Payments 101: Part 2 – Is Cash still the king?

This is part 2 in my Payments 101 series. In this article, I will take about the trends in cash usage. Other articles in this series can be found here:

  1. Payments 101: Part 1 – An overview

  2. Payments 101: Part 2 – Is Cash still the king? (this article)

  3. Payments 101: Part 3 – Enterprise Systems: Check, ACH and Wires

  4. Payments 101: Part 4 – Core Consumer Systems: Credit and Debit cards

 

Cash is one of the oldest form of payments. It is also the only payment system that can be used anonymously on the part of both the sender and the receiver (we will ignore cryptocurrencies like Bitcoin as they have not yet reached the scale of cash).


The evolution of cash:

The world’s first true coins are widely believed to have been minted around 640BC. They were made of an alloy of gold and silver. The deign (a roaring lion’s head) symbolized the ruling dynasty at that time.

The first banknote/paper currency was issued in China in AD806-821. Sweden was the first European nation to experiment with paper money in the 1660s.

Swedish paper currency from the 17th century


In the US, the first $2 notes were issued on June 25, 1776 (i.e. 9 days before US’s independence day). The Continental Congress authorized issuance of the $2 denominations in “bills of credit” for the defense of America. US paper currency is referred to as “greenbacks” because of the green paper that was used for printing the currency during US civil war. Southern states published currency of their own to finance their war efforts during the Civil war.

Responsibility for issuing the banknotes was entrusted to central banks of various nations. However, it also led to fear that central banks could engage in printing too much money, which could lead to inflation. This led many governments to join the Gold Standard. The Gold Standard was a mechanism that fixed the values of coins/banknotes in terms of fixed quantities of gold. This ensured that the money supply remained stable (as the world’s gold reserves were quite stable), which would keep prices/inflation stable. It also fixed the exchange rates between nations that participated in the standard. If the US set the price of gold at $20.67 per ounce, for example (as it did from 1834 until 1933), and the UK set it at three pounds 17 shillings and 10.5 pence, as it did from 1844 until 1931 (apart from a period after the First World War), an exchange rate of $4.867 dollars to the pound necessarily followed.


The Gold Standard worked very well while everyone played fair. However, during the first World War, many countries started printing money to finance their war efforts and the Standard broke down. In 1931, Britain left the Gold Standard due to massive outflows of gold. In 1971, the US also left the Gold Standard and the Standard was all but over.


A one million Mark banknote that was introduced in Germany in 1923 after World War 1

Since 1971, the world economy has largely run on a system of floating exchange rates, with gold-backed currency replaced by what is called “fiat money”. This is money that has no intrinsic value and obtains its worth entirely on the basis of governmental decree. For example, the intrinsic value of US paper notes is only around 15-20 cents per note (a $100 note costs 19.6 cents to produce). 


Advantages/benefits of cash usage:

  1. Simple, easy, robust payment mechanism that requires no ancillary technologies

  2. Cash provides a security against potential disruptions to electronic payment systems

  3. Cash also acts as a safe asset in which to invest savings and its usage can involve a high degree of privacy

Disadvantages/costs of cash usage:

  1. Consumers may have to pay fees to withdraw cash from automatic teller machines. It is estimated that banks collected at least $1.9B in ATM cash withdrawal fees in 2018

  2. Cash can be lost due to theft, misplacement, or accidental destruction of cash

  3. Businesses must pay for cash delivery with armored trucks (an industry with estimated annual U.S. revenues of $2.8B) and security systems to dissuade thieves or robbers. In 2017, 26% of all US robberies took place at a gas station, convenience store or a commerce building as cash was readily available in these places and could be stolen

  4. U.S. businesses lose about $40 billion in employee cash thefts per year

  5. Cash transactions take more time. For e.g. salad chains Tender Greens and Sweetgreen reduced transaction time by going cashless: Tender Greens estimates that cash transactions are four to five seconds slower than card transactions, and Sweetgreen found that its cashless locations processed 5 to 15 percent more transactions per hour

  6. Some portion of retail staff and managers’ paid time is spent counting cash and reconciling tills

  7. Because cash leaves no electronic record, wage earners and businesses are able to underreport (in general, illegally) how much cash they receive in order to reduce their tax payments. Thus, cash contributes to the tax gap—the difference between what the government is owed and what is actually paid

A 2011 study by economist Layne-Farrar estimates the transaction costs associated with cash, check, and debit for five types of retailers, including quick serve retailers, big box discount stores, supermarkets, gas stations, and travel retail stores. The study found that even when including costs like point-of-sale transaction time, back office costs, counterfeit costs, and fraud prevention, cash was cheaper than debit in terms of cost per $100 of sales. Cash cost retailers $0.53 per $100 of sales, compared to $1.12 for signature debit and $0.81 for PIN debit.


Merchants are not required by law to accept cash, as some people think. The “legal tender” reference on a note is to the use of cash to settle debt. The airlines have been leaders in stopping acceptance of cash entirely—for onboard sales of food, beverages, and entertainment. This trend has led some commentators to worry that such “no cash” policies disadvantage many low-income consumers who lack access to bank accounts and credit cards. Therefore, 2 states (Massachusetts and New Jersey) have banned cashless business. Similarly many cities (San Francisco, Philadelphia) have banned brick and mortar stores from refusing to accept cash.

Cash usage statistics:

The following chart shows an approach to classify customers based on their cash usage. The % refers to the share of the population. This study ran over a period of 3 consecutive days and “all days” in the chart refers to this period of 3 days. The 4 type of consumers identified are:

  1. “Cash Lovers” – consumers who held and spent cash every one of the three days of the study

  2. “Just-in-Case Holders” – consumers who held cash every day of the study but didn’t use it during their three-day study. This group may view cash as a safety net or a contingency fund

  3. “Cash-Averse” – consumers who neither held nor used cash as a payment instrument during the three-day study

  4. “Limited Choice Spenders” – consumers who did not hold cash at the end of each study day but spent cash every study day

The Just-in-case category is an interesting classification and something that I fall into personally. It indicates that customers want to carry cash in their wallet just in case there are situations in which they cannot use their other payment instruments like mom-and-pop stores that accepts only cash below a certain transaction amount or parking meters.

Some other statistics related to cash usage are below:

  1. Consumers use cash for 26% of their transactions (compared to Debit card, which is used for 28% of transactions)

  2. Cash is heavily used for smaller payments and accounts for 49% of transactions below $10

  3. Cash is used for 35% of in-person payments (i.e. the usage % is higher than 26% for all transactions)

  4. Individuals aged 18 to 25 have the highest share of cash use, 34 percent, followed by those 65 and older who report using cash for 33 percent of payments

  1. Cash use was most popular for gifts and person-to-person (P2P) transfers. However, there have been shifts in payment usage within this payment type. Both debit and credit cards were also used for gifts and transfers, indicating the popularity of peer-to-peer apps such as Venmo, Apple Pay, Square cash, etc.

The following chart shows the value of US currency in circulation. It can be clearly seen that the $100 note represents the biggest % of all cash in circulation.

This is because $100 note is a good medium for storing cash “under your mattress” i.e. consumers who want to keep a safety stock of cash with them for emergencies prefer $100 bills as it occupies less space. $100 bill is also a popular medium for illicit activities like money laundering, drug payment etc. A significant portion of the currency in circulation is also held overseas – either illegitimately (by drug lords, terrorists etc) or by governments in their reserves – as shown below.

The lifespan of cash notes varies by denomination and depends on a number of factors, including how the denomination is used by the public. For example, larger denominations such as $100 notes are often used as a store of value, which means they pass between users less frequently than lower-denominations such as $5 notes, which are more often used for transactions. For e.g. a $1 note lasts for 6.6 years while a $100 note lasts for 22.9 years.


Case study on decline in cash usage:

Sweden: The use of cash in Sweden dropped from 40% to 13% of transactions between 2010 and 2018. Displacement of cash is due largely to consumer preference. Various explanations have been offered for Sweden’s growing preference for electronic payment methods. Sweden is a technology savvy country and Swedish companies have developed fast and easy payment technologies like iZettle and Swish. Some observers have also suggested that Swedes are especially trusting of institutions and thus have fewer privacy concerns. Some have noted that the timing of the start of the decline in cash use among Swedes coincided with the start of a transition to new Swedish banknotes and coins. They suggest that this spurred people and businesses to make a switch not to the new bills and coins but instead to electronic payment methods. The following chart shows the average value of Swedish banknotes and coins in SEK Billion. It is ironic that Sweden was the first European country to introduce paper currency and may be the first European country to fully embrace a cashless economy.

 

To read the 3rd part in my Payments 101 series, please click here: Payments 101: Part 3 – Enterprise Systems: Check, ACH and Wires