Regulated liability network
Fedcoin contender
The cryptocurrency phenomenon fused a small number of genuinely novel financial ideas with a pathological lack of interest in the history or even the present of the actually existing monetary system. Failure to understand the system with which they were engaging is now bringing many crypto projects to an end, but the ideas they brought into the world may yet find a more permanent home.
On November 15th, while the world was watching FTX’s sordid bankruptcy, the New York Fed rather quietly announced that it would move forward with a proof-of-concept project for a regulated liability network. The project is hosted by the NYIC, a collaboration between the New York Fed and the Bank for International Settlements, and builds on a whitepaper signed by a long list of top-tier money-center banks.
The regulated liability network stands out among digital asset experiments carried out by public and private financial institutions. For one thing, the US central bank is on board. What’s more, the project is styled not as a remaking of the monetary system, but as a technological upgrade to the existing system. There is a lot to be said about the proposal; in this post I focus on the fact that its tokens inherently represent liabilities.
Crypto tech, built on actual liabilities
A shortcoming of crypto’s offer to remake the monetary system is that crypto tokens are not the liabilities of any entity. They are instead empty tokens that enact a weird monetarism, in which tokens’ value is anchored only by their scarcity. From a banking perspective, this is weird because it is only in monetarist theory that money’s worth comes from its scarcity. The banks and central banks that operate the existing system don’t think about money’s scarcity; they think of money as liabilities, promises to pay on the part of issuing institutions. Money’s value has to do with the validity and enforceability of those promises, whether they are scarce or plentiful.
But that doesn’t mean that tokenization is a bad idea, it just means that it matters what the tokens are meant to represent. Sensing opportunity perhaps, the RLN proposal uses tokens on a distributed ledger to represent and denominate the liabilities of familiar institutions. They are a new way of representing financial relationships; they are not a new kind of financial relationship. RLN tokens exist within the legal structure, they don’t defy it or ignore it. Computer code doesn’t make the law, as the whitepaper’s authors make clear.
Every token on the RLN represents a unit of liability of a regulated financial institution. These T accounts illustrate how the RLN’s proposed technological substrate interacts with familiar financial relationships. Above, in line (1), is a representation of deposit-based bank money: the public holds deposits at a commercial bank; the bank in turn holds reserves at the central bank. Below, in line (2), the same relationships are represented instead by tokens:
(1) and (2) do not differ in financial structure; they differ in the technology used to represent and transact within this structure. I have indicated this technological layer with the dashed rectangles above. The outer rectangle is the RLN shared ledger itself. Conceptually, this is a database, a rectangular dataset whose rows are tokens representing the creation and destruction of financial relationships.
The RLN differs from the existing system in that it creates a single shared ledger for the transactions of many parties. This spares participants the labor of having to confirm that all parties see the transaction the same way: instead each party makes reference to a single shared source of truth. Technologically, this could be a distributed ledger, but as the RLN whitepaper notes (if one makes it to Appendix E), the same result could be achieved with a centralized database.
Any regulated institution—a central bank, a commercial bank, a non-bank e-money issuer—can create liability tokens on the RLN. Each such issuer operates a partition, delimited by the inner rectangles in the T accounts above. Each partition is a disjoint subset of the shared ledger. What is gained from all this is that all RLN tokens are instances of a single class, differing only according to specified parameters, so that the fungibility of various forms of money is built at a deeper level of the financial infrastructure.
Fedcoin, maybe
In other words, the RLN puts all regulated liabilities into a single account, then divides that account into parts by issuer. The hypothesis, which might be true or might not be true, is that centralizing records of money issuance could save time and expense, and allow the benefits of programmability, simultaneity and so on.
Unlike countless other digital asset whitepapers, this one is actually a theoretically sound, incremental technological change. It would entail transition costs, but might yield benefits. Or maybe not. It sounds a lot less revolutionary than much of what we’ve heard before, and for that reason it seems far more likely to become a reality.