How will Ecuador’s new ‘digital currency’ work?

Under a new monetary code, the Ecuadorian government in August released more information about plans for what they call a digital currency.

40% of Ecuadorians do not have access to a bank account, says Pablo Paredes, director of the Institute of Economics at the Universidad San Francisco de Quito. From December 2014 people will be able to exchange physical cash for digital money that they will keep in an electronic wallet on their mobile phones. “It’s no different from other mobile wallets offered in other countries.”

Who will use it?

It will take time for it to take off, says Alejandro Salas, the regional director for the Americas at Transparency International. People will have to learn to use mobile technology for banking, leaving the older generation particularly vulnerable to being excluded. Ecuadorians will also need to trust that their money is safe when they no longer have it in their hands. “It will take a change of mindset,” adds Salas.

As in other countries, it is likely that the electronic wallet will be used in addition to cash, and not as a total replacement by users, Paredes adds.

Yet digital units do have appeal over cash as they offer a cheaper way to transfer remittances and a more secure way to store their money, says Ben Dyson, founder of Positive Money.

“Economically, it should also boost the economy because more people will be able to trade further than they would have been able to do in the past.”

Are comparisons to Bitcoin, the stateless digital currency, accurate?

Absolutely not, according to Dyson. “Bitcoin is creating new money, which the Ecuadorians won’t. [Ecuador’s digital initiative] is someone giving you a box to put your cash in then giving you an electronic number that says how much money’s in the box.”

The new legislation requires the digital money to be 100% backed which means for every electronic dollar that they create there has to be a physical dollar at the Bank of Ecuador.

“What is interesting though is the central bank here is saying that the big banks aren’t doing what we need them to do for financial inclusion so let’s just bypass them – that’s quite a big step forward for any central bank to take.”

There is much speculation about whether Ecuador is trying to replace the US dollar. Why has the announcement been so controversial?

The proposed “digital currency”, according to Salas, is the government’s attempt to set up an alternative currency system to the US dollar, the currency it has used since its banking crisis in 2000. But it will run in parallel to the dollar, as there are currently no plans to scrap cash completely.

The article in the monetary code that most concerns people, according to Paredes, is one that suggests that the central bank can oblige people to sell their foreign currency to it.

“The question is this: if I have to sell my foreign currency to the bank for its ‘digital currency’, what will it give me in return when I later want to exchange back to cash? A new currency? Government bonds? We just don’t know whether this part of the code will be enforced.”

Ultimately, will the ‘digital currency’ make transactions more transparent and are consumers safe?

The intention is that it will – you will have more controls in the system and it will be easier to establish if there are flaws and where money goes, according to Salas. It should be easier to spot counterfeiting.

However, transparency will depend on how the institutions behind this system behave.

“This can become a huge invasion of privacy because with electronic banking you can follow, even detect where the person is, and how much the person is spending. It has the potential to be a surveillance programme.”

Old constitutional regulations covering consumer protection at traditional financial institutions must be updated to cover this new digital system and a proper regulatory framework set up to deal with these issues, says Salas.

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