Currencies will be digital; Crypto-currencies will not survive

Currency Will Become Digital; Crypto-Currencies Will Not Survive

Burst of Private Crypto-currencies Globally

Bitcoin, the most celebrated private crypto-currency is valued at over Rs. 5 lakh rupees per coin in India presently. Use of Bitcoins in India for payment in India is not permitted by the Reserve Bank of India (RBI), the Central Bank in India. Use of Indian payment system in trading or dealing in the crypto-currencies is also not permitted by the RBI. Consequently, bitcoins cannot be officially bought and sold in the country. Nobody knows how many crypto-currencies exist in the World. Some publications suggest that a little less than three thousand crypto-currencies are traded in some manner with their market capitalization exceeding $200 billion. None of these crypto-currencies are allowed to be used for payments in India like bitcoins.

All operating crypto-currencies in the world have been created by private entrepreneurs/ speculators using the block-chain technology in decentralised, non-permissioned mode. There is no pre-assigned value/ denomination of these private crypto-currencies. Their price fluctuates depending upon demand and supply situation. Most crypt-currencies have larger supply than demand. Their prices are accordingly quite low. Some have no buyers and therefore fall off the system quickly. Only some like bitcoins have controlled supply and therefore still command price, albeit demand is more borne out of expectations of speculative gains. There has been some use of crypto-currencies in payments, including international transfers, but it is not gaining any traction as there is no fixed/stable value, which is the most essential condition for any currency to be a currency.

There is hardly any official crypto currency thus far though a few countries have initiated steps to launch digital currency, which might not even be using block-chain technology or using it in permissioned mode. In the permissioned mode, there is some entity like a Central Bank which literally controls the system and the participants need ‘permissions’ for carrying out certain transactions.  Libra, envisioned by the Facebook, is also, in design, a permissioned crypto-currency.

Only a few of the private crypto-entrepreneurs are motivated by any noble cause like reducing cost of payments, especially international payments, transfers and remittances. Presently existing modes of international payments, transfers and remittances involving conversion in different sovereign currencies and use of international banking and non-banking channels are indeed quite costly.

Almost all private crypto-entrepreneurs are, however, motivated by the desire to make personal fortune by creating an “asset class”, which spirals into higher valuations, in some cases, based on speculative demand. Incidentally, as there is no standard price of any crypto-currency, all these ‘gains’ are relative to their conversion price of an official currency. There have been wide gyrations in the “value” of even the bitcoin. In the last two years, one bitcoin’s value has vacillated between Rs. 2.5 lakh rupees to Rs. 12.5 lakh rupees. Others have varied 10 times or 20 times during this period. Some have simply disappeared. Many who invested have lost their real money. Those who are still invested are most likely to meet the same fate in times to come. Private crypto-currencies are unlikely to survive.

What is Currency and Money?

Currency has a standard or commonly accepted value, divided in a number of nominal units, and is used to express nominal and relative value or price of all economic goods and services paid for or exchanged in the jurisdiction where such a currency circulates.

Most prevalent form of currency today in the world is “paper currency or bank notes”, issued or allowed by the Central Banks of the countries. The Central Banks also have responsibility of maintaining the value of currency, which they discharge by controlling inflation.

Money is expanded form of currency, as some currency gets into the system without being issued in the physical note form. It is the “money” supply, which actually does the function of making payments and transfers. “Reserve Money”, the money issued by the Central Banks, primarily comprising currency notes issued and money created against deposits and other liabilities with the Central Banks, which forms the monetary base. How a Central Bank manage the monetary base has enormous effect on the “value” of the currency of that country.

There are many other forms of “deposits” with Banks which also acquire the character of money depending upon their “liquidness”. There are different moneys based on inclusion of “deposits” in terms of their liquidity. These are classified into different kinds of “money” like M1, M2 M3 and now M4. M3 is generally accepted as the broadest definition of money. In India, this is made up of currency with the public plus demand deposits (current and savings bank deposits) plus deposits with the RBI plus post office savings bank deposits plus the time deposits with the Banks. Essentially, it is paper currency issued plus all the deposits with the Banking system, RBI and the saving deposits of the Post Offices.

There is a certain relationship, albeit varying from time to time, between aggregate value of goods and services produced in an economy or its Gross Domestic Product (GDP) and the aggregate money issued and existing in an economy. This ratio- GDP divided by Money- expresses the velocity of money in an economy.

In the beginning of December 2019, paper currency with the public in India was Rs. 21.85 lakh crore. Reserve Money was Rs. 28.86 lakh crore. M1 was Rs. 36.85 lakh crore. M3, the broad money, was Rs. 161.65 lakh crore. India’s GDP is expected to be about 200 lakh crore in the year 2019-20.

Currency issued in India, like all other countries in the World, is paper currency. RBI prints and gets printed currency notes of different denominations- currently Rs. 1, Rs. 10, Rs. 20, Rs. 50, Rs. 100, Rs. 200, Rs. 500 and Rs. 2000. RBI releases the currency to public through Banks while buying other assets like Government Bonds and Foreign Currency assets.

Evolution of Currencies

The world has seen many “things of value” performing the task of currency or money. Prior to universalisation of paper currency, silver and gold have performed this role for many decades/ centuries. In the case of these things of value, the value of other goods and services was expressed in relative terms to their own values- so many meters of silk equals one gram of gold and the like.

The paper currency has no intrinsic value as the paper on which the currency is printed is hardly of any value. Therefore, aggregate value of money, inclusive of paper currency notes, has to be maintained relative to the goods and services produced in the economy. When more paper currency is issued or broader money is created relative to the growth of GDP, the result is inflation, which is nothing but the depreciation in the value of currency. Unlike gold or silver which derived their fixed value on account of limited supply, which then acted as the standard of value (this belief also got disturbed in times of new discovery of gold etc.), value of paper currency has to be maintained by the Central Banks by regulating issuance of currency and creation of money.

Deposits with Banks, including the demand deposits (deposits in current and savings account, which have acquired the character of demand deposits), have grown faster as the base Reserve Money expands and the savings of the people expand. Increasing development of digital technologies allow very efficient use of deposits in making transfers and payments. As deposits become larger and payments become digital, relative growth of paper currency slows down.

Currency in India has fully normalized in 2018-19, after grossly depleted notes of currency after demonetization in 2016, were remonetized in next two years. This year in 2019-20 so far, currency with public has grown by only about 5% in eight months.

It is possible to visualize, as digital payments become more and more common (In India, still less than 15% of payment transactions are carried out digitally, where in China it is more than 85%), growth of currency will further decelerate, first in relation to growth of paper currency relative to growth of GDP and then even in absolute numbers.

Lot of currency functions today are carried out digitally. Whenever one makes payment or transfer using UPI (United Payment Interface) or other modes of digital payments like Debit Card, RTGS, IIMPS, NEFT etc., no use of paper currency is involved.

Currency is fast becoming virtual.

Problems with Private Crypto-Currencies

Crypto currencies, built on block-chain technology, as in case of Bitcoin, is a different form/method of issuing or creating “currency or money”. Block-chain technology is a decentralised technology, which allows, every holder of a piece of crypto-currency to be part of a decentralised ledger. Transactions in crypto currencies are “mined” or located by the “miners” or the computer programmers, who get paid for in the same crypto currency.

Paper currency is issued by the Central Bank of a country and in this sense it is a centralized currency with any individual owning or being part of the currency only to the extent of currency notes or broader money actually owned by her. Currency technology has evolved over time since time immemorial. Gold and Silver, the valuable metals ruled as currency bases for long. Paper currency, which replaced the metal currency, has been around for quite some time. Increasingly, the currency is becoming digital now with more and more payments and transfers being made digital.

Crypto- currencies, based on decentralised block chain technology, can be understood as another potential evolution in issuance of currency and creation of money. In such a case, no paper currency, as we know today, need to be issued or only required number of small denomination notes can be issued in paper form for small transactions, with the bulk of money/currency being issued and managed using block chain technology. Such a currency, the crypto-currency, would have a decentralised ledger, with all participants owning a part of the crypto currency stock, keeping the entire decentralised ledger and then transacting- making and receiving payments- using this decentralised ledger.

Currency and monetary system are very large. Maintaining the value of currency and money is complex. Block-chain technology is designed to keep decentralised record, but it has no algorithms or programme which can manage, maintain or move the value of currency with the real economy and stable conversion with the real/official currencies.

Inherent technological deficiencies can possibly improve in future, though it is not known at this stage. What, however, has gone crazy is that the currency issuance function has been taken over by the private entrepreneurs and that too mostly in secretive, manipulative and cryptic manner. 

There are three basic problems with the private crypto-currencies:

1. Is it currency or a commodity? A currency primarily serves the purpose of making payments for goods and services. A commodity is the good which has value for the consumer. Some commodities like gold and silver have also served the purpose of currency. That required stable value of such a commodity. Value of gold and silver also fluctuated some-times and the size of economy grew much faster than the growth of gold and silver leading to abandonment of these valuable metals also as currency. A crypto-currency is not a commodity with any intrinsic or commonly acceptable value. For some, it might have value like crazy work of art. Moreover, as crypto-currencies can be created in almost unlimited quantities, these, by economic logic, have no value as the supply far outstrips demand. Given the nature of private crypto-currencies, there are no attributes of currency. Even as commodities, these seem to be regressing towards being of no value.

2. How do you maintain the value of a freely supply crypto-currency? The most basic feature of a currency that it serves as a standard unit of value to enable payments to be made for goods and services in the economy. This standard unit of value cannot be set or discovered in isolation of the production and exchange of goods and services in the economy. The Central Banks, using their monetary policy tools and instruments, maintain the value of currency or money.

The crypto-currency private entrepreneurs do not have any ability to maintain the value of currency. In fact, they mostly destroy the value by expanding supply, which can be limitless. That is the reason these crypto-currencies, barring a few, have not survived as payment medium, including for making international remittances and payments, the purpose for which these were arguably designed. This is what is reflected in demise of many crypto-currencies or almost total loss thereof.

The social media giant, Facebook, is attempting to come up with a decentralised block-chain based currency, in permissioned mode, called Libra to enable easier payments. Libra is not intended to create quick fortune for Facebook as other crypto-currency entrepreneurs have tried to do.  Libra’s design is based on its standard value being set in relation to a basket of currencies. It is more like an attempt to use the concept of Special Drawing Rights or SDRs created by IMF.

Facebook can succeed in socialising the concept of SDRs for making payments, but in such a case, no new crypto currency will be created. It will be a digital currency based on the value of underlying basket of official currencies.

The integrated world of today needed a common language. English is increasingly serving that purpose. The integrated financial world of today also needs a common currency. US dollar is serving that purpose. English language is not owned or controlled by the British, the US dollar is by the United States of America. The world needs a global currency which no particular nation controls. Libra is possibly trying to meet this need.

Facebook, however, would find it difficult to implement the thought behind Libra.

First, the Facebook would have to create enough of Libra by buying and retaining all the underlying currencies in the ratio of value as Libra fixes to determine the nominal/standard value of Libra. It will cost a lot. Any attempt to keep only a fraction of underlying aggregate value would be fraught with lot of risk for Facebook.

Second, as none of the payment receivers and makers actually will have Libra as its own currency, the users would do conversion of Libra in their own currencies. Even for those whose currency is used as a part of the pool, would find its value differently moving as the movement relative to their own currencies can be quite different. Building the confidence in the value of Libra would be quite a tough task for the Facebook.

Finally, Libra would not make any money for Facebook which will be managing this system, as either it will not charge anything for making the payments (as it does for messages) or, if it charges, it might not be large enough to cover the costs as the incentive of people to use Libra would disappear relative to making payment in their own currencies using normal banking channels, if charges are quite high.

3. Can a currency be issued by a private entity? Value denominated on a currency note is many times more than the intrinsic value of underlying paper. If any private person or entity is to issue such a paper currency, can it work at currency?

Let us see it in the context of paper currency first. If any person can issue a paper currency, why would everyone not print currency? If such a thing happens, it would only lead to chaos. There would be no demand for such worthless paper currency. Therefore, such a paper currency, even if permitted, would not come into being.

The same logic applies to private crypto-currency. It costs nothing to issue a crypto-currency, except burning units of power, akin to the cost of running a printing press. Therefore, in the situation of full information symmetry and everyone being able to issue crypto-currency, no such crypto-currency will have any buyer or user. As there is considerable information asymmetry and it is believed by many to be a big technological innovation known to only a few, for a short period of time, crypto-currencies may have some fans. When others catch up technology, as many are already doing, the crypto-currencies would become a totally useless and valueless commodity. It will lose value very fast. Recall the hullaballoo over dot.com mania earlier and its eventual disappearance.

For the reasons stated above, I am convinced that private crypto-currencies would have a very short future. However, some people will make profits and lot of gullible people would lose. It is generally the small persons who suffer. If today’s valuation is anywhere close to $200 billion, the crypto-currency magic must have made some billionaires, obviously at the cost of lot of people who have purchased these essentially worthless codes.

Money is fast becoming digital

With economy fast becoming digital, currency and money cannot remain physical. Paper currency will increasingly become insignificant.

It costs to print paper currency and manage the system of paper currencies. As it is easier to fake paper currency, the Central Banks have to constantly upgrade the security features embedded in currency notes. Thieves take some time to catch up, but they do. If any enemy country is interested in sabotaging, such attempts become much more serious. Building upgraded security features require new paper notes to be printed. It costs. Paper notes have limited life. Replacing the paper notes with plastic material or other material is costlier. Physical movement of paper currency notes also costs money. It costs also to store notes, stuff the same in ATMs or deliver it on the counter of banks. Digital transactions relatively have almost no cost. Yes, the digital systems can be hacked. The Central Banks have to build appropriate security systems. Relatively, still the digital money management is lot cheaper than the cost of managing the paper currency system.

Despite the costs, the Central Banks/Governments make lot of profit in paper currency business. Cost of printing and managing paper currency system is a fraction of total value of currency notes issued. Some Governments/ Central Banks treat the difference between nominal value of currency and the cost thereof as profits. Most treat the difference between the returns on financial assets purchased from the currency issued less the cost of printing the currency notes as profits. In India, it is the latter. Tension and tussle between the Government and the RBI over the surplus is actually the sharing of this profit.

The Central Banks create ‘digital money’. M3, which is generally the broadest measure of money supply, is several times the paper currency held by public. The difference between the broad money and currency is largely the deposits of various types held in banks. Deposits in the banks are increasingly used to make payment digitally.

Digital payments are expanding fast.

While being cautious in liberalizing payment systems, India has been quite a good innovator in several aspects of payment system. The Unified Payment Interface or UPI is one such innovation. By bringing all the bank account balances digitally together under one digital system, National Payments Council of India (NPCI) allows every account holder to make or receive payments using their bank accounts. The system is quite simple and well designed. UPI payments have crossed 100 crores transactions a month. In November, 122 crore payments were made using UPI, transacting payment of Rs. 1.89 lakh crore in the process. It is growing quite fast.

Digital transactions, including UPI and other methods, are also growing quite fast having crossed 2100 crore transactions in first 8 months of 2019-20.

UPI led digital payment system in India cost almost nothing compared with the system of paper currency-based transactions. The ease of payments and almost no cost of transactions has been enabled by integrating all the bank account balances in one digital system.

International transfers and payments cost much more. A World Bank study estimated this cost in 2017 to be of the order of about $30 billion or about Rs. 2.1 lakh crore. Indian diaspora ends up paying about 2.5% or more for small ticket transactions. Immigrant workers of some countries lose 15-20% of their earnings in transfer of funds to their homelands.

All this happens because there is no integration of bank accounts and its balances internationally. In fact, most developing countries and even many advanced countries, have not been able to do so even domestically.

One possible way is to take the concept and technology of UPI to all over the World. Beginning can be made from countries in Middle-East. Once this integration takes place, all that is required to do is to fix a reference exchange rate, which the Central Banks can do. This will almost eliminate the cost of international transfers and payments as well.

This will make currency and money digital domestically as well as internationally. You don’t need crypto-currencies to do that.

Final switch over to digital money

It is possible to conceputalise the final make-over from the paper currency system.

In the securities system, dematerialised record keeping of securities has replaced the physical system of securities. No longer are share or bond certificates are issued or held by the holders in physical form. A depository keeps all the shares and bonds in its ledger. Holders only have a statement noting their beneficial ownership of the number of shares and bonds of different companies and governments they hold. But, they buy, sale and transfer these securities with total ease and at much less cost compared to what used to be the system when these required physical transfers.

In India, stamps required to be affixed on the registration documents are also now being issued increasingly in dematerialised form. It allows much easier use and the Governments also collect their revenues more efficiently. Recently, the Government of India and the State Governments have agreed to collect stamp duty on securities in a seamless manner digitally using a centralised collection system.

It is possible to dematerialise currency notes also.  The Central Bank can issue currency in dematerialised form. The Central Banks issue currency when they buy bonds or foreign currencies or other instruments from the Banks. The Central Banks can do by paying in dematerialised digital currency. Holders can hold dematerialised currency in a digital currency card or virtually. Only small notes which are required for very small denomination transactions can be issued physically for some time till everyone gets ready to move fully to digital.

The Central Banks would benefit more as they would continue to get the seigniorage as they are getting presently. In fact, this would be somewhat higher as the cost of printing physical notes would be saved.

People would be real beneficiary as making payments would be much easier, faster and less costly.

It is time to make a move towards full digital currency or money.

To summarise,

The crypto-currencies, only a few motivated by noble intention to make international payments and transfers fast and costless, with most being contraception to make quick money for some at the cost of millions, are completely unnecessary to make the world of currency and money digital.

Decentralised ledger technology is a very good innovation which may find valuable use in several fields, including for organizing and delivering financial services. Use of this technology, appears to be wasteful in currency issuance and management even when issued officially. Use of this innovative technology does not justify its use by private persons to create crypto-currencies.

There is fast movement towards digitalization of currency and money. It is going to get faster and deeper. It can be visualized that in 2020s the paper currencies would decline massively all over the World and in many countries, its prevalence would become quite insignificant.

Greater collaboration in integrating bank accounts and balances globally using the concept and technologies like UPI will make international payments and transfers costless and instant.

Finally, it is possible to conceptualise dematerialization of currency and money and make the final move to say good-bye to paper money and move over to digital money.

SUBHASH CHANDRA GARG

Subhgarg10t.e2030@gmail.com

NEW DELHI 03/01/2020