Please note: this was originally written in November 2019. Since then, there have been major global developments in the realm of Central Bank Digital Currencies, and Facebook’s Libra has rebranded as Diem and has committed to pegging it to the US Dollar. Article presented below in original form.
Facebook made headlines this past June with its declaration that it was going to transform the way people send payments over the internet by creating a digital currency called Libra. This announcement was a huge wake up call to central banks around the world, many of whom had not previously seen digital currencies such as Bitcoin as a threat to the existing system. In response the US Congress began to review whether the Federal Reserve currently has the authority to create a digital version of the US dollar.(Source2) Outside the US, the Swedish government has contemplated an electronic version of its Krona, and just this past month The Peoples Bank of China announced that it’s close to launching a digital currency of its own tied to the Yuan. With these huge innovations in the works, the world of digital currencies and blockchain can sometimes be confusing.
First — what is a cryptocurrency?
A cryptocurrency (e.g. Bitcoin) is a revolutionary technology that allows assets and value to be securely exchanged on a digital platform (a blockchain network) much in the same way that information is exchanged over the internet, potentially removing the need for a centralized intermediary such as the Federal Reserve. People exchange their fiat currency for the digital coins as if they were converting dollars to, let’s say, Euros and then spend them in a direct peer-to-peer fashion, like cash.
Next — why is this revolutionary?
When you pay for something with cash, it’s as simple as handing money to another individual — an anonymous transaction between you and another party. On the other hand, when you pay a credit card, or through an app like Venmo, those entities perform as an intermediary, allowing the transaction to occur and keeping a record of your data with it. The way digital currencies work, is that it allows you to perform that same, cashless transaction you get from using a credit card while cutting out the third party intermediary to process the request. It’s also nearly instant. When sending money outside the US, it can often take a couple of days for the funds to show in the recipients account. With digital currencies, this settlement time can be reduced to minutes or even seconds.
Why is this relevant?
Up until recently, a lot of people viewed Bitcoin as a novelty invention and it largely flew under the radar until 2017 when prices skyrocketed and subsequently crashed, but the implications of the technology have rapidly become clear. In 2017, Global consulting firm Mckinsey & Co predicted that these digital currencies will have major disrupter impact in the coming years, specifically emphasizing the banking and financial industry, and that it could break into the mainstream by the early-mid 2020s. In fact, we have already seen innovations in the financial world. JP Morgan announced their propriety “JPM Coin” this past February and several banks, including HSBC and BNP Paribas, have partnered with consulting firm Bain & Company to build a blockchain platform for sending documents.
To limit the volatility typically associated with common cryptocurrencies, as was seen in with Bitcoin in late 2017, The digital currencies being built by governments and financial firms would be backed by fiat. That is, $1 in physical USD cash notes would have the same value as $1 in digital USD coins. However, that 1:1 ratio won’t always be the case. Libra, for example, will be backed by a mix of six major currencies, though the US dollar does weigh the heaviest in their formula. Notably, the Chinese Yuan was not included.
There are plenty of questions still surrounding how these types of innovations will be adopted on the larger scale of society, but it is clear that the race to the digital dollar has begun.
