In Bitcoin We Trust?

by | March 15, 2021

The only thing that might rival the rocket-like advance of the price of Bitcoin is the fast-accelerating number of words written about digital currencies. Sadly, the important differences between the various digital offerings are often not understood, nor are the advantages and disadvantages of using ‘crypto’ fully recognised. Such a lack of clarity is deliberately, or inadvertently, apparent in the many articles from investment banks and institutional investors talking about the ‘digital’ possibilities in client portfolios.  

Before we explore this new currency world in detail, it is worth considering a fundamental question – what is money? 

If we go back to basics, money was ‘invented’ as a generally recognized medium of exchange, either for current transactions or to pay taxes, as well as being a unit of account, a store of value, and a standard of deferred payment. Hence, it should be durable, portable, recognisable, divisible and stable. Over different periods of time, gold, the pound sterling and the US dollar have achieved dominance, while cowrie shells and the Weimar Papiermark have not.

It is certainly the case today that governments generally control the issuance of currency – legal tender to settle those unpleasant debts or to pay those irritating taxes. Of course, in the past money was often issued by private banks. So the first question to ask about any digital currency is: who is issuing it and why?

Bitcoin, Etherium, Dogecoin and similar are privately issued. Indeed, that is their attraction to libertarians, those with criminal tendencies, speculators attracted to price volatility, or investors worried about the prospects of much higher inflation should central banks lose the plot. In a recent article on Jackson Hole Economics, Willem Buiter was quite right to criticise Bitcoin:

“…it has no intrinsic value; it never did and never will. It is a purely speculative asset – a private fiat currency – whose value is whatever the markets say it is. It is also a socially wasteful speculative asset, because it is expensive to produce. Only those with healthy risk appetites and a robust capacity to absorb losses should consider investing in it”. 

To an economist, Bitcoin has few of the characteristics of money. It is not a store of value, nor is it easy or cheap to use in transactions. It is more akin to a volatile commodity, not least because it is electronically ‘mined.’ requiring energy consumption equivalent to a mid-sized economy. 

However, there are two other types of publicly regulated or publicly issued digital currencies, which could prove rather useful to citizens, businesses and governments in coming years, although the potential downsides also need to be recognised. 

The first of these are ‘stablecoins’, privately issued but regulated by the authorities. The prime example is Facebook’s plans for Diem (previously Libra), initially linked to the US dollar or eventually to a basket of major currencies. In theory, Diem could assist global trade and capital flows by sharply reducing transactions costs. However, regulators have been worried about the potential downside for monetary stability, as holders could quickly switch back and forth across national currencies. A further concern is whether the assets really exist to back up such a digital currency. According to a Financial Times report, the New York District Attorney’s office recently took action against Tether, a “stablecoin without stability” with tokens that were “never fully backed at all times” due to window-dressing via temporary cosmetic cash injections. Regulation and public-private partnership will be the keys to future success for stablecoins. 

Digital technologies can also be used by central banks. While many central banks are still at the stage of experimenting or planning a settlement technology, allowing money to be stored and transferred via digital wallets, several versions are already live. The Sand Dollar was launched last October, boosting access to financial services across the 700 islands that make up the Bahamas. The Bank for International Settlements (BIS) has carried out three surveys of central bank digital currencies (CBDCs). A key conclusion was that ‘a growing awareness of the cross-border implications that CBDCs can have for the financial system has spurred international collaboration between central banks to find common ground on policy’. Wholesale or retail versions would in effect mean that both citizens and businesses have an account at the central bank, not just favoured banks and parts of the financial system. 

China is more advanced than many, although it should be noted that its e-renminbi is not based on the distributed ledger technology that Bitcoin uses. China issued packets of digital currencies to selected individuals to test during the recent New Year holiday. China may be using such experiments to try and set global technical standards. 

Alternatively, and more negatively, “The digital renminbi is likely to be a boon for Communist Party surveillance in the economy and for government interference in the lives of Chinese citizens,” argued a recent Centre for a New American Security report. Depending on its final version, Beijing could use CBDC to combat money laundering, corruption and crime by strengthening the already formidable surveillance powers of the Communist party. Such a project would also affect the e-payments platforms dominated by Ant Group and Tencent.

Other central banks have more prosaic reasons for adopting CBDC. The BIS survey noted that in some emerging economies, an advantage of CBDC would be financial inclusion, in terms of payments safety as well as reduced fees and transaction costs versus traditional payments systems. For other countries, digital coins would ensure continued access to central bank money for households and companies at a time when cash usage is declining. A survey in Norway revealed that last autumn less than 4% of spending was made using cash. Another survey estimated that about 5% of American households have neither a savings nor a checking account. Digital coins could offer new avenues for financial inclusion, a subject of more concern to governments following the pandemic. 

Additionally, CBDC could also have a role in enhancing fiscal and monetary policy. For example, economic stimulus funds could be granted with expiration dates to ensure that they are spent quickly rather than saved. CBDC accounts could also make much greater use of negative interest rates, to get around the zero lower bound problem. 

Today, much interest in digital currencies revolves around their appeal as a glittery new technology or a ‘must buy hot commodity’. But their intrinsic worth resides in more mundane uses, such as expanding financial access in more attractive ways. At the end of the day, to quote a recent Federal Reserve paper, “money is a social and legal construct underpinned by trust”. Whether Dogecoin, Diem or Digital Dollars, success in years to come will depend on that key foundation – trust.

Filed Under: Economics . Featured

About the Author

Andrew Milligan is an independent economist and investment consultant. He is a Board member of the Asia Scotland Institute, an adviser to the Health Foundation, to Balmoral Asset Management and to the Educational Institute of Scotland, and a Fellow of the Society of Professional Economists. From 2000-20, Andrew was the chief market strategist for the global fund manager Aberdeen Standard Investments.

After graduating from Bristol University, Andrew started in H.M. Treasury where he specialised in the IMF and World Bank’s handling of the Latin American debt crisis. He then worked in turn for Lloyds Bank, the broker Smith New Court, and New Japan Securities as an international economist. In 1995 he entered the asset management industry, becoming Head of Economic Research and Business Risk for Aviva Investors. In 2000 he moved to Edinburgh to work as the Head of Global Strategy for Standard Life Investments, in charge of a team covering economic and market research, tactical and strategic asset allocation decisions, client advice and communications for retail and institutional clients globally.

After its merger with Aberdeen Asset Management to form Aberdeen Standard Investments, the company became the second largest active fund manager in Europe with over 30 offices across the major financial centres. Andrew is well known as a public speaker while his writing, commentary and interviews have appeared in all the mainstream media.

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