Digital currencies have been gaining traction in recent years. It started with Bitcoin and today there are hundreds of cryptocurrencies. Everything from stable coins to tokens that are designed for a specific purpose. However, the most interesting one is Central Bank Digital Currency. While the traditional cryptocurrency community prefers a truly decentralized currency that is anonymous, in order to analyze the implications of a digital currency, digital currencies issued by central banks should be the area of focus.
Digital currency is essentially cash (physical paper money) in a digital form. So it is not “money in the bank”. It is coins in a wallet. In this case, digital coins in a digital wallet. Paper money and coins have a manufacturing cost associated with them. The United States made pennies with copper. But when copper became expensive, people started to melt the pennies and sell copper extracted from them. This was later criminalized. Today the penny is not pure copper. But the high cost of minting them persists. There has been a debate to round off prices for goods and services to the nearest 5 cent amount as the US loses money for each penny that is minted. Digital money almost eliminates this cost.
Digital money has many advantages in addition to almost eliminating the cost of minting physical money. Governments often give out money to its population. In recent times, it has been the Covid-19 stimulus payments. But it has also been giving out money to low income famalies, and money to retired citizens in form of Social Security payments. While developed countries have a majority banked population, the emerging world has a predominantly un-banked or under-banked population. Handing out physical money to them can be a challenge. Digial currency makes this much easier. For cases like giving money to poorer citizens, the digital money can also have restrictions programmed into it. For example, it can be programmed to only be spent at a certain category of merchants like grocery stores or for fuel. In cases like Covid-19 stimulus, the money can be programmed to have an expiration date. Countries like Zimbabwe have had physical currency that expires. This forces people to spend the money and does its job of stimulating the economy as opposed to people just hoarding and investing the money.
One common area of concern is lack of KYC (Know Your Customer). Opening up bank accounts requires you to provide personal information to the bank, preventing financial crimes. This ties into AML (Anti-money laundering) enforcement. Cryptocurrency circumvents this system. This has been seen as a major drawback. But most of this is overblown and not of much concern, because major crimes are still committed with physical bags of US Dollars. Drug cartels and criminals still use bags of high denomination USD or EUR, as shown by busts by law enforcement. In fact, having a digital trail of cash can reduce crimes. An area that does face challenges with digital money is Capital Controls. Some countries have laws that prevent citizens from exchanging local currency for foreign currency. This is common in countries like India and China. The goal is to prevent outflows of their national dollar reserves. Citizens can only exchange their local currency for foerign currency for educational or medical expenses in another country, or are given an allowance to exchange a set amount of money each year for foreign investments. Despite these laws, most people use the black market to exchange money anyway. But digital currency can act as a layer of convenience in this black market. While it helps in circumventing capital controls, they are being circumvented anyway in the black market. So digital money is just making it slightly easier to swap money.
The final piece of this is the most interesting. It is sanctions. Countries like the United States employ the use of sanctions to make other countries act in a favorable way. Since all global trade happens in US Dollars, which travel through the US financial system, it gives the US a lot of leverage. But this is because US banks deal with US dollars. If we dont need banks, countries like Russia and China can exchange digital money without going through banks and financial sanctions could become a thing of the past. This is one of the major concerns specially for the US that could lose its global dominance to a certain extent.
Digital currencies are inevitable at this point. The genie is out of the bottle and it is just a matter of time before they become widespread. As the different concerns get addressed, more people will move towards using it and in a few decades people would not remember ever using physical money.