Digital Wallets Will Destroy Central Bank Power by Enabling Seamless Currency Arbitrage



One of the prerogatives of central banks is the ability to inflate government-issued currencies as a way to impose a hidden tax on the citizenry. (OK, neo-Keynesians call it "stimulating demand," i.e. people rushing to buy goods before the value of their money declines further.) But central banks may not be able to do this for very much longer.

Over at the New York Times, a fascinating op-ed, "The Digital Wallet Revolution," by Indiana University media professor Edward Castronova and Washington and Lee University law professor Joshua Fairfield, argues that the advent of digital wallets like the recently announced Apple Pay will dramatically reduce the power of governments to manipulate their currencies. How? By implementing seamless currency trading and arbitrage as an app.

The professors explain:

Apple's digital wallet, if widely adopted, could usher in a new era of ease and convenience. But the really exciting part is the fast-emerging future that it points toward, in which virtual assets of all sorts — traditional currencies, but also Bitcoin, airline miles, cellphone minutes — are interchangeable, opening up enormous purchasing power for consumers and creating tough challenges for governments around the world. …

Frictionless exchange is a killer app. Some companies might lose value in their loyalty programs, but others will find enormous value in issuing their own currencies for advertising or data-tracking purposes, or even just because the creation of a successful virtual currency or digital wallet lets companies make money by making money. That's certainly Apple's bet.

The revolution is what comes next: an exchange that connects and trades these different stores of value to find the most cost-efficient one to use, both within your wallet and between wallet users, worldwide. Let's say you want to buy an audiobook from Best Buy. It costs $16, or 1,000 My Best Buy points, or M.B.B.P.s. Your wallet contains several hundred dollars and 200 Best Buy points. The wallet software automatically determines that, at the current exchange rate between M.B.B.P.s and dollars, it is better to buy using the points. …

But then let's say you only have 50 M.B.B.P.s. The wallet system searches its clients and finds someone — call her Hannah — with enough M.B.B.P.s for the transaction. It buys the audiobook with her points and sends it to you, and sends Hannah dollars from your account.

Following Bitcoin's protocol, the wallet software broadcasts these transactions to the network, and every wallet in the world updates the M.B.B.P.-to-dollar exchange rate.

The idea is that you can buy anything, with anything. The wallet will find the best deal and execute it. In so doing, it will ignore the historical and cultural differences between dollars, points, coins and virtual property. It's all bits anyway…

This sort of digital wallet raises difficult problems for regulators, who rely on institutional intermediaries like banks as the point for monitoring transactions. But a digital wallet can be a phone app; just like the cash in your pocket, it doesn't require accounts with any intermediary. A wallet app can be written by anyone, downloaded by anyone and secured and maintained by everyone. In this huge river of money, there is no narrow channel from which the state can divert flow into its own fields.

Of course, governments will fight hard to stop this currency revolution as my colleague Brian Doherty points out in his article, "New York Tries to Regulate Bitcoin Right Out of the State."

The whole op-ed is worth your attention.

For more background, see also Reason TV's "Tech Visionary George Gilder: "Bitcoin is the Libertarian Solution to the Money Enigma" below: