Jonathan Payne on Platforms, Tokens, DeFi and Smart CBDC

On Thursday, June 9, Jonathan Payne joined Markus’ Academy for a lecture on Token, Defi and Smart CBDC. Payne is an Assistant Professor in the Bendheim Center for Finance and Department of Economics at Princeton University.

Watch the full presentation below. You can also watch all Markus’ Academy webinars on the Princeton BCF YouTube channel.

[0:00] Introductory Remarks
[9:47] Different digital currencies and ledgers
[22:03] Decentralized Finance
[35:28] Centralized, Programmable Ledgers
[48:42] Open banking
[55:07] Central Bank Digital Currency

Executive Summary

• [0:00] Introductory Remarks. Recent trends in technology allow for exciting developments in finance and money. Social networks can provide tokens, and supply chains can be managed on blockchains, increasing efficiency and information extraction. Platforms try to limit interoperability and their exclusion power allows them to extend uncollateralized creditas beyond what banks can do. Digital currency will look different across the world: some areas focus more on consumer CBDC, while others focus on stablecoins or tech companies that aim to improve consumer convenience. Generally, private companies want to issue stablecoins to generate seigniorage for themselves and then get a regulatory stamp and guarantees. CBDC provides a public alternative that could also act as a catalyst to improve the banks’ payment system offerings.
• [9:47] Different digital currencies and ledgers. There are digital reserves at the Fed, but also digital dollars in bank accounts, cryptocurrencies, stablecoins, and other types of tokens. Each of these require a ledger of some sort, and each of these technologies ends up with a different kind of ledger. There can be central ledger control, transparent ledgers, some degree of payment anonymity, and varying levels of public access. There has been an emergence of transparent, programmable ledgers that have token accounts and “smart” contracts that can execute transactions specified by conditions in the contract. To enforce these, there needs to be access to information flow and the control of the payment flow. These technological shifts leads to a “segmented” world of enforcement in which the standard legal system has imperfect enforcement, yet the digital ledger cannot enforce things off the ledger.
• [22:03] Decentralized Finance. DeFi aims to rebuild finance without intermediaries, by using smart contracts blockchain ledgers to create financial instruments. This includes decentralized control (ledgers are updated by consensus protocols) and decentralized governance (voting power around topics like interest rates is approportioned by “tokens” given to users and creators). These smart contracts create “financial primitives” which can be used as building blocks for “decentralized” applications. DeFi aims to eliminate rent-seeking intermediaries, respect privacy, decrease barriers to entry, increase financial inclusion and transparency of ledgers, as well as increase interoperability (techniques allowing blochains to communicate and transfer assets/data).
• [35:28] Centralized, Programmable Ledgers. Supply chains often involve producers without collateral who need to borrow, buyers and sellers who need to find trading opportunities, and the need for a currency that can be used as a medium of exchange. Private platforms can offer credit, matching services, and a digital ledger. Payments and contracts are organized through this ledger. The platform designs ledger interoperability, meaning an exchange rate for moving tokens to dollars and portability of information to other ledgers. When shifting between ledgers, the transfer of information and currency needs to be managed. These platforms are able to use the synergies generated by combining information about trade and control of the digital ledger to provide uncollateralized trade-credit. However, these platforms can also exploit their control of the ledger to increase their market power by restricting the movement of tokens and limiting information portability..
• [48:42] Open banking. Gives users control of the portability of their information on the digital ledger. Buyers choose to port their transaction histories so the new platform can provide high service quality, while sellers choose to restrict the portability of their loan contracts so that they can move to a new platform and default. Ultimately, this means no platform would want to set up an uncollateralized credit market because they fear a new platform will come in and allow all the agents to default.
• [55:07] Central Bank Digital Currency. CBDC could be legal tender on a non-programmable ledger. These CBDC would “dollarize” private platforms, and platforms would have to intermediate payments to provide uncollateralized loans. A “smart” CBDC with a programmable ledger could lead platforms to use the ledger to write and enforce contracts if CBDC becomes the dominant currency, and other platforms provide information. CBDC can enhance or eliminate potential synergies, and unless the ledger is able to replicate these synergies, it is unclear whether CBDC will be welfare improving.