Wednesday, July 3, 2019

Redefining money in a digital age

Economics textbooks use a definition of money as an asset that can be used as a means of payment, that constitutes a unit of account and serves as a store of value. This definition is being used often in debates about new forms of digital money and payments (including cryptocurrencies).

I would like to argue that this characterization of money is
a) not a definition
b) not a very useful one to compare alternative forms of payment
c) fails to understand how digital payments and new technologies have changed the nature of money

Let's deconstruct the "definition" to see what is wrong with it. 

Unit of account and store of value

Prices and wages are denominated in a unit of account that we identify with money or the currency.  This one is quite straightforward but we cannot rule out a world with multiple units of accounts. There are countries where we have several currencies being used in parallel which does not stop people from using different forms of money. At a much smaller scale:
- when you travel abroad, you use your debit card to do a purchase in a different unit of account
- Bitcoin based debit cards (such as bitpay) allow you to use Bitcoin to pay for goods and services priced in US dollars
- Libra (the new currency launched by Facebook and partners) is also likely to follow this model

Aren't all these examples forms of money? They are. Of course, different units of account add risk and volatility. The risks will depend on how the value of these assets correlate with the value of your other assets, your income,... Individuals will have to understand the trade offs between these risks and potential features that these new forms of money provide (more on this later).

In some sense this is linked to the idea of money as a store of value. All assets are a store value. When we say that money is a store of value we typically mean is a "stable store of value". And stability depends on its intended use. It is reasonable to argue that that an asset whose main function is to facilitate payments should be stable in value relative to the price of goods and services (and this can be guaranteed by a stable and low inflation rate). But we can have competition here as well. 

Asset that can be used as a means of payment

Here is where things get much more interesting. Paper money is an asset (owned by the person holding it) that can be used to buy goods and services by exchanging the physical piece of paper. No separation between the asset and payment.

But when payments are electronic, the connection between the asset (the value being exchanged) and the payment is not straightforward. Economic textbooks already struggle with this. They think of different assets according to how close they are to "cash", the most liquid asset. They already admit that it is a matter of degree (how liquid an asset is) and not a question on whether an asset is "money" or not. So they label a "checking account" as money because one can write checks (yes, checks!) or use debit/credit cards to access its value for payments. But there are plenty of other bank accounts that can easily be made liquid by transferring its balance to the checking account. Because of this lack of clarity, we produce a set of measures of money depending on how liquid those assets are (M1, M2, M3,...).  

So textbooks already acknowledge that there is no obvious definition of a liquid asset, that it is a matter of degree. But what new technologies have done for us is make that definition even blurrier. 

I would argue that to make sense of these new technologies, we need to deconstruct money and separate the asset, its value and possibly other characteristics of it from the payment technology. Something that was impossible with a bank note but that is required when it comes to electronic payments. 

A payment involves two (possibly distinct) elements:

1. A balance of value (an asset) that is being held in accounts that possibly have features that are unrelated to payments (one might collect an interest rate on the balance, the institution holding the balance offer deposit insurance, or guarantees against cybercrime, fraud, etc.).

2. The payment technology that access the value of the asset and transfers it to someone else. This technology requires an infrastructure that might require many pieces. For example:

    a) a network that connects the institutions holding the money
    b) a protocol, governance rules on how this network operates
    c) a device that allows users to access those accounts (a debit card, a cheque, a smartphone,...)
    d) a way for users to identify themselves in a way that is secure
    e) the ability to do anonymous transactions

Different payment technologies come with different features that might reduce the costs of using them (or their risks) and make them better forms of payment. All of these technologies could potentially be accessing the same asset, the same balance stored in the same institution. But they might not as well. It might be that accessing that balance is impossible for technical, regulatory or other reasons and then the payments technology comes with its own form of money. 

Here are some examples:

- M-Pesa redefined money and payments together by providing balances through mobile telephony operators and accessing those balances via telephones.

- Bitcoin also redefined money and payments together through the creation of a universal repository of money ("we all bank at the same bank") and a technology to execute payments on these assets

- Bitcoin debit cards (such as bitpay) allow you to use your Bitcoin balance to do purchases in any store even if prices are denominated in a different currency. Money (your Bitcoin balance) is separate from the payments technology

- Wechat, Paypal, Apple Cash and many others use a separate payment technology to access assets which might be located in your traditional depository institution, your bank. You can connect your bank account to the payment technology and separate the two (and you can also hold a balance within their own system if you prefer to do so). In some countries (Europe, Singapore,...) regulation is pushing for these type of solutions by forcing banks to open up their systems to external payment technologies.

What all these examples show is that the definition of money and payments has become much more fluid than in the past. Using the three traditional criteria to compare alternative forms of money is not very useful. What we need to do is deconstruct the properties of both money and the payment technologies to understand the features that make one solution better than others. Given current technology trends, it is likely that we end up with a continuum of technologies involving more than one unit of account, assets stored in different types of institutions (from mobile telephone companies to banks to large tech companies to cryptocurrencies), being accessed through a variety of payments technologies that involve different players (your smartphone manufacturer, your social media account, your bank, credit card companies).

Antonio Fatas

on July 03, 2019 |   Edit