The world—as we know it—has entered a new era, one we couldn’t have possibly imagined. With the pandemic hastening this so-called ‘revolution,’ the realm of business and finance has been one of the first to succumb to the proliferation of digital payments, cryptocurrencies, e-commerce and mobile banking. Numbered are the days of rushing to the bank, attending long meetings, of waiting in line at a store and in-person transactions!
It is a welcome development: why wait for a check to clear for 2-4 business days when you can send funds almost instantly anywhere in the world with little—if not entirely zero—fees? Why waste your time AND risk your health going to a physical establishment when you can buy, sell, and work from the comfort of your own home and in the convenience of your own time?
Covid19 has undoubtedly accelerated the transaction ecosystem and made shopping and doing business more convenient. It required the necessity of adaptability and digital mobility. Thus, technology has taken a giant leap forward and the simplicity of everyday transactions naturally followed (with just as much distance too!).
Do you remember the last time you used a cash or issued a check? In all likelihood, probably not! Because most businesses would have transitioned into using apps instead.
Apps like Apple Pay, AliPay, Paypal, Grab and Gcash are to thank for saving you a trip outside. And they aren’t banks that charge you multiple fees to boot! You’ve also probably heard of Bitcoin and how this magic internet money could potentially replace the money you’re using right now.
So, what is happening?
Well you and I are in a turbulent transition period many in the space would call the “Internet version 3.0” or “Web3” (with the Internet itself as version 1.0 and the mobile web as 2.0). With big tech companies threatening the existence of banks and the probable extinction of cash, the subsequent birth to a truly cashless society is not too far off.
This revolution is actually already happening: with China experimenting on a ‘digital yuan’ in select special economic zones and billions of dollars in monopoly fines levied against Jack Ma’s Alibaba; Sweden spearheading its Central Bank Decentralized Currency; the Philippines’ BPI blocking deposits to and from cryptocurrency exchanges and most recently—if not most eagerly—El Salvador adopting Bitcoin as legal tender! It is the first country to do so and it certainly won’t be the last…
All these turning points have set-off central bank alarm bells, with some governments questioning cryptocurrency legitimacy and big tech monopolies, there are still many others stuck in the gray area between bold adoption and outright banning.
I’m sure most of this would sound ridiculous to you: apps replacing banks and, instead of exchanging our local currencies for physical goods on these platforms, we’d be exchanging them for magic internet money!
But why should you care about these changes? What can you get out of it?
Well…we could be exchanging Bitcoins for a cup of coffee in the near future; people would be earning remotely on job-boards ‘in the cloud’ instead of showing up at interviews; we could also be storing our wealth in the same cloud without the need for banks, having as much—if not more—validity and security as banking regulations. Our lives could drastically change beyond our comprehension in just ten or fifteen years!
But perhaps these may also be ramblings of a madman whose belief in crazy new technologies was brought upon by FOMO (the fear of missing out) or hype. Do you think digital payment platforms and Bitcoin are as transformative a breakthrough as the Internet? You may think otherwise—that all these are just a passing fad or a bubble that is due to burst anytime soon. These changes may never happen…
But in the very likely event it does—that maybe you’re reading this about an app (one NOT owned by a bank) that allowed you to easily invest your savings at the tap of a button or art dealers buying memes—then read on!
Because there is one vital concept at the very center of it all, one so commonly misunderstood and taken for granted that if you boil down all of these events, one common denominator remains—and that is money. For as long as there is civilization, there is money and it has evolved alongside us. Modern fields of study such as economics, business and finance have been birthed by money and its functions. Without it, we relapse into primitive methods of providing for our needs and our infinite wants. Imagine devolving into hunter-gatherers: foraging, hunting and moving from place to place, using cattle you found from a cold continent to pay for a bushel of wheat harvested from another warmer continent. Unthinkable, right?
How we transacted in the past with seashells, salt, beads, copper, silver then gold, and eventually money; how using tried-and-tested monetary goods paved the way for us to specialize and improve our quality of life through financial, medical and technological advancements—all these past occurrences with money at its center has shaped the sophisticated society we know today (and looking back again can tell us just how much it could change in the not-so-distant future).
Hence, a basic understanding of money is indispensable, I cannot stress this enough. Don’t worry, I won’t get too technical about this. But let’s start by asking—and subsequently answering—these three questions:
1. What is money and what are the drawbacks of cash today?
2. What are the effects of Fintech on traditional banking?
3. and how Bitcoin and other cryptocurrencies may finally be the nail in the coffin for fiat currencies.
This three-part article series—the Fintech and DeFi revolution—will cover each of these questions. It also aims to introduce and interpret the fast rise of fintech (financial technology) and defi (decentralized finance) advancements which are changing the landscapes of conventional retail banking and the payment industry. Brew a cup of coffee, find a comfortable place to sit and let’s dive right in!
PART 1: What is money and what are the disadvantages of cash today?
Traditional banking has always been a delicate matter. But all you had to know was depositing your money at your bank would be the fiscally responsible thing to do, instead of hoarding it in a wooden chest, or under your mattress. Saving for buying something you want or simply saving for a ‘rainy-day’ (in our case, an aggressive pandemic) is a simple and essential practice. But phenomena such as inflation, interest rates and the likelihood of banks being unable to return your deposits due to some financial crisis threaten the sacred act of saving.
Central banks are now considering overhauling the use of cash for all the right reasons and the difference between cash-on-hand (hereafter referred to as paper rectangles) and digits on a screen is growing. Not to mention, the U.S. dollar and its status as a world-reserve currency is falling in value and prices of certain commodities are going in the opposite direction. All these events threaten the value of your hard-earned money and merely saving won’t help. You may be asking yourself: but money is just the paper rectangles we need to buy the stuff we want, pay bills and settle our taxes with, right? How would these events affect my overall wealth? And why are people fighting over what it is and what it could become?
I am a person that until very recently did not understand the very abstract concept of money—because it is very abstract to begin with! But in order to answer these questions (questions we have to ask ourselves with increasing urgency as regulations are being extensively reassessed and tech companies are churning out newer features), there is no shortcut but to understand money: its functions, its characteristics, its history, the problems it solved in the past and the pitfalls it possesses today.
So, what exactly is money?
Francis Amasa Walker, who was an American economist, had a pretty good description of money if you break it down into phrases: “that which | passes freely from hand to hand in full payment for goods | in final discharge of indebtedness | being accepted equally | without reference to the character or credit of the person tendering it, & | without the intention on the part of the person receiving it to consume, enjoy or otherwise use it than by | passing it on sooner or later in exchange.”
In the last two phrases, money is a means of exchange for stuff": you cannot eat your bank notes or coins nor can you wear your bank account. Gold, silver and the paper rectangles in your wallet or purse fit this description perfectly. And at the same time, not quite. Money has tried to solve one problem that has persisted for as long as we humans have existed: how to move economic value across time and space?
The simplest method to exchange value to one another is by exchanging valuable stuff with one another—and one of the ways is through barter. This type of direct exchange is still practiced today but is only practical within an extremely small circle of people who are familiar with each other and in possession of an equally limited selection of goods and services to trade with.
Back then, when division of labor didn’t exist, people exchanged only the basic necessities for survival between themselves. Remember my example earlier about exchanging cattle for a bundle of wheat?
As a barter economy grew, people specialized in the production of more goods and services and exchanged them with a larger number of people.
But an economic phenomenon called the Double Coincidence of Wants arose from this: what you want to buy is produced by someone who does not want what you have to sell! And there are three facets to this problem:
1. Lack of Coincidence in Scales: what you want to buy may not be equal in value to what you are willing to sell and dividing them up into smaller units may not be practical. For example, wanting to sell your cow for a house. You may not purchase the house in small pieces like a room, door or windows each equivalent to one cow. Nor does the owner of the house want to own all your cows whose value is equivalent to the house he is trying to sell. And let’s not talk about how you plan to pay when both of you agree on a fraction…
2. Lack in Coincidence in Time-frames: what you want to sell may be perishable and what you want to buy must be long-lasting and valuable, creating the problem that it may be difficult to accumulate enough of your perishable good to purchase the long-lasting good at one point in time. It certainly isn’t easy to collect enough berries to acquire a house at once before they rot away.
3. Lack of Coincidence of Locations: you may want to sell a house in one place to buy a house in another. Last time I checked most houses weren’t portable.
These three sub-problems of the double coincidence of wants make direct exchange—even in a specialized economy—highly impractical and it has led people to find additional layers of exchange to satisfy their needs. The only solution to this would be through indirect exchange: you try to find some other good one person would want to exchange for their bushel of wheat, who would then exchange it with you for the cow you are trying to sell. The ‘good’ in this scenario would aptly be called a medium of exchange.
And a medium of exchange is the first function of money.
While any good would fill the gap between your cow and his bushel of wheat (like seashells, pebbles, salt or gold and silver), it would also be a huge hassle to find another good others would accept for every other exchange that will happen. One dude might want seashells and the other might want pebbles and all the other homies prefer gold and silver. Should you have to carry all of these with you?
This problem has occurred in the past and one medium of exchange naturally surfaced from all the disagreements that ensued. And that medium of exchange is money. In Francis Amasa Walker’s description, it is a good “not to be consumed, nor to be enjoyed or used in the production of other goods, but primarily for the purpose of exchange between other goods.”
There is no law that stipulates what can and cannot be used as money. Any person choosing to buy stuff—not for its own sake—but with the intention of exchanging it for other stuff, is considered money! But as we know, you and I differ, so does what our opinion on and choices of what constitutes money. Throughout history a vast assortment of monetary goods has served that role. As we are subjective creatures, there is no right or wrong for what we believe to be money.
But there are of course consequences to these choices.
Currency systems effectively make barter/direct exchange obsolete. One characteristic of money is it being saleable, or how readily it can be sold in a market.
Going back to the three-sub problems of the Double Coincidence of Wants, money should have the ability to be divided into smaller units to better fit the economic needs of the parties using it: you as a farmer can sell your cows for money and buy the house—or rent a part of it—which the seller is willing to accept (because they do not need your cattle and can use your money to purchase something they do need). Through money’s salability across scales, the lack of coincidence of scales is satisfied.
Money should also be saleable across space, making it easy to transport and transact with. You heard that a certain country in Central America is willing to pay you $30 in Bitcoin to live in their country, so without a second thought, you sell your condominium in the Philippines for money and use it to buy a house and lot in El Salvador—the lack of coincidence of location is also addressed.
But most importantly, money must still be useful across time whereby your seashells, salt or pebbles can hold their value well into the future. And thus, the lack of coincidence across timeframes is also satisfied, allowing its user to store wealth in it.
The second function of money therefore is a store of value—a good you can rely on to save for something you want in the future or for a rainy day. For a medium of exchange to check this box, it has to be immune to rotting and other types of deterioration. However, it is also possible that a good may lose its value even if its physical condition has endured the test of time. For a medium of exchange to maintain its value it is essential that its supply must not increase too much during the period the holder has it in his possession.
To expound on this a little bit, there are two broad forms of money:
1. Hard Money and
2. Easy Money
Money which is difficult to produce is called hard money. For something to be an effective monetary good that is useful through time, it has to be costly to produce or find. Hard money allows people to think about the long term—it allows to save and invest more in the future and both of these aspects are the key to economic growth.
Easy or soft money, on the other hand, has its supply always increasing therefore destroying the incentive to save and store value in it, devaluing the good to the point of worthlessness.
Gold and silver were used as hard monetary goods because they were both rare metals and difficult to mine. The media of exchanges that survived the longest were the ones that had very effective instruments in place to restrict their supplies (such as but certainly not limited to: difficulty in finding the good, its rarity, costly raw materials and processes to put them together).
While anyone is free to decide which monetary good to use, those who choose hard money will benefit the most by losing very little value when their supply does increase. And those who choose easy money suffer the consequence of losing as much value as its supply increases.
Looking back, it is not so much as preference that dictates what money is and isn’t (as many were led to believe), it was more of what the consequences were that people had to suffer as a result of choosing easy money.
Another distinct characteristic of money is its acceptability. There may be dozens of hard media of exchanges in a given market but the most widely accepted out of all of them is the best monetary good.
Although not strictly being hard money, physical cash is one of the best ways to almost-instantly and reliably conduct commerce today. Why? Because it is universally accepted and understood as a medium of exchange. Which, according to Mr. Walker fits the description of it being equally be accepted (however please don’t carry around wads of cash if you don’t want to be robbed, or worse, audited by authorities).
A widely accepted monetary good is also an effective unit of account, which is the third function of money.
A monetary good which is divisible and countable—and at the same time limited in supply—would be adopted by markets relatively quickly. One reason why gold and silver didn’t make it on top as the dominant currency despite being remarkably hard money was that they were rather difficult to divide into smaller pieces for smaller transactions. It was also difficult to determine their exchange rates, relative to one another.
With money being countable, prices of all goods and services are expressed in terms of the same unit rather than “twenty cows for one house.” Money then serves as a metric for accurately measuring value, and in whole, an entire economy. This essential function allowed an accounting for profits, losses, income, expenses, debt and wealth—a universal understandability that allowed for economic growth since people knew how much stuff was.
An economy is a vast collection of markets and its growth is entirely dependent on factors like access to natural resources (oil and natural gas), population or labor, technology, etc. But the ease with which to do commerce is as much a significant determinant for economic success as the other factors. So, it stands to reason that the need for transactions to be as simple as handing over a paper rectangle and accounting for your gains and losses afterwards also correspond to how rich a country is.
Thus, our sophisticated society would not exist today without money acting as medium of exchange so we could drop the barter economy and go into specialization or jobs; it also serves as a store of value that incentivized people to direct resources into investment instead of consumption which, in turn, spurred economic growth; and money as a unit of account to quantify this growth and make informed decisions with.
The evolution of money has seen many types of media of exchanges with different hardness and qualities that were dependent on the advancements of each era. From seashells to salt, to cattle, to gold and silver, to gold-backed paper rectangles and now finally government-supported paper rectangles backed by nothing! History has shown us all the new developments and benefits of each new monetary good, and by extension, their drawbacks.
What are the drawbacks of cash today?
The world saw the rise of the Gold Standard from the years 1880 to 1914, when sovereign currencies of governments were backed by a sound, hard monetary good: gold. People had bank notes as receipts to freely convert them into gold. Their currencies and other forms of money had their prices fixed by certain weights of this precious metal. The Gold Standard was—undeniably—a period of unprecedented economic growth.
However, when World War I reared its ugly head, countries involved needed to finance the war and cannot do so (at least efficiently) with only a limited amount of gold in their reserves. Thus, the central banks of these countries resorted to printing money more than what they actually had in their gold reserves (leading to catastrophic economic events).
The gold standard was still dropped after the fact. Most countries however are still keeping gold in their reserves (in case of a currency crisis) but do not have it tied to their sovereign currencies. Post-war governments then resumed the practice of printing in a futile attempt to revive their staggering economies.
Hence, fiat money was introduced. Fiat is a Latin term for “so I decree,” which is appropriate as a term since fiat currencies are government-issued money not backed by a physical commodity. It has no intrinsic value but it has value simply because a government maintains it has value and we all agree that it does (that’s right, paper rectangles).
Do you see the problem here? Cattle, silver and gold are more difficult to produce versus fiat money which is incredibly easy to print. And as we already know, easy money has its value decreased as more of it is produced at a given period of time.
History has shown us that governments will inflate their money supply—usually for good reason, like alleviating the effects of a pandemic—but it still does not come without consequences.
Rising inflation is one of these consequences, and while inflation is a healthy force towards economic growth (targeted by central banks at 2% per year), money printing without effective controls leads to a catastrophic economic event—hyperinflation.
Hyperinflation is inflation on steroids and it is a 50% increase in price levels in a month! The purchasing power of your paper rectangles shrink so much that you cannot literally buy a good tomorrow that would be purchasable today.
This event is unique to fiat currencies and there was never an instance where hyperinflation occurred in countries operating with a gold or silver standard. As an asset class, cash is meant to provide stability and liquidity—but not in the face of inflationary circumstances.
Cash is known to be riskless precisely because of its liquid nature. But say that you deposited $300,000 in your bank for emergency purposes and some apocalyptic event occurred—God forbid—that plunged your economy in a country-wide bank failure. The FDIC or Federal Deposit Insurance Corporation insures only $250,000 of your deposits (₱500,000 for the Philippine Deposit Insurance Corporation). That cap is protected by a government guarantee and above this threshold, we are taking on pure bank credit risk…
Wait a minute, did I just use the words ‘government’ and ‘guarantee’ together in a sentence? I definitely did! But governments tend to inflate the money supply which consequently deflates purchasing power. While they do indeed intend to protect your deposits, you will only receive $50,000 less in the event commercials banks fail. You also wouldn’t be able to buy even the full $300,000-worth of emergency goods in the future!
That’s the odd thing about cash and deposits—we do not revalue them. We are so sure about their deceptive stability and just consider their face value that we fail to see the various risks in play.
Holding cash in an inflationary world where the government monopolizes its supply is unwise and depositing it in a bank—just as much. While I am not a financial advisor, interest from deposits in a savings account (0.6% average annual returns in the U.S. while it’s 0.175% in the Philippines) will hardly get anyone over rising inflation and/or unforeseen crises in life—and that’s common knowledge, not financial advice.
With cash steadily losing its third monetary function as a store of value, its role as a hard currency is threatened. The popularization of mobile devices in the past decade and their digital payment platforms also serve as proverbial dissidents in this revolution.
And with Covid19 as another catalyst (central banks explicitly restricting its use since the contagion has been shown to hitch a ride on your paper rectangles), its impeachment—if not death—seems all the more inevitable.