Cai Wei-de: A new type of currency war is sweeping in and is subverting the world's financial landscape

In recent years, the new (digital) currency war has slowly started. Regarding the digital currency war, the event that is easily associated with is the release of the Libra (later renamed Diem) white paper by Facebook on June 18, 2019. This event caused a great response, and many people around the world are actively looking for ways to deal with it. Although I predicted that this event would definitely shock the world before Facebook released the Libra white paper, many people were still not mentally prepared at the time, and some economists even believed that Facebook’s event was not important and would not cause any changes to finance or the market.

1. Libra reflects unprecedented changes in the global financial system

The International Monetary Fund has published a comprehensive report on digital currencies, which states that Facebook's stablecoin is the world's first compliant global digital currency. In the past, all currencies were national or regional currencies, such as the US dollar is the currency of the United States and the euro is the currency of the European Union, but Libra is a global currency, so its emergence has a global impact.

The International Monetary Fund believes that this is an unprecedented historical event that has changed the structure of financial markets, foreign exchange management, world reserve currencies, regulatory systems, and financial stability. At the same time, digital currencies may replace local legal tender. Therefore, many governments at the time believed that Facebook's event was a new monetary hegemony and neo-colonialism.

The emergence of Libra stablecoin gave birth to a new concept: digital currency is a commercial behavior with both monetary and commercial attributes. In other words, Facebook's launch of stablecoin is Facebook's own business activity, not a country's hegemony, or that national hegemony is hidden behind Facebook's stablecoin. The new currency war raises issues such as transaction speed, security, supervision and policy. When digital currency appears, all aspects of the problem will change, which will be very different from the exchange rate and interest rate of the traditional currency war.

2. The “823 Incident” triggered a new currency war

The speech by the Governor of the Bank of England in the United States is an important node in the new digital currency war. The launch of Facebook's stablecoin is mainly a commercial activity, but August 23, 2019 is the real outbreak point of the new currency war, which can also be called the "823 incident". On that day, the Governor of the Bank of England, Mark Carney, expressed his position to the Federal Reserve, believing that the GDP and trade status of the United States in the world are showing a downward trend, but the use of the US dollar is still the most common, which is unreasonable. Therefore, Mark Carney put forward three new views:

Cross-border trade and cross-border payments are the most important factors in determining the world's reserve currency (not determined by national GDP);

The currency used for cross-border trade has a network effect. The more people use it, the higher its value. The higher its value, the more people use it. Therefore, the use of the US dollar has inertia and is difficult to convert.

The world will become multipolar, with the US GDP no longer dominant (so even in terms of GDP, the US dollar as the world’s reserve currency is not justified).

Since most cross-border payments now use the US dollar, the world's reserve currency is the US dollar. However, this logic and status are changing. Many countries, including China, are playing an increasingly important role in world trade. The position of the United States has been challenged, and similar changes are also reflected in other areas. Therefore, it is not reasonable for the US dollar to continue to be the world's reserve currency.

At the same time, Mark Carney also proposed three solutions:

One is to continue using the US dollar. Although this is not reasonable, it is necessary to maintain the status quo from a feasibility perspective.

Second, although the status of China's economy will promote the widespread use of the RMB in the near future, the degree of internationalization of the RMB is still relatively low, even lower than some weaker currencies.

The third is to refer to the Bancor proposal put forward by the British representative at the Bretton Woods Conference in 1944, that is, a "synthetic hegemonic digital currency" based on a basket of legal currencies should be used as the world's reserve currency. Because speed and convenience are key to cross-border trade, digital currency should be used instead of traditional currency.

Mark Carney cited a theory from Princeton University ("Digital Currency Areas"), which believes that digital currency will change the structure of the world market, which has also been recognized by the International Monetary Fund. Digital currency is born out of connection, but is divided due to competition. Ultimately, the development of digital currency will make the world financial market more divided, so he used "Digital Currency Areas" as the name of the theory.

Money has three functions: medium of exchange, unit of account, and store of value. Mark Carney believes that the most important function of the world's reserve currency is the medium of exchange, so the medium of exchange should be the most important factor in determining the world's reserve currency. This is also based on the theory of Princeton University, which guides the measures and layout of the US currency war.

3. The “new platform” is greater than the “old center”

The left side of the picture below is the current cross-border payment architecture (provided by the International Monetary Fund in October 2020), which goes through SWIFT and agent banks, etc. The right side is an architecture based on blockchain and digital currency. It can be seen that the right side is already very networked and distributed rather than centralized. This is a distributed architecture formed by blockchain and the network, and the entire market structure has changed.

The international financial market has changed. The traditional financial center is the bank, and the digital financial center in the future will be the blockchain or blockchain network platform (this is also a focus of Princeton University's theory). This theory inspired Facebook's Libra 2.0 in 2020 to "abandon the coin to protect the chain". For countries that are unwilling to accept Facebook's stablecoin, Facebook said that Facebook's chain will be provided to the country, so that these countries can have the technology to develop their own stablecoins and the country's central bank digital currency (CBDC). This is the basic spirit of "abandoning the coin to protect the chain". It can be seen from this that the new digital currency war is very different from the traditional currency war.

The Bank of England began developing the digital pound in 2015, and claimed that the purpose of developing the digital pound was to provide British people with better payment methods and better financial services. But a few years later (July 2019), the Bank of England stated that its real intention was to take back regulatory power. Because most payments in the UK belong to third-party payments that the Bank of England cannot see, the Bank of England must obtain regulatory power through the digital pound payment method. However, in August 2019 (one month later), it stated that this was a new type of currency competition.

4. Although the dispute has not been resolved, countermeasures must be implemented first

In November 2019, Harvard University economist Kenneth Rogoff published a short article about the new currency war, which talked about the United States launching a new currency war. The article stated that if Princeton University's theory is correct, then the first step to protect the dollar is to make the dollar more circulated. When Princeton University's theory appeared, some economists, including experts from the International Monetary Fund, explicitly (and publicly) opposed it, believing that the theory was too new and unreliable. They believed that the volume of GDP took precedence over the liquidity of money. However, Princeton University's theory had a profound impact. After Mark Carney finished speaking, the European Central Bank, the Federal Reserve and many experts held several meetings to discuss this theory.

Rogoff believes that this theory is at least partially correct, and if it is correct, it will have a great impact on the United States. Therefore, before the theory is fully proved or disproven, the United States must take countermeasures. Rogoff said that the digital currency war can be divided into at least two camps, perhaps more such as three camps or four camps, and it is a camp war. The two major categories of markets include compliant markets and underground markets, which are very different from traditional currency wars. The concept of currency bloc was mentioned in the report of the International Monetary Fund in October 2020, which is the concept of "digital currency zone".

Rogoff also mentioned that underground markets involving gangs, smuggling and money laundering are difficult to manage effectively, so they can be managed indirectly through regulatory technology and taxation.

In November 2019, Harvard Kennedy School and MIT jointly organized a simulation of a national security conference, which mentioned that the new currency war would cause SWIFT to lose some of its functions. Previously, some people believed that SWIFT would not be abandoned (for example, it would not be replaced by digital currency), and digital currency was not a war, but the possibility of completely replacing SWIFT emerged at this conference.

5. Three major arenas of war: technology, market, and regulation

The new currency war also has three major arenas, namely technology, market, and regulation. Technology is considered the most important because regulation has become regulatory technology and the market has become market technology. The new currency war is a financial war, an economic war, and a technological war. Some people have always had the idea that computers will not change finance. But the Facebook incident has undoubtedly proved that computers have changed finance. Rogoff believes in his short article that there is no need to discuss this topic anymore because technology has changed the financial market. The current work is to prepare for this new currency war.

Rogoff believes that this is a comprehensive currency war, but this kind of commercial war does not need to be declared by the government. One of the most important things is that the US Congress proposed 22 bills in December 2019. In fact, this is a preparation for war, because legislation means that even if the president changes, this matter will not change. The United States has long insisted that it will not legislate for digital currency, even after Facebook released the white paper in June 2019. The United States will not legislate for these. But in December 2019, the United States suddenly introduced 22 bills, which reflects the importance of this matter.

Regarding the three arenas, the technology aspect is represented by Libra 2.0, which will use new technology to eliminate all the original technologies and establish a new payment network (this is an idea proposed by the US Treasury Department at a public meeting in 2020). Examples in the market include US banks being able to participate in blockchain, etc. In terms of supervision, the United States has a new type of regulatory technology.

6. Libra platform brings many inspirations

The current blockchain-based digital tokens (Bitcoin, Ethereum, etc.) are neither currencies nor payment systems, but just a closed commodity system. A payment system must involve multiple assets and multiple institutions, so Bitcoin, Ethereum, and Hyperledger are not payment systems. The new blockchain should focus on multi-asset transactions that conform to the laws of the modern financial market, which is different from the traditional blockchain.

Therefore, when doing blockchain research, we should not take the old blockchain viewpoint as the starting point, but should take the new blockchain and new digital currency as the starting point. The following figure is designed based on the needs of the new currency war and currency market. Some characteristics of blockchain will change, and the entire architecture of LSO (Ledgers, Smart Contracts, Oracles) will also undergo tremendous changes.

7. Changing competition landscape poses a threat to the status of the US dollar

Brooks, a former official of the U.S. Treasury Department, said in January 2021 that the purpose of implementing banking reforms, allowing banks to issue stablecoins and approving banks to participate in blockchain and other operations, is to protect the U.S. dollar. Many central banks in the world are reducing their dollar reserves and investing in other currencies. In order to make the dollar more competitive, the U.S. Treasury Department has proposed a series of plans, among which digital stablecoins and blockchain can contribute to protecting the position of the U.S. dollar in the world financial market.

According to public data released by U.S. regulatory technology companies, the top ten banks in the United States are all engaged in stablecoin trading. Even though banks cannot participate in blockchain operations and cannot legally issue stablecoins, the average daily transaction volume is already $1 billion, which means that digital currencies have already penetrated the compliance market. This is based on data collected by U.S. regulatory technology companies in 2020.

US regulatory technology companies have also discovered that the underground market has been circulating around the world, and a large amount of funds have long been circulated around the world through Bitcoin, without being managed by SWIFT. At the same time, the liquidity of Bitcoin has exceeded the legal currency of many countries such as the British pound. This has indeed shocked the US financial community.

Traditional currency wars are competitions between fiat currencies (for example, a country does not use local fiat currency but the US dollar). After the emergence of Facebook's stablecoin, there is competition between stablecoins and fiat currencies. Now that the underground market has penetrated the world, Bitcoin has appeared in the competition landscape, which means that the original two-way battle has become a three-way battle (fiat currency, stablecoin, and digital token), becoming a more complex form of currency war.

When Facebook released its white paper in June 2019, the chairman of the Federal Reserve said that there was no need to worry about Bitcoin challenging the US dollar, because the small size of Bitcoin would not have any impact on the US dollar. But in February 2021, the Federal Reserve said that the US dollar would definitely beat Bitcoin, which means that Bitcoin can already challenge the US dollar. There is only a 19-month difference between the two periods, but the situation has changed.

8. STRISA may replace SWIFT

The US layout is to promote the new currency war by taking regulation and technology as the first step. Therefore, we have obtained relevant data, which are mostly public information collected and released by US technology companies. For example, the 1 billion transactions of US banks every day are data obtained by US regulatory technology companies.

In order to solve the problem of digital currency management, the Financial Action Task Force (FAFT) proposed the Travel Rule, and the US regulatory company established the TRISA (Travel Rule Information Sharing Architecture) system based on the Travel Rule. The TRISA system may become the Domain Name Server (DNS) of the world's financial institutions, that is, the domain name registration center. Not registering in this registration center means being excluded by the world. This is a networked system, different from the traditional centralized SWIFT system.

As mentioned above, the mock White House conference held by Harvard University in the United States stated that there should be a system to gradually replace SWIFT, and this replacement system may be TRISA. Since it is not registered on it, it will be excluded.

In June 2020, we said that we must start researching new regulatory technologies instead of old ones. At that time, the United States had already made TRISA, but we found that the TRISA system had loopholes and needed to be more rigorous, so our team made the STRISA system to strengthen the functions of TRISA. With STRISA and the subsequent regulatory platform (blockchain data lake), digital currency and digital asset transactions can be regulated, which means that fund management in new digital finance can be carried out through the STRISA system, which is a brand new technological development.