The future of money is digital, but is it Bitcoin?

The idea that much of today's cash use will shift to digital tokens is neither faddish nor outlandish, as long as you don't start equating the future of money with Bitcoin.

Sure, governments will borrow some elements of the distributed ledger technology behind private cryptocurrencies, but they will very much want to retain control of what circulates as money in their economies. Some will succeed.

Don't be surprised if by the end of the current decade, the e-wallet on your smartphone resembles a multicurrency account. But instead of dealing with commercial banks, you may be a customer of central banks. Several of them, in fact. 

Sound far-fetched? Apart from the Bahamian Sand Dollar, there's no official online currency in mass circulation yet. Still, digital yuan pilots are gathering pace as Beijing aims for a possible rollout coinciding with the 2022 Winter Olympics. Sweden may be the next major nation to follow suit. The Bank of Japan has no immediate plans, but it acknowledges the possibility "of a surge in public demand" for official digital cash going forward.

Even in the U.S., which is only toying with the concept, digital payment vehicles that don't rely on traditional bank accounts can increase financial inclusion among cash users, according to a September 2020 paper by Federal Reserve Bank of Atlanta President Raphael Bostic and others. Treasury Secretary Janet Yellen says a digital dollar is "absolutely worth looking at."

Once China and the U.S. are both in the fray, virtual money is bound to become a tool for wielding global influence by carving up the world into new currency blocs. That's because any token will have dual uses outside the issuing nation's borders. The dollar or yuan that pops up in a phone wallet in Indonesia or India — backed by a solemn promise of taxpayers in the U.S. or China — could be used for buying goods, services or assets internationally.

Just as easily, this new money can end up replacing domestic currency in people's daily lives. Although this is no different from traditional dollarization that occurs in countries plagued by inflation and exchange rate volatility, the convenience and accessibility of central bank-issued digital cash could enable "substitution at a faster pace and larger scale," according to Tao Zhang, a deputy managing director at the International Monetary Fund.

To stay in control of monetary policy, authorities in smaller economies will need their tokens to be attractive in domestic situations. The goal for bigger nations may be different: China and the U.S. may want to offer add-ons that make the e-CNY or the FedCoin the preferred choice for foreigners in settling international claims. 

An efficient future will be one in which all central banks' digital currencies are interoperable. In other words, they'll interact with one another — and with private-sector alternatives including Bitcoin, says Sky Guo, the chief executive of Cypherium. The U.S. enterprise blockchain startup is a member of the Fed's Faster Payments Council and of the digital monetary institute of the Official Monetary and Financial Institutions Forum, or OMFIF, a central banking think tank.

Guo is working on the challenges that will arise when sovereign money gets digitized: How to process high volumes of transactions quickly, cheaply, and with a strong consensus among registries updated automatically across a network? How to give people a sense of privacy in everyday payments, even after the anonymity of cash is lost?

Central banks will have to make choices. Not all smartphones can run advanced virtual machines, effortlessly executing the software code for automated contracts. Choose the wrong technology, and the unbanked population might once again get excluded. Ditto for overseas remittances, a $124 trillion-a-year opportunity for tokens to replace an expensive network of correspondent banks moving money by exchanging SWIFT messages. But it won't work for small transfers if the computing power to verify transactions in a decentralized network costs too much. 

The ideal technology doesn't necessarily have to be a blockchain, but it should be something "lightweight, flexible and capable of working with legacy systems," Guo says. Above all, the distributed ledger must be transparent.

There will be other obstacles. "A driving force for lobbying against central bank digital currencies has been established among payment processing giants like PayPal, Venmo and Stripe," Guo tells me. "FedCoin won't need these intermediaries to send funds. As these companies fall victim to innovation, it'll be interesting to see how they try to protect themselves from disruption." 

Andy Mukherjee.

PayPal Holdings Inc., which owns the person-to-person service Venmo, contests Guo's assertion as false. Supporting and distributing central bank digital currencies is part of PayPal's vision of an inclusive future, Chief Executive Officer Dan Schulman told investors last month. Former Bank of England Governor Mike Carney, who has proposed an alternative to the dollar through a network of central bank digital currencies, recently joined the board of Stripe Inc.

One way to resolve the tension may be to co-opt the private sector. As IMF economists Tobias Adrian and Tommaso Mancini-Griffoli have argued, an official virtual currency could be like Apple's iOS operating system, with commercial banks and e-money providers running apps on top of it. The Apple Health app may be fine for a lay user; an athlete will want something more sophisticated. Money could go the same way.

Countries will also have to cooperate with one another. Take m-CBDC Bridge. The project for 24/7 cross-border remittances using central bank digital currencies was begun by the Hong Kong Monetary Authority and the Bank of Thailand, but has now been joined by the central bank of the United Arab Emirates and the People's Bank of China.  

Many emerging-market central banks might think that to retain control of their nations' money, they must chain the population to using a single virtual token — the one they've issued. But that may simply encourage mass migration to private cryptocurrencies that are pegged to legal tender and, therefore, less volatile. Diem, as the formerly Facebook Inc.-backed Libra project is now known, could be one such stablecoin. 

Sovereign currency issuers will have to think of themselves less as lords and masters and more as service providers in a free market of digital cash. After all, they'll be pushing their products into crowded wallets and hoping that we like them more than a rival offering from another central bank. Those that lose the plot might lose their citizens' loyalty.