Much of the Western world already operates in a nearly cashless society.
Credit cards are accepted almost everywhere, people are using tap and pay more and more, and payment apps like Venmo and Paypal are a part of most people’s wallets.
During the 2020 pandemic, digital currency became even more popular, with some establishments even switching to no-cash policies.
Adding fuel to the fire, cryptocurrencies like Bitcoin and Ethereum and the marketplaces on which they’re sold have taken the financial environment by storm. These coins skyrocketed in value during 2020, making billionaires of early investors… before values fell, that is.
Yet, it still seems like new coins and platforms are popping up every day.
And now, governments are racing to develop their own digital currencies to put some authority back into the hands of the central banking system.
It’s no question that digital payment systems and currencies will continue to impact the global financial system.
But the question is, is cash still king? Will digital currency replace paper money?
Plus, should you invest in digital currency?
What is Digital Currency?
Digital currency is thought of in two very different ways: one is that it is any form of digital cash, such as how you pay for online purchases, send electronic transfers, etc.
This type of digital currency is a digital form of the national currency, i.e., the US dollar or the euro. It’s tracked using bank account or credit card numbers through the traditional financial system and it holds the same market value as physical currency,
Cryptocurrency is another type of digital currency. Cryptocurrency, in particular, originated with the idea that people could both send and receive money digitally and anonymously, without being tracked.
Since their beginnings, cryptocurrencies, such as Bitcoin and Ethereum haven’t been tied to any national currency. Thus, their values are completely based on what people think they’re worth. Stablecoins, on the other hand, are cryptocurrencies that are supposed to be pegged to a national currency, like the dollar, but many have failed to retain their value.
Until, now, this is how people have thought of digital currency: digital dollars and cryptocurrencies. But, that’s all about to change…
Private Digital Currencies vs. Central Digital Currencies
Private digital currencies differ from central bank digital currencies in a few ways. Originally, private digital currencies like bitcoin and dogecoin were created to decentralize finance.
Cryptocurrencies, such as these, have no tie to any national government. Global government agencies have had a difficult time regulating cryptocurrency activities.
A central bank digital currency (CBDC), however, would very much be tied to the government. Money held as CBDC will be equivalent to a deposit at the central bank.
So, rather than depositing money into a commercial bank and paying for a purchase with a debit or credit card, you could theoretically deposit money into an account with the central bank and use your new central bank digital currency to make electronic payments. Ideally, it would be the most stable form of digital currency.
How the World is Taking Action
Many countries are beginning to implement a central bank digital currency, and the US may follow suit.
President Biden recently issued an executive order calling for research and development efforts into the potential design and deployment of a United States CBDC and the actions required to launch if a United States CBDC is deemed to be in the best national interest.
But it’s not just the US. China and Europe are working on their own versions of digital money too.
Why are central banks creating central bank digital currencies?
A few big reasons are to limit the monetary risk posed by digital currencies and to regain some control over what has been the wild wild West of industries. Central banks are responsible for the safety of the monetary system and private digital currencies pose a risk to that safety.
Let’s explore some of those risks.
The Risks of Digital Currency
Digital money is relatively new. With anything new, there’s always an inherent risk. But digital assets like cryptocurrency coins carry additional risks, including a high potential for theft and fraud and extreme volatility.
Here’s what you need to be aware of.
Cryptocurrencies, in particular, have been the subject of a lot of fraud. Because they’re held in a digital domain, they’re somewhat insecure and vulnerable to talented coders and hackers who want to steal them.
And once a digital currency is stolen, it’s incredibly difficult to retrieve. In 2021 alone, tens of thousands of crypto scams were reported, resulting in losses of more than $680 million. And the number of scams is only expected to grow.
Lack of Control
One of the reasons central banks are researching their own digital currencies is that they have little control over existing digital money.
Even digital payment apps like Apple Pay aren’t under the government’s authority. And crypto is a completely new realm with very little regulation.
When you invest in crypto, your money isn’t backed by any official institution. This means it’s not protected against fraud, loss, or theft.
Plus, cryptocurrency regulation could potentially harm the industry, leading to a devaluation of popular coins, which could crush investors.
With a CBDC, though, digital money would be federally insured. Any CBDC holdings would be protected through the federal reserve.
Not Widely Accepted
Unlike using a credit card to make digital payments, making purchases with cryptocurrency is highly impractical.
While some merchants have started accepting coins as payment, the majority don’t. And if you can’t use it when it’s worth something and it decreases in value, you could be in big trouble.
However, if a digital currency backed by the central bank starts to circulate, more merchants may accept digital currencies. Even then, they still may choose not to accept crypto.
Since their existence, digital currencies have been incredibly volatile.
No one knows whether they will go up or down in value — and most of them have no intrinsic value to peg them to. Their prices are based on speculation and hype.
While extreme price swings may be the reason some people are drawn to invest in crypto, it’s far too easy to lose everything. And Rule #1 of investing is “Don’t Lose Money.”
This lack of financial stability is one of the key reasons why crypto is not for value investors.
There are plenty of other types of investments that you can confidently put your money behind, without the fear of losing it all.
The Benefits of Digital Currency
There are a few benefits of digital currency, though. And if these benefits outweight the risks, it could mean a US CBDC is on the way.
For one, digital money makes online transactions, cross border payments, and consumer access to funds quick and easy.
We already have access to faster and cheaper payments through current modes of digital currency, so what’s different about a CBDC?
In the case of a CBDC, it could also provide a highly liquid safe-haven for funds. Currently most of the world’s cash is tied up in commercial banks, which are subject to the throws of the economy, as we saw in the crash of ’08.
A central bank digital currency could provide an alternative “safe” option for citizens to store their cash outside of regular bank accounts.
It’s important to note, however, that a CBDC would not be like the cryptocurrencies we’re seeing currently.
It wouldn’t be anonymous or decentralized, which are the key reasons people were drawn to cryptocurrency in the first place. Depending on your point of view, this could be a positive or a negative.
Will Digital Currency Replace Paper Money?
So, with all this talk of digital payments, will the cash beneath your mattress become irrelevant?
According to the Federal Reserve, instituting a central bank digital currency would be a means to expand safe payment options, not to reduce or replace cash.
They say they’re committed to ensuring the continued safety and availability of cash or paper currency. However, although no one can predict what may happen, the continued progression toward digital currencies may ultimately render cash obsolete.
But it could be decades before this occurs.
In the meantime, what should you do? Stay the course, and make smart investments in wonderful companies.
Is Digital Currency a Good Investment?
If you’re a Rule #1 investor, you already know how I feel about digital currencies like Bitcoin. I advise against investing in highly volatile, immeasurable, and speculative assets, and this includes cryptocurrencies.
While a central bank digital currency issued by the federal reserve bank does alleviate some of the risks associated with other digital currencies, it’s not likely to produce any real returns.
Rather, CBDCs issued by government agencies would be backed by the currency of that nation, meaning investing in one would be equivalent to investing in cash.
If you want to grow your wealth, you’re much better off investing in wonderful companies that can grow your money over time. To find great investments like this, grab my guide to The Four Ms For Successful Investing.
This guide will show you what it takes to qualify as a worthy investment — and digital currency, in my opinion, is not it.
Phil Town is an investment advisor, hedge fund manager, 3x NY Times Best-Selling Author, ex-Grand Canyon river guide, and former Lieutenant in the US Army Special Forces. He and his wife, Melissa, share a passion for horses, polo, and eventing. Phil’s goal is to help you learn how to invest and achieve financial independence.