In this interview, Jean Diederich, Chairman of APSI and member of Digital Europe explains fundamental notions related to the future of money.
Fiat vs digital currencies
The main idea behind the financial technology (FinTech) revolution is that the Internet helps to create innovation and disrupts fundamental aspects of society like “Money” and Payments. Different visions for the future of money have appeared in the last years and the COVID-19 shutdowns have accelerated a shift towards digital and contactless payments, prioritising a digital vision of money over physical cash. On one side the digital currencies include “Crypto-currencies”, “Stable-coins”, and “Central Bank Digital Currencies (CBDCs)”, on the other side, traditional “fiat” money is born since President Nixon’s decision to decouple the USD from Gold in 1971. A system of national “fiat” currencies, issued by Central Banks, is now used globally worldwide. In this context it’s important to understand that the term “fiat” derives from the Latin word “fiat”, meaning “it shall be” or “qu’il en soit ainsi” or „So sei es“.
As a consequence, the value of “fiat” money, in a broad sense, represents all kinds of money that are made legal tender by a government’s Central Bank decree, called “fiat”, and which is on the accounting balance of the Central Bank, like it’s the case of the ECB, the FED, the BoE, the SZB, …. This has evolved in the second part of the 20th century, the development of computer technologies allowed “fiat” money to become electronic as all money transfers between central banks and commercial banks are done in an electronic form. It’s important to understand that the electronic money isn’t changing the value of the “fiat” currency.
Since the appearance of the Bitcoin, a battle started between public issuing of money and private issuing of money, on one side “fiat” and “CBDCs” are or will be public Central Bank issued currencies, where “Stable-coins” and “Crypto-currencies” are private issued currencies, bringing up a strategic discussion about who’ll issue money in the future, or what’ll be the mix? In China the fight is probably the most advanced. For the moment it’s very difficult to predict what will happen from a political point of view in Europe and the US. That’s why we just want to describe here the different forms of money in a neutral form and not predict what’ll be the outcome of the ongoing battles of the future of “money” in the next years.
As we have already described what “fiat” money is, it’s important to understand the different digital currencies in competition.
Let’s start with the “Crypto-currency” form of money for which a payment transaction can be cleared with no trusted third party (like a Commercial or Central Bank, standing between the payer and the payee). It’s digitally designed using cryptographic to ensure that the payer has the funds, and that each transaction is completed. The most widely known “Crypto-currency” is Bitcoin.
For most “Crypto-currencies”, a transaction is a block in a blockchain, which records that a “Crypto-currency” amount was transferred from a payer to a payee. In some blockchains or Distributed Ledger Technology (DLT) other digital elements can also be recorded, for example the Ethereum blockchain can embed “smart contracts” that take actions when specified conditions arrive.
In order to be part of the Bitcoin blockchain, a certain technical knowledge is needed and if a participant loses its private key, that person’s token can’t be accessed and are lost. That’s why many service providers have emerged (Exchanges) to enable participants to operate in a more user-friendly account-based setup, some provide “wallets” that store the private keys, some verify participants’ identities, enabling to comply with AML/KYC regulations.
It’s important to understand that a “Stable-coin” differs from a “Crypto-currency” through the fact that it’s value is linked to some other valuable asset, via matching to reserves of that asset, such as “fiat” money (EUR, USD, … in some cases it could be gold). For example, Tether is “promising” that if a client gives it a USD, a EUR or a few other assets, it will issue an equivalent value of Tether “Stable-coin”, while holding the USD as a reserve. In this context it’s also important to underline that most “Stable-coin” sponsors are unregulated. As a consequence, there is a large space for fraud of the underlying management of reserves. The most discussed “Stable-coin” was The Facebook-led, called Libra, now known as Diem.
Concerning CBDCs, design decisions interact with each other and are likely to influence the willingness of different types of actors to use the CBDCs. As “fiat” money, they are issued but a public Central Bank, as long as the national money has value, there is no danger that the value of a CBDC will go to zero. But as the CBDC’s value is locked to the value of its national money, it will be affected by inflation as “fiat”.
For the moment it’s very difficult to predict the future mix of “CBDCs”, “Stable-coins” and “Crypto-currencies” and how they are going to co-exist alongside with traditional “fiat” currencies?
Two final considerations are important, but will not help to predict the outcome of the ongoing competition in the next years:
- “CBDCs” are for the moment in a stadium of proof of concepts and don’t exist. Central Banks are late in the financial technology revolution, meaning “CBDCs” will not be rolled out on a global basis before 5 to 7 years, that’s a long journey, which means that the privately let digital currencies still have a lot of time to go and impose themselves and get more and more a buy in form the citizens, who will stop this success?
- As “CBDCs” initiatives are late, it’s most probable that governments, authorities and Central Banks will start battling against (following the example of China), and trying to ban them or regulate them through financial authorities, but will this be possible in the short term?