Bitcoin has been on a tear lately, participating in the bid-up of alternative assets as the market has anxiously anticipated the 2020 U.S. elections.
It’s important to remember, though, that there is a fundamental difference between cryptocurrencies such as Bitcoin, and digital currencies such as the ones being developed by companies like Morgan Stanley [NYSE: MS] and Facebook [NASDAQ: FB], or being explored by the world’s central banks.
Cryptocurrencies are decentralized, with transactions being validated by a variety of consensus mechanisms and recorded in a permissionless, distributed database (also known as a “blockchain”). Digital currencies, on the other hand, are centrally administered, and often have a record of transactions which only defined users can access.
Indeed, the open blockchains of Bitcoin and other cryptocurrencies are only apparently anonymous. In reality, crypto transactions of all but a handful of obscure “privacy coins” are open for all to see — and governments have many tools they can leverage to discover the real-world identities of crypto users.
Since we began covering the world of cryptocurrencies and digital currencies a few years ago, we have pointed out that governments would be big fans of these instruments, because they can easily be used to increase control and surveillance of financial transactions. Over the years, many central banks have developed plans to issue their own digital currencies. Some of the events in 2020 surrounding the monetary response to the Covid pandemic demonstrate the utility that central bank digital currencies (CBDCs) may have in the future.
In early October, the Bank For International Settlements published a study title “Central Bank Digital Currencies: Foundational Principles and Core Features.” Reading between the lines, we found a few items that suggest central bankers’ motivations for pursuing the direct issuance of digital currency.
A CBDC would provide a simple and targeted way to “helicopter drop” money to citizens in the event of a crisis. The distribution of government stimulus through existing channels is difficult and vulnerable to fraud in a variety of forms. Of course, the document notes that to avoid fraud with digital currencies, they would need to be linked to a nationally digital identity — something that would give pause to many civil liberties advocates.
CBDCs could therefore also be highly targeted and engineered. If issued as stimulus they could be targeted to particular industries or demographics, for example, or be used to expunge student loan debt. These currencies could be structured in a way that would more effectively implement interest rate policies (of course including negative interest rate policies) by building in a rate of “decay”:
“Theoretically, a …CBDC could pass on policy rate changes immediately to CBDC holders (which might also incentivize banks to pass on rates faster too)… Beyond bearing interest, there has also been public discussion about CBDC use to stimulate aggregate demand through direct transfers to the public (so-called ‘helicopter drops’), possibly combined with ‘programmable monetary policy’ (e.g. transfers with an ‘expiry date’ or conditional on being spent on certain goods).”
CBDCs, in conjunction with digital assets issued by private banks, would allow monetary authorities a highly effective mechanism for increasing the money supply, since CBDC deposits could be lendable and therefore would have a “money multiplier” effect, just as other deposits currently do.
All in all, the discussion about CBDCs, in the context of the extraordinary monetary and fiscal policies connected with the pandemic, and the other pandemic-related surveillance proposals (such as contact tracing, vaccine passports, and the like), draws our attention to the bigger picture. While cryptos and digital currencies were originally presented as tools of freedom and anonymity, governments and central banks seem determined to turn them into tools of policy. Particularly if governments succeed in winning public trust to CBDCs, the pandemic-driven trend of cashlessness could be an accelerant of a digitized financial system that makes this year’s interventions more the norm than the exception — and Bitcoin itself, and other cryptos with public blockchains, will not be an escape route.
With that said, however, the recent announcement by fintech giant Paypal [NASDAQ: PYPL] that it is rolling out crypto integration shows that cryptos and digital currencies are definitely moving from the fringe to the mainstream. While Bitcoin will not function as a tool to evade the taxman or the lawman, and may never develop sufficient infrastructure for high transaction volumes, it may well appreciate as a store of value — particularly if CBDCs ultimately usher in an era of digitally enabled Modern Monetary Theory (MMT). (As we’ve discussed before, MMT is the controversial and dangerous academic theory which holds that sovereign nations who issue their own currencies can expand their money supply indefinitely without the risk of creating inflation.)
Investment implications: Although central banks and governments are bent on deploying their own digital currencies to better implement their own policy agendas, certain cryptocurrencies remain intelligent speculative vehicles. Networking effects may well make cryptocurrencies a “winner take most” proposition. Cryptos focused on privacy will likely suffer from lack of adoption as they are shut out of the formal financial system.
