Digital money - a dystopian future?
From the announcement of Libra by Facebook in June 2019[1] to El Salvador’s adoption of Bitcoin as an official currency in September 2021,[2] the financial system is now digitising fast. But how far is digital money away from becoming a globally recognised store of value? This article discusses the three digital models vying to shape the future of money and payments, and the potential ramifications of widespread adoption of digital money.
The three models of digital money
Digital money (also known as digital currency, electronic money, cybercash or electronic currency) is any currency that is managed, stored or exchanged on digital computer systems.[3] Digital money can either be centralised, where the transactions are facilitated by third parties, or decentralised, i.e. blockchain-based systems that not rely on central intermediaries to offer traditional financial instruments.[4] Prominent cryptocurrencies, such as Bitcoin and Ethereum, are examples of decentralised digital currencies.
There are three approaches to digital currency – two of which operate under centralised systems. These models are the:
1. Private-centralised model: big tech firms such as Facebook and Amazon are following in the footsteps of Chinese giants like Tencent and Alibaba to create new digital payments networks that operate using their own versions of digital money. In August 2021, Facebook announced that its digital currency wallet – Novi – is ready for launch. Novi will be integrated into Facebook apps and would offer free person-to-person payments both domestically in the US and internationally.[5] Whilst Facebook did not reveal the precise timing of a Novi launch, the wallet will be holding Diem coins (a stablecoin[6] created by Facebook).[7]
2. Public-centralised model: the public-centralised approach has been adopted by governments and is more commonly known as central bank digital currencies (‘CBDCs’). CBDCs are issued and governed by a country’s central bank – they are the digital version of a country’s currency. 81 countries (representing over 90% of global GDP) are now exploring CBDCs, indicating that central banks are fighting for control over their monetary systems as the crypto market becomes a greater threat to fiat currencies.[8] The Bank of England has already launched a taskforce on digital cash[9] and the European Central Bank is in its investigation phase of a digital euro project[10].
3. Decentralised model: some are pushing for a completely decentralised route with payments and other financial services made and verified through purpose-built blockchains. No single person or entity has control over the digital money. Rather, all users collectively retain control.
All three of these models already exist to some degree and they are all developing fast. The key question now is which of these models can be built on a bedrock of sufficient trust for them to be a globally recognised store of value.
A universal adoption of digital money – the pros and cons
There are plenty of benefits to digital money. It leverages technological efficiency: instead of relying on traditional intermediaries, such as banks and clearing houses, money transfers and payments could be made in real-time. These instant transfers eliminate/lower transaction fees, reduce the complexity (and paperwork) of transactions, and provide a digital record of proof of transaction. Crucially, digital money can provide the two billion unbanked adults access to money transfer, boosting economic activity.
Governments would also be able to utilise digital money to implement economy-boosting measures efficiently. For instance, should governments need to transfer money to the population (like many did during the pandemic), this would be completed much more quickly if money could be deposited directly into people’s digital wallets. Under the CBDC model, money can also be programmed by the government. China has tested expiration dates for its digital yuan to encourage users to spend it quickly in times when the economy needs a jump start. Additionally, the Bank of England has said that its digital pound would allow parents to programme their kids’ allowance.[11]
The biggest con of adopting centralised digital money is that they give unprecedented power to policymakers/big tech firms by allowing them to track people’s spending in real time and keep a record of all money movements in their economies. This will undoubtedly spark huge debates around privacy and basic freedoms. Additionally, a sudden widespread shift towards digital money may risk banking disintermediation, resulting in economic instability. Regarding decentralised models, the current lack of trust (and thus, users) over DeFi keeps decentralised digital assets too volatile to be used as a dominant store of value.
Even if these concerns are resolved, digital money inevitably poses heightened cybersecurity risks for everyone. As third parties may hack into these digital systems, strong security and auditing structures, and robust and effective regulatory enforcement systems must exist to minimise such risks. Whether or not the world is ready for digital money, they are here to stay.
[1] https://www.cnbc.com/2021/04/20/facebook-backed-diem-aims-to-launch-digital-currency-pilot-in-2021.html
[2] https://www.cnbc.com/2021/10/01/el-salvador-just-started-mining-bitcoin-with-volcanoes-for-the-first-time-ever-and-theyve-already-made-269.html
[3] https://en.wikipedia.org/wiki/Digital_currency
[4] https://www.investopedia.com/tech/what-are-centralized-cryptocurrency-exchanges/
[5] https://www.ft.com/content/a8512417-1fde-481a-b282-2f892e3c3b51
[6] Stablecoins are digital currencies pegged to a fiat currency. Digital currency group Diem Association, formerly known as Facebook’s Libra project, plans to launch a US dollar stablecoin as the big tech giant scales back its global ambitions to focus on the US. The association, which comprises 26 financial firms and non-profits, will run a blockchain-based payment system that allows the real-time transfer of Diem stablecoins. The California-based Silvergate Bank will issue the Diem USD stablecoins and manage the Diem USD reserve. Diem said it would launch a pilot of the stablecoin, but it did not say when.
[7] https://www.reuters.com/technology/facebook-backed-crypto-project-diem-launch-us-stablecoin-major-shift-2021-05-12/
[8] https://www.atlanticcouncil.org/cbdctracker/
[9] https://www.bankofengland.co.uk/news/2021/april/bank-of-england-statement-on-central-bank-digital-currency
[10] https://www.ecb.europa.eu/press/pr/date/2021/html/ecb.pr210714~d99198ea23.en.html
[11] https://subscriptions.finimize.com/content/Q29udGVudFBpZWNlOjMyNTU=
