I highly recommend having a read through a recent report from London based investment research house Cross Border Capital, entitled “Lonely Bytes – Cryptocurrencies & The Future of Money: A New Technology Solution Desperately Seeking A Problem?”.

This short and pithy note ranges far and wide but has a fairly incendiary conclusion – which is that electronic ledgers like blockchain have the potential to destroy the high street banking model. Along the way, we’ll see central banks become ever more powerful.

The dynamo for these changes is obvious – the rise of cryptocurrencies which depend on blockchains. The biggest of all, of course, is Bitcoin (US$185 billion) followed by Ethereum (US$84 billion) and then Ripple (US$35 billion). These three crytos account for more than two-thirds of the entire cryptocurrency universe by value. (A year ago, the top three made up an ever larger 94%). But according to Cross Border “they seem somewhat less popular on Main Street, since in 2016 only five of the Top 500 US retailers accepted Bitcoin and last year this dropped to three!”.

Not unsurprisingly the report takes issue with the narrative of crypto hegemony, rightly regarding them as poor substitutes for real, hard money – they might have some use as a source of value accumulation but as a day to day source of information and value they are a poor substitute. The Cross Border report observes that “ while its transaction fees appear to be minimal, Bitcoin’s operating costs are sky-high. For example, it costs roughly 2 cents to process each cash transaction, 12 cents per credit card and 26 cents per online transaction. This compares to US$2.80 for a blockchain settlement, which itself takes at least 10 mins to verify and sometimes hours. Industry estimates claim that the blockchain system can currently settle at a rate of seven transactions per second. But this compares to the major credit card companies who settle upwards of 65,000/ second, and then by using only around ½% of the energy required for blockchain.”

What’s much more interesting is the blockchain transaction technology which sits behind currencies such as Bitcoin. “A blockchain transaction not only involves the transacting parties, but embraces every member of the network as well, and each member must validate every transaction before it can be executed. Their multiple signatures allow a transaction to be accepted by the network, conditional on the approval of a certain number of agents from a pre-defined group. Each change once approved, is immediately reflected in every subsequent copy of the ledger”.

Like many neutral observers, I’ve long thought this is the most interesting part of the digital money puzzle. On paper these blockchains could be hugely disruptive but so far, I’ve yet to see many real world products which excite me. Cross Border though think’s we’re looking in the wrong place – they reckon that the idea lurking behind blockchain called distributed-ledger technology (DLT) “offers huge attractions to the existing Monetary Authorities in helping them digitise their existing monies”.

Here’s the key passage for me on these DLTs – “This single digital ledger, in economist’s jargon, describes a narrow banking model, much like Peel’s 1844 Banking Act in the UK that legally split the Bank of England Issue Department from the Banking Department in order to more clearly identify the gold backing for the note issue. With a recognised central authority policing settlement, the plodding and costly blockchain verifications can be easily swapped for instantaneous and cheaper digital settlements. These e-dollars and e-pounds simply become the digital equivalent of paper notes, but available via, say, smartphones. (Note that alongside this emoney, notes and coins may still physically exist.) The net balances of e-money will attract zero or low-interest rates from the Central Bank. (Note that the Bank of England has proposed the possibility of ‘negative’ interest rates on these e-accounts to further improve its monetary control and so stimulate spending.)”

These DLTs could put central banks back at the very centre of the real world of commerce and daily transactions – displacing the high street banks. According to Cross Border “the dinosaurs out there are what we term ‘bank money’ and the traditional high street banks. They face extinction. Traditionally, these banks developed as ‘safe’ places to physically deposit cash, with safety determined, first, by the quality of the assets that ‘secured’ their deposits and, second, by their unique access to Central Bank funding in extremis. These advantages effectively allowed the commercial banks to create money at will, since the State effectively guaranteed their deposits. Put differently, all modern money is credit, and whereas in the 19th-century private banks, of varying reputation and quality, issued their own bank notes and promissory notes, today the cheque is the modern equivalent, whose acceptability depends entirely on the issuing banks’ perceived credit rating…..Thus, the notional ‘Barclays pound’ today exchanges for the same as an ‘HSBC pound’ because of these State guarantees. …It is this par price that is likely to breakdown in the future, since it seems unclear why the State would continue to underwrite banks’ deposit liabilities? In this new World, a commercial Bank failure is unlikely to disturb the payment function of money because this will be exclusively handled by the Central Bank, but it still may affect credit provision. In other words, in the new digital World, credit risk may become a more obvious feature of banking and deposit-taking.[my emphasis]”

The bottom line? Money market funds will compete for deposits, and, in turn, fund specialist lenders (e.g. car finance, mortgages, student loans) while High street banks become dinosaurs: wholesale money markets and specialist lenders will replace them. The shadow bankers come out of the gloom and take a central role alongside the central banks, which in turn become the central transaction interconnects of a new financial system. If all my emoney is handled by central banks, why bother with High Street Banks?

This is I think a revolutionary set of conclusions. I’m not quite as cynical about crypto currencies though I readily concede their obvious flaws. And this explanation of DLTs in an age of emoney seems much the most concrete example of a new style blockchain.

Crucially this ambitious narrative also rings true in a more obvious sense. The old credit creation model of high street banks with their giant leveraged investment arms might start to seem horribly outdated and terrifically risky – especially as much tougher banking regs reduce their room for leverage. The old banking system was in essence a giant Ponzi scheme which requires the government via central banks to stand behind their magic of credit creation. If that trust breaks down and the only people we really trust with our money are central banks, DLTs could be the future. That in turn leaves the shadow bankers with their lightly regulated models to work at the coalface of credit creation. But as Cross Border observe this new world puts credit risk as an even more central systemic risk? Can we really trust the promises made by central banks for our money? And how will central banks work to create credit within this new distributed system, making day to day decision on who they lend to? Might the BoEs Funding for Lending scheme act as a role model for a new world of central bank-controlled finance? And should we trust central bankers with this much power?