As part of Singapore Fintech Festival 2021, Ravi Menon, Managing Director of Monetary Authority of Singapore (MAS), talked today (November 9) about the future of money, finance and the Internet, likening these three pillars to Roman gods.
Sharing more about its history, Ravi said that money has always been used as a medium of exchange, and is named after the Roman goddess of money, Juno Moneta.
It has greatly evolved over the years, from bullion coins to paper notes, paper notes backed by gold, to fiat currency backed by central banks, and now digital money.
Finance, which is the intermediation of savings and investment, existed in many ancient civilisations. The Roman god of wealth, Plutus, comes close to being the presiding deity for finance.
Finance too has come a long way — foreign exchange markets and bills of exchange emerged in the middle ages before modern finance took shape with fractional reserve banking, stock markets, mutual funds, and insurance.
The Internet is more recent, with its official birthday listed on 1 January 1983, though the concept itself — namely a computer network which enables information sharing among users — goes back to the US defence industry in the 1960s.
The ancient Romans clearly did not have a god for the Internet, but perhaps, Mercury, the god of commerce and communications, comes closest, noted Ravi.
He added that the future of Judo, Plutus, and Mercury, is increasingly becoming entwined largely due to technology, but what exactly have they been up to lately?
Three new developments in the finance world
In the past decade, new forms of money have been emerging. But before we can make sense of this “new money”, Ravi went on to refresh our understanding of existing money.
Today, we keep money in two forms: physical cash in the form of notes and coins, and digital money in the form of deposits with commercial banks.
Most of our money is privately created by commercial banks and is in digital form. Bank deposits account for 92 per cent of the money supply in Singapore, and they are the basis for all electronic payments by households and firms using debit and credit cards, e-wallets, and account-to-account bank transfers.
On the other hand, commercial banks place reserves with the central bank to settle interbank transactions arising from these electronic payments.
“Confidence in money is anchored by the central bank. Central banks conduct monetary policy to ensure low and stable inflation which safeguards the purchasing power of our money. In addition, by regulating commercial banks and acting as lenders of last resort during crisis periods, central banks underpin the overall soundness of the banking system,” explained Ravi.
“So the credibility of money is underpinned by this two-tier monetary structure where commercial banks create money, and central banks preserve its value.”
However, he observed that three new developments have emerged in the past decade that has fundamentally challenged this two-tier monetary structure: cryptocurrencies, stable coins, and central bank digital currencies (CBDCs).
Is crypto a new form of money?
“A cryptocurrency is a digital token issued and managed by a decentralised protocol, or within a decentralised protocol, such as a distributed ledger or blockchain. It represents an asset in a digital form that can be transferred or traded on the protocol,” he explained.
The word ‘crypto’ comes from the Greek word ‘kryptos’, which means secret, he added.
Indeed, the anonymous nature of crypto tokens has unfortunately made them well-suited for facilitating illicit transactions, including money laundering.
Cryptocurrencies have also helped to fuel ransomware, one of the fastest-growing crimes in cyberspace.
“But are cryptocurrencies money? So far, the answer must be no,” said Ravi.
Cryptocurrencies have performed poorly as a medium of exchange, a store of value, or a unit of account. MAS prefers to call them by their more accurate, technical name: crypto tokens. We define tokens that are used for payments as digital payment tokens, and entities which provide services related to such tokens in Singapore are subject to licensing and supervision by MAS, primarily for money laundering and terrorism financing risks.
MAS frowns on cryptocurrencies, or tokens as an investment asset for retail investors. The prices of crypto tokens are not anchored on any economic fundamentals, and are subject to sharp speculative swings. Investors in these tokens are at risk of suffering significant losses.
– Ravi Menon, managing director of MAS
However, MAS is also of the view that blockchains and cryptos can bring many potential benefits.
The blockchain is suited for applications where it is important to know the history of ownership and transfer of value, but there is no trusted central party or reliance on a central party is too costly.
“A potentially strong use case of crypto tokens is to facilitate cheaper and faster cross-border payments and trade finance, but to be regarded as money, crypto tokens need to be more stable in value and have credible backing,” said Ravi. “Hence, the emergence of the second phenomenon: stable coins.”
We need to keep stable coins on a tight leash
Stable coins seek to combine the credibility of fiat currencies with the advantages of the blockchain.
“The more prevalent stable coins are pegged to the US dollar. They promise to redeem at par and claim to be backed by reserves. Will Juno accept stable coins as money? Well, an encouraging sign is that stable coins are beginning to find acceptance outside of the crypto ecosystem,” said Ravi.
Some technology firms have already integrated stable coins into their payment services. For instance, Visa and Mastercard both allow transactions to be settled using the USD coin.
“Stable coins are more akin to the Chimaera, a monstrous fire-breathing hybrid creature in Greek mythology. Stable coin issuers look like banks when they take money and offer to return it on demand, but if they do not intermediate credit, would bank regulation be appropriate for them?”
“They may seem like money market funds, but are capital market rules sufficient to ensure that reserve backing is really there behind these crypto stable coins? We don’t know.”
Stable coins can potentially pose financial stability risks. For example, if there’s a run on a significant issue of a stable coin, there could be contagion risks to financial markets should the reserve assets be rapidly liquidated.
Ravi said that MAS has been “thinking deeply” about these issues, even as they continue to license crypto token players and encourage experimentation in this space.
We have to approach this Chimaera with flexible regulatory chains, which will allow us to harness its potential benefits, but can be tightened quickly if the beast threatens to breath fire.
– Ravi Menon, managing director of MAS
Will MAS issue a digital Singapore dollar?
According to Ravi, the history of privately-issued money without public banking “has not been inspiring”.
Will people put their faith in crypto tokens or stable coins that are not backed by central banks, which are dedicated to protecting its value? At the same time, is there not a way to harness the potential benefits of distributed ledgers through some form of digital currency?
These are what spiked the global interest in central bank digital currencies (CBDCs). It is a direct liability of, and payment instrument issued by the central bank.
There are two types of CBDCs: wholesale CBDCs, and retail CBDCs.
Wholesale CBDCs are restricted to use within the banking system and are akin to the reserves commercial banks play with the central bank today. Meanwhile, retail CBDCs are issued by the central bank to the general public, very much like the digital equivalent of today’s notes and coins.
So what is MAS’ stance towards CBDCs?
MAS sees much promise in wholesale CBDCs. They have the potential to radically transform cross-border payments, but since wholesale CBDCs by definition are not meant to be used as currency by the general public, they are not money.
Retail CBDCs are essentially digital versions of cash. Interest in retail CBDCs has risen sharply in the last two years. According to a survey by the Bank for International Settlements, six out of 10 central banks are experimenting with retail CBDCs.
– Ravi Menon, managing director of MAS
MAS has been carefully studying the economic merits and implications of a retail CBDC in the Singapore context. In fact, the central bank has just released a detailed paper outlining its current thinking.
Currently, there are three possible reasons for MAS to issue to the public a digital Singapore dollar.
“Firstly, a digital Singapore dollar would make available the benefits of using central bank money in the growing world of online transactions,” said Ravi.
“Like notes and coins, digital Singapore dollar issued by MAS will be safe, widely accepted, and bear the authority of the state.”
He added that cash is the “ultimate risk-free asset and means of final settlement”. The rapid displacement of cash in favour of electronic payments based on bank deposits or e-wallets is one of the chief motivations for countries like Sweden and China to consider retail CBDCs.
“(The) second reason (is) a digital Singapore dollar could potentially foster an efficient and inclusive payment ecosystem. It could make it easier for smaller firms to build new payments and related digital services.”
For instance, startups can integrated with the retail CBDC and need not build their own e-money and user base.
This financial inclusion rationale has been a key motivation for countries like Cambodia and the Bahamas to adopt retail CBDCs.
“The third reason is, a digital Singapore dollar could mitigate against the encroachment of privately-issued stable coins or foreign CBDCs in Singapore’s payments landscape.”
“As these global digital currencies enter our market and become widely accessible in the future, they could potentially displace the use of the Singapore dollar in domestic retail transactions.”
A digital Singapore dollar that is issued by MAS that is congruent with the needs of a digitalised economy could definitely help to mitigate this risk one way or another. However, issuing a retail CBDC is “not a straightforward decision,” said Ravi.
Retail CBDCs can potentially pose significant risks to monetary and financial stability. There could be some disintermediation of banks, particularly during stress periods, if people can switch deposits into risk-free central bank money at the click of a button.
“Even in normal times, if people held a significant portion of their deposits in the form of digital Singapore dollars with MAS, it would considerably reduce our banks’ ability to make loans. We can likely manage these risks by designing the retail CBDC with sensible safeguards, such as stock and flow caps on the amount of digital Singapore dollars that anyone is allowed to place with MAS.”
At the end of the day, he feels that the case for retail CBDC in Singapore is “not urgent”. In fact, for a subject that is so controversial and has attracted so much attention, there are “neither strong reasons for or against a retail CBDC in Singapore.”
Explaining this statement, Ravi said that firstly, physical cash is likely to be with us for quite some time and the need for a digital version of cash is moot at this point.
He added that the financial inclusion benefits of a digital Singapore dollar are not compelling. A high proportion of Singaporeans have bank accounts and electronic payments in Singapore are highly pervasive, efficient and competitive.
Lastly, a possible currency substitution by foreign digital currencies is now a “remote tail risk”. The issuance of a retail CBDC is ultimately a socio-economic, rather than a monetary consideration.
Moving to a fully cashless society with all money in the form of bank deposits will not make a significant difference to the conduct of monetary policy.
“The question is whether the public is comfortable with holding only bank deposits, and whether there is public demand for a state-issued currency that is as safe as cash, but in digital form. So for now, there’s no strong case for a retail CBDC but at the same time, MAS recognises there could be potential benefits offered by innovative retail CBDC solutions in the future.”
MAS is therefore embarking on Project Orchid to build the technology infrastructure and technical competencies that are necessary to issue a digital Singapore dollar should the country decide to do so in the future.
MAS will pursue Project Orchid in close partnership with the private sector, building on the rich findings from the Global CBDC Challenge that MAS launched earlier this year, which received more than 300 proposals from over 50 countries in response to the problem statements that they posed.
What does the future of finance in Singapore hold?
Finance is becoming increasingly digitalised with new types of financial service providers, business models, and collaborations.
Ravi highlighted two developments that are shaping the future of finance: the quest for real-time cross border payments, and the rise of collaborative data platforms.
Five years ago, MAS began experimenting with blockchain technology and wholesale CBDCs through Project Ubin to make cross-border payments cheaper and more efficient.
The success of Project Ubin has inspired the development of Partior, a blockchain-based interbank clearing and settlement network jointly established by DBS Bank, JP Morgan and Temasek.
It enables banks to settle cross-border payments in different currencies in real-time using either commercial bank digital money, or wholesale CBDCs.
Project Ubin has also served as a foundation for Project Dunbar — this is a blueprint for a multi-currency settlement platform that operates across countries using wholesale CBDCs. It is a partnership among MAS, the Bank for International Settlements Innovation Hub, the Reserve Bank of Australia, Bank Negara Malaysia, and the South African Reserve Bank.
Commercial banks will be able to transact directly with one another using the wholesale CBDCs of their respective countries, eliminating the need for intermediaries and reducing the time and cost of cross-border transactions. If Project Dunbar succeeds, not all cross-border payment improvements need CBDCs or the blockchain.
Singapore’s real-time retail payment is PayNow, and it’s building direct linkages with other countries’ payment systems. PayNow has already linked with Thailand’s PromptPay, enabling individuals in the two countries to transfer funds directly to one another’s bank accounts using just the payee’s mobile number.
PayNow also plans to link up with Malaysia’s DuitNow, and India’s Unified Payment Interface (UPI) next year.
“But establishing bilateral payment linkages, one jurisdiction at a time, is hard work. We need a multi-lateral solution,” said Ravi.
MAS is therefore working with the BIS Innovation Hub on Project Nexus, which is a common blueprint for how countries can fully integrate their real-time payment systems on a single cross-border network. If it works, it will make PayNow globally interoperable much faster.
The next key development is collaborative data platforms. Industry collaboration through technology and data-sharing platforms will become an important driver of innovation in the future of finance.
MAS has been promoting such collaboration since the beginning of its FinTech journey in 2015.
Three recent initiatives include ChekFin, a decentralised credentials platform to support partnerships between financial institutions and fintech firms; Project Greenprint, a technology and data platform to support the green finance ecosystem; and COSMIC, a platform for financial institutions to collaborate using data analytics to combat the risks of money laundering.
“The future of finance cannot be divined without considering the future of the Internet. This new age of the Internet has been dubbed Web 3.0. We could think of (it) as the personal Internet, empowering each end user through applications that allow the decentralisation sharing of information,” said Ravi.
“Information is no longer in silos; it is decentralised and shared. The key enablers for this new paradigm are smart contracts and tokenised assets.”
He added that smart contracts and tokenisation are already being used to enhance the market infrastructure for financial assets in Singapore.
Web 3.0 can also potentially disrupt the world of finance. This is through the phenomenon of decentralised finance (DeFi), where end users perform financial transactions directly with one another using smart contracts without the need for financial intermediaries.
It is a fundamentally different approach to financial infrastructure compared to the centralised systems of today. DeFi is already a growing reality, albeit still nascent. Crypto tokens are now being bought and sold on decentralised exchanges without the need for intermediaries to clear and record the trade.
– Ravi Menon, managing director of MAS
Another example that is worrying for financial institutions is borrowing and lending, where anyone can theoretically lend and borrow directly to others.
While a liquidity pool managed by a smart contract DeFi has the potential to yield significant economic and social benefits by replacing intermediaries and central counter-parties, these open crypto networks can potentially reduce the cost of finance.
When firms of all sizes, and even individuals can directly access financial infrastructure, it could mean more competition and inclusion.
But DeFi is not without risk and vulnerability, warned Ravi. These open crypto networks are not at the stage where they can meet the highest standards of governance, security and resilience that are required by central banks and regulators.
“There have already been unsavoury practices in this space. Flash loans are being used to manipulate prices in the market, bots are being used to front run retail trades and with decentralised governance, who do you approach to recover lost accounts or reverse accidental transfers of money?”
“Existing regulatory frameworks will need to be adapted for application if DeFi becomes a reality. Regulations crafted to manage risks in a world of intermediaries are ill-suited, and intermediaries are being replaced by smart contracts. Enforcement (becomes) more challenging when control of governance is dispersed across the blockchain.”
As such, Ravi said that MAS will follow Web 3.0 and DeFi developments closely to deepen their understanding in this space and seek to harness the benefits, while managing its risks.
“We will work closely with both the financial industry and the broader ecosystem to find the right balance. It will be a learning journey, and what better way to learn than by experimenting? We will facilitate experiments for blockchain and definite innovation through regulatory sandboxes.”
MAS launched the FinTech regulatory sandbox five years ago to support live experimentation of technology innovations, and two years ago, MAS enhanced it with Sandbox Express so that businesses can begin market testing low-risk activities in a pre-defined environment faster.
MAS will further enhance this regulatory sandbox with Sandbox Plus to broaden participation to include early adopters of technology in addition to first movers. Financial grants will be provided to support their technology, human capital, and market development.
“The future of money, finance and the Internet will have far-reaching effects on economies and societies. It is important that public authorities and the financial and technology communities work together to shape that future,” said Ravi.
“Money finance and the Internet can be forces for good, helping to expand economic opportunity, enhance social inclusion, foster stability and protect our planet. Ultimately, money, finance, and the Internet must serve the people who use them.”
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Featured Image Credit: Monetary Authority of Singapore (MAS)