Digital Payments and the Vanishing Role of Cash

Today, paper currency seems practically scarce!  Most consumers receive their wages through direct deposit and use credit cards, debit cards, electronic checks, or digital payment services to purchase goods and services.  As a result, the need to handle paper - be it paycheck or currency - is relatively rare.  Often, it is so rare that customers are left scrambling on the occasions that they need cash, such as a small business that does not take credit cards or electronic payments.

History of Transaction Costs in Market Exchanges

Barter Era

Thousands of years ago, early humans used barter in market exchanges.  Goods were exchanged for goods in negotiated trades.  This system was inefficient and had very high transaction costs related to time, energy, and risk of loss.  Both parties had to spend time and energy investigating the quality of the other’s goods and weighing the opportunity costs of sacrificing X units of their own goods for Y units of the other’s goods.  For example, based on the perceived quality of someone else’s chickens, is it worth trading my cow?  

Precious Metal Era

Obviously, barter was very inefficient, and led to a myriad of harms, including theft and murder.  When traders carried all of their available goods to market with them, it made it easy for ne’er-do-wells to engage in crimes of opportunity.  Over time, therefore, people quickly evolved to use currency as mediums of exchange rather than bartering directly.  Currencies that became successful over the long term also served well as a unit of account - they had objective value that could easily be measured.  Instead of having to keep a tally of one’s entire inventory of goods, traders could simply keep a tally of the total value of their currency.

Effective currency, in addition to being an efficient medium of exchange and unit of account, also had to be a good store of value.  This meant that the currency had to hold its value over time and not become devalued as a result of inflation.  Unfortunately, this often conflicted with medium of exchange: the more convenient it was to create units of currency, such as paper notes, the more inflation tended to occur.  Many societies settled on precious metal coins, such as gold and silver, as currency due to the rarity of these metals and their ease to work with.  Gold and silver were easy to melt and craft into coins of different sizes, allowing for a relative achievement of all three conditions.

Gold-Backed Currency Era

Gold coinage was preferred in the West for hundreds of years, but faced some challenges.  Carrying gold coins was not always very convenient, reducing their efficiency as a medium of exchange.  Since the value of gold fluctuated based on supply and demand, the value of gold coins was often based more on weight than stamped denomination, making it a less objective unit of account than desired.  Finally, counterfeiters (or governments themselves) could also create coins out of other metals and simply coat them with a thin layer of gold or silver, causing some inflation.  As a result of these inconveniences, a hybrid system developed: gold and silver notes.

Gold and silver notes were paper currency that could be exchanged for gold and silver, thus allowing customers and merchants to enjoy the convenience of paper notes and the peace of mind of precious metals’ store of value.  Nations created gold standards where they linked the value of their paper currency to the amount of stored gold.  In theory, every paper note was backed by a pre-determined amount of gold, preventing inflation.  However, this hindered monetary policy by restricting the amount of new currency that could be created.

Fiat Currency Era

The Great Depression created a swift need for new government spending…but new money could not be created without gold!  As a result, the United States and other nations abandoned their domestic gold standards and created fiat currency - currency rendered legal tender by government decree.  In 1971, the United States also ended its international gold standard, no longer allowing foreign states to convert their holdings of U.S. dollars to gold.  After this point, all major currencies have had their value based entirely by supply and demand - we value our paper currency because we implicitly trust our society to keep running.

Digital Payments Era

Credit cards, issued by banks, entered the picture during the 1950s, allowing consumers to purchase goods and services with the bank’s money and then reimbursing the bank.  By the 1970s, these cards were expanded to allow purchases almost anywhere, thanks to electronic messaging systems.  Today, thanks to the Internet, credit and debit cards can be used almost universally, regardless of the issuing entity.  Transactions are recorded almost instantly, and consumers can easily check their running balances on credit card or banking apps.

In addition to credit and debit cards, digital payment services like Apple Pay, PayPal, Venmo, and Cash App are extremely popular by reducing transaction costs even further than cash: there is no need to store wads of bills or bundles of coins, and there is also no need to issue or collect change.  Consumers are also at less risk of being targeted for theft or cash-based scams; they can always say “I don’t have any cash on me.”  Stores often post signs indicating that they carry little cash - possible thanks to the prevalence of electronic payments - and consumers who are robbed can use an app to simply turn off their card!  

Economic Implications of Becoming a Cashless Society

Benefits

The rapid evolution of developed nations into cashless societies has economic implications, mostly beneficial due to reduced transaction costs.  A greater ease and security of purchasing leads to more purchases, helping with economic stimulus.  Credit card and digital payment companies also frequently offer lines of credit to consumers, helping them continue to purchase even when facing temporary loss of income.  This is typically far easier than taking out a traditional short-term loan from a bank.

Drawbacks

However, there are some drawbacks to going cashless.  While consumers and larger businesses enjoy lower transaction costs and greater safety, some smaller businesses struggle due to credit card processing fees and the need to purchase credit card processing equipment.  They may also suffer from chargeback fraud, where customers can easily use their credit card apps to fraudulently claim that they did not receive what they paid for.  The credit card company then blocks payment, often with little information required from the cardholder, leaving the small business with a financial loss.

The very poorest consumers, without access to smartphones, will also likely suffer in a cashless society due to their continued reliance on cash.  A number of businesses no longer accept cash, as doing so requires costs related to sorting, storing, and depositing that cash.  Poor individuals without access to credit cards, debit cards, or smartphones are theoretically unable to frequent those businesses.  While most businesses do still accept cash, their number will inevitably dwindle as digital payments become more convenient for the vast majority of consumers.

Those with smartphones but without access to traditional banks, known as the unbanked population, may be at greater risk of financial losses due to their money being uninsured.  Unlike money in an insured bank, money in a digital payment app is at risk of loss if the parent company goes out of business.  Those relying solely on digital payment apps are also at risk of being unable to make purchases if their phone runs out of charge or is lost; they would need to access a charged device to use the app.