From Barter to Bitcoin: Part 4 – digital money

The Disappearing Currency

When was the last time you made a payment with cash? Or the last time you saw someone carrying cash? Today, a majority of monetary transactions are done using credit cards or a variety of payment platforms (like in India, GPay, PhonePe, Paytm, BHIM most of which are using the amazing UPI – a true made in India initiative). Digital money is omnipresent. We are today in the e-money era where plastic money, internet banking and contactless payments dominate all transactions and the physical currency is fast disappearing. In fact, it is not inconceivable that the physical currency will slowly disappear just as the gold support to the physical currency once did.

In the past, physical money was always backed by something. For instance, every dollar was backed by $0.40 worth of Gold until the dollar was set free by president Richard Nixon in 1971. The value of metal coins or paper money was then guaranteed by governments. When transactions started to happen mostly with paper money, governments started to slowly become oblivious to the ratio of the physical currency to precious metals available. Soon, paper money became completely disconnected with precious metals and people only trusted governments for the value of money. In the current world, however, this trust in governments is diminishing. We are now moving away to a decentralised form of currency.  Over time, this gave way to plastic money and then to digital money that proliferates today.

The Plastic Money

The first ever store card that became popular was the Diners Club Card. The card’s founder, Frank McNamara, created the card in 1950 as a result of wanting to leave his wallet at home while dining out. People who used this card would be charged for their meal with the card. Then, the restaurant would send the bill to the Diners Club. In turn, the Diners Club would send payment to the restaurant on which they’d earn a small commission. Cardholders would be required to pay the amount at the end of every month to Diners Club. In 1958, American Express came up with the first charge card. Later, in the 1960s, Forrest Parry invented the first credit card with a magnetic strip. 

Advent of internet and online banking

In 1983 an extraordinary invention took place: the Internet. The way people connected significantly changed with this invention. In 1993, The Stanford Federal Credit Union became the first ever financial institution to offer online banking. Seeing the success of online banking, other banks took an interest in this convenient method. Not long after, an all-digital bank known as Ally Bank was founded in 2009. In addition to checking, savings and CD accounts, Ally bank provides loans, investing and retirement services. Today, nearly two thirds of the US population uses digital banking. Similarly, about 90% of India’s population signed up for a digital ID within a decade of 2010 and half of them linked this ID to their bank account. Online banking has become ubiquitous with consumers having access to their accounts 24/7. They can keep track of their accounts from anywhere and on any device. The recent pandemic forced people to manage money remotely which caused a sharp rise in people using mobile-apps for banking. While digital banking went through a rapid growth in recent years, traditional bank branches began to close.

The unified payments interface (UPI) is an interface through which you can transfer money across banks in India. Using this mechanism, you can send or receive money or scan a QR code to make a payment. All you need to make a payment is a single mobile application and a particular UPI code. You can easily make a payment without having to go through a long process. This interface is free of charge, making it accessible for anyone. UPI was launched in 2016 by the National Payments Corporation of India (NPCI) that’s governed by the Reserve Bank of India. Its main goal was to drive India towards a digital economy. With payments becoming so convenient, the need for physical currency has also been getting diluted. Even extremely low value transactions (like Rs 5 or 10) can be done online without incurring any transaction cost.

When the Gold Standard existed, each bank note was backed by gold in a 1:1 ratio. Gradually, this ratio became diluted. Later, one dollar was backed by only $0.40 worth of gold. Then currencies became completely dissociated with gold and the supply of money proliferated. As the world moved to a digital age, the physical money in supply became limited and digital money became unlimited. In fact, today, about 95% of the all global money supply exists only on computer servers; coins and banknotes (the physical currency) constitute only about 5%. Fiat money and then digital money was backed by trust in the governments, banks and banking systems. But what happens if this trust erodes? Theoretically, it would take people holding just 5% of the money around the world to bring down the entire banking system. 

With the world becoming increasingly connected digitally and trust becoming a depleting resource, a trustless, decentralized currency system was an idea just waiting to happen.