On October 31, 2008, a research article titled ‘Bitcoin: A Peer-to-Peer Electronic Cash System’ appeared on the Internet; it was written by Satoshi Nakamoto. The world soon realised that Satoshi was a pseudonym and the search for real Satoshi continues.
Satoshi proposed a peer-to-peer payment system “without going through a financial institution”. While the paper does not criticise the role of financial institutions in the financial crisis, the timing of the release made the intention clear.
Part I and Part II of this series narrated how money eventually became a centralised government-controlled activity. Some economists kept questioning this centralisation. In 1976, a leading Austrian school economist and Nobel laureate Friedrich Hayek wrote an article favouring denationalisation of money. The liberalisation phase of the1980s and the 1990s across the world led to the exit of governments from quite a few sectors of economic activity. However, the monetary activity of issuing money and setting interest rates remained with the central banks. People continued to trust their banks and central banks — till the 2008 crisis.
The 2008 crisis shook that central pillar of the monetary system: trust. All these years trust was taken for granted and most researches did not even mention the word trust. Post-2008, economists started to scramble for it. Even the Bitcoin article mentions the ‘trust’ 14 times, which is rare for a technology-based article.
The Bitcoin paper not just led to thinking on building a decentralised monetary system, but also pioneered a revolution in the form of digital currencies. After all if such a system was to be created, the currency under circulation will also be a new one. So, after several decades of fiat currencies named dollars, pounds and rupees, we had a new digital decentralised currency named Bitcoin which had no reserves and drew its value from the trust shown by the users.
Suddenly after all these years, the Hayekian vision of denationalising money was coming to fruition. The vision was possible due to technology which has for long shaped money and banking. The designers of coins and notes have used technology to not just bring new designs but also keep counterfeiters away.
Alas the vision did not last long.
Private Digital Currencies
The Bitcoin idea led to several such private digital currencies. Just like Bitcoin, all these currencies used the existing cryptography technology and hence were called cryptocurrencies. These cryptocurrencies changed value like any other financial asset and became hunting grounds for speculators earning the moniker crypto-assets. They did not serve the three functions of money mentioned in Part I and the central banks/economists broadly rejected the developments.
Moreover, the cryptos were also used for illegal purposes such as kidnapping, ransom, etc. leading to some countries actually banning them.
In 2019, the cryptocurrency game became serious with the advent of the Facebook-backed cryptocurrency named Libra (renamed as Diem in 2021). Facebook had a large subscriber base and thought it could develop a currency to transfer funds among its subscribers. Libra was also designed as a stablecoin backed by a reserve of major currencies, doing away a major limitation of the earlier cryptos.
Libra shook the world of central banking like never before. The central banks woke up to the challenge of digital currency and some decided to convert this into an opportunity. They started working on a central bank-issued digital currency. The central bank digital currency (CBDC) will try and have most features of existing cash while being offered on the digital platform laid out by Satoshi.
Birth of CBDCs
The COVID-19 pandemic further added speed to the CBDC project. The CBDC has also invoked the once asked questions of how banking systems will work under a new form of currency. The central banks can now issue these currencies directly to people limiting the intermediary role of banks. Denmark has cited this as the reason for not working on the CBDC. The other major issues are whether the CBDC should be token-based or account-based, which once again takes us to history where similar questions were asked as humans worked on physical currencies.
Interestingly, the objectives of issuing the CBDC differ across countries. The Chinese and the Europeans see the CBDC as a way to challenge the hegemony of US Dollar; Cambodia sees the CBDC as a way to increase usage of its own currency over the US Dollar; the Bahama Islands see the CBDC as a way for higher financial inclusion; Sweden to counter the decline of physical cash, and so on.
A problem which all CBDCs have to address is lack of anonymity and privacy. Cash allows both these features which have helped spread its usage as well. The CBDC instead allows States to snoop on people's transactions which could act as a hindrance over spread of the CBDCs.
India and CBDC
India has surprisingly been an outlier in this CBDC race. The government and the Reserve Bank of India banned cryptocurrencies in 2018, which is odd given India’s push for digital payments and digital financial inclusion. Ever since the 2016 demonetisation, the government has pushed for increasing usage of digital payments. The technology used in cryptocurrencies such as blockchains etc. could have led to some more innovation in the space. The RBI recently reiterated its stance on dangers of cryptocurrencies, but said it is studying whether India needs a CBDC or not.
The three parts in this series take us through this long journey of the evolution of money from cowries, gold, fiat currencies to a futuristic CBDC. Historical experiences tell us how humans have worked around these new changes and this should give us confidence on our ability to handle this new transition as well.
However, history also tells us the mistakes humans make while mistaking hubris for confidence. History beckons humanity once again and we have to wait and watch which side of history will the CBDC project lie. (This is the third and last in a three-part series on the evolution of money. Please read Part I here and Part II here.)