The notion of using money placed online to make payments has been floated numerous times since the day the internet became a part of daily life. Digital currency, electronic cash, and electronic money are terms that have been used for more than 30 years.
The concept makes perfect sense. When we make a cash payment, we simply give the recipient cash (banknotes or coins) to finalize the transaction. It is therefore simple to imagine having some type of digital cash and sending such digital coins or banknotes to the recipient when making an online payment.
About every ten years, the idea of digitizing money returns. The first wave, which occurred roughly 30 years ago, led to the development of electronic money. Prepaid or stored-value cards were the first forms of electronic money. A computer chip that was integrated into a plastic card included financial information. Payments could be made at specialized payment terminals and the card could be topped up at ATMs. Avant was one of the first such cards ever offered by the Bank of Finland, but many other markets afterward saw the development of comparable products. There were numerous other cards, including Mondex and Geldkarte. Due to the flaws in the idea, none of them exist today. The use of credit and debit cards was superior.
Ten years or so after the invention of e-money, the concept of “digital money” was once more proposed. This time, digital currency came in the form of cryptocurrencies rather than prepaid cards. But cryptocurrencies also turned out to be defective, just like e-money did previously. They also never spread to be a common form of payment. They are difficult to use and expensive to run, just like e-money. Although they didn’t completely vanish, cryptocurrencies gained popularity as a distinct product category. They do not function as payment items but rather as collectibles or speculative investment products.
Digital money’s third wave only recently began. This time, central banks are once more considering the possibility of digitizing money. The same concepts and exact solutions are being discussed once more. What we currently refer to as CBDC is very similar to what we referred to as e-money thirty years ago. The Bank of Finland’s Avant initiative is more proof that the same commodity could be referred to as CBDC in one age and e-money in another.
A crucial aspect of making payments in a digital environment is overlooked by these three generations of digital money: digital payments don’t require digital money. The notion of delivering digital coins or banknotes in place of actual currency is oversimplified and takes us in the wrong direction.
Again, digital payments do not require digital currency. The magic of digital payments is that they don’t require the digitization of money. We can continue to use physical money and still make internet payments. That is the true innovation, the epiphany that every person working in this field should have.
How then do payment systems operate? You need banks first. In essence, a bank is a storage facility for cash. The money is placed there, and it remains there. The bank protects the funds and maintains track of how much is in each person’s account. The math isn’t that difficult.
You also require a messaging system. By the way, the internet is essentially a communications system. You can make payment messages that are digitally signed by an account holder using the messaging system. When the bank receives a payment message, they first verify that it is genuine—that is, that it is signed by the account holder—and only then do they make the necessary account adjustments. Never does the money leave the bank. You don’t need to digitize it because of this.
No matter what you name it—e-money, cryptocurrency, or CBDC—trying to digitize money won’t make the payment system better. It already functions flawlessly. It’s not damaged. It can certainly be made quicker, safer, more smooth, and more automated, but the reasoning at its core will remain the same. Any attempt to create a new “digital money”-based payment system will be less effective, less user-friendly, and doomed to failure.
If we discuss CBDC, we can consider whether the payment system should be managed by a public agency or by the private sector. That is a valid query. It’s a whole different kind of problem, but each strategy offers advantages and disadvantages. Payments can be improved by several technologies and regulations, but digitizing money is the wrong approach.