Sila CTO Alex Lipton Co-Authors “Digital Trade Coin: towards a more stable digital currency”

Alex Lipton - Chief Technical Officer at Sila

Updated July 29, 2019

MIT Fellow Says Facebook ‘Lifted’ His Ideas for Libra Cryptocurrency – Yahoo News

Several aspects of the social network’s much-ballyhooed global cryptocurrency project uncannily resemble the vision laid out in a paper published last year in the Royal Society’s Open Science publication.

Quant Lipton pans Facebook’s Libra – Risk.net

Like an “elephant in a china shop”. That’s how Alexander Lipton, former co-head of the global quantitative group at Bank of America Merrill Lynch, describes Facebook’s effort to launch a digital currency, called Libra.

July 18, 2018

The following is an excerpt of the research paper, “Digital trade coin: towards a more stable digital currency” co-authored by Sila Chief Technical Officer Alex Lipton, Thomas Hardjono, and Alex Pentland, published on July 18, 2018 for the Royal Society of Open Science as part of MIT Connection Science, Massachusetts Institute of Technology, Cambridge, MA, USA for the Blockchain Technology special collection.

Abstract

We study the evolution of ideas related to creation of asset-backed currencies over the last 200 years and argue that recent developments related to distributed ledger technologies and blockchains give asset-backed currencies a new lease of life. We propose a practical mechanism combining novel technological breakthroughs with well-established hedging techniques for building an asset-backed transactional oriented cryptocurrency, which we call the digital trade coin (DTC). We show that in its mature state, the DTC can serve as a much-needed counterpoint to fiat reserve currencies of today.

1. Introduction

This paper describes the concept of the asset-backed digital trade coins (DTCs), currently under development at MIT [1]. It outlines an approach to building a consortium of sponsors, who contribute real assets, a narrow bank handling financial transactions involving fiat currencies, and an administrator, who issues the corresponding digital token in exchange for fiat payments and makes fiat payments in exchange for digital tokens. In short, our proposal is to apply distributed ledger technology to give a new lease of life to the old notion of a sound asset-backed currency, and to use this currency as a transactional tool for a large pool of potential users, including small and medium enterprises and individuals. We intend to build a currency, which encourages legitimate commerce, but makes illegal activities difficult. Our contribution should be viewed as a position/vision paper, as at the moment there is no working prototype for the DTC.

We wish to replace physical cash with a supranational digital token, which is insulated from adverse actions by central banks and other parties, due to the fact that it is asset-backed. We believe the DTC is ideally suited as a medium of exchange for groups of smaller nations or supranational organizations, who wish to use it as a counterweight to large reserve currencies.

Supranational currencies have been known for two millennia. For instance, Roman, and later Byzantine and Iranian gold coins were used along the entire Silk Road; Spanish and Austrian silver coins were prevalent medium of exchange in the Age of Sail. Closer to our time, the British Pound was used as reserve currency for the British Empire and, to a lesser degree, the rest of the world; the Dollar and the Pound were used as a reserve currency basket for the world economy in the twentieth century, to which the Euro and the Yen were added in late twentieth century; and now the Yuan might be used along a revived Silk Road.

Today, for the first time ever, there is a possibility of designing a digital currency that combines the best features of both physical cash and digital currencies, including finality of settlement, partial anonymity and usability on the web. This currency is largely immune to policies of central banks that control the worlds’ reserve currencies. Such a currency has enormous potential to improve the stability and competitiveness of trading and natural resource producing economies. In the DTC, we propose to develop a trade-oriented asset-backed digital currency, aimed at facilitating international trade and making it as seamless as possible. This currency will be based on a proprietary framework combining the most recent advances in blockchain and distributed ledger technology, cryptography and secure multi-party calculations, together with time-tested methods for preventing double spending. In view of the fact that our framework relies in part on our own research and in part on ideas readily available in public domain, we do not anticipate specific intellectual property right issues. Unlike Bitcoin, it will be fast, scalable and environmentally friendly. It will also be transaction friendly because of its low volatility versus fiat currencies, not to mention cryptocurrencies.

Over the past decade, potential advantages and disadvantages of distributed ledgers or blockchains, have been discussed by numerous researchers (e.g. [2] and references therein). While numerous potential applications of blockchains have been entertained in the literature—including title deeds, post-trade processing, trade finance, rehypothecation and syndicated loans, to mention but a few—the main usage of blockchains has so far been in the general area of payments, more specifically cryptocurrencies.

Worldwide interest in distributed ledgers was ignited by Bitcoin, which is a cryptocurrency protocol operating without a central authority. It was described first in the seminal white paper by Nakamoto [3]. Since then Bitcoin has inspired creation of more than a thousand of other cryptocurrencies, all with various degree of novelty and utility (if any). One of the most promising is Ethereum, which is significantly more versatile than Bitcoin, not least because is supports so-called smart contracts [4]. Another interesting and popular cryptocurrency protocol is Ripple [5]. The Ripple system departs from the Nakamoto consensus approach. It is not truly decentralized because it does not rely on the thousands of anonymous (pseudonymous) mining nodes that form the peer-to-peer network underlying Bitcoin. Instead, the Ripple system uses a small set of nodes that act more like notaries, validating transactions at a higher throughput and much lower cost compared to Bitcoin. Unlike Bitcoin, most entities in the system are known and not anonymous. By their very nature, all of these currencies are native tokens, residing on a blockchain. Their transition from one economic agent to the next is controlled by the set of rules that are inherent or ‘hardwired’ in the blockchain set-up and are needed to maintain the integrity of their blockchain as a whole. However, until now, attempts to build tokens backed by real-world assets—first and foremost, fiat currencies—have been unsuccessful. Yet, until this all important problem is solved, it is virtually impossible to make cryptocurrencies a part of the mainstream financial infrastructure, because otherwise the inherent volatility of cryptocurrencies will severely curtail their usability.

Although potential application of distributed ledgers mentioned earlier, such as post-trade processing and trade finance, are very important, they are technical in nature and lack the revolutionary spirit. However, a distributed ledger can potentially play a truly transformative role and bring a dramatic departure from the past by making central bank digital currency (CBDC) and stable cryptocurrencies a reality.

In this work, we propose a stable asset-backed cryptocurrency which we refer to as DTC. It can be viewed as a natural extension of a fiat-backed cryptocurrency called the utility settlement coin (USC) [6]. Setting aside operational aspects of gathering and managing collateral assets, we need to design a ledger associated with value transfers. Since, by design, Nakamoto’s approach is neither scalable, nor efficient, we need to use a different design. Our analysis indicates that combining blockchain with an earlier approach for issuing electronic cash (e-Cash), developed by Chaum [7,8], seems to be promising. Recall that Chaum introduced a blind signature procedure for converting bank deposits into anonymous cash. On the one hand, Chaum’s protocol is much cheaper, faster and more efficient compared to Bitcoin. It also offers an avenue towards true anonymity and unlinkability (as in paper cash), as compared to the weak pseudonymity of Bitcoin. If true anonymity is not desired, there are variations on the Chaum approach on offer, for instance, anonymity for the purchaser but not for seller and so forth. However, on the other hand the basic Chaum model and many of its variants rely on the integrity of the issuing bank. To alleviate this issue, we propose the use of blockchain technology itself to track the relevant transaction parameters, reducing the opportunity for parties to be dishonest. Payments are still direct between users as in Chaum’s proposal.

In the DTC, we propose a solution to the stable cryptocurrency problem, which boils down to assembling a pool of assets, contributed by sponsors, appointing an administrator, who will manage the pool and digitizing the ownership rights on this pool. In addition, we build a special-purpose narrow bank, which facilitates activities of the administrator. By construction, neither the pool itself nor the supporting bank can fail due to market and liquidity risks. Their operations are streamlined as much as possible to limit operational risks. It is worth noting that operational risks are always present; this statement is true not only for the set-up we are proposing, but for an ordinary cash and bank deposits too, not to mention cryptocurrencies, which are notorious for their operational risk exposures. The narrow bank receives fiat currency submitted by the users, passes it to the administrator and ultimately to sponsors, while the administrator issues digital tokens in return. These tokens will circulate within the group of users in a fast and efficient manner by using distributed ledger mechanism, thus creating native tokens proportionally convertible into the underlying assets at will. Their value is maintained in a relatively narrow band around the value of the underlying asset pool, with lower bound enforced by arbitrage, while the upper bound is enforced by the administrator assisted by sponsors.

The key insight of the paper is that the properly designed DTC can serve as an international reserve currency, remaining stable in the long run and serving as a much-needed counterbalance to fiat currencies issued by individual nations, which can be easily affected by their respective central banks.

The paper is organized as follows. Background on asset-backed currencies is discussed in §2. Design of Bitcoin and Ripple, including their similarities and differences, is outlined in §3. CBDC and closely related USC are discussed in §4. DTC is discussed in §5. Conclusions are drawn in §6.

Published by the Royal Society under the terms of the Creative Commons Attribution License http://creativecommons.org/licenses/by/4.0/, which permits unrestricted use, provided the original author and source are credited.

Please visit The Royal Society of Open Science website to access the original article.

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