Is physical money destined to disappear?

Is physical money destined to disappear?

In this 8 November 2021 photo, a vegetable stall in a market in New Delhi, India, displays the QR code of Paytm, a digital payment application for mobile phones.

(AFP/Sajjad Hussain)

For many young Swedes, a banknote is little more than a relic. Many can go for months without seeing one, but why would they, when there’s Swish, a mobile app that lets you pay in any shop, instantly, and send money to whoever you want? Meanwhile, in China, the birthplace of paper money, Alipay and WeChat Pay have completely taken over the payments market: it’s as easy as showing a QR code on your mobile screen, on the same app you use to talk to your family or to shop online. How can a banknote compete with these apps?

It has been 72 years since the first charge card, Diners Club, appeared and, since then, the payment system has evolved so fast that China’s central bank has, for some time now, been testing the digital yuan in several cities, with the not-so-distant intention of reducing cash payments to a minimum, if not making paper money disappear altogether. The European Central Bank is also studying the creation of a digital euro, although it would “complement” rather than replace cash: “A digital euro would give you an additional choice about how to pay and make it easier to do so, contributing to accessibility and inclusion,” says the institution.

For all types of governments, the idea of having a record of all their citizens’ transactions is a dream come true. For the most authoritarian and intrusive, being able to know what their citizens do with their money, in real time, would mean a tidal wave of data, and the potential to hunt down ‘undesirable’ payments or transactions. Even for liberal states, which rely on private enterprise and protect the privacy of every operation, logging transactions would, at the very least, help to prevent under-the-table payments and tax evasion. And then there is also the potential to make one-off stimulus payments to citizens by sending money to their wallets, without the problems that the US or Brazil, to give two examples, had in locating the recipients of their stimulus programmes during the Covid-19 pandemic.

But would such a change really facilitate the financial inclusion of the most disadvantaged? There are reasons to think so, but there are also clear risks involved in such a change.

What about the elderly and the disadvantaged?

The idea of using digital money is quite plausible. Of course, if there is one financial instrument that has become widespread in the world, it is payment cards: according to the OECD’s 2020 survey, 70 per cent of people in a range of developed and developing countries had some form of payment card, a figure that was as high as 81 per cent in the organisation’s member countries. But this figure also points to a clear reality: there are large numbers of people who are unwilling, or unable, to access these systems, even in developed countries, where the vast majority of the population has stable access to the internet and a bank account. As recently seen in Spain with the “I am old, not an idiot” movement, older people have great difficulty adapting to the new mechanisms. According to a recent research published by Statista, in 2019, just 8.3 per cent of the over-65s in the United States – one of the world’s biggest technological powers – used mobile banking primarily to manage their savings. It was only among the under-35s that a majority (62 per cent) of digital users were found.

But there are two other groups that also have problems accessing these services: residents in areas without a stable internet connection and the most disadvantaged, precisely those who cannot afford to pay to maintain a mobile connection or provide data to open a bank account. And it is precisely these two groups that are very prominent in developing countries.

India has developed a system to keep track of its more than 1.38 billion people, called Aadhaar, which uses biometric –iris data, for example –and demographic information to identify each person. With this system, a person can be linked to a bank account, and subsidies can be transferred directly to those at risk of poverty or who meet certain demographic requirements. The difference here is that Aadhaar is not a direct payment system, but merely an identification system. But this combination can help people at risk of poverty: Brazil’s Bolsa Familia programme sends cards with the programme’s money by post to the female head of the household, so that she can go to a bank to withdraw the money. A system that links each person to an account would facilitate the process, as new cards would not have to be sent every month.

But the Indian government itself has provided an illustration of the risks of indiscriminately eliminating cash: in 2016, Prime Minister Narendra Modi announced the demonetisation of the two most widely used denominations of banknotes, to force citizens to exchange them for new notes or pay with cards.

The aim was to uncover alleged ‘black money’ hidden by criminal groups, to encourage the use of cards and other payment methods and to reduce the number of counterfeit banknotes. The result, according to Gabriel Chodorow-Reich et al. (2019), was a two point fall in GDP, a similar contraction in credit and little or no evidence of success in the other areas, except incentivising the use of digital payments. Was it worth the cost?

One response to some of the obstacles mentioned has been the development of an ‘analogue’ financial system that attempts to copy some of the features of digital, but without the need for widespread internet access.

In Africa, for example, payment and remittance systems have been developed using non-smart mobile phones, such as M-Pesa, Airtel or mKesh, allowing remittances and payments to be made via SMS, with a network of locations where cash can be withdrawn and balances managed. According to a 2021 report by the Bill and Melinda Gates Foundation, these systems increase consumption and financial resilience, improve the employability of their users and replace informal savings.

In another group of countries, there is the problem of currencies hit by galloping inflation, such as the two landmarks of hyperinflation, Zimbabwe and Venezuela, or those such as Argentina, where inflation is rarely below 10 per cent a year. In these countries, the disappearance or scarcity of cash is common for two reasons: central banks are unable to keep up with the need to print money and create larger banknotes as prices rise, and citizens want to use the local currency as little as possible, often leading to de facto dollarisation. Such financial systems come under enormous pressure: governments do not formally accept the currency that citizens want to use, and the currency that the government does accept is a hot potato that people want to pass on to someone else as soon as possible.

In these cases, digital money is key, as carrying around wads of worthless banknotes is a huge inconvenience, and the speed at which the money circulates means that banknotes are damaged and need to be replaced at an impossible rate. It is much easier for everyone to have point-of-sale terminals for making payments. The problem is that what people really want is to be paid in dollars: these banknotes are welcome everywhere. Eliminating cash payments altogether, in such cases, would damage the economy by preventing people from using their preferred currency. You don’t have to go far to see the Venezuelan government’s failure to introduce a cryptocurrency, the petro, to try to replace (or back) the hyper-inflated bolívar and make the reviled dollar unnecessary.

Are cryptocurrencies the future?

But if there is one instrument that seems destined to replace cash – or so say its proponents – it is cryptocurrencies, which, in theory, should allow immediate and free payments, without the risk of inflation or third-party control. These characteristics, however, are rather questionable: Bitcoin can only handle around seven transactions a second, compared to the 65,000 that Visa can handle. The huge volatility of its value, with no institution to manage and support it, causes substantial price fluctuations. And the system is based on an incentive structure requiring the payment of transaction fees, which are usually higher than those charged by banks.

All this aside, the problem is that its use is extraordinarily complex and combines all the obstacles already mentioned. There is still a huge percentage of the population that does not use mobile banking as their main means of access, but with cryptocurrencies it is the only way. The system requires a permanent internet connection and modern technology. And, unlike other currencies, there is no one to back up their value, to monitor the conduct of the participants or to offer redress when citizens are the victims of theft or losses.

A forgotten password could mean the loss of a person’s savings, an unaffordable risk for the vast majority of citizens.

Added to this is the extraordinary complexity of the savings and investment mechanisms, the so-called Decentralised Finance or DeFi. Given that the average financial literacy score in OECD countries, according to its 2020 study, is 62 out of 100, and most citizens rarely buy products more complex than an ordinary loan or a fixed-term deposit, it is hard to imagine a wave of investments in smart contracts managed with stablecoins.

In an ideal world, governments, education systems and other stakeholders would do their utmost to educate people financially and facilitate their access to all kinds of payment and savings mechanisms. Unfortunately, differences in human and economic development make this goal impossible. As seen in Africa, financial innovations, however analogue they may be, help boost household economic growth and well-being. The best way forward, in this case, is to go to where the people are and offer them improvements and solutions that are adapted to their context. Attempts to implement top-down mechanisms, such as the single digital payment, that leave out a significant percentage of the world’s population will only result in poverty and exclusion. Virtual money already coexists seamlessly with physical money. But paper banknotes still have a lot of use left in them.

This article has been translated from Spanish.