Indulge me for a moment and pull out your wallet. Reach in and study a ÂŁ20 note. Acknowledge the greatness of Adam Smith. Then look closely.
A Bank of England bank note says, âI promise to pay the bearer on demand the sum of twenty poundsâ. It is signed by Chris Salmon who is the chief cashier at the Bank of England. What you have in your hand is called a âbearer securityâ.
A bearer security requires no proof of ownership. You donât have to register to own it. If itâs in your possession â if youâre the bearer â youâre entitled to the payment attached to the security.
Cash is one of the few remaining bearer securities. People use cash because itâs easy, readily accepted, and allows direct (even anonymous) transactions between two willing parties.
Yet cash usage is losing share to electronic payments. Contactless payment cards are preferred by many Britons for the same reason they used cash. Theyâre easy to use and convenient. Cash isnât dead yet. Mr Salmon can keep on signing those bills. But for how long?
Before computers, the owners of financial assets held bearer certificates. If you owned a stock or a bond, that certificate was valuable in its physical form. Iâm not quite sure what would have happened if the dog ate it. But I imagine it was a cause for a bad day, although the dog might be nominally richer for the experience.
The widespread adoption of the mainframe computer from the 1970s allowed the registered system of ownership to take hold. Banks or custodians would assume responsibility for the ownership of customer assets. Up until now, that system has worked well. But an even better way of doing things lies ahead.
The blockchain replaces the coin
Youâre about to witness the return of bearer certificates in electronic form. This return was inspired by bitcoin. And itâs now gaining momentum with the roll out of blockchain technology. To recap what I described yesterday, the engine behind bitcoin, known as the blockchain, will remove the âcoinâ and replace it with a traditional asset.
Another term for blockchain applications is âsmart contractsâ. Javier SebastiĂĄn, an analyst for the Spanish bank, BBVA, wrote about âsmart contractsâ in a recent research note. He wrote that:
âThe main purpose of smart contracts is to enable people to do business with strangers, usually over the Internet, without the need for a trusted intermediary. The idea is that software can automate much of the process, allowing the enforcement of contractual promises without human involvement. The blockchain assures that everybody is seeing the same thing without one side having to trust the other side to be honest, because anything that is in the blockchain [cannot be forged].â
The smart contract could be a promise to trade gold bullion, BP shares, French government bonds or even cash. This technology enables financial transactions to be highly secure whilst dealing costs virtually disappear. The assets will then be held in an electronic wallet that is yours; there is no requirement for an intermediary.
In effect, the current system of registered record keeping goes back to the bearer system that existed pre-computers. Thatâs why I described this exercise as âback to the futureâ in yesterdayâs Capital and Conflict.
I wrote an article for the London Bullion Market Associationâs Alchemist magazine titled âGold and the blockchainâ. I was asked to write it ahead of their recent conference in Vienna to raise awareness of what is inevitably going to happen in the gold market.
Distributed ledger
The work highlighted was being carried out by Mike Greenacre, the CEO of Autilla. He is developing a membership-based âdistributed ledgerâ using a new version of bitcoin known as the G-Bit.
Unlike bitcoin, where the blockchain is open for all to see, access to the G-Bit ledger will be restricted to market participants such as refiners, custodians (vaults) and dealers. Autilla will initially focus on the professional end of the market for security and compliance reasons, but will allow partners to embrace retail customers as the network evolves.
The gold will remain in a bar provenance network, using LBMAâs standards, which will establish trust. The ownership will be represented by G-Bits, which he describes as a âcryptographically generated smart contractsâ.
The brokers would create and redeem G-Bits in a similar way to how âauthorised participantsâ currently issue new shares for exchange-traded funds (ETFs). The G-Bits would then be freely transferable within the network. But what does all that mean for you?
It means you could store any amount of gold in your electronic wallet. That could be accessed via your mobile phone or computer and there would be no need for a brokerage account. Furthermore, you could spend your gold wherever you liked or transfer it to a third party in a fast, reliable and secure manner.
The transaction size could become minuscule. One of the criticisms of gold as a safe asset during a crisis, is that you âcanât buy a cup of coffeeâ. According to Sharps Pixley, a gold sovereign is worth ÂŁ184. That would buy you more coffee than you would probably want. The G-Bit will enable you to pay ÂŁ2.50 (or less outside London) for a single cup, leaving ÂŁ181.50 of gold in your wallet.
Liberating gold
This same process could happen with any asset you care to choose. I believe the future for holding and trading shares and bonds will move onto a network of private blockchains, or as the industry prefers to call them, distributed ledgers. In a way, this process âliberatesâ gold. Through technology, the value in gold is unlocked for day-to-day expenses, should you choose to use it that way.
The technology is being developed as I write. But, as usual, the greatest obstacle comes from regulation. There are hurdles. None are insurmountable.
You can imagine that the idea of transferring millions of dollars worth of gold to a stranger over the internet as something that will raise eyebrows.
Currently, regulators would view that as money transfer. A money transfer requires a banking licence. It would be onerous if you had to apply for a banking licence to transfer money. But as you might expect, there is a technological solution to the problem. Let me explain.
A bitcoin transaction is deemed to be anonymous, because a wallet address looks like this:
1MwLKaCyzGDNXyhk8iUjwdcepUhqoPZehZ
Thatâs my bitcoin wallet address, by the way. Feel free to send me some bitcoin if youâre enjoying this series. But my point here is not to enrich myself. Itâs to show how thereâs a simple solution to regulatory worries about the anonymity of bitcoin transactions.
If my wallet address was âCharlie Morris, Pimlico, Londonâ instead, and if my identity could be proven as much by passport checks and proof of address, then in time, the regulators will come around to the idea. In fact, theyâll end up having more information about our financial affairs then ever before. For a regulator, whatâs not to like?
Financial networks, such as the G-Bit, could be programmed so that they are only able to transact with âcompliant walletsâ. Once standards for these become accepted, there will be no stopping the growth in blockchain technology. Until then, regulatory issues will be the primary stumbling point.
Once overcome, youâll see an explosion in the number of businesses and individuals embracing the new technology. Blockchains will become widespread and takeover the financial system. I believe one of the most exciting developments will occur when the Bank of England issues electronic pounds and other countries follow suit.
The implications of virtual or electronic money are mind blowing. They would enable cash transactions over the internet. This would improve the speed and security of doing business online, without the need for your credit card details.
Notice how I describe this breakthrough as electronic money rather than electronic payments. People often get confused by these concepts and believe todayâs money exists in digital form. It really doesnât. It is just a digital representation of a 19th century bank account. The bank has assets and a series of ledgers that describe what belongs to whom.
Electronic bearer certificates
Currently, an electronic payment can be made over the internet, but it involves a series of ledgers following the process. The settlement is likely to happen at the end of the day and cleared funds may take even longer.
Electronic money is quite different. With electronic money, you will be able to transact and settle in real time, without the need for a bank. Letâs call electronic money the âePoundâ.
By using ePounds, a transaction can take place directly between the two parties. The centralised ledger, a private blockchain operated by the Bank of England, will act as the sole record keeper. The concept of cash now exists in a digital form.
You could buy a small item, such as a news story, quickly and easily for a small sum. Doing this now is cumbersome using a credit card. Furthermore, your details wonât need to be stored anywhere. By using ePounds, when you send money, you are not only making a highly secure payment, but also proving your identity at the same time. The recipient has no ability to store your details, just acknowledge the payment.
These ePounds will be bearer certificates, just like todayâs cash. Transactions can take place without the need for a bank. The current account wonât need to exist and will be replaced by software.
The High Street banks will want to launch digital wallets. And donât forget Silicon Valley. Theyâll feel like anything to do with electronic money is their turf. You can imagine Google or Microsoft dominating this highly disruptive industry. Or a newcomer.
I can imagine a world in which the babies born today never have a current account at a bank. With electronic bearer certificates, the concept of the bank itself serves a less useful purpose.
Are there risks?
The recent hackings of customer data at Ashley Madison or Talk Talk wonât be possible because companies will no longer need, or be allowed, to store our financial data. Hacking is growing rapidly. But by removing much of the bait â your personal details attached to your credit card number â there will be less incentive to hack. Perhaps the growth in hacking is precisely because corporations store our data.
I have a confession to make: I love economic statistics. If the financial system moved to ePounds, these statistics would be materially improved and become available in real time. That would make the financial system more stable. More accurate information will help companies to make better decisions in areas such as capital investment and levels of inventory.
This remarkable piece of computer code will transform the financial system. It will remove layers of intermediaries that are no longer necessary. Transaction speeds will rise, security will improve, costs will fall and ecommerce will explode beyond recognition.
Thereâs one thing you can be sure of: the banks wonât give up their privileged position without a fight. One role that needs to be considered is the fractional reserve system. The banks will still be entitled to create money, just as they currently do.
However, I question how they manage this on the existing scale? If the current account becomes irrelevant, their deposit base will fall. New forms of lenders, such as crowd funding and the bond market will need to step in.
Whatâs it really worth?
In economic terms, the ePound will be no different from the existing pound. It will inflate and, in every sense, will be fiat money. The ePound is a brilliant âtechnologicalâ concept, but there are privacy concerns. Yet again, George Orwell will prove to have been right.
Those that have access to the ePound ledger (the Bank of England, the Inland Revenue, the Police and possibly the CIA), will know how long we spent at the pub, what publications we read and where we travel. Our spending habits say more about who we are than a biography. Iâm all too aware of the downside, but letâs leave that for another day.
Over the next two days, I will share my thoughts on how to value bitcoin. The price is close to $400, but whatâs it really worth?
Category: Investing in Bitcoin