Cost of Cash: United States

On the island of Yap, in the Western Pacific, large discs made of lime stone — some up to 12 feet in diameter — were used as form of currency for important social transactions such as marriage, inheritance, political alliance and, in times of great need, in exchange for food. Most of the time, these heavy stone discs did not change hands; everybody in the village just acknowledged that the stone had a new owner. The stone need not even be on the island to be regarded as something of monetary value. Once upon a time, according to Yap lore, a stone disc was lost at sea by a crew bringing it back from a limestone quarry on another island. Everyone on the island accepted the crewmen’s account that the stone lay at the bottom of the sea and so, granted someone’s claim over its value. This stone, or the idea of it, was thereafter considered good money and accepted as fair compensation.

Money is an abstraction built on trust. As such, alternatives to the most tangible form of money — currency or cash — and its replacement with cashless payments have become possible. Such an ecosystem is one where no transaction requires money in the form of notes and coins, and where value can be exchanged through the transfer of information between transacting parties. There have been multiple waves of such alternatives. Established alternatives to cash include checks, credit cards, debit cards, and prepaid debit cards. More recently, innovative options have sprung up that not only threaten to imperil the ubiquity of cash but also upend the traditional payment ecosystem. These include smartphone-enabled credit card acquirers, such as Square, and Automated Clearing House or ACH acquirers, such as PayPal and Dwolla. And then there are even more ambitious alternatives to cash that have been proposed, such as Bitcoin, a web-based cryptocurrency. Unlike traditional money, such alternatives do not derive their value from government fiat. Each of these alternatives have evolved networks within which they are uniformly accepted as a means of payment; the more established alternatives, of course, have the widest networks.

This study starts from a simple observation: cash derives its value from the information it contains and is a classic information good, which can be replaced by a digital substitute.

Today most information goods with a sufficiently developed digital substitute have been disrupted and displaced. Cash, however, is different from the usual examples that spring to mind: communication, music, movies, and, increasingly, books. Money in the form of cash is a tangible embodiment of value. Cash is itself nothing more than a promise to pay: a completely interchangeable, transferable promise to pay the bearer. The purpose of money is to have stored wealth on hand for purchases today and tomorrow. Individuals derive a certain utility from holding cash that stems from many factors combining rational, behavioral, institutional and emotional drivers. That said, cash must be held in physical form, counted, guarded, and accounted for. It can be difficult to transport and send. Being possibly the last thing you can expect to recover from a stolen wallet, acceptable everywhere, and anonymous, it is inherently insecure. In any serious quantity, most legitimate businesses prefer some other party, such as a bank, to handle cash on their behalf. In other words, cash satisfies two of the most significant criteria of digital disruption: there are viable digital alternatives with wide networks of adopters and cash presents the carrier with multiple forms of disutility or costs.

This begs the questions: why has cash not been completely displaced, what are the costs and benefits of its continued use, and what are the implications for innovation in the use of cash and its alternatives?

There are many factors that account for the continued prevalence of cash use:

First, there is a powerful force of habit and inertia that helps lock in behaviors and expectations, particu-larly when there are multiple stakeholders involved. Both parties to a transaction must be plugged into a compatible network. Both the payer and the payee must have compatible payment accounts, whether with depository institutions, issuing and acquiring banks, or disruptive innovators such as Bitcoin and Paypal. If payer and payee do not have compatible accounts, third parties such as check cashing stores must stand in for one of the counterparties’ depository institutions. Merchants are used to processing payments in the same way their customers are used to paying for them. Everyone finds the status quo convenient and can be assured that all stakeholders accept cash as a legitimate form of payment. Adopt-ing a new payment interface, whether it involves a new interface for an existing account or a new set of hardware to acquire payments from familiar payment cards, entails new behaviors, risks or expectations that merchants and consumers are ill-equipped to assess.

Second, network effects are hard at work in endowing money with value. Because more or less everyone accepts it — including the government and banks — money is the natural way to denominate prices in the economy. Cash can, in principle, be used to buy, well, anything that money can buy. The origins of curren-cy notes are in promises to redeem the notes for something scarcer still: a quantity of precious metal, or an amount of money issued by a different authority. But with the closure of the gold window in 1973, money became a snake biting its own tail, a promise to repay the bearer with an abstraction, a dollar is, ultimately another identical currency note. Cash represents the ultimate guarantee to all sides of the transaction. In a way, holding cash provides a sense of comfort and assurance, which is an important consideration for consumers who wish to have a certain minimum amount of cash.

Third, cash gives the spender a sense of control over spending and visibility over how much of a budget has been expended. This feature is convenient not just for the spender but also for others who care about the spender’s budget — for example, parents who wish to establish limits on their children’s spending.

Fourth, cash offers anonymity and financial privacy. This feature is a strong motivation for many consumers who do not wish to establish a traceable record for their personal transactions in general or for particular purposes.

Fifth, there are multiple alternatives to cash, ranging from credit cards and checks to mobile payments services, among others. The field is quite fragmented, particularly for newer alternatives, which creates barriers to adoption, since every potential adopter may worry about whether they can reliably use the option as a substitute for cash in a sufficiently wide variety of transactions.

Sixth, in order to truly see cash replaced with alternatives, key traits of the tangible features of currency would have to be replicated. Something or someone would have to ensure that when an e-dollar entered one person’s wallet, it also left the wallet of some other person. An e-dollar, shouldn’t be allowed to be in two places at once, but there are very few examples of such technology in the world. By default, most computer files can be copied. If one copy of an e-dollar exists, as many copies of that e-dollar as one might want can be created. A whole field of cryptography undergirds the software used to decide whether or not a book can be read on a specific Kindle, whether or not a song can be played on a specific iPod. Attempts to circumvent that digital rights management (DRM) software are a felony, and the subject of contentious debate on college campuses and in Congress. The technology to implement DRM, essentially a system of cryptographic locks, on every e-dollar in the economy is just not there yet. And there is good reason to suspect it never will be. DRM is highly contextual: it only works within a given ecosystem of software used to read and play the files. It also depends on a central database of permissions that decides whether or not to allow the file to be read. So aside from the bandwidth and hardware requirements that would be necessary to create true digital money, the anonymity of cash would also have to be compromised. A dollar bill has no idea who is holding it. But a system of digital payments, such as mobile money, cannot operate independent of the notion of account holders, at least not today. Mobile money systems, for all the metaphors, behave much more like bank accounts than they do like money itself. So with digital innovation one must be on guard against misnomers and false analogies.

Seventh, major factors that get in the way of scaling up alternatives to cash, such as mobile payment systems, are the regulatory constraints and the separate silos within which the relevant industry players — banking services, telecommunications, software, retail — operate. Mobile payments require a degree of cooperation across these industries. Such coordination and agreement is difficult to orchestrate.

In summary, cash has several benefits and there are switching costs that deter users from turning to alternatives and displacing cash altogether. Currency retains several appeals as a means of payment, only some of which will be replicated by innovators. It requires no intermediaries; any two counterparties can come together face to face and transact with precision and speed. It is anonymous as it bears no record of the user’s identity. All other payment systems are based on account balances tied to identities. There is no mobile money or other digital solution on the market today that provides the same type of anonymity cash provides. Cash is tangible, and bearers get constant feedback about current balances (provided balances are small). Transactions are usually instantaneous, and once money is handed over the remaining balance is visibly lessened. This constant feedback about remaining balances can be leveraged for any variety of purposes, such as sticking to a budget or reinforcing the pain of spending. Because digital signals can be replicated, there is no such thing as a unique copy of a file that can replicate this tangible, anonymous, and disintermediated store of value in the same way that a coin and a currency note can.

On the other hand, the central inconvenience of money is its very physical manifestation. Because money is somewhere, it must be brought somewhere else in order for a payment to be completed. No fax machine or website shopping cart can move the money from your wallet to the merchant. Bills distributed by mail take pains to warn the payer not to remit cash by mail, since the cash might be lost in transit. In order to transact in cash, two counterparties must arrange to meet face to face, or entrust a courier with the cash for delivery. These costs of travel, and the risks of loss, make cash seem hardly an ideal medium of payment. And yet cash comprises a large proportion of transactions in the economy, and not only in the peer-to-peer space where electronic payments were (until recently) expensive to accept.

So, then, what benefits can be gained from continued use of cash, and what costs might push users to more widely adopt alternative payment methods? This report is part of a larger study, performed by The Fletcher School at Tufts University’s Institute for Business in the Global Context (IBGC) that seeks to ascertain the private costs and risks of cash management facing each of a set of stakeholders in the American economy: consumers, firms, the government, and also financial institutions. It does not intend to evaluate the likelihood of cash use falling to a given level. Unlike much of the academic work previously done in this area, which focuses explicitly on the analysis of social costs with a view to inform public policy, IBGC’s approach uses opinion surveys to collect data from stratified samples of American consumers and merchants to understand the real costs and risks they face as private actors in their usage of cash. The findings are then integrated with estimates based on secondary research and analyses.