Digital + Currency + Local = Good. That is the summary of my last article. The concept is not totally new, WIR Bank in Switzerland has been doing this since 1934. Of course, you could skip the digital part of that equation; the town of Lewes in Southeast England has long ago done just that with the Lewes Pound.

More recently, the city of Liverpool in Northwest England has announced the introduction of the Liverpool Local Pound. App and Blockchain based no less.

That last announcement fills me with dread. I am dedicated fan of Liverpool FC, but having grown up in the UK in the 1980’s, I would not go anywhere near big city UK local council offering a banking or payments service. For fun look up Derek Hatton on Wikipedia.

Why the worry? Was it not me who suggested digital local currency would be good for the community?

Two words: credit risk. This is also known as issuer risk.

If you put 100 pounds in your bank account at Northern Rock, in the first instance you are taking a risk that Northern Rock will be around to let you use that 100. To help mitigate that risk, lots of countries have depositor protection schemes. In the use, the FDIC insures the first USD 250’000 of your credit balance. In the UK, Deposit Protection is good for the first GBP 75’000. So bank equals “some protection”.

There are also rules to protect client assets; in the UK, the CASS scheme, and in the US, section 15c3 of the 1934 SEC Act.

But, protection is limited. In the naughties, many people bought products from Lehman Brothers which promised capital protection and the promise of the upside performance in something or other. They lost their money. And this was in spite of Lehman being a regulated entity.

And, regulation does not always bite; investors also lost money in the Maddoff collapse, even though Maddoff was regulated.

So, when somebody wants to take your money and give you a digital asset in return, you should ask: “How do I know you will be able to give me my money back on demand?”.

The very smart people at ICON Capital Reserve have solved this for gold; they have a method of ensuring that there are gold bars backing the digital gold they issue.

For a digital currency, to achieve the same thing, you would need to back the currency with “real currency”. This requires an exchange and a process to secure the underlying balances. In and around the Blockchain and DLT world, this is known as CBDM, Central Bank Digital Money.

If you could be sure that the digital asset you hold was backed by “real money”, then your view of the risk will change completely.

Lessons to be Learned:  

  1. Local currency can be a force for good.  Money goes round locally.
  2. Digital local currency can be a greater force for good. It would enable local communities to collect fees for residence and target the resulting spending to the local community. This would raise the cost for absentee owners.
  3. Digital local currency backed by real money can be an even greater force for good. If the process is robust enough to ensure that credit risk is eliminated or substantially reduced, then there are fewer obstacles to adopting the new capabilities.

About the Author: I help banks master their post trade processing; optimising, re-engineering, building.

I understand the front-to-back and end-to-end impact of what banks do. That allows me to build the best processes for my clients; ones that deliver on the three key dimensions of Operations: control, capacity and cost.

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The Bankers’ Plumber’s Handbook

Control in banks. How to do operations properly.

For some in the FS world, it is too late. For most, understanding how to make things work properly is a good investment of their time.

My book tries to make it easy for you and includes a collection of real life, true stories from nearly 30 years of adventures in banking around the world. True tales of Goldman Sachs and collecting money from the mob, losing $2m of the partners’ money and still keeping my job and keeping an eye on traders with evil intentions.

So you might like the tool kit, you might like the stories or you might only like the glossary, which one of my friends kindly said was worth the price of the book on its own.  Or, you might like all of it.

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Cash & Liquidity Management

An up to date view of the latest issues and how BCBS guidance that comes into force from Jan 1 2015 will affect this area of banking. Kindle and hard copy.

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