The pandemic delivered a boost to cashless commerce, but fresh designs for digital money will disrupt far more than coins and bills.
A century ago, the U.S. government established the Palo Seco Leper Colony on a 500-acre fruit farm near Panama City, complete with a plaza, a chapel and its own currency. As in many other countries, Canal Zone authorities believed separate coinage would avoid the spread of what is now called Hansen’s Disease and discourage any thoughts of escape. Pathogens and payments have a long, intertwined history.
As markets take the measure of fresh inflationary pressures in the cyclical recovery, the current pandemic has sped the secular shifts to digital payments amid concerns that coins and bills might transport the virus and lockdown measures that encouraged online commerce. But it has also accelerated a far bigger shift in the way governments and people think about money, presenting enormous potential opportunities for businesses and even larger potential headaches for policymakers.
Of all the ways the “new normal” may be different from the “old,” this may be near the top of the list.
Coins, of course, were revolutionary themselves as they moved commerce beyond simple barter. China gets credit for the first paper bills in the 7th century to ease large transactions, and America counted as many as 8,000 cities, banks and even churches that issued currency on the eve of the Civil War. Government involvement since then introduced greater security and reliability, but also more rules over who could spend money on what.
“Of all the ways the ‘new normal’ may be different from the ‘old,’ this may be near the top of the list.”
These days, the cheap digital storage, mobile networks and powerful data algorithms offer the prospect of turning currency and bank deposits into digitized tokens that both store and move value without the encumbrance and cost of account settlement. Three kinds of digital currency get most of the attention.
Bitcoin and other cryptocurrencies draw headlines for their wild swings in value and foundational premise that governments are not to be trusted. The idea is that exotically named but strictly limited issuance will hold value far better than the dollars, yen and euros that governments print with reckless abandon. Meanwhile, the distributed ledgers that track and enable transactions ensure complete anonymity.
“Stablecoins” are a type of cryptocurrency but differ from others in that they rely on the backing of actual government currencies or gold rather than a common conviction. The Diem Project, formerly known as Libra, has drawn most of the attention thanks to its founding sponsor, Facebook. These stress the advantages of secure, inexpensive payments and broader access to financial services.
As always, governments have been slow to the party, but they are catching up fast with “central bank digital currencies” (CBDCs or see-bee-dee-sees to the cognoscenti). These are designed to have all the familiarity and trust of the current lineup of “fiat” currencies but also the convenience and cost advantages the crypto versions.
In part, governments don’t want to lose control of a world that is shifting away from physical cash. But digital currencies are touted for their potential to bring the poor and unbanked into the financial system without, for example, the crushing expense of payday lenders. They also offer the possibility of enormous efficiencies for all financial intermediaries—and just about anyone else who handles money.
“The cheap digital storage, mobile networks and powerful data algorithms offer the prospect of turning currency and bank deposits into digitized tokens that both store and move value without the encumbrance and cost of account settlement.”
China is famously first out of the gate with an “e-yuan” that will flow through an economy already substantially cashless but reliant on two private payment systems, Alipay and WeChat Pay. The government has already been priming the pump over the Lunar New Year holiday by distributing some “free samples” in a lottery that will serve as a field test for a larger launch before the Beijing Winter Olympics next year. There is also a political agenda that will allow better monitoring of internal financial flows and, in time, help establish an international alternative to dollars that can’t be blocked by Washington’s sanctions.
At the other end of the size/control/weather spectrum is the Central Bank of the Bahamas, which must contend with providing money across 700 hurricane-vulnerable islands to some 400,000 people, including many without bank accounts. The digital “Sand Dollar” can make payments when bank networks are disrupted and offer different levels of privacy, depending on the size of the transaction.
Globally, there are a dizzying array of experiments underway, as tracked by OMFIF’s Digital Monetary Institute, with different approaches to the knotty questions ahead. How best can these technologies balance the need for governments to monitor criminal and terrorist activity with a rising desire in many countries to protect personal privacy? What is the best way to blend the stability and trust that come from government sponsorship with a private innovation that will allow more convenient and less expensive ways of moving money?
The operational challenges are even harder. If individuals hold their money in accounts at their central bank, then how will commercial banks gather deposits to lend against? If digital currencies are distributed through banks, how will monetary policy transmission change? Can digital currencies pay interest directly to the holder? Can they charge interest if rates turn negative?
The acceleration of these efforts through the pandemic means that global investors can’t avoid these questions any longer. The roles of financial intermediaries are about to be significantly disrupted if commerce and investment shift to incorporate more digital currencies. Meanwhile, the very understanding of safe havens looks set to change as markets eventually judge the e-yuan against the digital dollar that the U.S. Federal Reserve has begun to consider. This could lead to a significant reshaping of global payments and reserve holdings if the world’s favorite safe asset doesn’t quite measure up to the new alternatives.