- Pascal Hügli
You don’t want to help bank the unbanked!
Updated: Feb 6
Within the established world of finance, Bitcoin is pretty much out these days. At least that is the impression you get from talking to bankers, asset managers, and professional traders, who have entered the “Blockchain” space. They’ve entered not because of Bitcoin and Ether, but because they see a huge potential in tokenizing traditional financial instruments.
As they see it, tokenization is going to change the financial system dramatically. Whether it be stocks, bonds, real estate or any other kind of financial derivative — they should all be tokenized one day! Cost savings and efficiency gains stemming from greater interoperability and increased liquidity will be the most obvious benefits to existing institutions, so the argument goes.
What makes these people even more excited is the fact that they see tokenization as a great advancement for the democratization of finance, because it’s supposed to turn previously illiquid assets into liquid ones. Particularly those from lower income classes shall be investing and profiting nicely, as traditionally illiquid investments become more approachable, bite-sized tokens carrying simple, blissful liquidity. After all, real estate and art, as well as other luxury items have become very expensive, which is why only wealthy investors get the chance of leveraging their wealth by investing in them. As a consequence, the wealth inequality gap widens. By making these houses, paintings, and luxury goods investable through tokens, investors can buy fractions of each, making it possible for them to invest, which must be an improvement over the status quo!
Tokenization — with a twist!
However, with all the excitement around tokenization, a few cautionary thoughts might be merited. What seems to be generally overlooked: Real estate, paintings, as well as other luxury goods, have gained such a prevalent status as financial assets today, precisely because the institutionalized money creation by a public-private partnership has been generating vast amounts of excess liquidity. Almost tsunami-like, this glut of excess liquidity is flooding every corner of our planet, desperately looking for any yield to invest in.
Of course, it might seem only fair to let hitherto excluded parties like the average Joe participate by making use of the tools and means that tokenization will offer. But the underlying problem of today’s institutionalized expansion of the money supply, which is responsible for massive asset price inflation of all kinds, is not likely to be solved — rather it stands to worsen in the long term. Because when more people are able to invest in all sorts of assets, more liquidity is unleashed into capital markets. This inevitably drives up prices — it’s as simple as that.
So, the fact that tokenization is also being promoted for goods such as artwork and other items that do not generate a passive return is connected to the expansion of the broader money supplies, too. In the case of real estate, tokenization might make sense to the extent that a passive return is generated in the form of a rental income, which can then be paid out to token holders.
This is not the case for items that do not yield a passive return. Here it is solely price appreciation that is supposed to incentivize a token holder. The fact that this appreciation has been a given over the past couple of decades is again a consequence of our monetary system’s constant monetary expansion. Without it, price appreciation of goods like artwork or other luxury goods would surely be less.
Not least for this reason, Bitcoiners, in particular, are critical of tokenization. Their fear is that it will serve as a welcome distraction from the actual problem of current money creation inherent in today’s system. As tokenization lowers the threshold for investment, it becomes less obvious and noticeable that it is institutionalized money creation in the first place that makes the threshold to the investment world unattainable for an ever-greater number of middle-class people. The root issues remain unaddressed.
Good intention, bad outcomes
For a similar reason, Bitcoiners also oppose the often-heard notion of banking the unbanked. This well-worn phrase is very popular among enthusiastic blockchain enthusiasts, fintech representatives, and progressive bankers. They rightly call for the empowerment of about two billion unbanked people to provide them with basic financial services.
Interestingly enough, with its new digital coin called Libra, Facebook is trying to do exactly that. But as benevolent as this scheme to help the unbanked and poor people of this world appears, chances are that first world institutions will be profiting the most.
As a powerful but nevertheless extended arm of the current financial system, Facebook is trying to tap into the savings of the unbanked. If this system truly scales, this could amount to a massive wealth transfer engine. First world economies would be the ones benefiting at the cost of developing economies. Why?
To use Libra, people will have to buy the stablecoin with their own fiat. With the local currencies that people trade in for Libra, a basket of reserve assets is accumulated to back the minted Libra coins. On the user side, for new coins to be created, there must be an equivalent purchase of Libra for fiat and transfer of that fiat to the reserve. Eventually, the money for this reserve that is backing Libra is coming either from initial investors or users of Libra.
The actual assets used as reserves to back Libra will be a collection of low-volatility assets, including bank deposits, government securities, and in currencies from stable and reputable central banks. These reserve assets will obviously yield interest, but users of Libra will not receive a return from the reserve. According to the people behind the project, “revenue from this interest will first go to support the operating expenses of the association — to fund investments in the growth and development of the ecosystem, grants to nonprofit and multilateral organizations, engineering research, etc. Once that is covered, part of the remaining returns will go to pay dividends to early investors in the Libra investment Token for their initial contributions.”
As Caitlin Long pointed out in her excellent tweet storm here, this kind of setup might be forced to undergo a change in the future. Facebook has already caused more than one outcry before. Politicians, as well as public intellectuals, are monitoring the company and its action very closely. If the interest gained from reserves is solely doled out among developed-world companies, there will be a lot of public outrage regarding their profiting off of developing-world savers. The scandal will be acute, and Facebook will have to react.
Be that as it may, even if interest was handed out to Libra users, Facebook’s globalcoin ultimately is a technology allowing the first world to extend its expansionary monetary policy to the third world. From a neutral economic point of view, it’s rather foolish to think that the third world will be benefiting from this in the long run. We once had territorial colonialism, whose overall record was considered a negative — rightly so, one could argue. Why should well-intended monetary colonialism be any different?
What we are witnessing with Libra is another attempt by the industrialized world to keep their debt-based monetary system functioning. Let us be clear: this is not an argument in favor of any conspiracy against the third world. It’s just incentives and practical constraints of the current situation that make people work toward the aforementioned direction. As a matter of fact, the marginal utility of debt and with it the marginal efficacy of our modern monetary system — see for its roots here — has been decreasing. Only if new savings can be tapped into, debt can be issued to keep things running.
Libra is doing exactly that. It’s tapping into whatever savings the unbanked have, channeling them into first-world debt. This will enable developed nations to leverage their power even more, exponentially increasing their edge over the less-developed world. Nic Carter has pointed to this fact by making the argument that the long tail of sovereign currencies will be damaged in his tweet storm here.
Whether to call Libra a cryptocurrency or not can be hotly debated. Facebook is trying to set up their blockchain as a permissioned network, with the goal of turning it into a permissionless one in the future. This is highly ambitious — probably overly ambitious. Having tasted the advantages of a permissioned, centralized structure, it’s hardly likely that they will be ready to freely relinquish it. It is again Nic Carter, who beautifully summarized this with his tweet here, mentioning a quote by Friedrich Engels. And it was Hasu who pointed out the forces that make decentralizing Libra a very hard thing to pull off.
But the cryptocurrency discussion aside, what is truly aligning Libra with the old paper money system is its pegging to the system’s most important assets, government bonds. So even if Libra was decentralized and could be considered a cryptocurrency, at its core, there still resides the same old paper stuff!
This leads us to the conclusion: All the talk about Libra being a threat to the dollar and well-established fiat currencies, in general, is missing one key fact. Its foundation is government bonds. The institutionalization of government bonds fostered one of the most “powerful” fictions of our modern world: that sovereign bonds are risk-free assets!
Interestingly enough, government bonds’ nimbus stems from a very sly monetary “innovation”: The combination of the profit motive with coercion. As sovereign bonds are ultimately backed by the coercion of the sovereign, they are backed by the most potent debtor of all. This makes them a very lucrative option for institutional as well as private investors seeking yield!
With Libra, especially if it can scale to global mass adoption, a new powerful force demanding well-established government bonds is born. By fostering great demand for these sovereign bonds, fiat currencies like the dollar will be strengthened. In the short term then, Libra will most definitely be beneficial for the worlds most popular fiat currencies.
In the long run, however, Libra is most likely opting for what will one day be considered fossils from an era long gone. After all, Libra is one more attempt at keeping our current but ceasing era of paper money from coming to an end. An end that is inevitable and is slowly but surely ushered in by the new digital age accompanied and fostered by Bitcoin and things coming from it!
Thanks to Nic Carter, simon Lutz and Crypto Voices for the valuable feedback!
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