Private Crypto Versus Public Digital

Governments have been creating public “fiat money”—financial instruments such as paper notes used to buy goods and services or repay debts, with no backing from physical assets such as gold or silver—for more than 1,000 years. Banks have been creating private money even longer, whenever they receive deposits and then make loans. For the past 15 years, non-bank entities also have been creating a new form of private money by promoting crypto assets such as Bitcoin and Ethereum as well as tokens and stable coins such as Tether, BNB, FTT, and XRP. In some cases, the result has been to create “something out of nothing” when crypto prices increased, sometimes exponentially. In other cases, the result has been “nothing out of something” when customer accounts lost all or most of their value.

All crypto assets in 2024 amounted to only 0.5% of the world’s money supply.²⁵ But they have enabled a lot of troublesome speculative behavior as well as illicit activities such as money laundering and tax evasion, financial scandals, illegal gambling, and financing of terrorism and the drug trade. Some governments would like to provide alternatives. China’s central bank introduced a digital yuan in 2020 that now has 260 million user wallets in 25 cities.^2,13 Sweden is contemplating a digital e-krona and would like to eliminate all cash, someday.³¹ The U.S. Federal Reserve has said the possibility of issuing a digital dollar is “slim to none.”² Nonetheless, at least 100 countries are studying what are called Central Bank Digital Currencies (CBDCs), including the U.K.^a,4,27

Central bank “digital currencies” are or would be public, whereas “cryptocurrencies” (a particular type of digital currency that relies on cryptographic encryption algorithms for security) are private.¹⁷ This means public digital currencies would be backed by central bank reserves, just like paper money or federally insured bank deposits. They would replace some cash with digital technology, but this goal itself seems secondary or unnecessary. Approximately 85%–90% of financial transactions in the U.K. and the U.S. are already electronic and, therefore, digital. Some 95% of money in these economies is also electronic, held in private bank (or money market) accounts.^4,30

So, do we really need public digital currencies? Some experts say no, current forms of electronic money and payment systems are adequate.^7,28 But one argument in favor is that CBDCs could be combined with better security and new payment technologies like blockchain-based smart contracts (though this technology could also be introduced for existing payment systems). New systems could be faster, cheaper, more secure, and serve as both transaction and innovation platforms, facilitating payments while enabling third parties to create new products and services, as occurred with smartphone app ecosystems.⁹ What needs sorting out are the pluses and minuses of public versus private digital currencies, as well as the implications of governments competing with private crypto and existing electronic payment systems.

Platforms and the Chicken-or-Egg Problem

At the moment of creation, all two-sided platforms face a “chicken-or-egg problem.” They must be accepted by two parties, such as buyers and sellers, or debt holders and debtors. You cannot have a new currency or currency exchange platform without acceptance from two sides, just like you cannot have ride-hailing services without drivers and riders, or smartphones without users and applications. The challenge is that multisided platforms have to start somewhere and they usually need a second side to appear at the same time. Solving this problem is necessary to generate network effects, the self-reinforcing positive feedback loops that increase a platform’s value with each additional user or complementary innovation. Network effects in particular increase liquidity in financial markets: The more people who accept a new digital currency, the more universal and reliable (for example, stable in value) it becomes as a payment platform.

There are at least three ways to attack the chicken-or-egg problem.⁹ One is to offer “standalone value” first, and then enable multisided platform interactions. Open Table started by selling table management software to restaurants—a standalone enterprise software product. Then, after a large number of restaurants became its customers, it opened up a second market side—diners. The new platform enabled diners to make reservations directly with Open Table.¹⁴ Other examples: Amazon offered standalone value by buying and reselling for its online store and then five years later added a two-sided marketplace linking buyers and sellers directly. Apple introduced the iPhone with bundled applications and then a year later opened the Apple Store to link app developers with users.

A second strategy is to subsidize two market sides simultaneously to encourage them to connect. Uber has done this by paying drivers to be available or offering bonuses not tied to rider fares while providing discounts to riders. (Two-sided subsidies can be expensive, though. Uber has lost about $30 billion since it was founded.¹⁰) A third strategy is to zig-zag between the two sides that make up the platform, subsidizing the most important side as the platform expands. Facebook did this by linking friends and friends of friends at one and then a few colleges, then more colleges, then high schools, and then adults and organizations, but always subsidizing users by making access to the social network free and then charging advertisers. Credit card companies and partner banks brought some customers and merchants onto their platforms simultaneously, but then zig-zagged through other types of customers and merchants while offering discounts or benefits both to individuals and merchants.

Bitcoin and Ethereum offer standalone value to speculators and scofflaws as long as someone is willing to convert them into some other store of value, though this can become illegal. For example, the popular Binance exchange accepted crypto deposits from activities such as darknet market transactions, ransomware attacks, and various financial scams, and then converted these deposits into or mixed them with fiat currencies.²⁰

CBDCs would immediately offer standalone value as well, and more stable value—equal to cash. Moreover, if superior technology accompanies a new digital currency that makes payments easier, cheaper, and more secure than credit or debit cards or other electronic payment options, then people and merchants will increasingly use it. If a new system is cumbersome and expensive, then it will fail. The challenge for governments and their central banks is to figure out where to start and then how to encourage wide adoption.

Negatives of Crypto Currencies and Exchanges

Probably the biggest obstacle to using crypto as a currency is the value on any given day depends heavily on speculation as well as algorithmic limits on supply. Bitcoin’s initial value, when first traded in July 2010, was merely a fraction of a penny ($0.0008).²⁴ During 2023–2024, the value ranged from $16,000 to more than $71,000. Bitcoin and Ethereum are accepted by some merchants and so they do sometimes function as private digital money. However, except for El Salvador and the Central African Republic, no countries have made crypto legal tender, requiring acceptance (although this is likely to change).³

Absolute anonymity and security or no-fee payments have never been guaranteed for crypto users. Crypto has always required an ecosystem of exchanges and wallet holders that will charge for transactions if users want to move their holdings back and forth with bank or money market accounts.¹¹ Hackers also have found ways to get into crypto wallets or disrupt blockchain transactions. Government authorities have traced crypto transactions and identified account owners.

Crypto exchanges and investment funds also can collapse almost overnight and will get no automatic government bailouts or deposit insurance unless legislation changes. FTX was a crypto exchange that offered its own FTT tokens and loaned money to customers (and to itself), based on the value of those tokens. The company went from a peak valuation of $32 billion to zero, losing nearly $9 billion in customer money. The CEO and other executives are in jail. Because of profitable venture capital investments, FTX in bankruptcy will likely return all lost customer money.²¹ FTX clients are lucky.

Private stable coins not backed by central bank reserves seek to minimize large fluctuations in their value, but they also have downsides. Tether has been the most popular, and the value of its circulated tokens recently exceeded that of Bitcoin. The iFinex holding company that issues Tether uses cash reserves to keep its value pegged 1:1 to the U.S. dollar or other currencies. There are daily website updates on reserves, which indicate the holding company can cover about 89% of the $112 billion in circulation.^b,23 Sometimes Tether tokens do serve as money but more often they function as speculative investments and financial instruments that companies use to raise money, substituting for stock or bond offerings.¹⁹ The company also has made loans denominated in Tether to investors who may not be able to pay these loans back in fiat currencies.¹⁵ And Tether tokens have financed terrorist organizations as well as illegal Chinese fentanyl suppliers, the North Korean nuclear program, and sanctioned Russian oligarchs.¹⁶ Binance also issues its own BNB tokens, though, in November 2023, it paid a $4.3 billion fine to the U.S. Department of Justice to settle criminal charges for money laundering.²⁶ The CEO was also sentenced to four months in jail.⁵

The legal status of crypto remains confusing and varies by country. Since 2014, the U.S. Internal Revenue Service has treated crypto as “digital assets” subject to capital gains or ordinary income taxes, depending on how long they are held.²² In July 2023, U.S. courts decided to allow buyers and sellers to treat crypto as “digital currencies,” if used for retail purchases.²⁹ Meanwhile, the U.S. Securities and Exchange Commission (SEC) has tried to regulate crypto exchanges similar to how it regulates stock exchanges but, under lobbying pressure, the House of Representatives (but not the Senate) voted to give oversight authority to the Commodity Futures Trading Commission (CFTC).⁶ Whether crypto assets are securities or currencies also has been the subject of litigation led by the SEC, with mixed decisions. For example, a July 2023 court case found that Ripple Lab’s direct sales of its XRP tokens to hedge funds and other investors was the same as unlawful sales of unregistered securities. At the same time, though, the judge concluded that the sale of tokens on open crypto exchanges was legal.¹⁸ Another ongoing case is the SEC versus Coinbase, the largest U.S. crypto exchange, for failing to register as a securities broker.¹² By contrast, China, a major source of cryptocurrency mining, avoided these controversies simply by banning crypto exchanges in 2017 and crypto transactions in 2021.¹³

Positives of Central Bank Digital Currencies

The major advantage of CBDCs is government-backing; their value is extremely unlikely to fall to zero. The stable value should eliminate speculation—but only if central banks do not overly restrict the amount of their digital currencies in circulation. That is not at present what countries are doing or planning. Digital currencies will be as secure as crypto currencies in that both will rely on computer-based cryptography and blockchains or centralized ledgers. But scarcity and lower transaction fees could discourage use or lead to hoarding and black markets.

A stated objective of the Bank of England’s digital pound study would be to introduce modern platform technology that encourages ecosystem innovations.⁴ Electronic transfers, debit cards, and paper checks all rely on banks, while credit cards eventually also link to bank accounts. These private payment systems have relatively high transaction fees (particularly for international payments) and use older technology that can take days to reconcile charges and balances. Nor do the older systems deploy the latest databases and cryptography. By contrast, public digital currencies could come with modern software containers and digital wrappers with open application programming interfaces (APIs) that allow programmers to embed easier and cheaper payment mechanisms for different products and services. If adoption spreads, more users will be able to send money peer-to-peer, without going through banks or credit cards and paying their higher fees. Senders and receivers will both need digital wallets, although these could easily be downloaded from smartphone app stores and connected to existing phone numbers, social security numbers, or bank and money market accounts.¹

Of course, digital currencies will reduce the need for governments to manufacture, transport, and store paper notes or physical coins, though some people will always prefer the convenience and anonymity of cash. And governments could more easily and cheaply send or receive payments, such as public-servant salaries, taxes and refunds, or fees. Since central banks would maintain the blockchains or central ledgers, the potential ability of law enforcement to intervene and expose the electronic trail of a digital currency would likely discourage criminal behavior.

Another benefit would be to bring easier and cheaper electronic payments to individuals who do not have bank accounts or credit cards. They will still need access to smartphones or computers and the Internet. And CBDCs may provide alternative ways to access or spend digital money, such as via smartcards or new ATMs. There also would have to be some means of facilitating offline payments if a user or merchant does not have ready access to the Internet, such as through the banking system.

New Solution or New Problem?

Some governments are ready to innovate, but private crypto is unlikely to disappear. Speculators will still want to bet on crypto assets. Scofflaws will still want anonymity to hide their identities and transactions. And regular citizens will still want incentives to move money out of interest-bearing accounts and into public wallets.

So, how will governments solve their chicken-or-egg problem? Central banks can offer to pay interest on money in public wallets, even though this benefit and funding the payment system could become expensive, like a two-sided subsidy. Governments can use new digital currencies themselves, such as to pay their employee salaries and other expenses. Governments can mandate use or offer discounts, such as when paying taxes or government fees with public digital currencies. More governments might outlaw crypto, as China has done, if for no other reason than the enormous waste of energy in Bitcoin mining.

Banks, credit card companies, and electronic payment firms like PayPal and Venmo are likely to protest loudly, along with crypto businesses. Public digital currencies paired with modern platform technology could “disintermediate” them by offering an alternative means for electronic payments, presumably with lower fees, probably subsidized by taxpayers. Then there is the thorny issue of privacy. Governments may promise to protect private information unless there is evidence of criminal behavior. But there is serious concern that public digital currencies and payment platforms will give governments too much power to track how individuals and organizations spend and receive money.⁸ That battle is just beginning.