Given the dramatic changes in global financial systems – cryptocurrencies, stablecoins, central bank digital currencies (CBDCs) and FinTechs – one might think it impossible to pinpoint which is the most 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 only really fundamental innovation that’s going to have a transformative effect in finance.”
“What bitcoin has done in a very big way is to combine all of these technological and design innovations that really create a bedrock for decentralized finance.”
Bitcoin was meant to serve as a standalone medium of exchange, Prasad said. In other words, consumers could use their digital identity without a trusted third party, such as a central bank or financial institution, acting as an intermediary. But that didn’t happen, he added.
“It didn’t work 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 generate stronger anonymity,” he said. “But whatever happens with this whole world of cryptocurrencies, and there are some crazy ones out there, I think blockchain technology will really be bitcoin’s true legacy.”
As for bitcoin, it was designed as a decentralized way to pay for things. But it’s not working very well, Prasad said. “One of the main attributes of a medium of exchange is its relatively stable value,” he said. “Bitcoin price 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 a stock or a corporate bond, it has value because it is a claim on future earnings. Bitcoin has no intrinsic value because it does not serve well as a medium of exchange.
This begs the obvious question: why does bitcoin have value given that it is 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 investors believe in them. There seem to be a lot of investors who believe that its price will only go one way and that is up. But I think that’s not a very sustainable source of value for an asset.
For some, this raises the question of whether bitcoins are a Ponzi scheme. But Prasad disagrees. While bitcoin may not be a conventional pyramid scheme, Prasad said many people fear entering the space because they see friends and neighbors making easy money.
“But I worry that a lot of relatively naïve, unsophisticated investors get lured into the lure of easy wealth and don’t know what they’re getting into,” he said. “So in that sense bitcoins are a risky scheme.”
In his book, Eswar talks a lot about CBDCs, so our first question to him was, do we need CBDCs?
The answer, unsurprisingly, is that it depends on each country’s individual circumstances. Central banks face different issues, such as replacing cash or promoting financial inclusion, where CBDCs could help.
“If you look at a country like China or Sweden, hardly anyone uses cash anymore. So countries that are turning to CBDCs seem to have a variety of goals in mind. In some countries, especially developing countries, the idea is that you use CBDCs for financial inclusion, i.e. to give everyone, whether they have a bank account or not, easy access to a payment system low-cost digital.
Another important question central banks need to answer before launching a retail CBDC is how it will affect innovation in FinTech and the banking space. According to Prasad, a CBDC “brings a lot of economic activity out of the shadows. This reduces the possibility that money issued by the central bank can be used for corruption or illicit activities, because after all, everything digital leaves. But he also suggested that as a payment method it could stifle private sector innovation in payments because after all, “what payment provider can possibly compete with the deep pockets of government?”
There may be a possible solution to welcoming a central bank digital currency without stifling innovation and actually relying on the private sector to make it happen. For example, if a central bank provides the back-end of the payment infrastructure, commercial banks and even telecom operators could help develop the front-end and foster competition among financial institutions to provide CBDCs.
Prasad left a final word of caution on digitizing the monetary system.
“The benefits of these revolutions may end up falling into the hands of a relatively small number of already well-off people, so we need to think very carefully about putting safeguards in place on these technologies so that they don’t do not aggravate existing problems in society.