Do digital currencies have the potential to hurt gold investors? Here we are purely talking about central bank issued digital currencies (considered to be distinct from cryptocurrencies).

What is a central bank digital currency?

A central bank digital currency is a digital form of fiat currency that is on a blockchain platform that is totally centralized, and the currency is issued by the state as legal tender. Additionally, there would be no physical version of the currency.

How likely is it that central bank digital currencies will be introduced?

Status of central bank digital currency projects worldwide (Source: Coin Telegraph)

There is a high probability that central bank digital currencies will be introduced. As shown in the above map, eightly percent of the world’s central banks are either engaged in research or experimentation in digital currencies. The areas shown in red on the map show where retail pilots have been completed.

How would digital currencies be administered?

There are three possible ways that a digital currency could be administered. The government could directly manage all payments and administration, including know your customer (KYC) and anti money laundering (AML). However, that would greatly increase the government’s work load and would require the development of additional infrastructure. Alternatively, the private sector (e.g. banks) may be involved as intermediaries to take on the required administrative tasks. Another option would be a hybrid system of the two.

Public incentives for accepting digital currencies

For any currency to be successful (digital or otherwise), it would be crucial for the public to be on board and have confidence in it. Advantages for the public when adopting a central bank digital currency include:

  • Convenient
  • Easy to use
  • No need to carry physical coins/notes
  • Fast transactions
  • Lower fees
  • No need for a bank account (improved financial inclusion)
  • Helicopter drops

Government incentives for introducing digital currencies

Governments will have their own incentives for introducing digital currencies. Being just another form of fiat currency, it it unlikely be backed by anything and so it could be produced in unlimited quantities with just the touch of a button. Digital currencies will also make cash hoarding and bank runs a thing of the past. Introducing negative interest rates would also be potentially easier, with the aim of stimulating inflation (something that central banks have been trying to achieve for a while). If people are told that their digital currency balance will shrink, or perhaps even be taken away at the end of each month, that is a sure incentive to encourage people to spend spend spend.

Every single transaction will be on a centralized blockchain ledger and could be easily tracked. The government would therefore be the proud owner of a huge amount of valuable and sensitive data. Because digital wallets will be centralized, any individual’s transactions could be blocked or controlled at will. Currency smart contracts could be introduced, and that has a number of potential implications. Not only could transactions be controlled through smart contracts, but perhaps the value could be also controlled. What if a currency could be programmed to increase in value if used to purchase certain goods or spent in a certain sector?

The effect of digital currencies on the gold price

Would digital currencies be detrimental to the price of gold? Possibly. Here are some ideas about the ways in which the gold price might be impacted.

Digital currencies could enable restrictions to be set on buying and selling physical gold by retail investors. Manipulation of the gold price may become easier. Value adjustment the currency downwards for gold purchases might be introduced. Variable taxation would also be easier to introduce. For example the percentage tax could increase with higher volumes of gold bought/sold by an individual.

Since physical cash would no longer exist, the legal tender status of gold and silver coins could be revoked. Perhaps the mechanics of accessing funds after selling offshore gold will be hindered by the existence of digital currencies.

Will digital currencies be successful?

The most important factor in determining the success of a central bank digital currency will be the level of acceptance and credibility of the new currency. The results of pilot programs in this arena will shed some light on this.

What effect would introducing a central bank digital currency have on the existing huge debt pile?

What would be the impact if the world’s reserve currency was replaced by a digital fiat currency? We know that for centuries, every single world reserve currency has been replaced by a gold-backed currency. Would the world have confidence in a new digital dollar in the same way that it has confidence in the current US dollar?

Conclusion

When it comes to currencies, confidence is key. If the majority have confidence in the central bank digital currency, yes there is potential for the gold price to suffer. Having said that, as discussed in a previous post, fiat currencies are not everlasting and there are multiple examples in history where replacing one fiat currency with a new fiat currency just didn’t work. Fiat currencies can become worthless overnight, but gold has always been accepted as money.