Nadine Baudot-Trajtenberg: The future of money - policy and
regulation
Remarks by Dr Nadine Baudot-Trajtenberg, Deputy Governor of the Bank of Israel, at the Eli
Hurvitz Conference on Economy and Society, Jerusalem, 20 June 2018.
* * *
Technological advances are affecting our daily routines, at home, at work, on our commute, and
pretty much everywhere we look around. Yet it is not often that as central bankers, we are faced
with a technological innovation that forces us to rethink the most basic way we understand
macroeconomics. The appearance of cryptocurrencies such as Bitcoin and others has
awakened a well-known and long debated issue surrounding
the role of money: What is it?
How much is needed? Who should provide it, and how?
But the discussion has now broadened considerably: if up to a few years ago we heard mostly
about bitcoins and other digital currencies, today the buzz is more about tokens, ICOs (Initial
Coin Offerings) and the use of DLT (Distributed Ledger Technology) in a very broad range of
sectors and industries. Some of the visionaries in the field think that this could bring about a
revolution as to how digital information is managed to create business and social models that will
return power to the private individuals, away from large corporations, organizations and even
governments. I must admit that I tend to be skeptical of utopian visions of the future, but this is
not to say that I do not recognize that this technology has the potential to make dramatic
changes, just as the Internet revolution dramatically changed the way we do things, and has
brought about new business models.
It is important to note that even the visionaries do not think that a new world order will appear
overnight. In the meantime it is important to understand what this new technology brings to the
table-that its predecessors did not-and as policy makers, how can we seek to reap its
benefits for the general public while balancing out the risks that inevitably accompany change,
particularly during a transition period between old and new.
People have asked, what is DLT's innovation for digital information systems?
As far as I can understand this new technological infrastructure, there are two elements of DLT,
or at least its early uses as we understand them today, that have the potential to improve upon
our existing systems:
1. Data and transactions are stored and documented simultaneously in a distributed manner,
not in a central data base and they have strong cryptographic security built into them.
2. The coins/tokens used in an exchange can embed all of the elements of a smart contract.
These two elements suggest a potential to markedly improve various exchange systems:
More secure data storage and internet based transactions -This is clearly important, we
are increasingly aware of data breaches that can jeopardize information systems, including
payment systems, and as we get to be increasingly more digital, our vulnerability to cyber
breaches has increased. Though governments and the business sector have invested
considerable resources and continue to add layers upon layers of cyber protection to the
various systems, DLT has built- in security features. Blockchain technology improves
resilience and secures our data by eliminating central targets altogether making it far more
difficult for theft, fraud and manipulation of data to occur. In addition, encryption that requires
full public verifiability and immutability of the information adds considerably to its security.
This by the way, comes at a cost, and the validation system is often slow and drains
resources (particularly energy) compared to existing clearing and settlement systems.
Decentralized management of individual data would impede on the rise of "data giants"
that can exploit their monopolistic power and the power that the network effect grants them
over individuals. Here we refer obviously, not only to financial institutions, which at times
have been suspected of exploiting their information advantage making it more difficult for
smaller and newer entrants to compete with them, but also to the data giants that make
considerable use of the information that they accumulate about individuals, without it being
clear as to the extent to which the users have really consented to that use. I must say that
we do not yet know if this technology can deliver on that promise-one that was similarly
made with the birth of the internet and which over time turned out to have been completely
wrong-particularly given that the governance and control of these new networks is still
heavily centralized. Quoting from R3, "The truth is that all these networks operate according
to a defined set of rules, and that 'who makes the rules matters at least as much as who
1
enforces them'".
Increased efficiency in executing and clearing complex transactions without the need
for intermediaries: Today, complex financial, foreign trade, and other transactions take much
time to complete, and require intermediation by many entities. The possibility of embedding
smart contracts into the protocol could greatly enhance the expediency with which the
transactions are processed. Essentially, this ability to merge functions that until now have
been mostly detached from one another, such as payment, contract specifications and
verification mechanisms promises great efficiency gains. To quote the Governor of the Bank
of England, Marc Carney, "Financial transactions that take nano seconds to be executed can
take days to be reconciled, cleared and finally settled."
This is very exciting stuff indeed, but what does it mean for money as we know it today, and to
what extent and in which direction is this technology expected, and perhaps should, change the
financial system as we know it today?
Money, past, present and future
Our "textbook" money combines 3 essential roles-it has to be able to serve as a Unit of
Account, Means of Payment and Store of Value. In order to perform all of these 3 functions, it has
to be easily available, affordable, durable, portable and reliable.
Over the course of history various forms of money have existed, reflecting in part the technology
available at any time, from metallic coins of various sorts, paper banknotes, ledgers recording
th
promises to pay (as in the ancient clay tablets of Babylon in the 17 century BCE, or the
Renaissance Bank of the Medici). But besides technology, these methods also reflected
economic and particularly legal arrangements to ensure the reliability of the payment.
In fact the history of the various forms of money is one replete with innovations and failures from
both public and private institutions. We have seen Governments betraying the trust of their
citizens by over-expanding the money supply, often to finance wars, or to attempt to recover
quickly from them, and as a consequence the value of their currency evaporated. Private banks
have been unable to repay the deposits to their clients, having made losses on their loans or
investments. Again quoting Marc Carney "With the wisdom borne from such sad experience,
most countries have now settled on centralised, public fiat money backed by robust institutions
in order to provide the public with money that is both highly trusted and easy to use".
Today's money takes 3 forms: cash and coins (about 10% of money in circulation)-and I can tell
you that considerable resources go into producing these in order to ensure their reliability,
electronic deposits that commercial banks hold as reserves at the Bank of Israel (a little over
20%) and the rest which are the deposits that commercial banks create when they extend loans
to borrowers which account for 70% of money in the system.
The institutional and legal framework as well as the infrastructure that supports these various
forms of money determines the level of trust we have in our money and the efficiency with which
our payments are made.
The Bank of Israel (as most central banks around the world) has been entrusted by the
legislature to ensure that the domestic currency-the shekel-indeed fulfills the 3 important
functions mentioned above.
The Bank is the sole provider of fiat money, and the newly issued series of bank notes uses
the most sophisticated technologies available to ensure that it will be almost impossible to
counterfeit.
It built and operates a wholesale payment system (RTGS) and clearing house for interbank
transactions, and is working to ensure a faster payment system for retail transactions as
well.
As supervisor of the commercial banks, the Bank of Israel ensures that those are properly
governed, with proper risk management in place to make sure that the money we deposit in
the banks is safe. It is important to us that the banks enable us to fulfill the "means of
payment" role of the money that they hold for us, as efficiently as possible, and the
Supervisor of Banks is in fact encouraging technological and structural improvements to
enhance efficiency. But we also enforce the public's demand for "clean" money, and ensure
that banks comply with the strictest level of the laws prohibiting money laundering and
terrorism financing. This introduces friction in the system, it takes time and resources, but it
is a necessary friction as it certifies that we have a law abiding network: as policy makers
we must design the mechanics of financial transactions to uphold ethical standards from all
individuals, corporations and institutions. This was not in our classic textbook definition of
money, but it should be included in a new definition of "clean money".
Perhaps most importantly, the Bank's Monetary Committee is charged with ensuring that our
money keeps its value, by managing monetary policy that will maintain price stability. The 6
Monetary Committee members, including 3 members of the public, meet weekly to discuss
the economic and financial environment and the policy required in order to maintain the price
stability. Essentially, the Committee answers the question raised in my introduction-"how
much money is needed"-and the answer is, enough to facilitate economic activity but not
too much that prices increase by more than the target rate.
This perspective is absolutely essential to the economic system. This is absolutely essential to
the system, countries that fail to do so have seen their currency displaced, in all 3 of its
functions, as a unit of account, as a means of payments and as a store of value. Thus, aspiring
providers of "private currencies"-digital or other-will not survive unless they exhibit that crucial
characteristic. No market economy, which is based on the price system signaling where
resources should be allocated, can thrive with a foggy, volatile and unreliable price mechanism.
This is the most important public good provided by central banks to their country's citizens'
welfare, and should not to be taken for granted.
So what about DC and Crypto assets?
I doubt that any of the crypto assets will soon be able to provide the stable value of the unit of
account so crucially needed in a market economy, and certainly the very recent past shows that
the price volatility they exhibit has been very problematic in this regard. As a means of payment
they are still very limited and suffer from the problem that if their value falls, people will be
reluctant to be paid with those assets, and if their value rises, people will hesitate to use it as a
means of payment for fear of missing out on the expected rise in value.
But the technology it brings to the table has great potential to integrate into a few crucial area of
the financial system.
First, the fact that it can merge functions that were until now split means that they can
greatly improve the more complex transactions we undertake-and there are many of those,
from buying a house to buying financial derivatives in a foreign market, and undertaking
import/export transactions. In all of those the numerous intermediaries-who today bring
value added due to the lack of information available-increases the cost and the need for
credit. Indeed when there is a gap in time between the execution of the transaction and its
final approval, credit must be taken out. So its biggest immediate potential is in complex
transactions that take a long time to settle-not in replacing cash or other immediate
payments.
Second, its built in capacity for more secure data management is coming at a time where
we face increasing cyber risk, and thus this technology may prove to be a solution to a
growing problem.
Third, it will bring about new business models, particularly matching consumers and
investors directly, through legitimate and viable ICOs. I emphasize viable because of the
thousands of ICOs appearing in the past few years, less than half survived beyond 90 days,
and I emphasize legitimate because a large number of the offerings we have seen appear to
be part of fraudulent investment schemes.
In order to fully reap those benefits, and the promise inherent in technology, all regulatory
authorities will have to work together to allow these technologies to deliver on their inherent
promise, while continuing to protect the citizens from fraud and reckless ventures that are liable
to erode the fabric of trust so much needed for our financial system to function as it should.
Therefore, the Bank of Israel is acting on this issue and intends to promote collaboration through
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a joint team, with the participation of all the relevant entities in the issue.
1
See R3, "Top Ten Obstacles along Distributed Ledgers' Path to Adoption", Sarah Meiklejohn, December 14,
2017.​