The future money is definitely digital
As cryptocurrency takes financial world by storm, could banks become obsolete?
Since 1971, when President Richard Nixon abandoned the gold standard, money has had no intrinsic value – beyond the paper it is printed on.
It only has value because virtually everyone believes it does. It has almost become just a psychological construct.
Today, most of what we think of as “money” is just entries on an electronic ledger. It is a trend that has been gathering speed over the past couple of decades.
It has never been more pronounced than with the relatively recent arrival of cryptocurrencies like Bitcoin and, now, its many imitators.
Crypto is 100 percent virtual. It does not exist in physical form at all. It is like millions of continuously changing spreadsheets of who has paid what to whom.
If current trends hold, within the lifetime of most people alive today bank notes and the banks that use them may very well become obsolete – just like the dinosaurs.
An good starting point for learning about digital currency is at Investopedia’s Digital Currency web site.
“Digital currency is a form of currency that is available only in digital or electronic form. It is also called digital money, electronic money, electronic currency, or cybercash,” it says.
Because digital currencies exist only in electronic form, they are only accessible with computers or mobile phones.
Typical digital currencies do not require intermediaries (banks) and are often the cheapest method for paying bills and being paid.
An important distinction to note is that “all cryptocurrencies are digital currencies, but not all digital currencies are cryptocurrencies.”
Cryptocurrencies are digital tokens that use cryptography to secure and verify transactions in a network. Cryptography is also used to manage and control the creation of such currencies.
Cryptocurrency is simply a unit of exchange recorded on a decentralized though massive ledger: there are many copies of the ledger and anyone who is part of the ledger has one – the same one!
Additionally, encryption techniques are used to regulate the generation of units of currency and verify the transfer of funds. The best known cryptocurrency is Bitcoin.
There are an estimated million Bitcoin “miners” around the world all trying to “create” the currency – and Bitcoin (first issued in 2009) is just one version of it; there already are at least dozen or more others, and they are multiplying rapidly.
For many who use it, digital currency is simpler – especially for people who don't have access to regular banks or don’t want to deal with them.
One can make international payments almost instantly with no spending limits and no concern about exchange rates or interest rates or bank charges.
So cryptocurrencies have their advantages but they also have some serious downsides.
“Mooning” is one term used by crypto traders: it is derived from “going to the moon,” as in, when the value of the currency is rocketing upwards. A more familiar – and precise – term is “volatility,” because crypto can also drop like a stone.
Charting the value of one Bitcoin illustrates this clearly.
It started 2021 worth about $29,000, then more than doubled to $63,000 in April – just four months. Three months later, it had dropped to $30,000 (less than half) in July. It reached its highpoint of the year so far at $68,000 in November (more than double in just four months).
You need a really strong stomach to tolerate such wild swings.
Just over the past weekend, the value of Bitcoin fell by more than 20 percent on Saturday Dec. 4 amid general instability in world financial markets. On the same day, it bounced back, ending down only 11 percent. On Tuesday, it was quoted at about $50,000. What a roller-coaster ride!
If you are forced to cash out in an emergency at the wrong moment for any reason, you would lose a bundle.
So, if you can deal with the wild price swings, you will need similar fortitude to feel your stash is secure.
Hacking into a bank account is relatively rare but it does happen – and has happened. In 2016, North Korean hackers got away with about $81 million from the central bank of Bangladesh before their heist was discovered and stopped.
Even cryptocurrency, protected by strong encryption, is not totally secure. Whereas bank deposits in the US are insured by the Federal Deposit Insurance Corp., there is no such backstop for cryptocurrencies.
The classic case of a “run” on a crypto exchange – the collapse Mt. Gox – has now become a legend in crypto folklore.
Users were in the dark in February 2014 when the Mt. Gox cryptocurrency exchange suddenly stopped all activity. Then its website went offline. Then, its Twitter feed disappeared. Something very big and not good was going on.
This scenario played out when the Japan-based Mt. Gox was hacked, with devastating results.
Mt. Gox was one of the biggest players in cryptocurrency and at its peak in 2013, handled almost three-quarters of all Bitcoin transactions worldwide.
In the breach, hackers accessed and stole 740,000 bitcoin from Mt. Gox customers and 100,000 from the company itself, roughly the equivalent of $460 million at the time.
The company could not survive such a loss and was bankrupt by the end of the month.
Just a few days ago, on Dec. 5 the crypto trading platform Bitmart confirmed in a statement that a major hacking had occurred and said $150 million was withdrawn from customer accounts.
“We are now conducting a thorough security review … At this moment we are temporarily suspending withdrawals until further notice,” the statement said.
Ouch! Sounds a bit like 1929 again!
Apart from the security concerns highlighted by the hackings, novel digital currencies also raise the question of the need for some government regulation. Central governments’ monopoly on paper money is a concept that is only a bit more than 100 years old.
After a series of financial panics and bank collapses tanked the US economy in the 1890s, the Federal Reserve System was created in 1913. Its mandate has been to maintain the stability of the financial system by regulating the supply and cost of money.
It is the only entity in the US authorized to issue currency, thereby controlling the supply of money. Its Federal Open Markets Committee (FOMC) sets interest rates which is how they control the cost of money.
Since the emergence of cryptocurrency – which the government as yet does not regulate like it does banks – officials have been struggling with how to approach it.
According to an Oct. 13 article Where the Fed Stands on Crypto and Digital Currencies the central bank of the US, the Federal Reserve System, has been exploring policy responses to the rise of cryptocurrencies and digital currencies.
In his press conference after the FOMC meeting on Sept. 22, 2021, Federal Reserve Chair Jerome Powell acknowledged that the Fed is actively assessing whether it should create a central bank digital currency, and a research paper soliciting public comment reportedly will be released soon.
While the Office of the Comptroller of the Currency is the banks’ regulator, the only entity authorized to to issue a crypto “dollar” is the Federal Reserve. It is studying the issue, and when it makes a decision, it is sure to be a huge development.
Big banks – which are regulated by the OCC – are chafing to get involved in digital cash. And therefore the OCC is rushing to draft rules for how they can do so.
It’s most recent iteration of the rules – one of a series of similar documents – came on November 23 in OCC Clarifies Bank Authority to Engage in Certain Cryptocurrency Activities where it announces publication of a policy confirming that “national banks and federal savings associations must demonstrate that they have adequate controls in place before they can engage in certain cryptocurrency, distributed ledger, and stablecoin activities.”
However, you have to be a real technocrat to consider this a “clarification.”
According to the announcement, “Today’s letter reaffirms the primacy of safety and soundness. Providing this clarity will help ensure that these cryptocurrency, distributed ledger, and stablecoin activities will be conducted by national banks and federal savings associations in a safe and sound manner,” said Acting Comptroller Michael J. Hsu.
Beneath all this bureaucratic gobbledygook the OCC is trying to reassure the banks – and the public – that they will have to get approval for their cryptocurrency activities to ensure they “are being conducted responsibly.”
This is clearly a step down the road towards government regulation. Undoubtedly, more is on the way.
The United States government is not the only one exploring the introduction of a digital currency. In fact, it may be coming late to the game.
In early September, El Salvador became the first country in the world to adopt Bitcoin as legal tender. Its congress approved President Nayib Bukele’s proposal to embrace the cryptocurrency in an effort to promote “financial inclusion,” investment and economic development.
“In El Salvador, we are trying to start the design of a country for the future. I believe Bitcoin could be one of these ideas,” Bukele said at the time.
Adopting Bitcoin means businesses now have to accept the cryptocurrency along with El Salvador's other currency, the U.S. dollar. President Bukele hopes Bitcoin will let Salvadorans avoid cash transfer fees when sending money home from abroad. Remittances make up about 20 percent of El Salvador's GDP. Seventy percent of Salvadorans don't have bank accounts. Bukele believes Bitcoin will give them more access to the financial system.
The president may indeed be correct, but El Salvadorans must have had a stomach-churning Saturday this past weekend when the value of Bitcoin dropped 20 percent before rebounding to finish down 11 percent. What a wild, one-day swing!
Despite their obvious drawbacks, digital currencies undoubtedly will play an increasingly significant role in modern finance. But the current environment seems more like a gold-rush than a prudent investment for the uninitiated.
Cryptocurrencies pose not insignificant risks both to those who use them and those who still prefer the touch and feel of paper bank notes or plastic cards.
The old adage certainly seems appropriate: Buyers beware!
How does a cryptocurrency start? Who decides? Who owns the original offering?
Seems as if it’s more akin to stocks, in that it only represents something that can be bought and sold and its price is volatile, although one is supposedly buying a piece of a company.
I can see how credit cards are becoming more prevalent than checks, but not sure about ccs.
The idea that people without bank accounts would have access to ccs seems silly. People who don’t have checking accounts often don’t have computers either.
As you can see I don’t understand much.
Warren, thank you for this excellent article on bitcoin and all its dynamic manifestations. As a retiree, I personally wouldn't touch bitcoin--it's far too volatile. That a country like El Salvador would jump into the deep end of the pool shocks me. China largely survived the 2008-09 crisis by not participating in the banker's' blood-letting associated with sub-prime mortgages. That proved to be very good sense. Now China is avoiding bitcoin at least partly to avoid risk, but also because its capitalism is thriving without financial gadgets.
I do have to laugh these days whenever I charge something with my trusty credit card. I often have to ask the clerk how to use the machine in front of me. Half the time, the clerk has a problem and mumbles an apology that it's a new machine etc. Just yesterday, one clerk had to help the first clerk with the correct usage of their new machine. I will say that I no longer write checks in the supermarket as I get stares from all the impatient folks in line behind me....
Many thanks Warren for your excellent work. RM