On the Future of Currency: Interview with Charles Hoskinson, Part 2

Charles Hoskinson is the Founder of Cardano and CEO Input Output Hong Kong. Cardano is a self-described third-generation blockchain, with use cases spanning from credential verification to decentralized finance to NFTs. Its native cryptocurrency, ADA, is the third most valuable crypto asset by market capitalization.

Apostolicas and Qi spoke with Hoskinson and Joel Telpner, Chief Legal Officer at Input Output Hong Kong, via Google Meet. Click here to read Part 1 and Part 3.

El Salvador is the first nation in the world to declare Bitcoin (or any other currency) as legal tender? While clearly a remarkable milestone for the crypto industry, do you think that this was a good decision for El Salvador itself?

It's going to happen. If you're a small nation state, and you have the ability to innovate, or try a risky thing, somebody is going to try a risky thing. We've seen this with the Internet standards, we've seen this with computing; we've seen this with Singapore, Hong Kong generations ago, which were among the first places that took huge risks on how to manage themselves, and they were wildly rewarded in that particular case.

So as El Salvador was trying, they said “Okay, there's this thing called Bitcoin that has gone from zero to trillion dollars in value in four years, and it seems to have an evangelist community. Let's embrace it, let's see what happens.” They're not crazy so they did a dual currency system: there's US dollar and bitcoin, and the wallet brand called Chivo; now 2.2 million el Salvadorans are using Chivo at the moment, which is pretty remarkable adoption. They have an ATM infrastructure. There's certainly a lot of growing pains in that rollout, and it needs to be seen if the government's capable of doing an effective rollout or if it gets mired in bureaucracy. That's the challenge, as a nation state. However, what's really cool is for the first time ever we're going to get real data on remittances, we're going to get real data on how a crypto economy actually works at a scale of 6.4 million people or GDP of US$28 billion.

The other interesting thing is this is forcing the United States to respond because a quarter of the entire population of El Salvador happens to live in the United States. And there's a US$4 billion remittance cycle that exists between El Salvador and the United States. So there's a lot of commerce and trading and financial regulation have to be sorted. Now from a geopolitical sense, there's a lot of reciprocal agreements about national currencies. So it is going to be an interesting question about whether these reciprocal agreements are going to be honored, and is bitcoin going to be recognized as a foreign currency or something else?

Regardless of how it's interpreted, these crypto assets are here to stay. And they're going to continue to have this type of influence and growth, even if there was an attempt to regulate them out of existence.

Telpner: It's an absolutely fascinating question because the concept of legal tender is in many ways, an imaginary made-up concept. A country designates something as their legal tender, and says, “This is the lawful way you can satisfy debts or pay bills or pay taxes in this country.” And we have a global international system where, when a country says, “This is our legal tender,” the other countries acknowledge and recognize and treat that as legal tender. So this is the first time where one country is saying, “We’re looking at this cryptocurrency, bitcoin, and we are saying that it's our legal tender.” And so on that basis, there is an assumption based on historical legal practices that countries around the world now should recognize these in the context of El Salvador, that bitcoin is actually legal tender. This means that Bitcoin’s ability for use in international banking for country-to-country payments starts to take on a very different dynamic and so we're now in a very interesting scenario where the rest of the world is either is going to have to say “Okay, El Salvador, if you say that Bitcoin is your legal tender we're going to recognize that as well,” or we're going to see for the first time countries starting to push back. This debate is going to be a fascinating one. And it has profound regulatory impact and a lot of geopolitical impact as well, on how crypto ought to be treated. El Salvador is one nation. What's interesting is, what impact will this have throughout the Northern Triangle, and what impact is it going to have throughout all of Latin America and the Caribbean. So, if El Salvador is a successful experiment I think we'll see a lot of copycat plays. Uruguay or Paraguay are both likely candidates but so are Guatemala and Honduras. There's certainly a lot of potential countries in the Caribbean.

Hoskinson: Regardless of how it's interpreted, these crypto assets are here to stay. And they're going to continue to have this type of influence and growth, even if there was an attempt to regulate them out of existence. China continues to ban crypto, and it has absolutely no effect on the market, and that's an economy of over a billion people with enormous GDP and a huge amount of geopolitical influence. Yet, that's just Tuesday for us as an ecosystem. There's nothing quite like it, it's pretty magical when you look at it from that perspective, and how it's having influences on small nation states. And one day it will scale to medium and eventually large nation states, and I think the majority of countries will be doing CBDCs.

Telpner: If you look at a lot of emerging markets, they have two problems in many cases. One is that a lot of people in the country are just physically not in close proximity to a bank. I live in New York and there are literally blocks where there is a bank branch on all four corners, but in some of these emerging markets and just to go to a bank, you may have to travel hundreds of miles. And if you get to the bank, you have a second issue which is that in a lot of these emerging market countries, banking services are often limited to people that have large accounts and the average person simply can't even afford to utilize bank services and so these countries. If governments want to take their citizens and bring them into the economic infrastructure of the country of the world, they have to figure out a way to get financial services to them; then, looking at blockchain and cryptocurrency is a really good way to start to empower people, and integrate them into global financial systems because as long as they've got phone or internet access, they don't need to be next to a bank, they don't need to put in large amounts into a bank just to get an account, they can now start participating in local and global financial activities, and that's what's going to drive all of this.

Could you ever see a scenario where ADA constitutes a significant portion of a nation state's economic activity? How does that make you think about maybe the monetary policy of Cardano?

It's an interesting question, I doubt that ADA will ever be considered a national currency. I mean it would be pretty cool to see a nation state make that decision. We certainly don't have that conversation with the leaders we meet with. I think international currency has three properties, it has to be a means of exchange, a unit of account, and a store of value. I would even argue that Bitcoin is suboptimal.

For example, say I’m in El Salvador and I want to buy this meal for 0.007 bitcoin, but the dollar value of that could fluctuate substantially. People think in terms of dollars, and you have to kind of get to a point where you create an instrument that has values stability, high velocity, and price predictability, so that you can use it for credit, because money is very closely related to credit. If your money is good, your credit is good. Money is not good if you can't really use it as a lending instrument.

For example, few people take loans and grants or oil. You could if you wanted to but it doesn't really make sense because neither the lender nor the person he lends to really know who's going to come out on top because of the volatility of the underlying asset. Now, that said, instruments like ADA and cryptocurrencies in general can be used to construct derivatives or structures that become tremendously good currencies.

These are called algorithmic stablecoins and we've invented one called Djed. We're showcasing here at the conference, so it's a great design, but there's dozens of ideas like MakerDao and all these other things floating around that are actually having these conversations in real time. And I have no doubt that, once you've gone to the act of adopting a cryptocurrency, or some form of crypto infrastructures national infrastructure. The next conversation you're going to have is, how do we use that to construct a stablecoin that’s built for us. For El Salvador, the sequel to their work will likely be a digital currency. And that digital currency will likely be value stable. And it would then make a great medium of exchange and unit of account. And it will have all the other properties that cryptos have: instant finality, ease of storage, programmability, with the signature for added security and support. So you can do all kinds of things you can program into that relationship. And on the other thing is as a digital currency, you can put KYC [Know Your Customer] and AML [Anti-Money Laundering] into it.

So we started with gold but then we created gold-backed money. Now we have crypto, and we may have crypto-backed money.

Additionally, as a digital currency you can put a rich amount of metadata in transactions, and you get an enormous amount of economic data that you just as an economist could never get before. So as nations move out of the realm of cash and into the realm of digital currencies, it makes a lot more sense to construct them on cryptocurrency rails as opposed to some centralized rail.

Telpner: Additionally, if you look at El Salvador, right now they use the US dollar as their legal tender. So in their decision to adopt US dollars, they gave up control over any type of monetary policy. Adopting bitcoin is no different. But what Charles talks about is where countries go because that's where it's interesting because if you, if you simply adopt the cryptocurrency as your legal tender, you don't have the monetary control over that because you don't control squat. But if you use that as a base and adopt some type of stable coin, now, you're not only getting the benefit of crypto but you do have the ability once again to also control the monetary policy and so I think in a way you get the best of both worlds.

Charles: Yeah, it's a replication of the past. In certain respects, history doesn't repeat, it rhymes. So we started with gold but then we created gold-backed money. Now we have crypto, and we may have crypto-backed money. There's definitely a parallel there that is worth exploring.

One of the major potential changes in the crypto space is the rise in how seriously central banks are considering issuing their own digital currencies (CBDCs). For example, we know that banks have considered using digital currencies to give expiring grants to induce people to spend during recessions. Do you think these proposals threaten the survival of non-public cryptocurrencies, or do most people you envision using crypto do so for privacy or freedom reasons independent of government policy?

I think they are going to coexist with each other. People have for the first time ever the freedom of choice in monetary policy. Before, we just inherited it, we just had to deal with it. You could be lucky and be born in a country that has great monetary policy like Switzerland, where the money's predictable. Or you could be born in a country with terrible monetary policy like Zimbabwe, for example, then suddenly you wake up and just in a 10-year spread, everybody's a billionaire. And that’s not a good thing. So there's a problem there.

So I think they're going to coexist, and I think there are innovations that CBDCs bring to the table that are quite interesting and exciting. It just depends on how open these systems happened to be. Bitcoin, for example, has no idea about other cryptocurrencies; it's not a smart enough protocol to understand the existence of Ethereum and Cardano and so forth. Yet, one of the most popular assets on Ethereum is Wrapped Bitcoin, where people have created protocols to lock Bitcoin and then create a synthetic version of it on Ethereum and people use it.

Analogously, you don't necessarily need a central bank issued digital currency in order to create a wrapped version of it to export it into a different blockchain. So let’s say the Federal Reserve creates a digital dollar, you could actually create a wrapped version of that digital dollar in the cryptocurrency space if they’re not interoperable with each other. The advantage of that is that then you can augment the capabilities of that digital dollar to whatever the ledger that we see fit is. This is the magic of programmable finance, there's this amazing kind of programmability where every time things move those things can gain new features like privacy or higher transaction throughput. You see this with Bitcoin and Lightning: Bitcoin is super slow, but then you put it onto the Lightning Network where you can have instant finality and super fast transactions at a very low cost.

So CBDCs are going to just accelerate that entire conversation. They're also going to create conversation around algorithmic law and programmable regulation. Currently, we have this problem that you will never have an international company in full compliance. You just can’t be: if you're in 100 countries, then at any given time, something you're doing is unlawful at least, in one of those countries, because it's an incompatible or incomparable legal system. So typically multinationals are pretty comfortable if they keep the European Union, United States, and China happy, but if they have a problem in Senegal, they’ll just sort of think about it. So that's inconsistent and problematic from a regulatory viewpoint.

You can program into transactions through libraries and APIs, so that the regulation is living right there. And, if the transaction settles, you’re in compliance. That's the world we can move to when you have CBDCs, and you have commerce running on crypto rails and programmability.

Telpner: I think that is exactly where we're going to go with it, which is awesome. But I also think it's helpful to think about CBDCs, in the context of one or two flavors. There's some that are just essentially wholesale and some that are retail. And so, in the developed world, we're more likely to see CBDCs that are what I would call wholesale used for interbank type of payments, where you can start to do more efficiently bank to bank types of transactions where you're building in a regulatory framework. In countries like the United States, that may not go into a retail level.

In other emerging market countries, you know, they're making more of a promise to take CBDC down to the individual citizen level. So, certainly when we're talking about wholesale, that doesn't have anything to do with stablecoins in the crypto world, so they're going to exist side by side.

In some emerging markets that potentially implement CBDCs, depending on the regulatory structures, they could certainly try to take steps to eliminate private sector stablecoin competition but I think overall they will exist side by side because they're going to serve different roles. In other words, as Charles said, especially when you start to be able to integrate identity, and other types of regulatory frameworks, CBDCs that make them very convenient for certain types of transactional activity. Then I look at, for example, crypto or stable coin as being the equivalent of credit cards, you're still transacting in those other forms of payment, and they supplement in feed back into the CBDC infrastructure.

Hoskinson: And what's really cool is that CBDCs actually give you the ability to do two very interesting things that we've not really been able to do yet. One is the creation of a world reserve currency. We've had soft, reserve currencies like the US dollar or China trying to get the Yuan to be one now. Before that, the Pound Sterling. The issue there is that it's really like which empire is on top. And in a global multipolar world, that's not exactly the thing that we should be pushing for.

And, the very same technologies that allow you to construct the algorithmic stable coins will actually allow you to create synthetic assets. So, a combination of many CBDCs as a basket could become an international unit of account for trade finance and for nation states and central banks to contend with.

The other direction at the individual level is with how difficult it was in 2020 with giving direct subsidies to people for COVID relief. They were arguing over whether the president should print this day while the check or not; it was a very difficult, painful time to get a payment through. People are talking about universal basic income. People are talking about incentives-based currencies like if you do environmentally sustainable things, you get a reward. So, if you want to grow into currencies that are connected to influencing human behavior or systems like UBI or direct payments to individuals, crypto rails are perfect for that. Because the cost of distributing that currency to the entire population is basically a single transaction: the central bank has a set of wallets that are registered, it clicks a button and it goes there.

It's a great way of instituting different tax policies. If you have great coverage for all commercial activity in your economy, you can actually look at the national sales tax or a fair tax instead of an income tax. Crypto allows you to actually explore these different things. You can even dynamically adjust tax rates based upon regions of commerce. Let's say you designate certain areas Special Economic Opportunities Zones and transactions there are free or subsidized; so everything's cheaper in Detroit, or everything's cheaper in let's say, certain areas in New York City. And then other areas that are more expensive or affluent, you actually charge higher taxes there and things like that, and that policy is doable dynamically on a daily basis, and it doesn't require any complex hardware or software; it's all built into the system. So it works in both directions at the transnational side where you're talking about how the league of nations, the collection of nations in the world, work with each other and create international standards on the monetary side. And, it goes down all the way to the individual side for things like direct payments to citizens and incentivizing citizen behavior and micro to macro scale. CBDCs can enable a future that is promising.

This interview has been edited for length and clarity. Apostolicas owns small quantities of various cryptocurrencies, including ADA.

Click here to read Part One, where Hoskinson discusses the aspirations of Cardano and cryptocurrency adoption in the developing world. Click here to read Part Three, where Hoskinson discusses the politics of regulation blockchains like Bitcoin and Cardano.