zero when no one is using it...
- So everyone who joins early, bets that the value will not be stable, but grow exponentially over time
This is not the recipe for how to construct something that should be stable, and be used as a digital currency.
Instead we should skip the decentralization part, and have a central bank guarantee the value. This makes it stable, and stable is something we definitely need for a currency.
Proof of work makes things worse
To get any value from a cryptocurrency you need to limit supply somehow, if there was infinite money, it wouldn't be worth anything. For Bitcoin, this is done by requiring each server to randomly try solutions to a tricky algorithmic problem. Solving it gives you coins.
Proof of work for Bitcoin is a colossal waste of electricity. Especially in countries where electricity is generated by non-clean energy sources. But even for renewables, is this really the best way to use our limited energy? Let's charge car batteries, construct fossil free steel, and capture CO2 from the atmosphere with that electricity instead.
There are other ways to limit supply in other cryptocurrencies, like proof of stake, and I agree that these would be better for a currency. But the easiest solution is to let a central bank guarantee the value, and avoid the need for a "proof of X" system at all.
Ease of use for crime is not a good feature
There is a reason crime groups love Bitcoin: Transactions are anonymous. All you need is a Bitcoin address to send money to. This means no taxation, as transactions are not tied to any individual. It also means that cyber criminals just need to transfer all proceeds from a hack to their own accounts, no need to hide things further.
When crime groups get the same access to capital as everyone else they can do more damage. I hope you agree that this is something we should try to limit. But this is not something that cryptocurrencies can do, because it requires a centralized authority that can act on suspicion of wrongdoing. We already have that system in place in our governments, it's just that cryptocurrencies are not built with stopping crime in mind. A new digital currency should take crime into consideration.
Of course, accessing your transactions should require reasonable cause as decided by a judge, and be protected by strict privacy laws. Probably better protected than your bank statement is today.
Another look at the El Salvador use of Bitcoin
When you look closer at how El Salvador plans to use Bitcoin a couple of things stand out:
- 20% of El Salvador's GDP is people sending money to relatives, and they want to encourage that
- All merchants will be mandated to accept Bitcoin as payment
- The government will accept the monetary risk of merchants by directly converting Bitcoin to US dollars (their native currency)
- There's a trust fund with $150 million to balance the risk
- They will continuously sell off Bitcoin to balance the trust fund
- There is talk of the state promoting bitcoin mining
This is not something other countries should try to emulate:
- Tying a country's finances to a volatile security like Bitcoin is a very high risk move. If the Bitcoin price where to crash, all the Bitcoin the government holds would be worthless. It could also rise, but this is nothing but reckless.
- Receiving money from relatives requires their relatives to accept the risk of holding Bitcoin. If you buy Bitcoin one day, it might be worth half what you bought it for the day after. The government will not mitigate that risk.
- The tech to accept Bitcoin might not be readily available to everyone, especially a poor country like El Salvador.
- As previously stated, betting on Bitcoin is not environmentally sound.
Requirements for an ideal digital currency
So let's sum up what I've talked about so far, in terms of what I believe are requirements for a digital currency.
- It should be stable, so it can be used for day-to-day transactions
- Environmental impact of running the system should be low
- Law enforcement should be able to access to transaction data when warranted
Let's add some things that Bitcoin is doing well:
- It should be available to anyone
- There should be a digital wallet that it's easy to send money to
- Transaction costs should be low, or even zero
Let's see if we can build a system that would satisfy all six requirements above, fully or partially.
A national digital currency
Each country should have their own digital currency, backed by that country's central bank. The digital money would be considered the same as paper money, and the central bank would be in control of minting new digital money, just like they are with paper money today.
They don't need a blockchain system for this, as there is trust in this system. So no proof of work, and no server farms. A simple database with a transaction ledger would be fine. Of course it needs to be protected like a bank's IT system would. This makes sure we're operating with low environmental impact.
A new government agency would be created whose job it would be to safeguard the transaction ledger in a privacy sensitive way. The agency should have strict rules for when transaction data can be disclosed to law enforcement and not. I believe separating responsibility like this would be an effective way to make sure there is better balance between the needs of law enforcement and privacy.
Every citizen should get a digital wallet from the government based on their social security number (or equivalent) or registered company ID. This account could be used for government payouts instead of other bank accounts. Ideally there should be a way to easily add accounts for people that live outside the system (paperless, immigrants living in the country, ...), so that these digital accounts really could be used by everyone.
There should be a basic interface supplied by the government for making payments, but also an API so private organizations could build other payment solutions using these digital wallets. Transaction costs should be low or zero when done through the government supplied interface, but third parties could add fees when doing transactions through the API. Allowing fees and an API ensures that there are ways for commercial companies to improve the payment flow in interesting ways.
I think a setup like this would be great for simplifying digital commerce in a country. It would expand access to digital services, open plentiful of new use-cases, and decrease the cost of making digital transactions.
Luckily, it seems at least 80 central banks are exploring this use-case. Let's hope we see more action, and less talk.