In 1987 the renowned economist James Tobin published an article in which he raised the question if “big financial institutions can be allowed to fail?”. Today, after the financial crisis of 2008, we know the answer. In his paper, Tobin suggested to grant the general public access to accounts with the Central Bank. 30 years ago this idea was hard to implement. But now the Bank of England (BoE) thinks it may be time to make this idea a reality – with a little help from the Blockchain.
Bank insolvency threatens saver’s money
In the modern world of finance the only way to save without the need to rely on a third party is cash. But notes and coins are not well suited to make digital purchases or to regularly transfer the rent to the landlord. Therefore, most people decide to hold their savings with a bank. The problem is that with doing so the consumer loses his ownership of the money. His deposit only represents a claim against the bank to pay out the money on demand. If the bank goes bankrupt this claim is endangered.
Therefore, most jurisdictions introduced deposit insurance schemes. This shall guarantee that savers get their money up to a certain amount if their bank crashes. But most of these insurances can only cover the bankruptcy of smaller institutes. Whereas if a big bank stumbles, it does not only threaten its own customers. But due to the heavy interconnectivity of the financial system it does also endanger many other credit institutes. Therefore, the governments prefer to stabilize these institutes with taxpayer’s money as the lesser of two evils. Thus, the proverb ‘too big to fail’ was coined.
Bank of England proposes central bank issued digital currencies
To solve this problem the BoE suggests to introduce a Blockchain, controlled by the central bank. The currency traded on this Blockchain would count as government issued fiat money equal to cash. Everyone could get access to this new type of money by installing a “Euro wallet”. Any money stored in this wallet would be held directly with the central bank. Thus, the risk of insolvency would be removed.
In contrast to cash, this new Central Bank Issued Digitial Currency (CBDC) comes with all the advantages of today’s electronic money. Even more so, since a transfer of money on the Blockchain can be resolved nearly instantaneously. And in contrast to traditional banks it works 24 hours a day including weekends and holidays.
Blockchain guarantees security and sparks innovation
In a Blockchain based monetary environment a crisis in the financial sector becomes less terrifying. With an insolvency proof alternative, it becomes a savers own choice to store his money with a commercial bank, for example to profit from higher interest rates. Going forward the bankruptcy of a financial institution could be treated like the bankruptcy of any other business.
This would also provide an opportunity to scale down banking regulation. Since the outbreak of the financial crisis in 2008, a myriad of new laws and agencies was introduced in the hope of preventing any further bank insolvency. But at the same time these rules make it much harder for newcomers and fintechs to enter the market.
If you have an idea of how to use the Blockchain today for an innovative business but are daunted by this jungle of regulations, our lawyers of banking and capital market law will help you to cut through the underbrush of rules and provide you with any assistance to see your business idea to fruition.