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Digital Currency Misses the Point

Categories : Cash does not require a technology infrastructure, Cash enables an immediate transfer of value
April 5, 2022
The idea of digitising money has re-emerged every ten years since the 1990s, starting with e-money, followed by digital money and now central bank digital currencies. But digital payments do not require digital money, says Aleksi Grym.
Aleksi Grym
Head of Fintech and Principal Adviser at Bank of Finland

This post is also available in: Spanish

From the day the internet became part of everyday life, the idea of putting money online to make payments has been presented many times. In fact, the terminology of “digital currency,” “electronic cash,” and “electronic money” has been around for more than 30 years.

The idea is very intuitive. When we pay with cash, we simply hand over banknotes or coins to another person, which completes the entire payment transaction. So it’s easy to conjure up an image where we have some digitised form of cash, and when we pay online, we send those digitised banknotes or coins to the other person.

This idea of digitising money has re-emerged every ten years or so. In the first wave, about 30 years ago, the result was the invention of e-money. The first implementations of e-money were stored-value cards or prepaid cards. Monetary value was recorded on a computer chip embedded in a plastic card. The card could be topped up at ATMs, and payments could be made at special-purpose payment terminals. The Bank of Finland introduced one of the world’s first such cards, Avant, but many similar products were developed in other markets. There were cards called Mondex, Geldkarte, and many others. None of them exists today because the concept was flawed. Credit and debit cards proved to be much better.

About ten years after e-money, someone again came up with the idea of “digital money”. This time, instead of prepaid cards, digital money took the form of cryptocurrencies. But just like e-money earlier, cryptocurrencies also proved to be flawed. They never became a widely used means of payment either. Like e-money, they are complicated to use and expensive to operate. Cryptocurrencies didn’t disappear; however, they became popular as a different kind of product category. They live as collectables or speculative investment products but not as payment products.

The third wave of digital money is very recent. This time it’s central banks that are again pondering the idea of digitising money. And again, the same ideas and exact solutions are on the table. We now call CBDC is remarkably similar to what we called e-money 30 years earlier. And the Avant project by the Bank of Finland is evidence that the same product could be called e-money in one era and CBDC in another.

These three generations of digital money miss an important point about making payments in a digital setting: digital payments don’t require digital money. The idea of making a payment by sending a digitised version of coins or banknotes is too simplistic and leads us off track.

Let me repeat; digital payments don’t require digital money. The genius idea about digital payments is that we can do it without digitising money. We can keep our money the way it is, physical, and still make payments online. That’s the real innovation, the lightbulb moment everyone working in this space should experience.

So how do payment systems work? First, you need banks. A bank is essentially just a warehouse for money. That’s where you put the money, and that’s where it stays. The bank safeguards the money and keeps account of how much each person has. It’s relatively simple arithmetic.

Next, you need a messaging system. The internet, by the way, is fundamentally a messaging system. The messaging system allows you to create payment messages digitally signed by an account holder. When the bank receives a payment message, they check that it’s authentic, in other words, signed by the account holder, and then they adjust the appropriate accounts. The money never leaves the bank. That’s the reason you don’t need to digitise it.

Trying to digitise money, whether you call it e-money, cryptocurrency, or CBDC, will not improve the payment system. It’s already working just fine. It’s not broken. Of course, it can be made faster, more secure, more seamless, and more automated, but the fundamental logic of how it works will not change. Any attempt to build a new payment system based on “digital money” will be less efficient, less user-friendly, and destined to fail.

If we talk about CBDC, we can ask the question: should a public institution operate the payment system, or should we leave it to the private market? That’s a fair question. Each approach has pros and cons, but it’s an entirely different kind of issue. Many technologies and policies can make payments work better, but trying to digitise money misses the point.

This post is also available in: Spanish