Ask Chuck: Digital currency — benefits and concerns

Dear Chuck,

Digital currency will be all the rage soon. Won’t it just make inflation worse?  

Digital Doubter

Dear Digital Doubter, 

There are a lot of new developments regarding digital currencies. It is inevitable that they will be introduced by central banks and become a normative part of our lives. It is also a development that has far more downsides than simply concerns over inflation.  

Just to be clear, a digital currency is a form of currency that is available only in digital or electronic form and not in physical form. Some refer to it as digital money, electronic money, electronic currency, or cyber cash. Some consider cryptocurrency as a subset of digital currency. That is a debatable point — more about it below.

Big picture of digital currencies 

China seeks to be the first major economy to introduce a centralized digital currency. It is speeding up its central bank digital currency (CBDC) trials in a move to issue a digital renminbi (their main physical currency). The country currently accounts for 44% of global digital payments. Digital renminbi would broaden surveillance by allowing the government to monitor all transactions. 

In April, the United Kingdom announced the creation of a taskforce to explore a CBDC. The Federal Reserve has also been researching central bank digital currencies for some time. The Federal Reserve Bank of Boston is working with MIT on a digital currency. 

The U.S. wants to develop “rails” to move money faster for unemployment benefits and stimulus checks. Treasury Secretary Janet Yellen says new rails would be cheaper and safer. A CBDC would enable central banks to maintain competition and operate the innovations along with cash and other forms of payment, while monitoring every transaction. Beyond concerns for out-of-control inflation, this raises privacy concerns as well. 

Categories of digital currencies:

• Decentralized cryptocurrency (Many experts think of it as a digital asset more than a digital currency).
• Bitcoin, Ethereum, Dogecoin, etc.
• Peer-to-peer network, no central clearing authority, distributed ledger technology (like blockchain) confirms valid tokens and log transactions, can be volatile. 

• Stablecoins.
  • Distributed ledger technology, less volatility because tokens are pegged to the dollar, a basket of currencies or a commodity like gold
  • Example: Diem (Facebook’s Libra)

• Central Bank Digital Currency (CBDCs).
• Tokens that represent a nation’s fiat currency, government assumes liability 
• The ledger (or rails) can differ from a commercial institution

In Mid-July, Jerome Powell, chairman of the Federal Reserve, appeared before the House Committee on Financial Services noting that stablecoins pegged to a traditional currency, like the dollar, need regulation to protect users. He was, however, undecided as to whether the benefits would outweigh the costs. “These [stablecoins] are economic activities that are very similar to bank deposits and money market funds and they need to be regulated in comparable ways.” 

Notably, a government-controlled digital currency would render many stablecoins and cryptocurrencies obsolete. The Fed plans to publish a report on a U.S. digital currency in September. My view is that governments will be forced to attempt to regulate all forms of digital currencies in the future to maintain their desire to exercise global monetary policy. 

The pros and cons: 

Justin Honse wrote an insightful article listing the reasons CBDCs will be viewed positively and reasons why you and I should be concerned. The lists below are directly from his article, The Ugly Side of CBDC. 

Benefits

• A new monetary policy tool for the Fed.
• Greater financial inclusion (see Banking for All Act).
• No account maintenance fees.
• Faster receipt of direct economic stimulus payments.
• Minimal to zero fees for money transfers and payments, possibly even across borders/Int’l.
• Real-time (or near-real-time) money transfers and payments.
• Possibility of being paid interest on our deposit balances in CBDC.
• Access primarily digitally via phone app or website.
• Potentially additional locations where Fed Account can be accessed, such as U.S. Post Offices.
• Streamlining of potential future UBI payments.

Potential downsides 

• Heavily monitored/tracked transactions.
• Loss of anonymity of cash.
• Restrictions/limits on savings.
• Restrictions/limits on what it can and cannot be spent on.
• Negative interest rates.
• Real-time monetary policy effects of inflation.
• Automatic tax collection.
• Automatic collection of government fines, tickets, child support, student loans, etc.
• Commercial bank disintermediation (i.e., banks could go away).
• Expiration dates on the currency (i.e., must be spent within a period of time).
• Eventual elimination of physical cash.
• The ability be to be shut off from the system without the recourse of cash.

In my recent book, Seven Gray Swans: Trends that Threaten Our Financial Future, I wrote about the risks of a cashless society and the “useful conveniences” created by technology that are actually potential losses to our economic, religious and social freedoms. In my opinion, the development and adoption of CBDCs must be carefully watched as a gray swan event — an obvious danger that we tend to ignore.