Bitcoin is a hot topic again as its price has skyrocketed in the last month and is close to reaching its all-time high that was set in 2017. However, Bitcoin is just one piece of a growing trend toward digital currency. In this post, we discuss some of the benefits and challenges of a future without cash.
Earlier this year, I took my sons to one of our favorite local golf courses. This was soon after golf courses had re-opened from the initial Covid shutdown. When we showed up to the clubhouse, I noticed a sign that said check-in was completely contactless and green fees were only accepted by Venmo. About 2 minutes later, I had transferred payment from my phone and walked out to the first tee. Afterwards, I thought about how forward-thinking the golf course management had been. I also thought that many people may have needed some instruction on how to pay their fees.
My golf experience is an example of how the pandemic this year has acutely accelerated the move toward cashless payments. We all have been swiping cards as a replacement for paper money for years, but technology has opened the door for a variety of payment systems. Beyond just payment systems, technology is disrupting the structure of currency and governments will soon have big decisions to make on how to regulate these changes.
Financial or tech company?
The technology sector has been the top performer this year in the market, and financials have somewhat lagged because of their economic sensitive nature. However, many companies that we may think of as financials are actually high performing technology platforms. If you look at the top ten holdings right now in the Fidelity Technology Sector ETF (FTEC), you will find Visa, Mastercard, and Paypal. The top holding is Apple, which has its own payment system and credit card. This is evidence that the delivery of financial services has expanded beyond the big banks and the traditional companies that we are used to. There is a lot of money to be made in financial technology and we expect innovation to continue.
Making payments just keeps getting easier
Online spending spiked this year due to the pandemic and many analysts feel that ecommerce’s increase in market share will not go down as we continue to recover from the pandemic. If we are doing our shopping online, there is a need for fast, secure online payments. Paypal, Square, Apple, and many others have done well at making it easy for us to click and pay. You may have also noticed an “Afterpay” button on some of your shopping carts. Afterpay is one of the recent companies that is capitalizing on a buy now, pay later method. Buy now, pay later is different from using a credit card, in that there is no interest charged on the purchase. It also doesn’t require a credit check to sign up. With better financing terms than credit cards, it has quickly become a popular payment option.
New kinds of currency?
These systems are all facilitating payments, but there has to be currency backing those payments. The majority of our currency is still dollars held in our banks. Digital currencies (also known as cryptocurrencies) are becoming more popular and every once in a while, I get asked if cryptocurrencies will replace the dollar. The answer is: Possibly, but there are a lot of issues that will have to be worked out before that happens.
Cryptocurrency now
There are many types of cryptocurrency and Bitcoin is the largest and most popular right now. A private cryptocurrency like Bitcoin is different from our normal currency in that it is not created or regulated by a central bank or government. This means that the value is determined by supply and demand instead of factors like monetary policy and exchange rates. Cryptocurrency functions much like a barter system. The currency is held in digital wallets and transactions are made between individuals or entities that agree to transfer values between each other.
Proponents of digital currency see the advantage of making transactions without intermediaries like banks or credit cards. They would also tout the anonymous nature of the currency since the transactions do not have to be linked to any personally identifying information. Another key advantage is the ability to transact all over the world at the same value.
However, there are some risks with the current cryptocurrency structure. The adoption of digital currency as a payment system is still in its very early stages. It is not a legal tender, so as a barter system, you have to find someone who will take payment with Bitcoin, for example. Also, the cost of transactions vary greatly depending on the exchange. Digital platforms that deal in cryptocurrency can be hacked or are subject to outages and there are no safeguards in place like FDIC insurance. Further, without regulation, transactions are subject to fraud and theft and transactions are not reversible.
Because digital currency is still in its early development, it currently acts more as a place to hold wealth instead of as a payment system. It has become somewhat like gold or other precious metals in that investors are converting money to take advantage of price appreciation but are not as interested in using their Bitcoin for payments. However, keep in mind that cryptocurrency investments are extremely volatile. They have exhibited large price swings since their inceptions and should only be considered by speculative investors.
A digital dollar?
Digital currencies are beginning to gain popularity. Recently, Paypal announced that they are offering a cryptocurrency wallet, allowing their users to transact with Bitcoin, Ethereum, Litecoin, and Bitcoin Cash. Adoption from mainstream companies like this is the first step toward trying to resolve some of the disadvantages discussed above.
As digital currency gains momentum, it will continue to disrupt our current systems and soon banks and governments will have to consider the threat to their business and structure. Earlier this year, China announced that they are increasing their efforts to introduce their own centralized digital currency. Other countries like Japan, Sweden and Russia are also working on their own national digital currencies. These countries recognize that if private currencies continue to gain popularity, this will make it more difficult to enact monetary policy. However, while a centralized digital currency may make sense in a regime like China, there are several risks when considering how to introduce a digital dollar in an American way.
What’s at stake
The American Dollar is the reserve currency for the world because of the size and dominance of our economy. This puts a lot of pressure on the U.S. to maintain our leadership as the world changes their monetary systems. Essentially, we must be conscious of any progress other countries are making, consider how it affects us, and continue to lead in economic strength.
As I discussed earlier, digital payment systems have advanced at a fast pace, but they still use several intermediaries and take a few days to complete transactions. With national digital currencies, central banks could effectively eliminate the middlemen. Individuals could potentially hold accounts or wallets directly with the Fed making banks unnecessary. This creates some obvious issues. Our large financial institutions are not going to go away without a fight, and it may not be economically feasible for that to happen anyway. The other major risk is the concern over privacy and surveillance. Many people would feel uncomfortable trusting the government to have complete oversight of their financial accounts. The government would also have to address some of the basic risks of cryptocurrency that we discussed above, like hacking and fraud.
With all the risks, there are some important benefits that a digital dollar brings. Digital currency provides data and governments can use more detailed insight on money movements to enact better and faster policies that help economy. For example, the government stimulus this year may been able to aid small businesses faster with more detailed information. Information also allows governments to reduce money-laundering and terrorist efforts.
A lot to consider
There are lot of issues to work out before we all are paying for our groceries with a digital dollar and you don’t have to worry about getting left behind. Since we value our freedoms and privacy, any developments of a digital dollar will no doubt have to include some involvement of the private sector.
It is always important for us to be cautious and take every effort to protect our information and finances when it comes to any online transactions. We also can be grateful and amazed that we live in a time with such innovation and technology that allows us to do things that other generations only imagined.
Disclosure: The companies or securities mentioned in this article are only for reference and this is not a solicitation for any of these securities. This is also not an endorsement of any of these companies and Centered Financial does not receive compensation from any of these companies. Clients of Centered Financial may hold these securities in their accounts.