The tedious transition from cash to digital currency
With the acceleration of the global COVID-19 pandemic affecting liquidity all over the world, the way we look at and deal with money is undergoing a major paradigm shift. The digital cash revolution is afoot, and there are several things that firms and policymakers need to do in order to respond to the needs of the new.
The Fall of Cash
The onset of the global COVID-19 pandemic brought under much scrutiny the handling of physical cash and currency notes – owing to the fact that various studies showed that incumbent viruses can stick to money over a period of days or weeks. Worldwide lockdowns and social distancing measures thus also motivated the use of cards and other digital forms of payment over the use of physical currency. According to research by Deutsche Bank, in the year 2020, “the number of sellers using only digital payments in the UK jumped from eight per cent in February to 50 per cent in April. By August, the number of businesses with digital-only payment systems had stabilised at about 33 per cent.”
Figure 1: Share of businesses choosing digital as their primary means of transaction
This is, however, not the first instance where an effort towards the digitisation of physical money has been observed. Global trends have been pushing towards ‘cashless’ digital-currency-based economies for a while now, and the pandemic has only helped to thrust the process forward quicker.
In fact, what the pandemic has helped highlight is not just the need for a digital currency, but also how far behind several countries are in their progress in the mission. Alarmingly for many, several countries at the forefront of digital currency development, such as Sweden and China, are already far ahead in terms of infrastructure and transaction volume capacities.
According to research, “The race (of the digitisation of cash) is led by Sweden and China and both have started piloting e-currencies earlier this year. They have three factors in common: (i) Both countries have for many years embraced digital payments; (ii) cash payments in both nations were declining well before Covid; and (iii) their governments play a pivotal role in promoting and supporting a digital payments infrastructure.” If competing countries do not catch up in terms of their digital infrastructure, they may find their companies being ‘forced to adopt the digital currencies and policies of other countries as payment mediums’. This is bound to cause a negative effect on both business profitability as well as the country’s balance of payments.
The Evolution of CBDCs over Cash
In order to combat the aforementioned, central banks globally are slowly rethinking the seventeenth-century cash model that exists today. A move towards accelerating the development and adoption of central bank digital currencies (CBDCs) is already underway. According to a study, “over the past two years, central banks and governments have multiplied and sped up digital cash initiatives (drastically). A January 2020 survey by the Bank of International Settlements revealed that 80 per cent of central banks are developing a CBDC, and 10 per cent, mostly in emerging markets, are already running pilot tests.”
The process, however, is a rather slow one – especially in advanced economies – where interest rates are rather low, and privacy still stands as a major concern. In emerging economies such as India, ill-designed policy initiatives such as the demonetisation fiasco of 2016 are only impeding the advancement of the original idea of moving towards a cashless economy. The route forward, though uncharted, will require changes in two key areas when furthering the CBDC agenda: low interest rates and privacy/cultural norms.
A higher interest rate will be primary in offsetting cash as the primary store of value. A Deutsche Bank survey found that almost 33% of Americans and Europeans ranked cash as their preferred means of transaction, with over half the population believing that cash will always be around. The challenge, of course, is further magnified in developing countries such as India, especially with regard to the setting up of adequate infrastructure and knowhow.
Governments’ cognisance of cultural factors surrounding privacy, usage and convenience is going to be crucial as well, as they will have a major discernible effect on the country’s adoption rates. The digital renminbi in China, for example, is set to allow regulatory authorities to see and trace every transaction (unlike cash-based transactions).
Figure 2: Global payment patterns, 2019
According to research, “Perspectives on these two poles – privacy versus convenience – vary from culture to culture. A survey showed that citizens in advanced economies are more worried about privacy than people in emerging economies. Only a tenth of Chinese survey participants reported concerns about anonymity and traceability, well below the Americans (22 per cent), British (21 per cent), French (29 per cent), Germans (42 per cent), and Italians (19 per cent).
This is favourable for emerging economies and is corroborated by the fact that China today leads the race of the world’s transition from cash towards CBDCs. Certain other factors, such as a higher penetration for mobile payments and a younger demographic setup will all act as positive catalysts towards CBDC advancement.
Currently, the priority for most governments must be the setting up of regional digital payment systems. On a global scale, payments in e-Commerce and point-of-sales are currently dominated by American and (emerging) Asian providers. The penetration of the smartphone, the rollout of 5G technologies and the advancement of digital ledger technologies, i.e. Blockchains are all going to be crucial in disrupting traditional payment systems.
“In light of these regional technological disruptions, central banks, governments, large banks, and the clearing system must collaborate to set up digital payment initiatives that allow consumers to transfer funds from one bank account to another without relying on cards. Here, there are two scenarios each with a roughly equal chance of occurring. Either the market finds a solution itself or, if the market fails, it should be imposed by regulation.”
CBDCs are set to replace cash in the future. The only question is how soon we can adapt to facilitate it.