Private Currencies vs. Public Money

Bitcoin is up 22% since last Monday.

Why? Nobody is sure.

It could be because of the end of tax season in the US. We could see money starting to pour in as people receive their tax returns.

Or it could have something to do with investor George Soros. He is looking to start trading in cryptos.

Or it could be for a totally different reason.

What we do know is that cryptos had an incredible year in 2017.

Bitcoin, one of the most popular, increased by about 1,300%. Yet it wasn’t the one with the most gains.

Ethereum rose by over 9,000% and ripple by over 36,000%.

While they have lost some of that value in 2018, cryptos are still raising questions about the future of money…and how they could potentially change our whole monetary system.

There is much hope placed on the technology behind bitcoin. That is, the blockchain technology.

If you are not familiar with blockchain, it is a shared public ledger — a database that every member in the network can see and contribute to.

In the traditional banking system, each commercial bank has its own ledger. Payments from one bank to another usually go through the central bank too.

Having one ledger checked by everyone in the network removes the need for a middleman. It also reduces costs.

The banks are getting on board with blockchain

Faced with new threats to their business model, commercial banks are starting to look at issuing their own payment methods.

In Japan, for example, a new law has banks scrambling for market share. The new legislation will allow people with money in the bank to give third party access to their accounts and data

This is from Bloomberg:

In recent months, lenders around the country have announced a flurry of initiatives designed to grab a slice of the $50 billion market for electronic settlements. Projects are under way to develop platforms using everything from QR codes to blockchain technology and digital currencies.

‘“Releasing their own coins and payment methods is what the banks need to be doing,” said Eiichiro Yanagawa, a senior technology and banking analyst for consulting firm Celent. “Banks that move too slowly will have their tastiest business eaten up.”’

This follows reports that Japan is ready to legalise Initial Coin Offering’s (ICOs).

We could be seeing the start of something that Friedrick von Hayek talked about in his 1976 book, The Denationalization of Money.

Hayek was in favour of having private currencies issued by businesses, instead of having a centralised currency. He argued that competition would keep these currencies in check, since users would flock to the most stable currencies.

It’s an interesting idea.

The idea behind having one public currency is that central banks will protect consumers if a private bank fails. 

Yet in the last few years certain central banks have been engaging in Quantitative Easing (QE). All to boost the economy after the 2008 great financial crisis.

Central banks have been printing money and using it to buy bonds to fund the government deficit. This has created long term low interest rates and has boosted asset prices. High valuations in the stock and property market are making some people feel very rich.

But it has increased debt.

Banks creating digital currencies to regain control

Also faced with competition and new technology, some central banks are also looking to issue their own digital currencies. They are concerned they have no control over these private currencies.

The Swedish Riskbank is clearly worried about the springing of private currencies. In a recent report they analysed the decrease of cash use and looked into issuing a central bank digital currency, the e-krona. As they noted:

The general public’s access to risk-free assets in the form of central bank money will probably almost cease entirely. Households will thereby have very few possibilities to save and pay in central bank money, which could contribute towards reduced resilience in the payment system. It is also worth noting that in practice we may find ourselves in a situation reminiscent of the period prior to the banknote monopoly, that is, private actors competing with the means of payment provided by the state, although now to a much greater extent. The question today is, if banknotes issued by the Riksbank in practice disappear, will we then have a situation where the general public only has access to commercial bank money, and what would the concept of legal tender then entail?

‘An e-krona could constitute a government-guaranteed means of payment without credit risk and be available for the general public in digital form as a complement to cash. This type of digital krona could be regarded as a modernisation of the Riksbank’s means of payment when the majority of society no longer wish to use banknotes and coins to pay for things and/or save money. A possible e-krona could also function as a complement to the payment forms that are currently offered in the private sector.

We will probably see more countries making the move into government-issued currencies. And we could even see a large-scale crackdown on cryptos.

Bitcoin is proof that the public is distrusting of government fiat currencies. Granted that they are still too volatile and are not widely used as transactions are too slow.

But the blockchain is definitely allowing people to think about the future of money and how we use that money.

And the rise of parallel currencies could increase competition for central banks. That is, if the central bank printed too much money and devalued the currency, people could flock to a more stable private currency.

Seeing what we have seen in recent years with monetary policy, are government currencies more trustworthy than private money?


Selva Freigedo,
Editor, Markets & Money

PS: The crypto boom is just starting. And, as with everything, there will be winners and losers. If you are interested in getting into this space, don’t miss out on editor Sam Volkering’s step by step guide on cryptocurrencies. You can access it here.

Selva Freigedo is an analyst with a background in financial economics. Born and raised in Argentina, she has also lived in Brazil, the US and Spain. She has seen economic troubles firsthand, from economic booms to collapses and the ravaging effects of hyperinflation, high unemployment, deposit freezes and debt default. Selva now writes from her vantage point here in Australia. She is lead Editor at the daily e-letter Markets & Money. And every week, she goes through each report and research note produced by our global network of trusted advisors to find the best investment opportunities for you in Australia and overseas. She packages these opportunities for you in Global Investor.

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