Tokenize the EURO!

When bitcoin was introduced, many believed that this blockchain-based crypto coin would replace “old” money such as the euro and the dollar (also known as “fiat” money). All payments would be made in crypto. Fiat would become obsolete. Users would no longer need banks. They would trade freely, globally and independently. Blockchain would also enable additional smart contracts to automate countless transactions.

This has not happened. Fiat money remains dominant and bitcoin use is hardly growing, if not declining. Blockchain is growing rapidly, but its deployment is often held back because there is no smooth interaction between blockchain and fiat money.

There are many reasons for bitcoin’s lack of success. From a business point of view, bitcoin is a disaster: its exchange rate is far too volatile to be useful in any serious business. On top of that, the lack of central points of control makes bitcoin an ideal instrument for laundering money or collecting the proceeds of crime. (There are also technical issues, such as bitcoin’s energy consumption, the number of transactions per second and the cost per transaction. I will not take those into account here, since there are second- and third-generation blockchains that have overcome many of these issues and could therefore be used to generate coins to replace bitcoin.)

Given the undeniable advantages of blockchain, I wanted to know whether it would be possible to combine blockchain with fiat money. To turn the euro into a cryptocurrency. To “tokenize” the euro, and so to provide a euro that functions as a cryptocurrency but does not have bitcoin’s volatility.

This appears to be remarkably simple.

To get there, one has to focus on what blockchain actually is. I will not go into technical details, but will focus instead on its main characteristic: blockchain provides an immutable ledger. That is all it is. To me, at first that did not sound too exciting, until I realized that nowadays, outside the blockchain, nothing digital is immutable: all information can and will be tampered with. Which is one of the main reasons why we still have banks to store our money. They have built large and expensive systems to protect the digital ledgers that state the euros we own. Banks are large and heavily capitalised so as to provide some comfort that, even if something goes wrong, they can refund us the euros lost or stolen.

Blockchain’s immutability makes all of that obsolete. Blockchain is made to store information about ownership in an easy, transparent and safe way. It is the ideal administrative tool for registering money and the transactions made with it.

Bitcoin is the proof of that. People are willing to pay thousands of euros for a non-fiat coin: backed by nothing, regulated by nobody. It gets even more interesting if one looks more closely at what a bitcoin actually is. A bitcoin is nothing more than a registration on the bitcoin blockchain (the ledger) stating that a specific account is allowed to transfer that bitcoin. Legally one could call that ownership. The account holder “owns” the bitcoins that the system attributes to it. So, strange as it may sound, that account holder owns a transferable registration of bitcoin on a computer system. Yet one can be rich just owning that.

So if we want a crypto euro, how do we do it? How could we tokenize the euro?

First of all, one has to grasp what owning a euro actually means. People who “own” euros do not have physical banknotes in a cupboard at home. They own a claim on the bank for the amount of euros the bank owes them, a claim that is registered in the bank’s systems. Owning one euro means that the bank owes you one euro. Only if people lose trust in a bank do they go to the bank to get a physical euro coin.

How much a person owns is registered with the bank. The bank’s ledger determines that amount. A payment of one euro made online, or in any way other than by handing over the coin, simply means that a claim on a bank of one euro is transferred to another person. So if one person pays another person one euro, that other person’s claim on the bank becomes one euro higher and the paying person’s claim on the bank becomes one euro lower. If both the payer and the recipient are customers of the same bank, that is easily accomplished by adjusting the amounts registered in both their ledgers. If they are customers of different banks, the two banks work together through interbank accounts, so that the recipient’s bank registers the recipient’s claim on it as one euro higher. And, of course, so that the payer’s claim on their own bank is one euro lower. The euro is transferred to the recipient’s bank by a similar system: it is noted in a ledger.

So paying and owning euros is all about ledgers. Tokenizing the euro means using another ledger. A ledger that is not owned by a bank but runs independently: on a blockchain. An immutable ledger which ensures that neither the number of euros nor the account holder can be tampered with. A euro registered to a certain account is “owned” by the holder of that account, much as people own bitcoin.

To answer the question whether this tokenizing is possible, I will analyse what would happen if a euro were transferred to the blockchain (and back), and what happens if payments are made through that system.

Transferring one euro from a bank account to a blockchain account means that the bank registers in its ledger that the claim of that bank account holder is one euro less, while the blockchain registers that the holder of the blockchain account is entitled to transfer one euro more. Or, rather, that the holder of the blockchain account “owns” one euro more.

What happens when payments are made using the blockchain? Between two people who both have blockchain accounts, the blockchain just registers a change of ownership. The amount the payer owns goes down and the amount the recipient owns goes up. Much as with payments made by two people who use the same bank. If a person pays a euro into another person’s bank account, the bank is registered as the “owner” on the blockchain and that other person is registered in the bank’s ledger as holding a claim on the bank for that euro.

All of this seems perfectly possible.

There is a catch, however: a claim on the bank would entitle the person who has it to demand payment in cash from that bank, in physical banknotes.

That is awkward in extreme circumstances where 1. people stop trusting the blockchain and transfer all their crypto euros into their bank accounts, and 2. then also stop trusting the banks, and 3. demand hard cash (2 and 3 resulting in a bank run). The lack of liquid assets that could finish a bank in the event of a bank run cannot be fixed. Nor can it be fixed without the blockchain. The blockchain might, however, add to the panic, since it could be difficult to predict which bank people would transfer their crypto tokens to. That could be mitigated if necessary. One could create a central cash pool. One has to realize here that if we were to tokenize the euro, wholly or partly, the amount of euros does not change, and neither does the amount of cash needed to ensure trust in the system.

Alternatively, one could simply provide that tokenized euros cannot be cashed in. That does make sense: tokenized euros are not affected by the bankruptcy of any bank, nor even by the bankruptcy of all banks. There is therefore no reason to exchange tokenized euros for hard cash. One could go on to argue that the price of no longer running the risk of bank failure is that you forfeit the right to turn your registered euros into cash. (As a side note: cash is still a privacy-friendly way of paying, and we should not get rid of all cash without effective privacy protection in place. That, however, is already an issue in the current, non-tokenized situation.)

So tokenizing the euro is simple. It would mean a giant leap forward. The technology is there. It will bring us a payment system that is easier to use, offers a myriad of possibilities, is immune to failing banks, open to everyone, and much cheaper and more robust.