The days of cold, hard cash are numbered. What will the shift to digital currency mean for investors?
Let’s face it, it’s pretty unusual to pay for anything with cash these days. It will only get more unusual as the world continues shifting toward digital currency. However, this shift will not be easy, and it may create some risks. Let’s start with the basics of digital and cryptocurrencies and their advantages and disadvantages, the risks and opportunities for investors, and what it all means for income investors, specifically.
Digital Currency Decrypted
Very simply, digital currency is any form of currency available only in digital or electronic form. Electronic versions of currency already dominate most countries’ financial systems. In the US, physical currency now makes up only one-tenth of the overall money supply. The rest, while based on the dollar, is held in banks in electronic form. But what makes digital currency different from the electronic money currently in your bank account is that it never takes physical form. It always remains on a computer network and is exchanged digitally. Currently, digital currencies are most broadly used among certain online communities, but that’s changing. Many small and online businesses now allow purchases with Bitcoin and other forms of digital currency. So do popular shopping sites like Etsy and Overstock.
Does the shift to digital currency mean we will all be paying for everything with Bitcoin in a couple of years? Probably not. It’s more likely we will have an established CBDC – a Central Bank Digital Currency – backed and regulated by the federal government. While it only exists in concept right now, at least 80 percent of the Central Banks around the world are running experiments on a CBDC. All of this is putting pressure on our own Fed to move forward quickly on an American CBDC. Even more pressure is coming from the expanding popularity of Bitcoin. Bitcoin, Ethereum, and other cryptocurrencies are a subset of digital currency that exist in unregulated form. They are controlled by their developers and use cryptography to verify transactions, and to manage the creation of new currency. Cryptocurrencies have been hot among speculative investors for years now. The question is, will that change, and if so, how?
The Digital Advantage
Digital currencies offer many advantages over physical currency. The main one is that transactions are made directly between a buyer and seller without the need for an intermediary like a bank. That makes them faster and cheaper. They also offer constant access. Currently, electronic money transfers that take place outside normal business hours can take longer. With digital currency, transactions work at the same speed 24/7. A digital system would also make government payments more efficient. With a CBDC, Uncle Sam could deliver your tax refund or Social Security benefit instantly rather than mailing you a check. Since all digital financial transactions are electronic, the need for transparency and documentation is automatically covered.
Currently, one major disadvantage to digital currency is confusion. There are so many cryptocurrencies being created across so many different networks that it is hard to keep them straight. Adding a CBDC to the mix would increase the confusion for consumers, which is just one of the many challenges facing the Fed. Another is the learning curve. Digital currencies take work to learn how to perform basic tasks. The entire system will need to get simpler for it to work more broadly.Another challenge is security and ensuring consumers that their digital accounts are safe from cyberattacks. Developing a CBDC will not only take time, but it will cost money – meaning your tax dollars. Finally, digital currencies have so far proven to be very volatile.
Impact on Investors
It is impossible to discuss digital currency without mentioning the impact this sector has already had on the financial markets, particularly among speculative investors. The topic is even more important now that Coinbase has become the first major cryptocurrency start-up to go public in the US stock market. Based in California, Coinbase allows people to buy and sell about 90 different cryptocurrencies, and the company went public in April. That’s significant because it means everyday investors who may have been nervous about getting in on the digital currency craze can now buy stock in a company registered with the SEC. That might make the entire prospect seem less speculative and less risky. But beware. Believing any kind of hype about a certain market sector or a specific new public offering is always risky. It can also greatly increase your overall risk if you adjust your portfolio based on the hype – especially if the adjustment involves putting all or most of your eggs into one basket.
Keep in mind that, according to a University of Florida study, most initial public offerings lose investors’ money within five years. Most importantly, keep in mind that every financial risk you take after age 50 is even more risky because you no longer have a lot of time to recover from a major loss, and you will soon need your assets to start generating income.
It is important to know that neither Coinbase nor any cryptocurrency company currently pays a traditional dividend on its stock or on its currency. Some do currently pay a periodic reward for simply holding the currency in a digital wallet or for taking a specific action. However, those are different from stock dividends, which are paid to shareholders from company profits. The point is: so far, the digital currency movement has not provided any practical opportunities for income-based investors, including those with a higher risk tolerance who want to stay in the stock market. Could that change? Of course. If anything is certain, it’s that the digital currency craze is more than a craze – it’s a significant economic change that’s here to stay.
The shift to digital currency is inevitable. We’ve probably all sensed that for years now as we’ve used our debit cards more and more and paper money less and less. However, the full switch to a federally regulated digital currency system will mean even more change. As this change unfolds, stay educated about the potential impacts on the financial markets. At the same time, be cautious of the hype surrounding unregulated cryptocurrencies. Most importantly, remember that regardless of whatever changes may come, it won’t change the strategic benefits of investing for income.