The Government Token Part 2: The How

The Government Token Part 2: The How

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In the The Government Token Part 1: The Why, we explored the incentives that have been leading the way for a government-backed stable token. Since the release of that piece, additional movement toward the first issuances of government issued tokens have been made by Chinese and Japanese regulatory agencies, and the amount of tether in circulation has continues to grow exponentially without proof of funds via a long awaited audit.

Now that this wholly necessary leap forward appears to be a matter of time rather than a moonshot, we’ll take a hypothetical closer look at a process by which stable-token issuance is likely to play out while exploring high-level subjects of token issuers, legislative hurdles, scalability and consumer protection.

ISSUER

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The first order of bringing stable coins to market is to determine who the most likely issuer of said tokens would be. The obvious answer would be a central government (given that you’re reading ‘The Government Token’), but another candidate, the financial institutions, may well be the leading contender.

For some insight into why this might be the case, I spoke with Nicholas Addison, the CTO of AgriDigital and a member of Fintech Australia. Addison is a leading industry advocate for the digital Australian Dollar and previously worked as the lead architect for FIS's real-time payments system in connection with Australia's New Payment Platform (NPP).

Addison explained that “central banks don’t want to deal with retail customers and business, but with a limited number of financial institutions”. It’s an issue of crafting monetary policy versus turning the government into a consumer-facing entity.

How would the two work together?

To be a government token, the value of a digital asset must be government backed and guaranteed, but the issuance itself would likely be performed by a consortium of large institutions at launch and provided as a bank-service. The token would be transferable between those entities, and any number of customers within the consortium’s purview.

The next question that this begs is the legislative aspect. Is it possible that adding a fundamentally new form of a fiat currency could be done without major federal legislation?

LAW & ORDER

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Put simply, the bar is currently too high to expect new major federal legislation in any developed democracy around DLT based currencies in the very near future when so many elected officials haven’t yet begun the educational phase of understanding the technology.

In the United States, a Blockchain Caucus exists in the Congress to explore the technology’s potential, and member representatives have heard from industry leaders like Coincenter’s Director of Research, Peter Van Valkenburgh in recent months. Still, much of the questioning in these sessions revolves around anti money-laundering and terrorist financing implications of the pseudonymous technology, long-associated with Bitcoin’s bad boy image.

Between these challenges, and the snail-like pace of major monetary changes, Addison noted that regulatory agencies were “going to be far more informed and willing to move quickly than would legislative bodies that are too often willing to throw the baby out with the bathwater”, he noted. There is sometimes a habit, Addison explained, to squash or limit the use of new technologies due to risks like those mentioned above.

Regulatory approval of this structure, especially if framed simply a business decision, is far more likely to receive the government OK. Simply put, the issuance and acceptance of immediately transferable and available funds could be viewed as a bank service, just as mobile check deposits or free bank-to-bank transfers are today.

Peripherally, this form of a government token would appear more to be a bank token with government approval, but as is the case with ICO tokens, which the US Securities and Exchange Commission states “may provide fair and lawful investment opportunities”, these fiat-stable coins must be removable from the bank or consortium’s ecosystem by customers (to be held or traded privately), and redeemable at a later time to truly represent a stable coin.

Issuing banks and governments would maintain access to the more private layers (possibly by using ring signatures) related to identification and balances, necessary to track customer funds and expected taxable events.

Additional regulations might state that the funds that back these tokens must be held by the issuing institutions to ensure the liquidity and a direct 1:1 match between tokens and fiat funds. Additionally, to better ensure solvency at all locations, agreements could exist to equally divide funds between institutions by initiating transfers at regular intervals to balance books.

SCALABILITY

How will all of this be executed, and which methods of scalability or consensus mechanisms best fit this system? The answer is likely through some level of re-centralization.

One option would be to utilize something like JPMorgan’s Quorum, which removes the proof-of-work element from this permissioned chain in order to quickly scale by using an older consensus mechanism called Raft.

From Quorum’s GitHub, “in Raft, a node in normal operation is either a "leader" or a "follower." There is a single leader for the entire cluster, which all log entries must flow through.” In short, “the leader of the Raft cluster is the only…node that should mine (or "mint") new blocks. A minter is responsible for bundling transactions into a block just like an Ethereum miner, but does not present a proof of work.”

Through a similar system, a few master-nodes primarily run by issuing entities (banks/governments) would remain the helm but keep each other in check, while other nodes might maintain some level of input on consensus as a fail-proof.

Time will tell if there is room for something closer to a future Ethereum that features true distribution, proof of stake consensus and a sharded chain to power such a system, but it’s more likely that a government-associated or supported chain would maintain some level of autonomy. These tradeoffs of privacy for stability would be well known to proponents of a trustless system, who know well the risks of giving a central entity this level of power over their assets. This system would exist as an optional feature, and no party would be required to buy in to, or to associate their private addresses with this chain.

CONSUMER PROTECTION:

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Given the implementation of this system, how much risk would end users face? Thankfully, this private/public chain-based partnership has a great deal of potential for consumer protection.

Tokens moved between consortium banks or partner entities would be insured or protected by those private entities. This is a case where customers would be using “the blockchain” without ever realizing it, seeing only their financial institutions user interface and not the back-end technology. Any hiccups or bugs would be identified, and tokens lost due to these would be burned and on a recurring basis an additional issuance in the amount of the burned pool would be reissued.

The risks would shift to the user if and when they opt to remove tokens from the issuer’s system and onto their own private machines. At this time they’d likely agree to a terms-of-service agreement noting that the tokens would still be redeemable by the bank as cash would, but that those customers now bear the responsibility for lost funds or misuse. At this point, customers would hold full-fledged stable coins, albeit with reduced privacy (now that their funds and personal wallet-address is associated with a bank-issued address).

This system helps to avoid over-burdening responsibilities for the issuer, and the open sourcing of the technology allows for both private ownership, and for additional entities or companies (like a Facebook or Snapchat) to adapt the now open-sourced technology without the need to go through an approval process with the consortium.

Finally, the institutions would likely maintain the power to blacklist addresses associated with non-KYC/AML verified exchanges to reduce the risk of losing track of funds to offshore holders or illicit businesses. After this, the stable coin would be far more traceable for purposes of AML and taxation agencies, and of lower risk than would physical cash. In short, central governments would control the entry and exit nodes.

All things considered, while this is a hypothetical breakdown exampling a realistic route by which a stable coin could be launched, the success of such a project would be incentive powered on both ends.

Author note: This piece is specifically geared toward imagining how a centrally issued stable coin could be issued and used. Public chain based solutions, like the collateralized DAI coin (an asset-backed token from MakerDAO team) and other privately built solutions are in development to try and solve these same user-end need for a stable token without the assistance of central entities.

Thanks to Joseph Schweitzer for this piece. 

 

arthur falls