The Future of Money: How the Digital Revolution is Transforming Currencies and Finance. 2021. Eswar S. Prasad. The Belknap Press of HHarvard University Press.
Today, you can’t turn on the TV or the radio without hearing an advertisement for cryptocurrencies or crypto exchanges. Many celebrities have endorsed crypto trading platforms, including professional athletes LeBron James and Tom Brady and actors Matt Damon and Larry David. Are cryptocurrencies the next big investment, fad or currency that will change the economic and financial landscape? What are the advantages and disadvantages of digital currencies? Who will benefit from these new currencies?
Eshwar S. Prasad attempts to solve these questions in The Future of Money: How the Digital Revolution is Transforming Currencies and Finance. Prasad, Talani Senior Professor of Trade Policy at Cornell University and author of several books on currencies, provides an interesting and insightful exposition on the transition from traditional paper notes to digital currencies.
Prasad begins his discussion of the future of money with a quote from Cecilia Skingsley, the deputy governor of Sweden’s central bank: “If we extrapolate current trends, the last note will be returned to the Riksbank by 2030.” Kingsley isn’t the only government official who sees a big future for digital currencies. China is another country moving away from paper currency. In the United States, President Biden, recognizing the importance of new digital assets, signed the Responsible Development of Digital Assets Executive Order in March 2022.
The book is divided into four parts. Part I, Laying the Groundwork, examines the future and prospects of digital currencies and provides an introduction to finance for those with little experience. Part II, “Innovation,” focuses on the history of fintech and the crypto revolution. Part III, Central Bank Money, makes the case for central bank digital currencies (CBDCs). Part IV, Ramifications, examines possible implications for the international monetary system.
The Innovations section of the book begins with a section titled “Will Fintech Make the World a Better Place?” Here, the author takes us through the history of fintech, which he says is an umbrella term for new financial technologies. It was first coined in 1993 when Citicorp formed the Financial Services Technology Consortium. However, some innovations, such as the ATM, have become so ubiquitous that we forget they were once new technologies. The story includes an interesting look at new innovations such as M-PESA, which has enabled people in Kenya to bank via mobile phone, as well as peer-to-peer lending, crowdfunding and on-demand insurance. Many of these new services will create challenges for traditional financial companies.
Today, fintech is most closely associated with cryptocurrencies such as Bitcoin and Ethereum. However, a discussion of cryptocurrencies cannot begin without understanding blockchain and how this technology is transforming business and finance. Blockchain technology has been touted as the future of finance and many other areas of business, including securing medical records, non-fungible token (NFT) markets, and monitoring supply chains and logistics.
Most investment professionals will be familiar with blockchain and the concept of a decentralized ledger on a peer-to-peer network, but many may not fully understand the technology. Prasad provides a detailed yet accessible explanation of how blockchain works, from its historical origins to the technology behind the system. The term “blockchain” is associated with many cryptocurrencies. However, the protocols used to verify transactions differ for different blockchains. In addition, each protocol has advantages and disadvantages. Will many alternative protocols continue, or will one become the industry standard?
Bitcoin uses a “proof-of-work” protocol to verify transactions, which requires block creators, known as miners, to solve a randomly generated cryptographic problem. This approach allows transactions to be verified without a trusted third party. However, this method requires significant computing resources, which require a large amount of electricity to power the computers. Another disadvantage of this approach is that it allows only a relatively small number of transactions to be verified at a time.
Ethereum uses a proof-of-stake protocol. Proof of Stake was created to deal with some of the inefficiencies of the proof-of-work approach. Here, the privilege of confirming a block is based on how many have been “supplied” by competing nodes. However, as Prasad points out, this less resource-intensive approach is not without its drawbacks.
Prasad debunks some myths about crypto and other digital currencies. For example, many see the use of cryptocurrencies such as Bitcoin as a way to maintain anonymity. The reality is that, unlike cash, digital currencies require identifiers for consumers to receive goods purchased with digital currencies, which removes anonymity. Blockchain has also been seen as a secure technology. Although this technology offers more security than other methods, Prasad shows ways to hack various protocols.
Like all new technologies, the fintech revolution has brought with it a whole new language to define new offerings, including hashing, Security Token Offerings (STOs), Smart Contracts, Initial Coin Offerings (ICOs), Hashing Time Locked Contracts (HTLCs), and stablecoins. The future of money allows investors to learn the new language of the field and consider which innovations may offer the greatest investment opportunities.
Reading a book is unlikely to provide any insight into how to value cryptocurrencies or how digital currencies like Bitcoin can replace government money as a store of value, medium of exchange or unit of account. However, Prasad offers a glimpse into the potential of digital currencies in the chapter, “The Case for Central Bank Digital Currencies.” He argues that CBDCs can improve the efficiency of wholesale trade by improving the way central banks allocate reserves to commercial banks for payment, clearing and settlement. On the retail side, CBDCs can offer several benefits, including providing a backup payment system, promoting financial inclusion, and improving monetary and fiscal policy.
While these chapters may be of more interest to economists and central bankers than investors, Prasad provides some insights that investors can benefit from. He summarizes a study that analyzed how some European countries’ policies to reduce the use of cash reduced the shadow economy and increased tax revenues. A thoughtful investor might ask which investments would benefit from these increased tax revenues. Will the additional revenue be used to finance infrastructure spending? Will countries use windfall profits to finance alternative energy projects? Perhaps countries governed by conservative lawmakers would prefer to return money to citizens and businesses through tax cuts. If this proves to be the case, which industries are likely to benefit?
Innovation creates winners and losers, creating new opportunities and challenges for incumbents. Financial industry innovation is no different. Understanding some of the current and potential future changes will allow analysts to better identify which businesses and industries may prosper and which may suffer. The future of money gives readers a window into some of the opportunities and challenges facing the financial sector.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, and the opinions expressed do not necessarily reflect the views of CFA Institute or the author’s employer.
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