Given the dramatic changes in the world’s financial systems —cryptocurrencies, stablecoins, central bank digital currencies (CBDCs) and FinTechs — one could think it’s impossible to determine which one is more revolutionary.
But when we posed the question to Eswar Prasad, professor of international trade policy at Cornell University and author of “The Future of Money,” the answer came quickly.
“It’s blockchain technology, of course,” he told PYMNTS. “It’s the one truly fundamental innovation that is going to have a transformative effect in finance.”
“What bitcoin did in a very masterful way was to combine all these technological and conceptual innovations that really creates a bedrock for decentralized finance.”
Bitcoin was supposed to serve as an autonomous medium of exchange, Prasad said. That is, consumers could use their digital identities without a trusted third party, such as a central bank or a financial institution, serving as an intermediary. But that hasn’t happened, he added.
“It’s not worked very well in that function, so now we have a new breed of cryptocurrencies, stablecoins, which create stable value because they’re backed by fiat currencies, and other cryptocurrencies that generates stronger anonymity,” he said. “But whatever happens with this whole world of cryptocurrencies, and there are some crazy ones out there, I think the blockchain technology will really be the true legacy of bitcoin.”
As for bitcoin, it was intended as a decentralized way to pay for things. But it’s not working very well, Prasad said. “One of the key attributes of a medium of exchange is its relatively stable value,” he said. “The price of bitcoin is extreme volatility.”
As a result, he said, bitcoin has become something it was never intended to be, a pure speculative financial asset. If you consider assets such as an equity or a corporate bond, it has value because it is a claim on the future earnings. Bitcoin lacks any intrinsic value because it’s not serving well as a medium of exchange.
That brings up the obvious question: Why does bitcoin have any value given that it’s a purely digital object? Bitcoin proponents insist it has value because it is scarce. But some economists, like Prasad, say that’s a dubious proposition.
“Bitcoins largely seem to have value because of investors have faith in it. There seem to be a lot of investors who believe that its price will only go one way, which is up. But I think this is not a very durable source of value for an asset.”
For some, it raises the question of whether bitcoins are a Ponzi scheme. But Prasad disagrees. While bitcoin may not be a conventional pyramid scheme, Prasad said there are concerns that many people get into the space because they see friends and neighbors making easy money.
“But my fear is that a lot of relatively naive and unsophisticated investors are getting pulled in by the lure of easy riches and not knowing what they’re getting into,” he said. “So, in that sense bitcoins are a risky scheme.”
In his book, Eswar talks substantially about CBDCs, so our first question to him was, do we need CBDCs?
The answer, not surprisingly, is that it depends on the individual circumstances of each country. Central banks are facing different problems like replacing cash or promoting financial inclusion where CBDCs could help.
“If you look at a country like China or Sweden, hardly anybody uses cash anymore. So countries that are turning toward CBDCs seem to have a variety of objectives in mind. In some countries, especially developing countries, the idea is that you use CBDCs for financial inclusion, that is to give everybody whether they have a bank account or not easy access to a low-cost digital payment system.”
Another important question that central banks need to answer before launching retail CBDC is how it will affect innovation in the FinTech and banking space. According to Prasad, a CBDC “brings a lot of economic activity out of the shadows. It reduces the possibility that central bank issued money can be used for corruption or for illicit activities, because after all, anything digital leaves.” But he also suggested that as a method of payment, it could stifle private sector innovation in payments because after all, “what payment provider can possibly compete with the deep pockets of the government?”
There may be a possible solution to accommodate a central bank digital currency without stifling innovation and in fact relying on the private sector to make it happen. For instance, if a central bank provides the back end of the payment infrastructure, then commercial banks and even telecom operators could assist in the development of the front-end and foster competition among financial institutions to provide CBDCs.
Prasad left a last word of caution about the digitalization of the monetary system.
“The benefits of these revolutions might end up going into the hands of a relatively small amount of people who are already well off, which is why, we have to think very carefully about putting guardrails on these technologies so that they don’t exacerbate the existing problems in society.”
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