Cryptocurrencies could lead to financial instability, author warns

Cryptocurrencies could lead to financial instability, author warns

By redistributing power away from government and Wall Street and back to the people, cryptocurrency will democratize finance, digital money enthusiasts say.

Economist Eswar Prasad, however, foresees a more complicated and, at times, dangerous reality.

According to Prasad, bitcoin is likely a long-lived bubble, and digital money could leave the government with more control than ever, while further worsening wealth inequality. He also sees other risks.

“Cryptocurrencies can contribute to monetary and financial instability, especially if they were to spawn a large, unregulated financial system that lacks investor protections,” he said.

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CNBC spoke with Prasad, a professor of economics at Cornell University and a research associate at the National Bureau of Economic Research, about the predictions of his new book, The future of money, published by Harvard University Press. The exchange has been edited and condensed for clarity.

Annie Nova: What does the emergence of cryptocurrencies tell us about what we expect from money?

Esvar Prasad: One gets the impression that the way the financial system is currently organized favors those who are already wealthy, that many of the investment opportunities are only accessible to them. And I think there is a desire to level the playing field. Cryptocurrencies could allow you to transact without, for example, having to go to a financial institution. And how much money you have doesn’t matter, at least in principle.

AN: What do you think will happen to the money?

PE: I think the convenience of digital payments will trump cash. This is already the case: there are rich countries like Sweden where cash is hardly used anymore. Similarly, in China and India, the use of cash is plunging very rapidly.

AN: You write about how Facebook will soon release its own cryptocurrency, diemand then there is already Amazon Parts. What are some of the concerns about private companies issuing their own money?

PE: There is a lot of. Maybe Facebook will just say, “Well, I don’t need my currency backed by US dollars anymore. I can just start issuing it.” And then you could have currencies issued by the private sector in direct competition with the currency of the American central bank. Then we get into all kinds of worrisome ground because now Facebook would have, you know, visibility into not just our social lives, but all aspects of our financial lives.

(Editor’s note: Facebook did not respond to a request for comment.)

AN: A lot of people talk about bitcoin as a bubble, but it’s been around since 2009. It looks like a long bubble.

PE: History gives us many examples of speculative manias that lasted a long time. And it’s worth remembering that while bitcoin has been around since 2009, the real jump in its value has only taken place in the last three to four years. But whatever happens to bitcoin’s value, I think it will leave a very important legacy. This is stoking a fire under central banks to start issuing their own digital currencies.

AN: You write that digital currency could give the government an additional instrument of control over citizens. How? ‘Or’ What?

PE: I think central bank digital currencies are the way of the future. But every central bank will want to ensure that its money is not used for illicit purposes, so that transactions are verifiable and traceable. And if every payment you make, including for a cup of coffee or for a sandwich, can be seen by a government agency, that’s an uncomfortable proposition. You could, in a more dystopian world, ask the government to decide what kind of goods and services its money can be used for.

AN: How could cryptocurrencies increase economic inequalities?

PE: Cryptocurrencies and their underlying technology promise to democratize finance by making digital payments and other financial products and services easily accessible to the masses. But because of existing inequalities in digital access and financial literacy, they could end up worsening inequalities. In particular, any financial risk from investing in cryptocurrencies and related products could end up falling particularly on naïve retail investors.