The Future of Emergency Recovery: Issuance, Remittance, and Settlement

A Broken System - The Current State

Emergency Stimulus is enacted during extreme periods of hardship. In recent memory, stimulus was released to combat the economic downturns resulting from 9/11 and the Great Recession. More recently, a number of stimulus efforts have been made to combat the impact effects of COVID-19 and the global lockdown. These current efforts represent the largest relief ever issued.

The COVID-19 relief efforts have also, once again, highlighted the impotence of our stimulus mechanisms. Not only are there massive opportunities for fraud1, but also outdated systems for issuance (i.e. paper cheques?!?), and remittance (i.e. snail-mail?!?). The fact that, in 2020, there remains a reliance on pre-18th Century “technology” is an indictment of our processes and our resolve to change.

The current process, summarized for brevity, looks something like this:

  1. The legislative body overseeing monetary policy issues a directive to stimulate the economy.
  2. The Fiscal/Monetary Authority issues stimulus funds through purchases of debt, quantitative easing, etc.
  3. The Authority oversees the delivery of the stimulus funds:
    1. Distributed electronically by local banks via direct deposit into recipients’ bank accounts; or,
    2. Distributed conventionally by third party remittance agencies via cheques, debit cards, etc., to individuals.
  4. The Authority leverages third parties for settlement and fraud activities.

While seemingly straightforward, the process is incredibly convoluted, requiring numerous checks and balances along the way, including (but not limited to) KYC/AML, anti-fraud audits, reconciliation of payments, etc.

The process also creates waste elsewhere, including the fees to remit the funds. In the United States for instance, issuing paper cheques will incur a cost of approximately $3.00 per cheque, resulting in an estimated $165M in fees. The alternative digital remittance, while better at a cost of ≤$1.50 per transaction, will still result in banks and service providers lining their pockets with an estimated $360M in the US alone.2 Together, this represents a half billion dollars that could be put into the hands of those that need it most. This also doesn’t take into account the cost of insuring the liabilities on the remittances, future audits, and numerous other costs and obligations incurred due to a lack of overall fidelity and transparency in the process.

There must be a better way. And there is…

Central Bank Digital Currency - The Future State

How it works3

Current technology now offers a robust alternative for recovery package execution in the form of Central Bank Digital Currency (CBDC). By leveraging a CBDC, a monetary authority can simplify the end-to-end process of issuance, remittance, and settlement, providing for lower recovery costs and greater overall fidelity. This is facilitated by leveraging a blockchain, smart contracts, and overarching recovery governance/legislation.

To clarify, we can walk through the (simplified) process for the European Union/European Central Bank (ECB). In the EU, recovery legislation is passed at the macro level, identifying the overall recovery terms and conditions. Each member state then enacts a program to issue, remit, and settle payments to its population.

The first task is for each member state to issue a digital currency. This digital currency could be a general purpose currency, like a digital Euro, or specific to the individual program, like a CovidCoin. Contrary to contemporary fiat issuance, however, is the fact that this CBDC would be linked directly to the Central Bank doing the issuing. For example, a German digital currency issued to tackle COVID-19 could be “CovidCoin_DE”, while the Spanish Central Bank would issue their alternative, “CovidCoin_SP”. This provides transparency with relation to where the digital currency is coming from, who the intended recipients are, and where/how it can be spent.

The “minting” of each digital currency is simply the function of a smart contract. Essentially, a smart contract would be deployed by each member state to issue the program’s funds. In order to limit the possibility of a rogue, runaway printing press, the amount minted could be pegged to a stablecoin4 reserve that digitally represents the fiat allocation of funds (in this case, an amount in Euros) earmarked for each member state by the ECB. These minted funds are placed into a country-specific Central Bank wallet ready for remittance.

The next step would be for recipients of funds to claim their stimulus allotment. This step requires the creation and/or identification of a recipient’s individualized wallet. Once the wallet has been identified and whitelisted5 for receipt, a smart contract would be triggered to process the remittance. The program funds are then transferred to the recipient for use.

Done. Simple.

Advantages of CBDCs

The primary advantage of this solution is the simplicity by design. With this type of solution, the government can interact directly with the people. There is no need for banks or third parties to intermediate the remittance or settlements. There is also no need to print and mail checks, debit cards, etc. Cost displacement drives the cost of operating the program down, providing greater efficiency so that less stimulus is wasted.

But the advantages do not end there. There is the added benefit of maintaining honesty amongst participants due to the transparent nature of the transactions. For instance, each member state can (and should) run a node. This means that all member states can view what is minted and where it is remitted. Such transparency can help avoid any member states acting in a rogue manner.

Additionally, CBDCs could be used to tackle the problem of velocity during crisis. One problem during periods of hardship is not just capital flight, but a reduction in velocity as people and companies conserve capital, especially cash. To combat this, spending incentives can be programmatically baked into the stimulus package via smart contracts to entice recipients to use their funds. An example would be additional stimulus top-ups to funds spent within a specific period of time. Alternatively, demurrage could be used to entice spending velocity by creating a “perishable” currency.

Hypothecating the stimulus is also an option. In this case, stimulus funds could be earmarked for specific types of whitelisted purchases like groceries. In this manner, the stimulus program would act similar to a tax hypothecation scheme, which are already commonplace.

Lastly, using this type of solution would help to avoid fraud and ease overall reconciliation processes. As stated earlier, all transactions are recorded on chain. Consequently, the auditing process is simplified, providing full transparency to the European Commission, ECB, tax authorities, regulators, etc., to see where funds are going and when and how they are being used.

How can we do this now?

There now exist solutions/platforms on the market that can perform this specific function. One such solution is Celo6, a mobile first solution aimed at open financial tools for all to use. Deploying to Celo, or creating an alternative consortium version, would be a simple process. Such a solution can also be adopted piecemeal by each member state over time. This would allow for the solution to be quickly deployed and rolled out over time, gradually scaling to the entire EU.

Notes

  1. Source: https://www.bankinfosecurity.com/economic-stimulus-payments-fraud-target-a-14145 

  2. Source: https://medium.com/@robertgreenfieldiv/providing-immediate-economic-aid-during-the-covid-19-pandemic-98c6905dc9b5 

  3. Please note - This description is an oversimplification for the purpose of framing only. 

  4. Stablecoins: https://www.coindesk.com/why-this-global-crisis-is-a-defining-moment-for-stablecoins 

  5. Please note - The recipient whitelisting process, including and KYC/AML, is not the subject of this document. 

  6. https://celo.org/