Private digital currencies are already living among us

The Facebook-backed Libra currency recently announced somewhat of a retreat from their hasty march across international borders in pursuit of global payments dominance via a "stable coin". Surrounded on all sides by regulators and governments, they will now try the "divide and conquer" approach by creating a more traditional payments network with coins tied to a local currency. And while no shots have yet been fired, it also remains to be seen whether any payments will actually be made.

It may not come as a surprise, though, that this revised concept effectively already exists. It exists in the form of financial institutions with direct access to the local payments network, who net what literally amounts to private digital currency payments between each other before settling in central banking money at the end of each day. All happening through...you guessed it...traditional payments networks.

Chesterton's fence - the principle that reforms should not be made until the reasoning behind the existing state of affairs is understood.

The principle of Chesterton's fence was articulated in the year of the great crash of 1929. The metaphor being that you should not take down a fence you come across until you know the reason why it was put up in the first place. It is a succinct description of the overeager reformer's war cry of "ready, fire, aim!". As applicable to the French Revolution as it is to (some) financial deregulation, and the hubristic and clueless motto of a certain technology company in 2014 - "move fast and break things".

Which isn't to say that innovation will not make a difference in the payments landscape. Payments are indeed ripe for innovation, from reducing settlement times to improving the facilitation of cross border payments, peer-to-peer domestic payments, etc. But the only way innovation will succeed is by understanding the existing payments landscape, how we got here, and how it is held together through rules, regulations, oversight, relationships, legacy systems, bureaucracies, and consumer habits.

Paradoxically, it is the existing payment system participants who are in the best position to introduce innovation in payments given their intimate knowledge of the landscape - but the least motivated to do so. Why risk an established position in the status quo? And on top of that - why actually spend money to disrupt it?

What Libra is up against - the current private digital currency system

It wasn't long ago that private banks were issuing their own banknotes to the public in Canada. If you were to go back in time to the roaring '20s with the bright idea of issuing your own currency, you would probably be mistaken for wanting to start a bank rather than upend the payments industry. That's because banks were issuing their own private currency back then and clearing obligations between themselves in their own currencies.

And they still are. Just not in physical banknote form.

The confusion is understandable in that our perception of money and banking, and the associated nomenclature we use, lends us to believe that money in our deposit accounts is...well...money. If I asked you how much you have in your bank account, you may not want to tell me, but you would not think the question to be oddly constructed. But what I really should be asking is - how much does your bank owe you? Oddly constructed for sure.

What makes the entire money game even more confusing is that we describe all forms of money as dollars. A loonie is a one dollar coin. Central bank money is measured in dollars in Canada. And your bank account is valued in dollars. So it all seems the same, even though your bank account is simply a liability of your bank. Back when private banks were issuing their own currency, there was less confusion between types of money because of this clear evidence of issuance. Sure, Bank of Montreal issued "dollars", convertible (hopefully) at part with Dominion notes, but they are clearly Bank of Montreal dollars - printed right there on the banknote.

Chesterton's pence

Perhaps by more clearly communicating the difference between central bank money and the private bank liability that is your bank account, tech entrepreneurs will consider stepping back from the fence long enough to contemplate the long history of private digital currencies that have existed really for centuries. It is indeed why clearinghouses exist among other market infrastructures.

So let's call the money in your bank account 'units'. And each financial institution has their own 'unit'. All throughout the day or payments cycle, Bank 1 units are being spent, and Bank 2 units are being spent, and on down the line. Then we net these units owing or owed to each bank, and then we agree that the unit difference can be settled with central bank money at par. And to reduce intra-day risk, these banks could perhaps post collateral with a neutral near-risk-free party (call it a central bank?) as part of a risk framework necessary for such a systemically important system of "unit" exchange.

Sound familiar? It's how the system works today.

So how will a 'new' private digital currency be any different? Or better? And how could it not be subject to the same regulations and oversight as the existing private digital payments system? This all remains to be seen.

In the meantime, while Libra and other stable coin startups continue swinging for the fences - we should probably make sure the fences remain standing. For now.