There's been a lot of talk about how cryptocurrencies and blockchain are at odds with policy objectives and nation-states, especially with the emergence of Libra and the reaction to it from policy-makers across the world. However, there are areas of collaboration where the spirit of bitcoin and the cryptocurrencies it spawned reduces the volatility generated by the conventional financial system.
One of the most underrated implications of the Great Recession in 2008 was how it showed the stark weaknesses and strengths of an integrated global economy and spurred policy innovations to break out of the silo of nation-by-nation monetary policy. One of the most direct mechanisms for this was the rise of currency swaps: open lines where central banks agree to swap their domestic currencies between each other to help alleviate financial problems in foreign jurisdictions that increasingly affected globalized domestic currencies.
This had been something tested with the Chiang Mai Initiative (CMI) and the Asian Financial Crisis, but the Global Financial Crisis of 2008 was the first time this regional set-up became a global reality and it is only now that cryptocurrencies and blockchain are playing an experimental role.
On December 12th, 2017, the Federal Reserve extended US dollar swap lines with both the European Central Bank and the Swiss National Bank, allowing both of them to fulfill domestic demand for US dollars. European and Swiss demand for US dollars was actually affecting short-term funding markets and interest rates. The currency swaps allowed the Federal Reserve to alleviate those pressures without directly funding foreign banks. The ECB and SNB stepped in instead.
After Lehman Brothers declared bankruptcy, the Federal Reserve voted to extend swap lines to other established G10 central banks as well as less established central banks "as needed to address strains in money markets in other jurisdictions."
Nor was the Fed alone in doing this. Soon, the European Central Bank would send Euros to Sweden, and the Swiss National Bank would send Swiss Francs to the ECB. Banks around the world had borrowed too many funds in foreign currencies, and central banks needed to have reserves in those foreign currencies to satisfy demand. In effect, a global and integrated economy needed a coordinated monetary response.
One of the most interesting decisions for central banks when it came to swap lines was just who to extend them to. What governments and central banks outside of the G10 would get the privilege? In the end, the Fed decided to also extend swap lines to Brazil, Mexico, Singapore, and South Korea, all of which were outside the established group of G10 economies. The criterion for these were not well-established beyond the fact that instability in these economies might have affected the American economy -- however, it showed what happened when a central bank, whose brand runs on trust, has to pick and choose which other central banks to trust.
In 2013, the Federal Reserve decided to keep the swap lines it had open during the crisis indefinitely open, turning what had been a temporary solution into a permanent backstop for the global financial system, ensuring that banks borrowing in foreign currencies could defray some of the risks of defaulting on those debts.
Currency swaps are political decisions -- and central banks resorted to keeping collateral at hand for those partner central banks they did not fully trust. Every extension of a currency swap creates moral hazard on the part of the issuer: European banks may have wanted US dollars because they had overextended their borrowing capabilities with this regard. A currency swap with the Fed guarantees they will never truly face financial consequences for that overextension.
Into this heady policy discussion and this new monetary tool, enter the Monetary Authority of Singapore and the Bank of Canada's first pilot executing a bilateral currency swap between each other via distributed ledger technology. In a talk at MIT's Business of Blockchain Conference, Chief FinTech Officer of the Monetary Authority of Singapore, Sopnendu Mohanty, explicitly mentioned the pilot and expanded upon it: "The next wave of central bank blockchain projects can make further progress by bringing technology exploration together with policy questions about the future of cross-border payments."
On stage, he talked about distributed ledgers as a potential solution to how to deal with central banks that were not as established in the global financial system as the G10 central banks and explicitly mentioned developing future pilots of cross-border currency swaps driven by distributed ledger technologies.
In the Canadian policy speech mentioning the domestic DLT experiment (Project Jasper) the Bank of Canada was to embark on, trade finance and cross-border currency swaps were explicitly mentioned with the Bank of Canada claiming "one estimate suggests DLT could enable banks to save as much as $20 billion a year in global back-office costs if applied to cross-border payments, securities trading and regulatory compliance" about as much money as the amount poured into fintech every year from an earlier part of the speech.
It is clear that DLT can help solidify the formation of currency swaps, even among partner central banks who may have reasons to doubt one another. DLT and blockchains allow central banks perform cross-border settlement near-instantly, allowing much-needed funds to flow quickly in times of crisis.
Beyond that, however, is a tacit admission that some of the principles of bitcoin and the cryptocurrencies it spawned have paradoxically addressed key points of weakness in the evolution of the global financial system.
Currency swaps are a realpolitik take on the reality that domestic monetary policy is eroded by foreign money markets. The ability to transact without a very high threshold of trust and the need to do so immediately harken back to a fundamental tenet of cryptocurrency.
While much has been written about the tensions between cryptocurrencies and central banks, in truth, we might be witnessing an ongoing Hegelian dialectic with the global financial system as thesis, cryptocurrency as anti-thesis, and the synthesis of the two yet to come.
