by Gary B. Gorton and Jeffery Y. Zhang[*]
[Full text of this Article in PDF is available at this link]
Introduction
The advent of cryptocurrencies—particularly stablecoins, which are digital tokens that can circulate as private money—has ignited a debate on the government’s role in providing a sovereign alternative. This sovereign alternative is oftentimes referred to as a “central bank digital currency.” Dozens of governments and central banks are now deciding whether to create one and, if so, how to design and operationalize it.
We seek to advance the debate on central bank digital currencies by presenting insights from a parable, The Orkney Slew, which is set in the archipelago of Monasis. In Part I, we begin by reproducing a translation of the parable, which is contained in a unique document found uncatalogued in the Yale University’s Beinecke Rare Book and Manuscript Library. We then propose possible interpretations of the parable, which contains references to different colors of the same item—a “grank”—that is used for cross-island trade and “magic” that can transform those colors.
In Part II, we advance the interpretive analysis of cross-border market failures by describing an episode from U.S. history when cross-border transactions between states suffered from similar frictions. Specifically, prior to the National Bank Act of 1863, trade across state lines was expensive and inefficient largely because the money used by traders consisted of private bank notes issued by banks all over the country. These private bank notes did not trade at par, but rather at discounts. As a result, it was hard to move capital around the country. By creating a uniform national currency, the National Bank Act significantly reduced financial frictions and facilitated trade and economic growth.
We then discuss lessons for today’s policymakers in Part III. These lessons include (a) the significant market failure that currently exists in crossborder international trade; (b) the role of interoperability and international standard setting in resolving that market failure; (c) the national security implications associated with the rapidly evolving payments landscape, including for Anti-Money Laundering/Combatting the Financing of Terrorism (AML/CFT) and the continued efficacy of U.S. sanctions; (d) the importance of viewing this task as building infrastructure; and (e) the necessity of experimentation in the policy process. Of note, the national security concerns are even more pressing now considering the sanctions imposed on Russia following its invasion of Ukraine in February 2022, including the expulsion of Russian banks from the Society for Worldwide Interbank Financial Telecommunication (SWIFT). The global financial and payments system is very likely to undergo significant changes in the coming years as a result.
To be clear, we are not advocating for countries to adopt central bank digital currencies at this moment. There might be significant technological and operational problems that defeat their feasibility, and which may have their own unintended consequences. We do, however, believe that central banks should cooperatively experiment in order to learn whether interoperable digital currencies could be developed to address the issues cited in this Article.
[*] Gary Gorton is the Frederick Frank Class of 1954 Professor of Finance at the Yale School of Management. Jeffery Zhang is an Assistant Professor at the University of Michigan Law School. The authors thank Michelle Tong for excellent research assistance. The authors also thank Meghan Greene, Howell Jackson, David Wishnick, participants at the Wharton Financial Regulation Workshop Series, and the editors of the Harvard National Security Journal— including Diego Negrón-Reichard, George Papademetriou, and Nicholas Weigel—for their thoughtful comments and suggestions.