Got cash, in pocket

Digital currency is about an alternative to banks, but it's also about an alternative to bank customers.

Earlier in the year, the Western Economic Association International invited me along to join a panel on central bank digital currency (CBDC) at their 2021 Virtual International Conference. I was there to provide some technology perspective on very interesting economic and legal discussions about how a digital currency might work and what the impact of a digital currency might be.

(I had published a paper on the implementation options for digital currency in the Journal of Payment Strategy and Systems, who kindly allowed me to post a PDF of that paper to my book’s web site. The paper is called Clouds, Chips and Chains and it discusses in some detail the evolutionary tree of digital cash before it looks at the various practical options for implementing a digital currency.)

To understand what these options are, first note that when people talk about digital currency, they generally mean something that can function in the way that fiat currency does. Broadly speaking, we use fiat currency in two ways: in the form of money that lives in accounts (which is almost all of the money in circulation) and in the form of cash. Cash doesn't live in accounts: it lives everywhere. There is cash in my wallet, in my pocket, in my car, in my kitchen, in my desk drawer. Money goes from my bank account to your Square Cash account. Cash goes from me to you.

We don't need a new kind of electronic money to implement digital currency. If we want have a digital currency that can only live in accounts then, well, we pretty much have that now. Just make debit cards and Venmo legal tender and the problem is solved. But that's not how digital currency will revolutionise finance and it's not why a measured and experienced observer such as Tom Noyes is moved to observe that a digital dollar might not only provide an alternative to the card networks in the mass market but also "end run the banks". The digital currency revolution is not about repurposing electronic money, but about creating electronic cash.

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Anywhere, Anyhow, Anytime

Just as cash can live anywhere, so can electronic cash. It must be in some sort of digital wallet, of course, but it does not have to be in an account. Right now, I have electronic cash in USB sticks, in the cloud and on my laptop. But in the not-too-distant future, it might be in my car, my phone, my fridge and my hat as well. And, crucially, if I send digital dollars from my car to your phone, they go from my car to your phone. They do not go from my car to a payment facilitator, aggregator, gateway, acquirer, scheme, processor, issuer, bank and back again, following the pathways established for electronic money.

What's more, for a real alternative to cash, electronic cash must be able to function in the absence of network connections. Even if we are out of coverage, I should be able to use my mobile to phone to pay for a bus ride or buy vegetables at a market. This is a design principle of the new Chinese digital currency e-CNY as well as the Offline Payment System (OPS) proposal from Visa, both of which require a digital wallet that has access to a secure chip (eg, the secure element in your iPhone). You can't do this with Bitcoin and, as Mu Changchun, deputy director of PBoC's payments department said back in October 2019), "even Libra can't do this".

If we use this kind of electronic cash to implement a Digital Dollar stored in secure digital wallets then we will build an alternative to the existing international money system at several levels: digital wallets give us an alternative to bank accounts and (and this may seem less plausible, but I think it will be very important going forward) as an alternative to bank customers.

An Alternative to Banks

Bank accounts are expensive to provide and maintain. Even without the provision of credit, the overheads associated with maintaining and managing bank accounts are much greater than the overheads associated with the maintenance of digital wallets. However, the margins on electronic cash transactions in those wallets will be zero. Therefore the business case for building these wallets (eg, Facebook's Novi) must extend beyond payments. A wallet is a place to store not only cash but also tickets and loyalty cards and identity documents and all sorts of other information to enable transactions and to make the life of a customer easier. Even if all financial services products are provided by banks, the argument for a wallet as a place to store the majority of the customer's transaction enabling data makes sense.

There's a good macroeconomic reason for implementing digital currency as electronic cash that works as an alternative to, but in harmony with, electronic money in bank accounts. That is because there is a problem with digital currency that competes with commercial bank money. For example, if the ECB were to introduce a digital euro [there is a concern] that Europeans would move trillions out of bank accounts (that banks depend on as a cheap and reliable source of funding) and into risk-free digital currency. But if I could move digital Sterling out of my bank account and store it in my phone, the amount would be limited for the obvious reason that if I lose my phone it will be a giant pain to recover the cash (if, indeed, the system allows me to recover it at all). Hence the balances in my digital wallet, my car's digital wallet and my TV's digital wallet will be for transactional purposes only and topped-up (by my AI virtual banker) as needed.

An Alternative to Customers

One of the most interesting aspects to the discussion about bank accounts versus wallets is that of the entities using them! It is a reasonable assumption that in the commercial landscape of the future, where the Internet of things (IoT) and artificial intelligences (AIs) combine to create an environment in which the majority of payments do not involve people at all we will need alternative structures to initiate and receive payments. We will need alternative structures for these nonhuman entities to interact commercially.

The idea that we will give these nonhuman agents legal personhood and set up them up with bank accounts seems a little far-fetched at present whereas the idea that we might provide devices, bots and other economic avatars with authenticated access to wallets containing both money and identity-related information of various kinds seems quite logical to me.

Since there are vastly more things than there are people, the number of transactions between things will dwarf the number of transactions between people. Digital dollars are not only about an alternative to bank accounts, but an alternative to bank customers!