Anonymity

An important quality of digital cash is that it has the potential of being entirely anonymous, through the use of mathematical “blinding” techniques, both with regards to usage and holdings. This means that, as with physical cash, there are few, if any, traces for the government or other institutions to survey.

When using credit cards, digital signatures are left that can be linked to the specific individual, describing where, when, and what was purchased for how much. This feature of credit cards has made many people claim that technological developments lead to greater control by the state or government over the individual. The anonymity of digital cash would be a development in the opposite direction. In other words, the widespread use of digital cash would render the prospect of a 1984 scenario, in which governmental surveillance creates a society of fear, suspicion, and suppression unlikely, and act as a guarantor of individual freedoms. Of course, all of this remains to be seen!

This anonymity does have its drawbacks, however. One example of this is criminal cases in which evidence of financial transactions are often integral requirements for correct judgement and sentencing. Thus, the financial anonymity of digital cash can make it harder to convict criminals than it might otherwise have been.

Anonymous financial transactions and holdings also make it generally easier for money laundering to take place. It can be argued, however, that this is relatively easy as it is today with few currency controls and falling costs of overseas banking. With the advent of anonymous digital cash, the costs and risks associated with money laundering would fall considerably. Tax evasion would also become easier for similar reasons.

Just as the increasing ease of international capital movements has caused governments worldwide to shift the burden of taxation from mobile to stationary capital, one consequence of the reduced disincentives to evade taxes may be increased taxation of geographically fixed assets. Hassle-free money laundering could lead to the extension of organized crime.

The End of Fiat

An intriguing property of digital cash is that, in theory, anyone can issue it, and it is by no means clear that banks will be the most successful players. The be all and end all of a successful currency is confidence, and the issuers who command respect among consumers have a huge advantage over others. Companies like Microsoft, Visa, and Coca-Cola would, therefore, have a good base from which to start due to their impeccable reputations and solid brand names.

An important determinant for which currencies will be accepted and trusted by consumers is what they are backed up with. At present, the vast majority of currencies are fiat-based (not to be confused with Fiat, the Turin, Italy-based car company). This means that they have no intrinsic value and are not linked to anything of market value. The only reason why people accept such paper currencies is that they expect everyone else to do the same.

Such a system, however, could not possibly originate from scratch. Digital currencies would, therefore, either have to be proxies for governmentally issued currencies, so that for instance, one “Coca-Cola-Dollar” can be exchanged into 3 USD, or backed by assets, such as precious metals, equities, or bonds in a fixed ratio.

Which of these two routes would dominate depends largely on the performance and reliability of the governmentally issued currencies. But, comparative economic studies show that currencies based on, for instance, precious metals are more reliable and stable than fiat currencies. This is exemplified by the successful operation of the pre-World War I gold standard, which played an integral part in the “Golden Age” of market liberalism.

Currency Competition Restored

Another implication of the prospect of digital cash is increased currency competition. In the current situation, currency competition is limited to competition among the various governmentally issued currencies. This means that if you distrust your local currency, as many people in Asia do at present, you may choose to accept only USD or GBP, and choose to keep your cash holdings in these currencies. The currency competition is, however, presently limited by the relatively dominant position of a local currency in an economy.

Currency competition has increased in recent years as a result of deregulation of financial transactions and currency regulation falling out of fashion. Some industry analysts claim that they can already see the results of this in the relatively stable, noninflationary period that major currencies, such as USD, DM, and sterling, have experienced.

Digital cash offers the prospect of competition much more intensive and extensive than what exists at present. The various players would have to compete on qualities, such as inflation, reliability, stability, confidence, and ease of use.

For private banks, there is an incentive to push the level of fractional reserve banking as high as possible. This means that they issue more in terms of credit letters such as loans, short-term credits, and, potentially, digital cash, than they have reserves to repay, by gambling on the unlikelihood that a majority of their creditors will want to withdraw their funds simultaneously.

The market mechanism balances this incentive to hold fractional reserves with the consumers’ desire for minimal risk (and, thus, a high ratio of assets to credits). The free operation of currency competition would thus drive the process toward the ideal balance according to the preferences of the consumers.

Consumers would probably get information about the reliability of the various digital currencies through the media and special consumer interest groups, and through the development of brand name reputations in the same way as they do with goods such as cars and furniture today.

Regulating the Regulators

The widespread use of digital cash would redefine the role of regulators, such as central banks and the Federal Reserve. With the establishment of a competitive market in which the laws of supply and demand determine the nature of the currencies in use governmentally, supplied currencies would either have to compete in accordance with the preferences of the consumers or obtain special privileges. Given the immense financial security of most major governments compared with most corporations, it seems likely that governments, if sufficiently aware of the situation, would be able to compete on equal if not better terms than the private sector.

When it comes to regulating the digital cash industry, however, governments would face severe difficulties due to its international nature. If a particular government decided to place restrictions on, or even forbid, the use of privately issued digital cash, nothing could keep the citizens of that very country from using digital cash issued abroad.

The only way in which it would be possible to effectively limit the use of digital cash, would be if a broad coalition of governments issued a collaborative policy to this purpose. Even then, small countries could act as free zones for digital cash issuance in the same way as they do with regards to offshore banking today.

The current failure of governments to effectively combat illegal material on the Internet shows that the ongoing developments of information technology place real restrictions on the governments’ power and that, in the absence of extensive and effective international agreements, digital cash would face very limited threats from the regulators.

Also worth noting is that some regulators seem reluctant to regulate digital cash. In particular, Alan Greenspan, of the U.S. Federal Reserve, has taken a surprisingly noninterventionist approach. This may be due to his background in Austrian economics, which advocates free banking and return to the gold standard.