REPORTS Q (The Economist) Technological change is disrupting finances. Bitcoin has grown from an obsession with anarchists to a $ 1 billion asset class that many fund managers insist belongs in any balanced portfolio. Swarms of digital day traders have become a force on Wall Street.
PayPal has 392 million users, a sign America is catching up with China’s digital payment giants. Yet, as our special report explains, the least noticed disruption on the border between technology and finance may end up being the most revolutionary: the creation of government digital currencies, which typically aim to allow people to deposit funds. directly from a central bank, bypassing lenders.
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These “govcoins” are a new embodiment of money. They promise to make finance work better, but also to transfer power from individuals to the state, change geopolitics and change the way capital is allocated. They should be treated with optimism and humility.
A decade ago, amid the Lehman Brothers wreckage, Paul Volcker, a former Federal Reserve chief, grumbled that the bank’s latest useful innovation was the ATM. Since the crisis, the industry has picked up its game. Banks have modernized their creaky computer systems. Entrepreneurs have built an experimental world of ‘decentralized finance’, of which bitcoin is the most famous part, and which contains a riot of tokens, databases, and conduits that interact to varying degrees with mainstream finance.
Meanwhile, financial “platform” companies now have more than 3 billion customers who use e-wallets and payment applications. Along with PayPal, there are other specialists like Ant Group, Grab, and Mercado Pago, established companies like Visa, and Silicon Valley wannabes like Facebook.
Government or central bank digital currencies are the next step, but they come with a twist, as they would centralize power in the state rather than disseminating it through networks or giving it to private monopolies. The idea behind them is simple. Instead of having an account with a retail bank, you would do so directly with a central bank through an interface resembling apps like Alipay or Venmo. Rather than writing checks or paying online with a card, you can use cheap central bank plumbing. And your money would be guaranteed by the full faith of the state, not by a fallible bank. Want to buy pizza or help out a broke sibling? No need to call the Citigroup call center or pay Mastercard fees anymore: the Bank of England and the Fed are at your service.
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This metamorphosis of central banks from the aristocrats of finance to its workers seems exaggerated, but it is underway. More than 50 monetary authorities, representing the bulk of global GDP, are exploring digital currencies. The Bahamas issued digital currency. China has rolled out its e-yuan pilot project to more than 500,000 people. The EU wants a virtual euro by 2025, Britain has launched a task force, and America, the world’s financial hegemony, is building a hypothetical electronic dollar.
One of the motivations of governments and central banks is the fear of losing control. Today, central banks are exploiting the banking system to amplify monetary policy. If payments, deposits, and loans migrate from banks to private digital realms, central banks will struggle to manage the business cycle and pump funds into the system in times of crisis. Unsupervised private networks could become a Wild West of fraud and privacy abuse.
The other motivation is the promise of a better financial system. Ideally, money provides a reliable store of value, a stable unit of account, and an efficient means of payment. Today’s money gets mixed ratings. Uninsured depositors can suffer if banks go bankrupt, bitcoin is not widely accepted, and credit cards are expensive. Government electronic currencies would score high because they are state guaranteed and use a cheap central payment center.
As a result, govcoins could reduce operating expenses for the global financial sector, which amounts to more than $ 350 per year for every person on Earth. This could make financing accessible to the 1.7 billion people without bank accounts. Government digital currencies could also expand government toolkits by allowing them to make instant payments to citizens and lower interest rates below zero. For ordinary users, the appeal of a free, secure, instant and universal payment method is obvious.
It is this call, however, that creates dangers. Without coercion, govcoins could quickly become a dominant force in finance, especially if network effects prevent people from opting out. They could destabilize banks, because if most people and businesses hid their liquidity in central banks, lenders would have to find other sources of funding to back up their loans.
If retail banks were starved of funding, someone else would have to take out the loan that fuels the creation of businesses. This raises the disturbing prospect of bureaucrats influencing credit allocation. In a crisis, a digital rush of savers to the central bank could lead to bank failures.
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Once ascendant, govcoins could become panopticon for the state to control citizens: think instant e-fines for bad behavior. They could also change geopolitics by providing a channel for cross-border payments and alternatives to the dollar, the world’s reserve currency and a mainstay of US influence. The reign of the greenback is based in part on the openness of US financial markets and property rights, which China cannot compete with. But it also relies on old payment systems, billing conventions and inertia, which makes it ready to be disrupted. Small countries fear that instead of using local money, people will turn to foreign electronic currencies, causing chaos in their homes.
New money, new problems
Such a wide array of opportunities and dangers is daunting. It is telling that the Chinese autocrats, who value control above all else, are limiting the size of the e-yuan and cracking down on private platforms such as Ant. Public companies should also proceed with caution by capping, for example, digital currency accounts.
Governments and financial firms need to prepare for a long-term change in how money works, as big as the jump to metal coins or payment cards. This means strengthening privacy laws, reforming the management of central banks, and preparing retail banks for a more peripheral role. State digital currencies are the next big thing in finance, and they promise to be much bigger than the humble ATM.
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