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Pan Chao: The Evolution of Alternative Central Banks

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History cannot be reloaded, but new soil can allow imagination to be reinterpreted. The open market and network of the blockchain once again gave private central bank currencies an opportunity to experiment.

Original title: "The Evolution of Alternative Central Banks"

Original source: Moneyness Research Institute, Pan Chao

In Economics Currency is one of the oldest and most controversial topics in the United States. On the blockchain, there are also few areas more topical than stablecoins. Whether it is the monetary discussion of Bitcoin or Ethereum, or the dispute over the stable currency model, or even the reverie of the central bank's digital currency. A core research hypothesis can be extended: Is it possible to establish a parallel currency system based on the blockchain, and there is an institution or program to perform the functions of the central bank?

This is a seemingly contradictory proposition. Since it is a central bank, does it mean a monopoly on currency issuance by definition? Globalized free competition and no need for entry? Conversely, can a currency issuer without financial support survive in a sustainable and stable manner?

This article hopes to explore the alternative central bank (Alternative Central Bank) by reviewing the different models of traditional central bank development and introducing the innovation of monetary institutions on the blockchain. feasibility.

Three Models of Traditional Central Bank Development

The Emergence of Traditional Central Bank and development can be broadly classified into three modes.

The first model is a government charter model represented by the Bank of England, which initially mainly financed the government . In 1694, the Bank of England Corporation was established with the permission of the government, obtained the monopoly right to issue legal tender, and raised funds for the government to borrow as funds for the construction of the British Navy. In 1931, against the backdrop of the Great Depression, Britain abandoned the gold standard, and the currency issued by the Bank of England became the only legal tender in circulation, no longer a certificate of gold. After World War I, the Bank of England began to implement monetary policy gradually, with the goal of managing the supply and demand of domestic money and stabilizing the price level. The Bank of England was formally nationalized from a private bank in 1946 and has since come under the policy of the Treasury. Although the Bank of England Act of 1998 gave the Bank of England independent powers to set monetary policy, the BoE has always been an integral part of the government.

Pan Chao: Discuss the feasibility of blockchain central bank from the traditional central bank development model

The second model is the government cooperation model represented by the Bank of Amsterdam, which initially mainly provided financing for enterprises. The Bank of Amsterdam, established in 1609, did not have the ability to lend at the beginning. It only kept and managed standardized precious metal currencies for merchants, provided checks and exchange services, and charged fees. This is similar to the function of Jiaozi in the Song Dynasty and the ticket number in the Qing Dynasty in ancient China. At this time, the Bank of Amsterdam is 100% collateralized, and each check is backed by a full amount of precious metals.

However, the full reserve system could not satisfy the important position of the Bank of Amsterdam in the global financial center at that time. Slowly, the Bank of Amsterdam began to engage in lending business, starting in 1657 Provided loans to the Dutch East India Company and the city government and became its main business. The Bank of Amsterdam also gradually assumed public policy functions, including providing liquidity and acting as a lender of last resort during the Panic of 1763. The Bank of Amsterdam has changed from an issuer of stable currency to a manager of legal currency, that is, a central bank in the actual sense. Prosperity lasted for more than 100 years due to its good reputation and the steady trade of the East India Company. The turning point was the Fourth Anglo-Dutch War. The war caused the East India Company’s trade volume to shrink and it was unable to repay loans on time, which increased the ratio of non-performing loans to the capital of the Bank of Amsterdam. In the end, the failure of the Anglo-Dutch War and the panic run on precious metals made the Bank of Amsterdam unable to support it and declared bankruptcy.

Pan Chao: Discuss the feasibility of blockchain central bank from the traditional central bank development model

The third model is the lender-of-last-resort model represented by the Federal Reserve, which primarily finances banks at first. The original design of the Federal Reserve in 1913 was not to lend to the government or corporations, but to lend to the banking system during seasonal cycles and times of crisis. Provide banks with reserves through the discount window, accepting commercial loans as collateral. It is worth mentioning that in order to limit the centralization of power, the Federal Reserve was very decentralized when it was first established. There was not a central bank, but 12 Federal Reserve Banks. However, with the engulfing of World War I, the function of the Federal Reserve had to become a wartime financing tool for the government. Compared with gold reserves, the Federal Reserve began to accumulate more government bonds and suspended the acceptance of gold. After World War I, the United States was one of the few countries that was able to restart and maintain the gold standard. However, the onset of the Great Depression and the subsequent World War II once again eroded the Fed's independence, subject to the policy directives of the White House and Congress.

It was not until the signing of the Fed-Treasury Agreement in 1951 that the Fed gained independence in setting monetary policy. An important event was the Nixon shock in the 1970s. In order to be re-elected, President Nixon put pressure on Arthur Burns, then chairman of the Federal Reserve, not only closing the gold exchange window, ending the gold standard, but also allowing the United States to enter decades era of easy money and inflation. What broke that relationship was Paul Volcker's presidency in 1979, who re-established the Fed's independence and credibility and addressed high inflation during his tenure. Since then, the independence of the Federal Reserve and the demands of the government have been like a tug-of-war between monetary discipline and flexibility. The law shows that when the economy falls into crisis and external shocks, fiscal intervention and influence are more obvious.

Pan Chao: Discuss the feasibility of blockchain central bank from the traditional central bank development model

Through the history of the development of the central bank, we found that although the development paths of the traditional central bank are different, the final result is the same Support from government agencies. However, the central bank monopoly on money and government backing features are an evolutionary consequence of modern monetary systems, not a requirement. In the parallel world of the blockchain, can there be an alternative central bank path that does not depend on government agencies, and serves as the central bank’s currency issuer and ultimate lender to provide services to the public?

An alternative central bank model on the blockchain

MakerDAO was born in The test network phase of Ethereum (an open source, programmable, open payment and settlement network) was officially launched at the end of 2017. As an application on a permissionless network, Maker is inherently market-oriented and does not rely on any sovereign endorsement.

At first, Maker's function was similar to that of the Bank of Amsterdam, keeping sufficient asset reserves and issuing redemption certificates (Dai). The difference is that the Maker vault does not keep precious metals, but the native asset ETH (Ethereum network denomination unit with limited resources) on the blockchain. These two products of seemingly different eras have similar monetary properties. Both belong to external currencies, that is, debts that do not belong to anyone (although the initial Ethereum currency is closer to the property of securities, and gradually becomes a decentralized asset).

Different from the early Amsterdam Bank’s role as a check number, Maker plays the role of a pawn shop. It is also the prototype of the modern repo market. The advantage of the over-collateralization model is that there is no need to price assets and quickly provide liquidity. Thanks to the consensus mechanism of the Ethereum network, Maker does not even need to standardize assets and verify authenticity, but only needs a rough price transmission system and proper risk management.

Pan Chao: Discuss the feasibility of blockchain central bank from the traditional central bank development model

It can be said that Maker initially adopted the Ethereum standard system, issuing rigid stable currency certificates. This Ethereum standard lasted for two years and provided liquidity support to the market during the continuous decline of Ethereum assets in 2018-19.

An important turning point is that the economic impact brought by the new crown virus in 2020, the sharp decline of Ethereum as a risk asset in a short period of time not only shrinks Maker assets , Triggered abnormal liquidation and bad debts, and also made the premium of the stable currency Dai hold high. The market price was once 10% higher than the issue price. People panic buying certificates to redeem assets, get their collateral back. Although Maker still maintains sufficient reserves at this time, it is in a liquidity crisis. In response to the crisis, Maker began accepting a wider range of collateral types, including fiat currency assets (offshore dollars such as USDC) and Bitcoin. The benefits are obvious, Dai's premium disappears, and the system successfully completes the restructuring of bad debts. And Dai has developed from a single Ethereum standard to a multi-asset collateralized issuance.

Although the collateral is diversified, Maker only passively manages the collateral. To run a complete monetary system, Maker needs to assume the same role as the central bank, not just a function similar to the discount window, but also to stabilize currency prices and respond to internal and external demand shocks and the role of lender of last resort.

Just as the Bank of Amsterdam lent to the East India Company, Maker began to make lease financing loans to American real estate developers in the form of trust SPV. Through the balance sheet overdraft, new Dai is issued to real estate developers, who will build sites and lease them to merchants, and Maker will collect interest as a priority debt. This is a major shift and a natural choice to meet the needs of global trade. Maker has changed from the issuer of the rigid stable currency to the creator of the currency, injecting flexibility into the system through the accumulated reputation, which also gave it the embryonic form of the central bank.

Pan Chao: From the traditional central bank development model to explore the feasibility of blockchain central bank

It can be seen that Maker's central bank The development model is most similar to the second type of financing for enterprises, the difference is that Maker does not have the cooperation of the government. What we want to ask is whether Maker will repeat the mistakes of the Bank of Amsterdam, or can explore an alternative central bank model that does not rely on the government.

In <An early stablecoin? The Bank of Amsterdam and the governance of money> Fiscal support to recapitalize banks when they fall into negative equity. However, this looks more like a hypothesis than a general rule. After the "3.12 Black Swan Incident", without financial support, Maker successfully recapitalized bad debts on the blockchain by issuing additional governance tokens, and turned losses into profits within half a year.

In order for a currency to be accepted, the central bank needs to have an endorsement, which includes assets, reputation, and sovereignty. One thing is certain, Trust is the cornerstone of a sound monetary system. On the one hand, this kind of trust comes from the value network itself on the chain, such as the proof of work guarantees the quality of the currency, and the smart contract improves the certainty of the transaction, etc. Security of business logic and due diligence on loan originators.

Whether sovereignty is a necessary condition is debatable, just as the traditional central bank development model can be understood as the government providing the ultimate guarantee for currency issuance and management, and also It can be considered that private central banks create money, and governments are only one of their customers. It is difficult for us to predict whether a central bank that does not rely on fiscal support can survive the test of multiple crises, or whether a non-powerful public sector and fiscal revenue can emerge on the Ethereum network, and cooperate with currency issuers such as Maker.

What we can see is that Maker has opened up an alternative central bank road, and then there will be constraints and innovations around DAO governance, as well as from The challenge of Ethereum's own consensus. The delicate trade-off of governance is that if the governance constraints are too large, it will reduce efficiency, hinder the expansion of stablecoins and meet market demand. Conversely, if governance is ineffective, wanton lending will eventually erode the trust of the issuer and affect the value of the currency. The challenge of the Ethereum consensus is more like the eve of the American Civil War. The instability of the basic value infrastructure will directly affect the asset-liability structure and independence of the currency issuer.

Pan Chao: Discuss the feasibility of blockchain central bank from the traditional central bank development model

History cannot be reloaded, but new soil can Let the idea be reinterpreted. The open market and network of the blockchain once again gave private central bank currencies an opportunity to experiment.

Appendix: Algorithmic stablecoin is a mechanism that automatically adjusts the money supply according to the program, and has gradually become the focus of attention. Although the algorithmic stablecoin considers currency elasticity, this elasticity is a zero-sum game. New credit creation (whether it is stablecoin or bonds or shares) is not supported by full redemption rights and profits, but completely depends on the later generations. of capital investment. The elastic rules for algorithmic stablecoins are not new money or credit creation, but degrading money and collecting seigniorage. In a fully competitive market, only collateralized and credit-backed stablecoins can operate for a long time, and algorithms have neither collateral nor credit.

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