China Embraces Ethereum

CBDC running smart contracts on Ethereum! That idea has now been proposed semi-officially in China, by Yao Qian, former head of the digital currency initiative at China’s central bank (see link below). The proposal is important both by showing how central bank thinking is advancing rapidly to embrace the idea of CBDC and cryptocurrencies operating in harmony rather than opposition, and also by raising the stakes for western countries concerned about being left behind by China.

Yao Qian’s describes a “layering” of access to CBDC, with banks at one level and the general public at a lesser level. Many details of his outline proposal remain to be filled in, but it seems unlikely that he is proposing that the public Ethereum chain should be used to operate CBDC itself — surely, central banks will want to retain full control of the network on which their own currency operates! So that leaves two likely possibilities.

A cloned private version or the real thing?

The first possibility is to clone Ethereum and operate a version of it as a private network for CBDC with smart contract capabilities, under full control of the authorities, rather like the Ubin proposal in Singapore. The second is to create coins that operate on the public Ethereum chain but are 100% backed by CBDC on the central bank’s private network.

The first of these may initially appear attractive, but arguably it offers the worst of all worlds. Having private sector agents operating all manner of smart contracts on the native network of CBDC is asking for trouble. Moreover, such a network would have to be updated like any software, either by continuing patches from the public Ethereum chain, or by expensive in-house development. And biggest of all, it would either have to have a fixed schedule of fees for transactions, which is uncompetitive and inappropriate in a world of fast-evolving new smart contracts; or, it would have to have its own internal shadow pricing. The public Ethereum chain, of course, is designed to do all of this — and one of the main purposes of its native coin, Ether, via purchases of gas, is precisely to provide that internal pricing for running smart contracts whose use of computing power varies quite enormously.

In short, the public Ethereum chain, as it develops, can do exactly the job that Yao Qian envisages, provided a form of CBDC backed coin can be developed to operate on it. See my earlier blog

What’s in a name: CBDC Mirror Units? Or CBDC-backed stablecoins?

The coins fully backed by CBDC could be called anything, but for most people in the crypto world, they would probably best be described as stablecoins fully backed by CBDC. However, central bankers have seen that current (not fully backed) stablecoins don’t regularly trade exactly at par, and they will rightly be concerned that this gap could very rapidly become far wider if the public lost faith – a kind of “bank run” on not-fully-backed stablecoins. So they may prefer a different name: “mirror CBDC unit”, for example (perhaps especially in China, which has banned stablecoins.)

Towards a Valuation for Ethereum

If Ether does come to play the role of providing the internal pricing for smart contract transactions in CBDC, there will be a natural demand for it linked to the volume of smart contracts and their complexity, because anyone executing such contracts has to buy a small amount of Ether to be converted to gas, and then burnt, to reflect the cost of the contract. Just as shares in a company that owns a stock market can be valued based on the current and expected volume of fees it earns from transactions, this would provide a way to work out a “fair valuation” for the market capitalisation of Ether. As with any kind of asset, being able to compute some kind of valuation metric does not eliminate price volatility – but it would probably make wild swings less likely.

And while it’s far to early to carry out any formal calculation of such metrics, the current valuation of about $300million (price of $2,600) does look intuitively low for a system that’s may before too long be providing the operating system for smart contracts using CBDC from many of the world’s major central banks.

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