Ecuador is set to launch their own digital currency in October 2014. Having recently banned all other alternative/digital currencies such as Bitcoin despite low adoption rates, the announcement was a surprise but made sense in light of their current situation. Ecuador uses the US dollar as its official currency, and its lack of flexibility in monetary policy has been exacerbated by a steady current account deficit. To finance this deficit, Ecuador has been unable to print more currency and instead has been forced to draw down on reserves in physical assets like oil and gold. With the country running out of those reserves, their solution has been to create a digital currency to use alongside the USD in order to pay their bills.
Disaster In Waiting
The move is allowing Ecuador to print money in the digital age. Previously, Ecuador would have had to bring back its old currency, the sucre, which was abolished in favour of the USD in 2000 after hyper depreciation. While sucre coins are still in circulation, people would have been unlikely to re-adopt the sucre given how poorly it performed before being demised.
Launching a digital currency is basically a market re-branding for a previously failed government currency. Unfortunately, the reasons for the sucre’s demise are still there and a current account deficit will put downward pressure on the new currency, digital or not. Articles announcing the new currency are decidedly pessimistic, and fears of inflation are real given both current account and fiscal deficits in the nation. As a refresher, the sucre lost almost 70% in the year before it was abolished, and that was just 15 years ago. Tying the digital currency’s value to “liquid assets” but not government bonds is unlikely to stem the likely tide of depreciation.
Opportunity For Change
We are also cautious on this new digital currency’s future. It would be very difficult for a central bank that has not managed its own fiat currency in 15 years (let alone a fiat one), to make this a success given the economic headwinds the country is facing. However, details are still sparse and there are several factors or models to emulate that could redeem a new digital currency in Ecuador.
The Bitcoin Model: Capping the Supply of Digital Currency
Fears of an unending supply of digital currency could be stemmed by specifying a cap in the amount of digital currency that could be produced. This would be similar to Bitcoin restricting the total amount of coins in circulation to 21 million. The cap on total available currency has caused speculative buying in Bitcoin and deflationary pressure as investors hoard coins – a “problem” that the Ecuador central bank would welcome. Allowing private citizens to mine the new digital currency would also help improve infrastructure and reduce the government’s own costs in launching and maintaining this currency. We expect the government to take inspiration from popular digital currencies such as Bitcoin, and would hope to see them adopt similar features for their own currency.
The M-Pesa Model: Streamlining Money Transfers
Reducing costs for transferring money and making it convenient to do so would spur adoption rates for this digital currency. This would be similar to M-Pesa, the heralded cash transfer system developed by Safaricom in Kenya. While smartphone ownership remains on the lower end, everyone has mobile phones and M-Pesa has proved successful without requiring the use of apps. A digital currency with low transfer costs would also benefit the Ecuadorian diaspora, helping to encourage remittances back home. Increasing adoption rates of this new currency would be key for its future survival, and adding features such as these could sway more people to begin using it.
The Estonia Model: Digital Services
A government backed digital currency is likely to remove one of the key benefits touted by other digital currencies: privacy. Digital currency accounts are likely to be registered with the government, and financial transactions would not be anonymous. On the flip-side, a country where every citizen’s ID card is attached to a digital bank account could also streamline government services. Tax payments and refunds could be streamlined, along with utilities and other bills. The model to emulate here is Estonia, one of the most wired countries in the world where its citizens can use their ID card to access over 600 different services. Everything from buying bus tickets to banking can be done using their ID card, with digital records of their lives stored from the day of their birth (including digital birth certificates themselves). The convenience factor is staggering, but the investment required to get Ecuador to that level would also be sizable. However, by tying a digital currency to a host of digital services, the Ecuadorian government could make a compelling case for adopting the new currency.
If Ecuador releases its new digital currency and uses it merely as a stop-gap method for funding its current account deficit, the critics are right: the new currency is doomed and likely to perform as well as the sucre did 15 years ago. However, as the first digital currency ever backed by a national government, we also believe that there is a chance for innovation. If Ecuador is able to adapt some of the features we mention, the currency may have more staying power than initially expected and represent a good buying opportunity given the amount of disdain for it right now. We intend to monitor how the currency develops since information is still limited.