These two constitute the banking system, but there is a serious problem with this hardware. It was built during the time when a central bank could not reach a customer directly. So the lending, as well as the deposit function, was leased to a bank branch.
In a population of 16 million where 40 percent of all people are unbanked, the Ecuadorian shift is going to take a long time for full implementation, particularly among the older and illiterate. It is like an official version of M-Pesa that succeeded in Kenya and some other parts of Africa. But even after one year, the Ecuadorian system is yet to become a popular choice. Not even 10 percent of the population has adopted it. Ecuador has a turbulent monetary history and it lives now with the U.S. dollar as the national currency.
This attempt at digital cash is aimed only at protecting against a future de-dollarization of its economy, and realizing savings on the printing cost of paper money. It not only kills the monetary autonomy of the individual, it gives a government absolute power in matters of taxation, inflation and interest rates. Any other central bank that tries to repeat this experiment in a politically active and diverse country will have to take into account of all these factors in order to avoid any backlash.
In less than eight years since its emergence, Bitcoin has grown to nearly 10 million user wallets, a daily transaction range of more than 200,000 and a market cap of more than $6 billion and rising.
A world where everybody can send free email or SMS to every other human being on earth would also expect a currency that follows similar ease of transfer. That is where a politically fragmented notion of money faces a serious challenge of evolution.
Even if these issues are resolved, the big challenge is when this digital currency would be issued. Will it wait for universal adoption of smartphones? Will it make free Internet availability a mandatory feature of its state system?
The First Dilemma: Equaling the Reliability of Cash
What happens next is only guesswork, but the historical shift is knocking at the door. We have entered a world where both peer-to-peer communication as well as transfer of value would ensure a better distribution of human output. Whatever network achieves this will gain political acceptability. Who will do it – nations, global technology giants or some invisible agencies – is not yet clear, but something is going to happen.
Photo AgnosticPreachersKid / Wikimedia
This poses a serious statutory risk to the monetary system, too. RBI has tried to bypass this issue by designing a new category of payment-only banks. It has given licenses to 11 new entities, half of which are telecom and payment app players. These banks may sort out the deposit and payment aspect, but the credit aspect remains unsolved.
One experiment now in the works is the Sistema de Dinero Electrónico (electronic money system) of Ecuador that replaced physical cash with digital money as of January 2015. But this is neither a new digital currency nor the digital equivalent of a cash-like bearer asset. All money is with the central database of government. So it is a domain of pull-payment and not push-payment like that of Bitcoin. Privacy concerns related to digital identity have been raised, but the Ecuadorian government has so far ignored them. It has banned the use of Bitcoin and other cryptocurrencies as well.
This is a guest post by Sunil Aggarwal. He runs an online learning solutions company, Theory Frames, and has taught about Bitcoin and blockchain at the National Academy of Legal Studies and Research in Hyderabad, India.
The global monetary system has reached a unique point in its history. The money that defines it is undergoing a serious shift.
This notion of fiat money has dominated the entire 20th century and continued to do so in the first decade of 21st century, until the emergence of Bitcoin. There was no political subjectivity involved in Bitcoin; it was based on the mathematical design of issuing currency as well as settling payment transactions through a continuously updating chain of distributed ledgers called the blockchain.
Will it establish a single payment terminal for all the citizens and bypass the separate bank terminals? Will it allow direct issuance of money through direct download of digital wallets or will it partner with banks? Will it be issued only to taxpayers? Will it be rationed through monthly or weekly issuance?
In India, the result is a sustained phase of stagnation in the economy. Within this binary, a central bank is proving to be only half-effective because it has to carry its bedfellow, commercial banks.
Will it ensure complete convertibility to other cryptocurrencies or will there be controls on that? Will it pursue a proof-of-work model or will it pursue proof-of-stake model or a hybrid of the two? What kind of dilution of monetary sovereignty will it tolerate because of the Triffin dilemma, in which short-term domestic objectives conflict with long-term international plans?
This model works with a central bank-commercial bank binary system. The central bank issues money, but a commercial bank extends it to the population through its branches and ATM network.
Even a small country such as Sweden that has nearly replaced cash with a digital payment system doesn't expect to do away with cash completely before 2025. Eliminating higher denomination currency notes has proved to be a very difficult task for central banks. The currency printing and distribution cost alone for RBI has been the equivalent of more than $5 billion for the years 2014-15.
But to go from a cash-based issuance system to a global seamless payment system requires a big political jump. It would require nations to raise their “interaction capacity” to the equivalent level of the permissionless regime of Bitcoin and many other cryptocurrencies. That is what is confusing central banks and presenting them with three big dilemmas, the answers to which will determine their futures.
The Third Dilemma: When to Issue
All central banks have issued a large amount of cash to their populations. For example, Reserve Bank of India has created a monetary base of more than 15 trillion rupees to date. This cash component makes up nearly 12 percent of the total money supply at present.
But this branch-driven system has aggregated a lot of hubris. It stretches the system through survival pangs as well as debt overhang. In the last four monetary policy steps, RBI has decreased the bank repo rate by 125 basis points, but the banks have transferred only 60 basis points to the end-user who needs funds.
The second fundamental issue is the existing structure of deposit and credit systems.
In a country with more than 1.2 billion people, this is a huge challenge. It would require that country to have a highly authentic register of citizens’ digital identities. And not just that – the issues of privacy need to be sorted out before people can be convinced to shift to a digital payment infrastructure.
If you add bank branches’ management costs, the overall inefficiency of the system brings with it a huge burden of maintaining the legacy structure of cash. The desire to go cashless has good intentions, but having citizens accept it as easily as they have accepted Facebook is a dream that may not become reality for most countries.
Some currencies are acceptable abroad, too. In such a case, the problem is how to recover this huge amount of cash and to replace it with a digital vault of cash. It would mean the creation of an equally reliable digital infrastructure of currency issuance and payment infrastructure. It would require that not only every citizen have a smartphone or a mobile digital device, but that he or she should also be in a position of using it with efficiency.
Bitcoin successfully solves the issue of double-spend that is a typical problem of digital money. It was quickly accepted by people because it was money, a payment rail and a messaging system all-in-one. It ensured both privacy as well as the security of a unique digital signature to every user without depending upon any intermediary.
Not only is this market cap of new currencies rising, but their daily transaction graph is increasing. It is expected that by 2020, there will be more than a billion cryptocurrency transactions per day as smartphone sales show a volume of 4 million units per day.
The Chinese central bank governor has announced plans to issue that bank's own digital currency, but no time frame and monetary design have been announced. Will it be a permissionless currency focusing on the privacy of the users, or will it be permissioned currency centered on the social order and security of the people?
People trust this cash because this is the best notion of a bearer asset they have at present. Currencies working within borders are fungible as well as anonymous, and they are backed by statutory guarantee.
All these questions are not only important for China, but are critical for every central bank. This is a step that would require a historical jump on the part of political elites. It is easier said than done. The realm of math-driven currencies is a totally new ballgame, and political design may not work well within the straightjacket of such a new paradigm.
The situation is even worse than that. Continuing with the example of India, public sector banks have a huge overload of non-performing as well as stressed assets. The market value of these banks is much less than their liabilities. The problem is aggravated by the rise in the number of willful defaulters.
The Second Dilemma: Non-workable Structures
At one time, there were nearly 200 national currencies, with the current figure just above 180. For a national currency to become global money, it has to undergo conversion to other currencies at the prevailing exchange rate. And outside its national borders, it is subject to the laws of supply and demand. A Bangladeshi taka would rarely be demanded on the global market as compared to the U.S. dollar. So for the global population, labor output is not measured in reference to any actual universal money, but by the power centers of different political regimes.
It's not just Bitcoin; this math-driven logic of currency has been improved by many others, and there are now more than 600 Bitcoin-like currencies. Four of these have market caps of $100 million, 10 have market caps of over $10 million, more than 50 have over $1 million and more than 150 have over $100,000.
A common bank does not interact with a central bank at all. A bank branch is the only connecting link between a customer and a central bank. A central bank is like the operating system, and a branch-led commercial bank network is the hardware.
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