Whether or not cryptocurrencies replace fiat currencies depends on everyday people. Governments and banks are moving to digital currencies, or emoney as some call it, to replace traditional fiat paper money. However, acceptance in everyday transactions depends where in the world you happen to be. In an IMF paper published in February, cash is still king in many countries around the world.
As the chart shows, many countries use a significant amount of cash for everyday transactions as a percentage of GDP. The US is in about the middle at 8 percent, but countries like Hungary, Japan, and Switzerland are above 12%. In contrast, cryptocurrencies only have about 35 million users worldwide. And that is with adoption doubling during 2018 when most of the cryptocurrency space was experiencing a very sharp 75% correction in prices.
Cryptocurrencies are becoming more popular for online transactions; however, recent evidence suggests that about 85% are speculative pricing transactions. People are not buying and selling them for reasons of decentralization, autonomy, privacy, or libertarian ideals about honest money. Rather, the vast majority of people are merely hoping to make money on the their holdings.
With the digital currency prices falling, some crypto holders have turned to alternate methods of making money on their stashes without selling their currencies at today’s lower prices. The rise of crypto lending in the last year has fed the speculative trading markets.
“I think it’s fair to hypothesize that the majority of crypto-collateralized borrowers are hodlers who are unwilling to sell at what they view is a depressed price, and are looking for a way to do something with the funds they have parked in crypto,” said Canary Data co-founder Galen Moore.
Therefore, while gaining momentum, the lending market currently has a fairly limited upside. Additional growth will need to come from legitimate money transactions where people are using the currencies for actual commerce instead of just trading for profit.
“We believe the next wave of growth will come from use cases that draw new users into holding and transacting in crypto assets,” noted Galen Moore.
Institutional investors, such as banks, have mostly shied away from the cryptocurrency space thus far due to concerns over liquidity and potential investment growth. However, that trend may be changing.
Banks such as JP Morgan are launching their own crypto coins to service institutional investors. The coins are not public currencies yet, but they do represent the first step that the banking sector is taking towards adoption of blockchain technology and digital currency assets. The bank is calling it the JPM Coin, which will be used to settle transactions between clients of its wholesale payments business.
The lender moves more than $6 trillion around the world every day for corporations in its massive wholesale payments business. In trials set to start in a few months, a tiny fraction of that will happen over something called “JPM Coin,” the digital token created by engineers at the New York-based bank to instantly settle payments between clients.
The JPM Coin differs from most cryptocurrencies because it is backed 1:1 by US dollars. Essentially, JP Morgan has developed a US currency equivalent in electronic form that can be redeemed back into US dollars by its clients. The JPM Coins; however, are not currently considered legal tender and are only used internally on JP Morgan’s blockchain network, Quorum.
In addition, clients of the bank must past rigorous KYC (know your customer) laws in order for the bank to validate whom it is doing business with. This stands in stark contrast to cryptocurrencies which can be purchased by anyone with basic computer knowledge and a desire to transact without providing background information to the crypto providers.
In anticipation of the institutional investment boom in the blockchain space, Forbes has launched a subscription digital newsletter called Forbes CryptoAsset & Blockchain. The newsletter is aimed at potential new institutional investors and aims to expand the publisher’s coverage of the growing blockchain and digital asset markets.
With consumers and banks working on their models for the blockchain and digital currency space, the IMF has commented on how nations can adopt a global model for emoney. The new model, as proposed, would place digital currency alongside national paper fiat currencies in a dual currency model.
The proposal is for a central bank to divide the monetary base into two separate local currencies—cash and electronic money (e-money). E-money would be issued only electronically and would pay the policy rate of interest, and cash would have an exchange rate—the conversion rate—against e-money.
The purpose of having emoney (aka digital currency) alongside cash is to encourage current cash users to switch to the digital model over time. Thinking back to the Cash is King chart above, the IMF understands that the majority of people will not accept switching to cryptocurrencies right now.
The reasons most people stick with cash is a general distrust of the banking system, cultural acceptance of national paper money for everyday transactions, and anonymity of purchases. While cryptocurrencies have been popularly accepted as offering anonymity, in reality they make transactions much easier to track than cash which has no associated and persistent online ledger. Authorities can link cryptocurrency accounts to the users’ funding mechanism, namely a credit card or bank account, using existing fraud and anti-money laundering laws.
So why are governments considering the complication and expense of a dual currency system? Essentially, economists are warning that the contemporary debt-based fiat money system has run out of headroom for dealing with recessions and the economic cycle. As a result, many central banks are already putting into place negative interest rate policy (NIRP) systems, and will utilize emoney digital currency as a way to implement the system.
Central banks have typically reduced interest rates by 3-6% to address economies in recession. The rate reductions are designed to stimulate borrowing and spending to inflate the depressed markets. However, per the IMF, only a few countries actually have high enough interest rates to perform such a maneuver today.
Most central banks, since the Financial Crisis, have implemented very accomodative monetary policy. This means low interest rates and cheap money. Originally, this policy was placed into effect to stabilize the banking system after Lehman failed. However, the low rates and easy loan policies were mostly never replaced with more stringent standards that typically characterize normal and healthy growing economies. Therefore, analysts believe that negative interest rate policy will need to be implemented during the next global recession. Per the IMF:
If another crisis happens, few countries would have that kind of room for monetary policy to respond. To get around this problem, a recent IMF staff study shows how central banks can set up a system that would make deeply negative interest rates a feasible option.
This is where national digital currencies come in. The IMF knows from previous attempts at negative interest rates that people simply withdrew their money from the banks to avoid the losses associated with paying banks the negative interest rates to keep their money over time. Holding cash is equivalent to having a zero interest rate and is an easy alternative to a system of negative interest rates at the bank.
When cash is available, however, cutting rates significantly into negative territory becomes impossible. Cash has the same purchasing power as bank deposits, but at zero nominal interest. Moreover, it can be obtained in unlimited quantities in exchange for bank money. Therefore, instead of paying negative interest, one can simply hold cash at zero interest. Cash is a free option on zero interest, and acts as an interest rate floor.
And with the peoples of so many countries having culturally strong affinity for cash, the banking system needs to setup another mechanism to implement NIRP policy. Only countries with lower cash per GDP rates have been able to implement NIRP policies with some success.
The euro area, Switzerland, Denmark, Sweden, and other economies have allowed interest rates to go slightly below zero, which has been possible because taking out cash in large quantities is inconvenient and costly (for example, storage and insurance fees). These policies have helped boost demand, but they cannot fully make up for lost policy space when interest rates are very low.
Enter the dual currency system. Where cash is electronic, banks can implement NIRP policy by simply discounting the emoney (e-dollars) portion of banking deposits by the discount rate. When an account holder deposits cash, the bank turns it into emoney and applies the discount rate. The IMF has provided an example of how this would work.
To illustrate, suppose your bank announced a negative 3 percent interest rate on your bank deposit of 100 dollars today. Suppose also that the central bank announced that cash-dollars would now become a separate currency that would depreciate against e-dollars by 3 percent per year. The conversion rate of cash-dollars into e-dollars would hence change from 1 to 0.97 over the year. After a year, there would be 97 e-dollars left in your bank account. If you instead took out 100 cash-dollars today and kept it safe at home for a year, exchanging it into e-money after that year would also yield 97 e-dollars.
Not only would existing deposits depreciate by the discount rate every year, which in this case is 3%. But banks would keep track of your transactions, and discount any deposited cash by the same rate as soon as you give it to them. Therefore, there would be no method for account holders to avoid the negative interest rates on their e-dollars unless they held all of their cash outside the banking system.
This step towards government-sanctioned digital currency would require relatively little change in legal and financial frameworks because it maintains the same rules for cash and banking. The major change would be quoting two currency rates for each national currency. Quoting systems would have to be changed to reflect the inclusion of emoney.
And contract language would have to be amended to reflect the two systems, but only to the extent that transactions are performed both with the new digital currency and cash. Existing cash contracts could stay in place, with an amendment that conversion in digital currency reflect the exchange rate between it and the paper equivalent.
The biggest issue may be in the enormity of the communications effort to global economic participants. This would take time, but would have the benefit of introducing the public to the concept of digital currency and providing a known mechanism, the bank account, for implementing the changes. It would not require people to learn how to use and trade cryptocurrencies by themselves using proprietary software. And it would reduce frustrations in picking one of the over 2000 existing private cryptocurrencies currently in circulation.
The US Constitution provides two requirements with respect to the issuance and acceptance of money. Section 8 allows Congress to coin money and regulate its value. Section 10 prohibits states the right to coin their own money. The framers rejected the right of Congress to issue a paper money, but also rejected a proposal to specifically deny the same right to the Federal government. The Constitutional clauses; however, make clear that Congress shall coin money, and states should only make gold and silver legal tender for payment of debts.
While it is clear that the Framers intended to limit money to coin in the form of gold and silver, they may have also left a back door open for the possibility of a paper money system. While the mention of gold, silver, and coining money clearly indicates a bi-metallic money standard, the US Supreme Court has ruled that paper banknotes are constitutional in McCulloch vs Maryland. The Court opined that the Necessary and Proper Clause allowed the Congress to create powers not specifically delegated to it by the Constitution, known as implied powers.
What we do not know is whether digital currencies will be afforded the same constitutional protections via Congress’s implied powers that the national bank and paper currency have been. It would seem that as soon as the Federal Reserve and member banks institute such a system, numerous legal challenges will be filed. Congress may be required to issue new legislation authorizing the dual currency system with digital currencies. And the Supreme Court may be called on to litigate subsequent challenges to the new laws.
What appears abundantly clear is that the framers did not intend for a centrally administered monetary system with negative interest rates designed to devalue the people’s money over time. Critics may rightly call this a system of theft to pay for the bad debts of previous generations made possible by the existing debt-based fiat money system. A digital currency designed to steal future wealth to pay for bad mistakes of the past seems a bridge too far to cross.
As I have written in the past, blockchain-based currencies suffer pretty severe technical issues. The first major issue deal with speed – the fastest of them typically process around 1500 transactions per second.
They do not tend to scale needed for national currencies. When many transactions occur, currencies such as Bitcoin have failed to quickly validate transactions for all participants, leading to forks within the blockchain. Putting all existing cryptocurrencies together would not yield the scale needed for global trade payments.
The second major issue has to do with security. Many of the crypto exchanges have been hacked and millions in value stolen. Additionally, attacks on the ledgers have succeeded in corrupting transactions, highlighting the need for more secure transaction mechanisms to be developed.
The last major hurdle is the ease with which the cryptocurrencies can be used and stored. Initial implementations required substantial knowledge of computers and using esoteric command line instructions. Newer browser-based wallets are springing up that allow users to purchase while online, but this functionality has not been combined with mobile payment systems and easy linking to existing banking and payment infrastructure. Vast improvements will need to be made to encourage wide swaths of the public to use the new digital currency systems.
While bank-issued cryptocurrency may address some of the aforementioned problems, it is likely that a dual currency system will need to be in place for about a generation before full acceptance of digital money will occur. Generally, changes in the monetary system need at least a generation for traditions to be changed and people to begin fully adopting their use.
However, I do not expect these factors to slow down the rate of innovation in the space. It appears digital currencies have caught the eyes of the banking and government sectors, which have tremendous assets available to speed development and implementation of digital currency processes and systems. The next generation of ever-expanding, debt based money appears to be here. It is only a matter of time, and perhaps many substantial legal battles, before digital cash becomes mainstream.
The only way to maintain value outside of this system will be to hold gold and silver. While lawmakers and money changers have long wanted to kill the monetary value of precious metals, they remain a viable option for those who still prefer a physical, honest money as envisioned by the framers of the Republic.
The next questions are whether the monetary complex will allow for gold and silver to remain lawfully held by the public, or whether they will open new assaults on them. That battle will likely be determined by how many people understand the value of gold and silver and are willing to fight for their inclusion into the national debate on honest money for the people.