ChatGPT is touted as the tech breakthrough that may revolutionize daily operations, raising productivity and ushering the world into a new era. 

However, a series of technological innovations, beginning with FinTech or the digitization of financial services, including blockchain and the arrival of cyber-currencies, is gradually but surely transforming the financial landscape.  As central bankers grapple with the complexity of digital money, they have come to realize that a new monetary system is already on the cards and may be close to reality.   

How would the new monetary system look like?

The Bank for International Settlements (BIS) is de facto the central bank of central banks or at least the holder of much of central banks’ liquid deposits for international settlements.  Its real function is to be the intellectual hub of central bankers to analyze and discuss emerging challenges and issues.   Its annual report is the authoritative view how mainstream central bankers see the world, but in recent years, it has led thinking by exploring the implications of digitization of money on the role of central banks.   Beginning in last year’s annual report, the BIS has started talking about three journeys – monetary and inflation trends, including interest rate tools (the real economy and finance); their impact on financial stability; and how technology is transforming the financial landscape.

Central bankers stand at the apex of the mainstream financial system, which is highly centralized and top-down (CeFi).  Central banks have been put in charge of fiat money (money created by the state), in which the state creates money by borrowing, and sovereign money is by law, the money by which you finally settle any debts.  The US dollar accounts for 80% of total foreign currency trading and half of global trade invoicing, which means that most foreign exchange is finally settled across the books of the New York Fed.  The US owes the rest of the world $16 trillion in net foreign exchange, so the Fed’s capacity to expand or decrease money has global power.

The big picture is that central bank power in terms of balance sheet size has doubled from less than 4% of global financial assets to 9% since 2007 through quantitative easing (QE or balance sheet expansion).  Central bankers are in charge of debt-based banks, which today account for half of global financial assets, but non-bank financial institutions (NBFIs), mostly fund managers and largely equity-based, today account for the other half.   After the 2008 financial crisis, the Financial Stability Board (FSB) was created to oversee global systemic financial stability, as the central bankers kept on trying to have oversight over the NBFIs.  The asset managers and politicians are unwilling to allow central bankers too much power, especially since central bankers are not democratically elected but appointed officials.

The countervailing power against CeFI is Decentralized finance (DeFi), which always existed bottom-up from informal finance, because the bottom-half of society are mostly unbanked and do not have access to formal, especially bank and equity finance.

Finance being networks linking billions of customers in terms of information and money, digital finance can empower billions of unbanked or underbanked people by cutting out traditional financial intermediaries that are top-heavy, expensive and in some cases, predatory.  Decentralized finance (DeFi), using the internet and blockchain (distributed ledgers) can not only compete against conventional CeFI, but also become opaque to official oversight.   If so, the state and central banks can lose control as private money replaces fiat money.

After shilly-shallying in regulating cyber-currencies for fear of stopping innovation, central banks allowed cyber-currencies to reach as high as $2 trillion in market value, becoming a force that threatened fiat money power.  This forced the central banks to think through how to use central bank digital currencies (CBDCs) to create a digital finance world in which CBDCs (namely central banks) still stand as the spider in the financial web.

Through the BIS Innovation Lab, central banks have been busy thinking through and piloting how the new monetary and financial system could work.  The mental break-through was the realization that money is not just conventionally thought of as a unit of value, means of payment, but also a store of value.  Digital money is really a token, a standardized module (lump) of information that contains not only data but also the rules by which the token can be exchanged for value.  Money has transformed from a lump of gold (coin) to a digital lump that contains not only your information but value.

Money is a token, because it contains all the information (value) that people are willing to trade.  Money can be transformed into complex instruments, such as securities, so what if all such information and the rules by which they are “packed” can be traded through a standard token can be exchanged through a global “unified ledger”?   Then this global unified ledger is effectively the tech platform whereby everything is settled through CBDC!   Voila, the central banks are now again in charge of the global digital financial system, including in control of the global securities markets (currently dominated by NBFIs).

This is enormously complex in design and execution, which means that most people would not understand how it works.  But it promises to produce a trusted, transparent, efficient and resilient financial system that avoids scams and enables official oversight.  The report suggests that this infrastructure can be built by the private sector, but with CBDC as the foundation token.   In effect, CBDC tokens are the building brick for the new world of digital money and finance.   Notice that technology tools like ChatGPT are hardly mentioned, because AI is only another tool on the journey to digital Nirvana.

Clever, but also brilliant.   Big brother is now truly in charge of digital finance, but he is now called central bankers.

This is a lot for most people to chew on.  Chapter 3 of the BIS Annual Report is a must read, since it sketches out the new monetary system’s foundational architecture.

If you think I am exaggerating, watch this space.  Your (money) future depends on it.

Contributed by

Andrew Sheng

Former central banker who writes on global issues from an Asian perspective.