The Digitalization of Existing Fiat Currencies
When you hear “cryptocurrencies”, you might instantly think: Bitcoin. Bitcoin, along with other cryptocurrencies, has exploded in popularity in recent years. In short, for those that may not know, Bitcoin is a virtual token with no tangible asset tied to it. It can be sent anywhere in the world in a matter of minutes, provided both the recipient and user have access to a computer. It can even be traded on digital marketplaces along with a slew of other cryptocurrencies. Before delving further into how Bitcoin works, a small but important distinction needs to be made between cryptocurrencies and digital currencies. “All cryptocurrencies are digital currencies, but not all digital currencies are crypto” (Frankenfield, Jake). Digital currencies are centralized and often backed by fiat money while cryptocurrencies are decentralized and backed by an intangible asset, aka virtual tokens. These virtual tokens are created through the process of “mining” within the blockchain. The blockchain is the database in which bitcoins can be created, stored, and transferred. The process of mining the blockchain entails maintaining the overall network by solving difficult mathematical computations that aid in transaction processing, network security, and network synchronization (Bitcoin). At its core, bitcoin miners are essentially working for payment in virtual tokens. Cryptocurrencies have been a subject of debate in recent years. There are some who believe crypto is the future; others believe crypto has no chance of materializing. Many struck down cryptocurrencies because the asset had no physical backing and a lack of governance. Regardless of how some may feel about cryptocurrencies, there is one undeniable advantageous feature: speed.
While many cryptocurrency characteristics make corporations and governments uneasy, some corporations have decided to entertain the idea. JP Morgan Chase & Co. rolled out their own blockchain database called Quorum, and consequently issued their own digital currency called JPM Coin (JPM Coin). JPM Coin is a cryptocurrency, which, by definition makes it a digital currency, however, there is an additional twist. Since JPM Coin is backed by the US dollar one-for-one, it is more specifically referred to as a stablecoin. Stablecoins are cryptocurrencies with substantially less volatility since they are pegged to “stable” assets. JPM Coin is off-limits to retail investors, and is strictly for use between authorized institutions. This has the potential to disrupt our current financial system. Here is why: Traditionally, a wire payment, $10,000 for example, would not only take several hours to be processed and ready for withdrawal by the expecting recipient, but will also cost a pretty penny in transaction costs. Banks, more often than not, share the burden of these costs with their clients as it is the price of doing business, but, in some cases, they might waive the fee for their clients in order to gain their business. As a result, the bank covers the whole cost. In either scenario, digital currencies will prevent these outflows and shorten this time frame, as it can be used to transfer any amount in a matter of minutes.
Recently, Facebook announced an initiative to launch their own digital currency, Libra. Facebook’s Libra is different from JPM Coin in a few ways, with the most notable difference being that its value will be pegged to a basket of low volatility assets across several currencies. This key characteristic will facilitate its use across borders (Adamczyk, Alicia). The intent for Libra, unlike JPM Coin, is consumer use for everyday transactions. Libra will also help reduce the cost of sending money between individuals that do not reside in the same country. Today, someone in the United States can send money to another individual in Belgium by way of a bank wire transfer through an eligible banking institution, which arguably offers more security and speed for a steeper price. Or, you can seek out a company within the international money transfer services sector where one might sacrifice speed for a lower cost, such as Western Union. In either case, money is being spent on transaction costs.
Although Libra is a solution to a problem, Facebook’s announcement caused a stir amongst regulators, corporations, and lawmakers. The idea of Facebook extending their reach into the fabric of society even further set off alarms, because many don’t see Libra being decentralized, given Facebook’s controversial past. Some examples of Facebook’s questionable past include the role they played in providing Cambridge Analytica with untethered information on billions of users (Bindley, Katherine & Seetharaman, Deepa), as well as their shady algorithmic practices that in some cases have led to censorship. While I understand the skepticism behind Facebook leading the charge in the development of a universal digital currency on US soil, dismissing the idea completely places the country at risk of falling behind. Some countries have already been experimenting with the idea of a central bank issued digital currency (CBDC), such as Uruguay, however it has yet to be completely adopted by a nation. The status quo is shifting, and others, particularly China, are ahead of the curve, intent on ushering in a new era.
China, home to the world’s second largest economy, has indicated that they are on course to release their version of the digital yuan very soon. This is a big deal. Although other much smaller countries have been testing digital versions of their currency, China has the ability to cause a larger ripple effect. It is important to note that the shift towards a partial or complete elimination of cash from circulation will not be an issue for many Chinese citizens. Cashless pay via Alipay and WeChat is already widely used in China. We can assume that China’s CBDC would not be decentralized, meaning The People’s Bank of China (PBOC) will oversee the ledger and have full autonomy. This kind of technology would undoubtedly result in political, economic, and financial consequences. From a privacy and political standpoint, anonymity will become virtually non-existent. The digital yuan will give the Chinese government the ability to track every payment and allow them to find out who is spending how much on what and where. Criminals may have a harder time doing business, but what about political activism? Will citizens be punished for contributing to causes they support? From an economic and financial standpoint, the largest potential impact behind the PBOC issuing a CBDC is their ability to influence consumer spending in a negative interest rate environment. It would be possible for individuals to be charged for holding onto their money, thereby incentivizing them to spend it which ultimately stimulates the economy. This would prove particularly useful in the event of an economic downturn. Ultimately, there is no way to know for sure how China will attempt to leverage this powerful tool as they are notoriously secretive, nor do we know if it will be successful. These are uncharted waters.
So, given this information, what course of action should the United States follow? The U.S. once dismissed the idea of central bank digital currencies, but no longer is that the case. The biggest risk to the U.S. with China’s CBDC is its ability to gain traction among global economies. If this were to happen, it would present a danger to the US Dollar’s reign as the world’s reserve currency. It is a big deal for a number of reasons, not the least of which is that the US dollar is one of the country’s most powerful foreign policy tools (Mukherjee, Andy). If the US digitizes the U.S. dollar in order to stay ahead of the curve, there will be more issues to deal with than just state surveillance.
Works Cited
Adamczyk, Alicia. “What Consumers Need to Know about Libra, Facebook's New Cryptocurrency.” CNBC, CNBC, 18 June 2019, www.cnbc.com/2019/06/18/what-is-libra-facebooks-new-cryptocurrency.html.
Frankenfield, Jake. “Digital Currency.” Investopedia, Investopedia, 18 Nov. 2019, www.investopedia.com/terms/d/digital-currency.asp.
“Frequently Asked Questions.” Bitcoin, bitcoin.org/en/faq#mining.
“J.P. Morgan Creates Digital Coin for Payments: J.P. Morgan.” J.P. Morgan Creates Digital Coin for Payments | J.P. Morgan, www.jpmorgan.com/global/news/digital-coin-payments.
Mukherjee, Andy. “Say Goodbye to Banking as We Know It.” Bloomberg.com, Bloomberg, 29 Dec 2019, www.bloomberg.com/opinion/articles/2019-12-29/china-has-edge-over-silicon-valleyto-end-banking-as-we-know-it.
Seetharaman, Deepa, and Katherine Bindley. “Facebook Controversy: What to Know About Cambridge Analytica and Your Data.” The Wall Street Journal. Dow Jones & Company, March 23, 2018. https://www.wsj.com/articles/facebook-scandal-what-to-know-about-cambridge-analytica-and-your-data-1521806400
