Money is one of humanity's most remarkable inventions. It enables the exchange of goods and services between distant locations and between individuals who may not know or trust each other. Over time, it also facilitates the transfer of wealth and resources. Without money, trade, commerce, and all economic activities would be severely constrained by time and space limitations.
The issuance of currency has long been equated with economic power. It’s no surprise that history is filled with examples of domestic and international currency competition. China was the first to introduce paper money, with merchant houses and local governments issuing their own notes and competing for centuries. State-issued and privately-issued currencies coexisted well into the first half of the 20th century.
The rise of central banks as the sole issuers of legal tender and stable currency eventually ended this competition. This transition occurred early in Sweden with the establishment of the world’s oldest central bank, the Riksbank, in the 17th century. Since then, currency competition has largely been between nations, with the relative value of currencies depending on the credibility and stability of their issuers.
Today, money is on the brink of another monumental shift. The gradual decline of cash and the rise of digital currencies could fundamentally alter the nature and role of money. While central bank money currently serves as a unit of account, medium of exchange, and store of value, the growing adoption of various private digital currencies—including some cryptocurrencies—could fragment these functions. This shift may weaken the dominance of central bank money and spark a new wave of currency competition, profoundly affecting many countries, especially those with smaller economies.
A Brief History of Currency
Ancient civilizations used items like shells, beads, and stones as money. The first paper money appeared in 7th-century China as deposit certificates issued by reputable merchant houses, backed by commodities or precious metals. In the 13th century, Kublai Khan introduced the first unbacked paper currency. The value of the Yuan dynasty's notes derived solely from his decree that everyone must accept them in trade.
Unlike Kublai Khan’s controlled issuance, later emperors were less disciplined. Throughout Chinese history and in other nations, governments often succumbed to the temptation to print money indiscriminately to cover budgetary shortfalls. This frequently led to soaring inflation, even hyperinflation, drastically reducing the amount of goods and services a fixed amount of money could buy. This principle still holds today. Widespread acceptance of modern currency stems from trust in the central bank, a trust that must be maintained through sound government policies.
The Decline of Cash and Rise of Digital Payments
For many, cash seems increasingly outdated. Cash transactions are becoming less common, replaced by the ease of completing payments with a few taps on a smartphone. This shift has occurred within just a few years in both wealthy nations like the US and Sweden and poorer countries like India and Kenya, where even essential purchases are now made online.
On the surface, this transition could exacerbate inequality. Elderly and low-income populations, often at a technological disadvantage, might be disenfranchised if cash disappears. However, mobile phone penetration has reached near-saturation levels in many countries. If implemented correctly, digital currencies could actually promote financial inclusion, providing access to financial services for households without formal bank accounts.
Yet, cash is not obsolete. During the COVID-19 pandemic, despite the growing prevalence of contactless payments, demand for cash surged in major economies, including the US, likely because it remains a recognized safe form of savings. Many US states have laws ensuring cash remains a legal payment method, protecting those who cannot or prefer not to pay by other means. Overall, however, consumers, businesses, and governments are embracing the digital payments wave, especially as new technologies make them cheaper and more convenient, further accelerating this transition.
The Cryptocurrency Revolution
The waning of physical cash, once considered the most authoritative form of money, is just one part of a rapidly changing financial landscape. A more powerful force for change is the rise of cryptocurrencies, which challenge conventional notions of money and finance.
Bitcoin, the cryptocurrency that ignited this trend, may not be its ultimate protagonist. Bitcoin was designed to enable transactions using digital identities without the need for a trusted third party, such as a central bank or financial institution. In theory, anyone with a computer could transact without a credit card or bank account. Bitcoin is issued and its transactions are verified by an automated algorithm; its inventor remains unknown.
Launched in early 2009 amidst a global financial crisis that eroded trust in governments and banks, Bitcoin’s timing was perfect. Despite its growing popularity, Bitcoin has fundamental flaws. Its value is highly volatile, prone to sharp swings, making it an unstable payment method. Furthermore, it does not guarantee anonymous transactions; determined parties can trace a user’s digital identity back to their real identity—a development that has curtailed its use for illicit activities on the dark web. Today, Bitcoin and similar cryptocurrencies are largely speculative financial assets with no intrinsic value, sustained only by investor confidence.
The Emergence of Stablecoins
A new generation of cryptocurrencies has emerged to address Bitcoin’s shortcomings. Stablecoins—cryptocurrencies pegged to stable assets like the US dollar or other reputable fiat currencies—are gaining popularity. They promise to be a reliable and convenient electronic payment system, making domestic and cross-border payments cheaper and faster.
Unlike fully decentralized Bitcoin, stablecoin transactions require validation by an issuing institution, which could be a bank, corporation, or online entity. This means users must trust that the issuer will only validate legitimate transactions and hold sufficient reserves—though regulators do not yet require independent verification of these functions. Consequently, despite their noble aims, stablecoins raise significant concerns.
Central Bank Digital Currencies (CBDCs)
Even with their growing pains, the cryptocurrency revolution has spurred innovation in electronic payment technology and prompted central banks to act. Many central banks, long seen as conservative institutions resistant to change, are now joining the digital currency race.
As paper currency becomes less prominent, many central banks worldwide are looking to issue official digital currencies. Major economies like China, Japan, and Sweden are testing central bank digital currencies (CBDCs)—digital versions of their existing banknotes and coins. The Bahamas and Nigeria have already launched their own CBDCs domestically. Countries like Brazil, India, and Russia are initiating similar experiments.
Some countries view CBDCs as a tool to bring more people into the formal financial system, offering safe, affordable electronic payment services even to households without bank accounts or credit cards. Others see them as a way to enhance the efficiency and stability of electronic payment systems. For example, Sweden’s proposed e-krona is intended as a safeguard; the current digital payment system is managed by private entities and, while generally reliable, could fail due to technical issues or a loss of public confidence.
In countries where electronic payments are becoming the norm, CBDCs may also help maintain the relevance of retail central bank money. In China, for instance, the dominance of Alipay and WeChat Pay in the digital payment market has accelerated the push for a digital yuan.
CBDCs offer additional benefits, such as bringing certain types of economic activity into the tax net (many cash transactions currently go unreported), reducing counterfeiting, and making it harder to use official currency for illicit activities like money laundering, drug trafficking, and terrorist financing. However, this could come at the cost of transactional privacy, as every digital currency use leaves a trace. Central banks, wary of illegal use, are expected to make CBDC transactions subject to scrutiny and tracing.
The Future Monetary Landscape
What will the world of money look like in 5 or 10 years? Many people might have e-wallets containing various forms of money: traditional currency in bank accounts, stablecoins managed by private companies, and one or two CBDCs, all freely exchangeable depending on the international context. However, it remains uncertain whether stablecoins and CBDCs can coexist peacefully.
For example, Meta (formerly Facebook) faced regulatory pushback in the US over its plans for a proprietary stablecoin, due to concerns about its intentions and the potential for the stablecoin to be used in funding illegal activities domestically and internationally.
While some argue that stablecoins represent a more efficient and accessible electronic payment method, this argument may be weakened by the advent of CBDCs. Stablecoins currently appear to be holding their ground; as of March 2022, over 30 stablecoins were in circulation with a total market capitalization of approximately $185 billion. Furthermore, stablecoins built within large commercial ecosystems, like Amazon, could become widely popular payment methods. Regardless, as long as a stablecoin’s stability depends on a fiat currency, it is unlikely to become an independent store of value. People will use stablecoins primarily because they are relatively cheap and convenient.
Implications for the International Monetary System
The digital currency revolution will inevitably impact the international monetary system. Cross-border payments are notoriously complex, involving different currencies, technical protocols, and regulations, making them slow, expensive, and difficult to track in real-time. Cryptocurrencies, which can be shared freely across borders, could reduce these barriers, enabling near-instantaneous payment and settlement. Widely adopted international CBDCs could also alleviate these frictions.
Improving the efficiency of the international payment system offers several benefits. It would make it easier and cheaper for economic migrants to send remittances home—according to World Bank data, average remittance fees currently account for 6% of the total amount sent. Costs are estimated to be even higher for remittances to low-income countries, where a significant portion of national income relies on these inflows.
In principle, easier cross-border flow of funds could channel investment to where it is most effective, enhancing global economic welfare and boosting GDP and consumption. However, easy cross-border capital flows also pose risks, making it more difficult for many countries to manage their exchange rates and domestic economies.
Challenges for Smaller Economies
The subsequent challenges are particularly acute for smaller, less developed economies. Their currencies could be replaced by private stablecoins or CBDCs from major economies, especially if they are inconvenient to use or highly volatile. This could lead to a loss of monetary sovereignty, stripping a nation of its ability to control the money supply within its borders—a phenomenon known as "dollarization," where a volatile domestic currency is replaced by a more reliable foreign currency. Many Latin American countries have long struggled with this fate. The proliferation of digital currencies could accelerate dollarization.
In countries like Iran and Turkey, where currencies have experienced significant devaluation, governments have imposed capital controls, but citizens have already used cryptocurrencies to circumvent these restrictions and move funds to safer investments abroad.
Even major reserve currencies may see changes. Although many countries have long sought to dethrone the US dollar as the world’s primary reserve currency, this seems unlikely in the foreseeable future. In fact, dollar-backed stablecoins are expected to become vastly more popular than those backed by other currencies, indirectly reinforcing the dollar’s dominance.
Competition and Concentration
Competition between private and state-issued currencies for the role of medium of exchange is expected to intensify. Theoretically, this could lead to more convenient and faster transactions for consumers and businesses, while also encouraging issuers—both private and official—to act prudently to maintain their currency’s value.
However, technology could also yield unintended consequences. The digitization of money might not lead to a fair competition and broader proliferation of currencies but could instead result in a further concentration of economic power. If major currencies like the US dollar and the euro become readily available globally as digital currencies, they could supplant weaker ones. Similarly, digital currencies issued by large corporations with strong commercial or social media ecosystems could gain favor due to their network effects.
Unless governments intervene, these private currencies might one day abandon their fiat currency backing and become independent stores of value. If multiple currency issuers compete within a country, causing currency values to fluctuate, the monetary system could become more unstable.
Conclusion
What is certain is that the digital currency revolution is underway, and the international monetary system is poised for significant change. Whether this ultimately benefits humanity as a whole or exacerbates existing domestic and international inequalities remains to be seen.
Frequently Asked Questions
What is a Central Bank Digital Currency (CBDC)?
A CBDC is a digital form of a country's official fiat currency, issued and regulated by the central bank. It is designed to function as a digital equivalent of cash, offering a secure and state-backed means of electronic payment.
How do stablecoins differ from cryptocurrencies like Bitcoin?
Stablecoins are a type of cryptocurrency designed to minimize price volatility by being pegged to a stable asset, like the US dollar. Unlike Bitcoin, which is decentralized and highly volatile, stablecoins are often issued by a central entity and aim to maintain a stable value.
Could digital currencies lead to the end of cash?
While digital currencies are becoming more prevalent, cash is unlikely to disappear completely in the near future. It remains an important payment method for certain demographics and a backup in case of technological failure. However, its role is expected to continue diminishing.
What are the risks of using private stablecoins?
The main risks involve the trust placed in the issuing institution. Users must rely on the issuer to hold sufficient reserves and validate transactions correctly, aspects that are not always subject to rigorous independent audit or regulatory oversight.
How might digital currencies improve financial inclusion?
Digital currencies, especially CBDCs, can provide access to electronic payment systems for people without traditional bank accounts. All that's needed is a mobile phone, which is widely available even in developing countries, enabling participation in the modern economy.
Will the US dollar lose its status as the world's reserve currency due to digital currencies?
In the foreseeable future, this is unlikely. The dollar's dominance is deeply entrenched in the global financial system. The potential popularity of dollar-backed stablecoins could even reinforce its central role in international finance. For deeper insights into global financial trends, 👉 explore more analysis on monetary systems.