Money in the 21st Century
In its simplest form, “money is identified by what it
does”. Whatever form it takes, a traditional consensus
amongst those who study the functions of money is
that it is must serve as a unit of account, a means of
payment, and a store of value. From the opening
discussion, in order to fulfill these criteria, a successful
form of money must also be universally trusted by
buyers and sellers. In the context of digital currencies,
modern discussions and debates often confuse ‘money’
with ‘systems of payments’ or, the mechanism by which
transactions are processed and settled. In the context of
modern debates and confusion about digital vs. physical
money, it is important to distinguish between types of
money and systems of payments
A. Types of Money
According to modern international standards, “broad
money” is defined as “all liquid financial instruments held
by money-holding sectors that are widely accepted in an
economy as a medium of exchange, plus those that can be
converted into a medium of exchange at short notice at,
or close to, their full nominal value.” 10 (IMF, 2016, p.180)
In a 21st-century context, these would include, fiat currencies issued by central banks, short-term digital credit facilities (swaps, credit cards, paypal, googlepay, payday
loans, WePay, AliPay, M-Pesa, etc.), digital currencies issued by private sector/nonprofits or central banks (Bitcoin,
Libra, etc). From the discussion in Chapters 1 and 2, we
can begin by distinguishing currency types across five
attributes, including: i) who issues and backs the currency,
ii) how acceptable is the currency, iii) are there transaction
costs, iv) how stable is the value over time (inflation/deflation), and, v) is it digital/electronic or physical.
Each type of money has both benefits and drawbacks
in terms of its usefulness. For example, a credit card
(digital) is widely accepted but may come with transaction costs and is backed by a private sector corporation, while cash (physical) may be less widely accepted
but has no transaction costs and is backed by the central
bank. This is why many forms of money coexist. In fact,
it is not uncommon for people to use more than one
form of money in a given day/week, making some payments with cash (a central bank liability) and some
others with transfers or credit cards (which are private
sector forms of money). To get a better understanding
of current usage of types of money, we asked 1,000
respondents across eight countries (Argentina, Brazil,
France, Germany, Mexico, Spain, UK, USA) what types
of money they most commonly use. The results are
shown below.
Use of Money types across Countries
Existing research has focused on the degree of centralization (issuer/backer), accessibility, and digital/physical
nature of money. For example, Berentsen & Schar (2018b) studied the different types of currencies and systems
of payments and their properties. In their research, they argue that Bitcoin specifically, but other decentralized
cryptocurrencies in general, use blockchain technology to present a unique type of currency. Each “coin” (unit
of money) is issued in a competitive setting and has both a virtual representation and a decentralized transaction process. Because of these properties, decentralized cryptocurrencies like Bitcoin can be considered a fundamentally different type of money when compared to the traditional forms we are used to (commodity money,
cash, and others).
In their study of the different types of currencies, Berentsen & Schar (2018b) propose a control structure to visually represent these different types according to three dimensions. Figure 4 presents this control structure and
wherein this visual classification different types of currencies are located.
Control Structure of Currencies
 |
| Source: adapted from Bernstein and Schar, 2018a |
As demonstrated in Chapter 2, it is important here to distinguish between narrow money that is created by
central banks from broad money created by commercial bank deposits and central bank cash. Both of these
centralized institutions make up almost all of the money we currently use and act as clearing houses for almost all
of our money transactions (system of payments). A recent IMF report has argued that these “two most common
forms of money today will face tough competition and could even be surpassed. Cash and bank deposits will
battle with e-money, electronically stored monetary value denominated in, and pegged to, a common unit of
account such as the euro, dollar, or renminbi, or a basket thereof” (Adrian and Mancini-Griffoli, 2019, p.1).
Building on this and the work of other academics/institutions, the IMF has recently provided a further dissection
of money according to its ‘type’ (is it a claim on another entity or an object), ‘value’ (fixed, variable or a unit of
account), ‘backstopped’ (government, private sector), and, degree of centralization (‘technology’). From Figure
5 below, we can see that several types of digital money have already been widely adopted (AliPay, WeChat Pay,
M-Pesa), while others probably do not qualify as money based on our definition of broad money above.
Types of Money in the Digital Era
Thinking about this in the context of cryptocurrencies, these are interesting because they bring a combination
of new and old ideas about money. Firstly, ownership rights are managed in a decentralized network as argued by
Hayek using a distributed ledger (no backstop). Because of this, there is no central authority responsible for
managing currency ownership rights, ensuring price stability, and regulating illicit transactions. Blockchain
technology also has a decentralized accounting system where “miners” are the bookkeepers and no debtor/
creditor relationship (i.e. cryptocurrencies are not a liability on anyone’s balance sheet). This decentralized
management of ownership of digital assets is a fundamental innovation of Nakamoto (2008). More importantly,
the system of payments infrastructure envisioned by Nakamoto (2008) was created with the intention to disrupt
the current financial system, by affecting all business and government agencies that have monopolized the
creation of money in the 20th century. With these new innovations in the early 21st century, some writers have
argued that this will mark the death of cash
B. The End of Cash?
In order to change a system, it helps to have a problem
with the existing one. This is a view shared by many
economists and policymakers who see physical cash
and existing digital money created by the central bank
and commercial banks as doing a pretty good job,
meaning there is no need to take unnecessary risks by
adopting an entirely new, and potentially risky, form
of money. So why has there been such a large push for
the adoption of digital currencies?
Some of the well-known downfalls of physical money
are the need for the buyer and the seller to be physically present at the same location or have a geographical
connection to deliver the cash, which makes its use time
consuming and impracticable for online commerce
Studies have also found
that physical cash is a
public health concern,
finding traces of fecal
matter, cocaine, heroin,
and bacteria (among
others) on dollar bills,
making it a good candidate for spreading disease across large populations, leading experts
to conclude that “if the
question of a cashless
society is approached
purely from a public health standpoint, the answer seems clear” (Maron,
2017). 10 This would be especially important in low-income countries that are more vulnerable to epidemics.
Another drawback of cash relates to tax evasion and
the financial operations of illegal activities, which
have become increasingly salient since the publication of Panama Papers in 2015 and Paradise Papers
in 2017. Money laundering, financing of illegal activities, and tax evasion all pose a pervasive challenge
to society in both developing and developed countries. In his study of how physical cash is related to
the daily financing of these illegal activities, Sands
(2016) suggests an interesting approach in order to
fight these financial crimes. His proposal is to eliminate high denomination notes (he gives as an example
the €500 note, the $100 bill, the CHF1,000 note, and
the £50 note). According to the author, these notes
are preferred in illegal activities, given the anonymity and lack of transaction records in the cash payment
system. Moreover, because they are of high value, it
is easier to transport and execute payments of large
value. By eliminating high denomination notes, it is
argued that we would make life a lot harder for those
perusing tax evasion, financial crime, terrorist finance, and corruption. Without being able to use high
denomination notes, those engaged in illicit activities would face higher costs and a greater risk of detection. The author concludes that the benefits from
the elimination of such high denomination notes far
outperform the drawbacks. Given the availability
and effectiveness of electronic payment alternatives,
these high denomination notes play little role in the functioning of the legitimate
economy, yet a crucial role in the
underground economy
In “The Curse of Cash”, Rogoff
(2017) goes one step further.
White Sands (2016) advocates for
the eradication of high denomination notes, Rogoff (2017) advocates getting rid of cash once and
for all. He extends the argument
of Sands (2016) by linking the increasing amount of money in circulation to the volume of cash bei n g u s e d for t a x e v a sion ,
corruption, terrorism, the drug
trade, human traffic; in summary,
by all sorts of illegal activities.
Nevertheless, he expands the
benefits of eliminating cash to
monetary policy. If policymakers
not only eradicated high denominations, but all notes (except very
small denomination ones and
coins), Rogoff (2017) argues that
this would in fact increase the effectiveness of monetary policy by,
for example, allowing for negative
interest rates. The idea of Sands
(2016) and Rogoff (2017) that
physical cash makes the financing
of illegal activities significantly
easier cannot be ignored. In fact,
Brazil’s Car Wash operation, the
biggest corruption scandal ever
uncovered in history, showed that
companies involved in illegal donations to parties developed very
sophisticated methods to raise
physical cash. They collected cash
from different small businesses,
sometimes even paying a premium in order to hold cash, so that
they could use this cash to perform their illegal activities.
Cash, however, still maintains
some unique advantages in comparison to other existing types of
currencies discussed above. Users
of cash can remain anonymous, in
the case of stable advanced economies it is widely accepted/trusted by sellers, and there is free access to cash payment systems (no
transaction costs). Users of cash
also do not need to open bank accounts or create a digital wallet to
use physical cash. Transactions
are final and people can engage in
trade even if they do not know or
trust each other. The electronic
money that we currently hold in
commercial banks, on the other
hand, involves counterparty risk,
requires the use of a bank account, and often has charges relating to
transactions (for example, transfers to other accounts).
Berentsen and Schar (2018a)
believe that there is a great demand for currencies issued by a
trusted party to save outside
the financial system. To prove
their point, they present the
number of Swiss Francs in circulation as a fraction of GDP
from 1980 to 2017 (see Figure 6
below). We can see that after
the crisis the demand for Swiss
Francs increased significantly.
This shift is explained as a move to
safety - the financial crisis and the
subsequent euro crisis have increased the demand for cash exactly because it is the most liquid asset
for savings outside of the private
financial system. In other words,
cash has been used as insurance
against the insolvency of financial
institutions.
Further evidence of the growing demand for physical cash issued by a
trusted backer was shown by a 2019
IMF Finance and Development article (‘Boom in the Benjamins’) which
attributed a rise in $100 bills to an
increased global demand for the US
dollars as a safe haven, as well as its
ideal anonymous role in illicit transactions in the underground economy.
High denomination notes also offer
higher seignorage returns for the
Federal Reserve, making the $100 bill
the most profitable to print. This
combination of factors leads the authors to conclude that American
dollar bills are not likely to dissipate
any time soon (Weir, 2019).
The extent that fiat money will be
used as an insurance mechanism
depends on the degree of trust that
holders of that money have in its
issuer. In this sense, Switzerland
and the US would be exceptional
cases where a run to safety resulted
in an increase in the demand for
cash in stable economies. Bech et al.
(2018) show that the amount of cash
in circulation has increased or remained stable in a large number of
stable advanced economies (see
Figure 8). Although the value of card
payments has increased significantly,
Sweden is the only country where
the cash in circulation has actually
decreased between 2007 and 2016
What Could Replace Cash?
As noted above, several centralized digital alternatives to physical cash have already become successful systems
of payments. For example, M-Pesa in Kenya (see Jack and Suri, 2014; Kaminska, 2015), AliPay in China, and
PayPal in the US (among many others). Cryptocurrency enthusiasts, central banks, and entrepreneurs are also
continually improving the design of blockchain-based digital currencies to rectify some of the practical defects
in previous designs. For example, Facebooks Libra will be backed by a portfolio of underlying assets and will be
managed to maintain price stability (a ‘stablecoin’) which was a key fault in Bitcoin’s ability to function as a true
currency. While these ‘updated’ cryptocurrencies still have practical drawbacks such as high fees, scaling issues,
and a lack of widespread trust, these problems could be improved upon over time with the emergence of large-scale
off-chain payment networks and transparent management. It is also important to remember that digital currencies are still fiat money which relies on a relationship of trust between the issuer and the user.
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