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Cryptocurrencies as Digital Cash – A Central Bank Perspective

By: Chris Henry, MA, MSc

CryptoCom 2020: Let’s get the conversation started

In April of this year we'll be inaugurating CryptoCom, a conversational engagement with industry and thought leaders from various communities across our North American economy. If you haven't registered yet, do; you don't want to miss out:

For my part in this upcoming and timely conversation, I’m excited to share my unique perspective as a former central banker on where money is headed in the future (or, as my friends at NetQash say, "how money is morphing"). However, I’m more excited to hear from you, and work together on fleshing out what this future means for your business. In the article below, I give some context around the relationship between cash and cryptocurrency – they’re not as far apart as you might think!

Whether you're a business, a banker, or a technologist (FinTech!?) keep the following questions in mind as you read, and let’s get the conversation started:

  • How do you see your cash operations evolving in the future, in the face of increasing digitization of payments?

  • Could cash services be provided in a digital form?

  • How could new forms of technology like cryptocurrencies promote financial inclusion, thereby attracting new members? #creditunions #underserved #localeconomy

  • What actions of the central bank or other regulatory bodies related to cryptocurrency could have an impact on local financial institutions?

  • What would happen if the Federal Reserve were to issue its own version of a digital currency?

Do central banks care?

With all the fuss about cryptocurrencies these days, one might ask: What does the Federal Reserve have to say on the matter? According to a recent Bloomberg article, apparently not much. “The Fed has no formal digital currency research effort”, the article notes, aside from an economist here or there keeping tabs on the topic. Former Federal Reserve Chair Yellen? “Not a fan”, as reported by Coin Desk. This is, of course, a fairly common view among central bankers. Governor of the Bank of Canada, Stephen Poloz, notably referred to cryptocurrencies as having a misnomer, arguing “`crypto’ yes, `currency’ no”.

Despite this sentiment, in other countries around the world there is a real sense of urgency by central banks to come to terms with the revolution that is cryptocurrency, spearheaded by the popularity of Bitcoin and its underlying blockchain technology. The Bank of Canada features a longstanding research program on e-money, including among its elements: an ongoing Bitcoin survey measuring adoption and usage; a project experimenting with use of blockchain technology to clear large scale payment transactions; international regulatory collaboration on the impacts of decentralized financial technology.

Another stark example comes from The Riksbank, Sweden’s central bank. In recent years Sweden has witnessed a drastic decline in cash demand, forcing the central bank to take a hard look at the possibility of a so-called ‘cashless society’, and pioneering research and discussion into Central Bank issued digital currency.

There are a range of factors motivating central banks to confront challenges posed by cryptocurrency. Here, we discuss one key factor: the function of physical currency – i.e. cash – in relation to the role of the central bank. Against the background of an ever-increasing digitization of payment technology, cryptocurrencies force central banks – not to mention all of us as consumers, financial institutions, and so on – to take a hard look at how and why we use cash, and what the future might hold.

Digitization of the payments landscape

The dominance of electronic forms of payment is evident in both the US and Canada. The Diary of Consumer Payment Choice, from the Federal Reserve Bank of Atlanta, shows that cash accounted for just over a quarter (26%) of the volume of transactions made by consumers in 2019. By contrast, card payments (credit and debit) accounted for over half (51%). Results from Canada highlight a picture of declining cash use over time: The Bank of Canada’s Methods-of-Payment survey program documents a decline in the share of transactions paid with cash, from 54% in 2009 to just 33% in 2017.

There are a myriad of reasons why electronic card payments are so dominant. For one, consumers in these countries have relatively high access to banking services. Credit card reward programs provide incentives for consumers to charge their purchases, an increasing number of which take place online. In Canada, proliferation of new payment technologies also plays a role. Consumers love the ease and convenience of ‘Tap-and-go’ contactless credit card payments which are driving much of the growth in credit card payments at the expense of cash, particularly for low value transactions where cash has historically dominated.

The full range of payment innovations available to consumers can be overwhelming to consider. Mobile payment apps are available in many forms - Apple Pay is likely to be widely recognized, as are store-branded payment apps such as Starbucks. The advent of Venmo has facilitated easier person-to-person transactions, without having to make a trip to the ATM. Or how about something with a bit more futuristic flair: Tired of messing about with quarters at the parking meter? How about letting your car pay for your parking spot? A small but increasing number of businesses even accept Bitcoin as a legitimate method of payment.

Sometimes, the not-so-sexy innovations can actually be the most effective. Canada’s debit card network, Interac, recently made improvements to the functionality of online bank transfers, making it as easy to send and receive money as it is to send and receive emails. This has proved incredibly popular among Canadians with adoption of close to 60%, facilitating increased ease of person-to-person and person-to-business transactions, the latter particularly for small businesses. Evidently, this is a prime example of a type of digital innovation addressing a real need in the economy.

Despite the wide range of innovations out there, however, widespread adoption and use is simply not the present reality – the numbers tell us that traditional payment methods of cash and cards still overwhelmingly dominate. What could a more extreme digitization of the payment landscape look like? For that, we often have to look outside of our own backyard. In Kenya, the proliferation of M-pesa has proven to be a truly transformational technology for the economy. Allowing users to deposit money into a mobile phone account, to send money via SMS, and redeem mobile deposits for cash, this ‘digital money’ leverages existing financial institutions and structures, while providing massive benefits to users. As of 2012 there were over 17 million registered M-pesa accounts, and the model has spread to countries such as Tanzania and Afghanistan, among others.

Is cash really dead?

Even with the trend toward digital innovation in payments, it turns out that cash is somewhat of a stubborn beast. No matter how many times it is declared dead, it doesn’t seem to be going anywhere. Growth in the number of banknotes around the world is a documented and surprising fact – in more countries than not, including the US and Canada, the value of banknotes in circulation grows roughly in line with GDP. One can find cases, such as Hungary, where banknote growth actually outpaces economic growth.

It turns out that cash is still useful – and therefore used – for a variety of reasons. Despite the decline in cash use for payments, Canadian consumers report holding on their person (in their wallet, purse, or pockets) around $100 of cash, on average. Over half of Canadian respondents also reported $200 or more in cash stored elsewhere, for example, at home for precautionary purposes. As a store-of-value, cash seems to do a decent job. This makes sense, especially considering the low opportunity cost of holding cash, a consequence of historically low interest rates offered on accounts at traditional financial institutions.

Why is cash so stubborn? In part, it has a unique characteristic not shared by other means of payment – anonymity. Cash allows us to transact with privacy. Of course, some (like esteemed Harvard Professor Ken Rogoff) will shout until the cows come home: only criminals want/need that sort of anonymity!; we should do away with high-value denominations, which are surely only used for criminal endeavors!; if we simply got rid of cash there would be no money laundering!; and so on and so forth. I don’t think the matter is so straightforward. In a world where data breaches are a common occurrence, and where credit scores have an outsized impact on our lives, perhaps the pendulum is ready and waiting to swing back towards a prioritization on privacy.

Related to this are issues of financial literacy and inclusion. A popular reality TV show in Canada, ‘Til Debt Do Us Part’, demonstrates the point clearly enough: a financial guru host advises monetarily hapless families on how to get a hold of their finances and start digging themselves out of debt. Step one in the process? Each month’s budget is given to the families via jars of cash. Could there be a better way to constrain over-spending and monitor your liquidity? Cash can serve as a powerful budgeting tool for the financially illiterate. With respect to financial inclusion cash is equally as powerful. Your bank may not approve you for a mortgage if you have bad credit, but no buyer turns down cash. In some ways then, cash is still very much king.

Central bank perspectives

What does this all mean for central banks? Why are certain ones paying such close attention to the evolution of cryptocurrencies? Based on the context provided, we posit two cash-related reasons.

First, the decline of cash has real implications for the very foundation/existence/operations of central banks. Often people talk about central banks ‘printing money’, and in one sense this is actually true. Put simply, seniorage is the money earned by the central bank as the difference between the face value of coins/banknotes and their cost of production. As cash declines this revenue stream will inevitably dry up, affecting the central bank’s ability to operate and maintain independence. Cryptocurrencies offer something unique from other payment innovations in the digital sphere, something that mirrors resiliency of cash – that key feature of anonymity. It is in this sense we might speak about cryptocurrency as a form of digital cash.

Second, central banks have reason be concerned with financial inclusion, i.e. greater participation in the formal economy. As digitization progresses, cryptocurrencies have the potential to meet some of the same needs that cash does in this respect. Anyone with a computer, or willing to hit up a Bitcoin ATM can purchase cryptocurrency and begin transacting online – no need to set up a bank account and provide your personal information.

As younger generations become increasingly technically savvy, barriers to entry are becoming minimal. Central banks need to decide how to respond to this development, which leads down the road to proposals for issuing Central Bank digital currency to fill the void. However, it remains to be seen whether such a product could – or even should – compete with private cryptocurrencies such as Bitcoin. Hence, why this is such a hot topic in central bank circles these days.


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