Money is not a concept that you need to give much thought to. It just is. But if you start thinking about it at any length, your faith in it may flounder. After all, money is based on confidence. However, money is currently undergoing a digital transition, perhaps the greatest transition since the adoption of modern money.
The money we use today is so-called fiat money. Fiat money is money created by a government with no underlying real assets backing it up. However, the creator of the money exercises legislative powers and possesses a credibility that maintains its value now and in the future.
Additionally, there are a number of characteristics that money must have in order to qualify as money. Money is needed for exchange and storage. Money is a medium of exchange, it stores value and serves as a measure of value. If any of these characteristics is lacking, it is not money, though something akin to money. As a concept, money stretches. In the narrowest sense of the term, it is banknotes and coins. A broader definition also includes securities.
Typically, the biggest threat to money is the loss of value, or excessively high inflation. If the inflation rate were to rise too high, money should be renewed or replaced by another monetary unit in order to restore confidence. Moreover, the banknote version of money is constantly exposed to the risk of forgery. With the biggest currencies, forgery remains a marginal issue. Another risk money is exposed to is competing currencies. Competition may arise from stronger and more credible currencies through the off-the-books economy.
New competing digital creations
As a result of digitalisation, people are increasingly convinced that all money will become digital. The race is on as to which of the existing forms of digital money will come up as the winner.
Over the past few years, we’ve seen the emergence of a crypto currency market worth 1,000-2,000 billion dollars. The best known of the crypto currencies is bitcoin. Facebook has for some time now been developing its own version of ‘money’ which appears to fall into the ‘stable coin’ category. New products emerge that compete with one another, but the actual struggle is with regulation. The new digital creations may pose a threat to regular money if regulation is mismanaged. Regulation is lagging behind, but it will catch up, no doubt about it. A prime example is China’s recent ban on the use of crypto currency.
We will see digital money issued by central banks
Amidst this race, central banks are creating their own digital currencies (Central Bank Digital Currency, CBDC). There are a number of variations of digital money on the drawing board. The simplest way of creating digital money is to open duplicate accounts with the central bank, which would be managed through banks. As a result, customers would deal with ordinary banks, not central banks. Another more extreme option is to offer these accounts directly to customers. It will be interesting to see next year which state will be first to introduce digital money, and which approach will be employed in its creation. In financially more advanced countries, the reform will give less value added compared to countries in which the economy still functions with banknotes and coins, and in which money transfers are not instantaneous.
Threats to digital money
Digital money is also exposed to threats. It could be prone to attacks by cyber criminals. It’s easier to produce bits than gold, silver or banknotes. Governments and their central banks may also create too many bits and so jeopardise the currency. Digital money may also be vulnerable as a currency.
In conclusion
Our existing currencies are worth preserving and it makes no sense to undermine them in the thrill of digitalisation. Here in northern Europe where the means of payment are already digital and money is transferred instantaneously, the reforms are part of the marketing efforts to maintain the appeal of the own currency. Any digital money created by central banks is real money. Unlike the name implies, the digital currencies created by others are mostly substitute products, and should be regulated as such. These other digital products will probably find their niches as investment products and vehicles for the storage of value that will be regulated accordingly. However, in today’s digitalised world, they may yet open interesting avenues for innovation.
The writer is VER's CEO Timo Löyttyniemi.
