The Currency Revolution
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- The Currency Revolution
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Bibliographic details
- Authors: CHRIS WELLISZ
- Published: March 2, 2022
Overview
- Eswar S. Prasad explains how technology is transforming the nature of money and how that will affect our lives.
- Interview conducted by Chris Wellisz, March 2022.
- Based on Prasad’s book, The Future of Money: How the Digital Revolution Is Transforming Currencies and Finance.
Cash and digital payments
- Digital payments’ convenience for consumers and businesses makes it highly unlikely that cash will survive much longer.
- Examples:
- China: Alipay and WeChat Pay have blanketed the economy with very low-cost digital payments, usable for small purchases such as fruit or dumplings from a street vendor.
- Sweden: Private sector provides very low-cost digital payments in advanced economies.
Cryptocurrencies and stablecoins
- Bitcoin:
- Has not worked well as a medium of exchange for day-to-day transactions.
- Main drawback: very unstable value (large intraday/interday value swings affect purchasing power).
- Operational drawbacks: slow and cumbersome to use.
- Stablecoins:
- Aim to maintain stable value by being backed by stores of fiat currency, linking their value to currencies such as US dollars or euros.
- Can make domestic and cross-border payments more effective and efficient.
- Risks:
- Verification and liquidity of backing assets: issuer claims to hold liquid securities—who ensures they do so?
- Runs: simultaneous redemptions may reveal that backing securities are less liquid than expected.
- Illicit finance: unless closely regulated, stablecoins could become conduits for illicit financing across borders.
- Cross-border regulatory challenge: cryptocurrencies know no borders, so unilateral national regulation will be difficult; global coordination of regulatory policies is needed.
Central bank digital currencies (CBDCs)
- Rationales vary by country:
- Developing countries: broaden financial inclusion for people without access to digital payments or basic banking products and services.
- Sweden (e-krona): envisioned as a backstop to private payment infrastructure where bank account access is widespread.
- China (digital yuan): seen as a complement to existing payment systems and a tool to increase competition against dominant private providers.
- Monetary policy and operations:
- If all citizens had an account with the central bank (e.g., the Federal Reserve), it would simplify operations such as stimulus payments (contrast with pandemic stimulus distribution problems: some households without direct deposit received prepaid debit cards or checks, many lost or misappropriated).
- Design considerations and risks:
- Threats to private payment providers: government-provided low-cost digital payments may crowd out private competition.
- Bank disintermediation: commercial bank deposits could be swept into central bank accounts, especially in troubled times when depositors prefer perceived safety.
- Possible solution: dual-tier CBDC system in which central bank provides underlying payment infrastructure and CBDC in digital token form while commercial banks maintain the digital wallets.
Implications for emerging market and developing economies
- Benefits:
- Friction-free international payments could benefit importers and exporters and ease international trade transactions.
- Risks:
- More conduits for international capital flows increase difficulty managing capital flow volatility and exchange rate volatility.
- Small and developing economies may face greater challenges managing domestic economic policies amid increased capital flow and exchange rate volatility.
- Global access to digital versions of major currencies (dollar, renminbi) and issuance of stablecoins by megacorporations (example cited: Amazon) could cause less-credible national currencies to be displaced by trusted foreign or private currencies.
- Central bank credibility factors:
- Dominance of a reserve currency depends not only on economic size but on institutional frameworks that maintain investor trust, including rule of law, an independent central bank, and checks and balances.
Policy and regulatory challenges
- Cross-border regulation: cryptocurrencies’ borderless nature necessitates global coordination of regulatory policies.
- User-case specificity: central banks must assess the specific user case for CBDCs in each country (e.g., the US context: payment intermediaries like credit cards impose high interchange fees; about 5 percent of households in the US are still unbanked or underbanked).
- Alternative domestic initiatives: example—“FedNow” project aims to increase efficiency of both retail and wholesale payments in the US, potentially addressing some needs a CBDC might fill.
Risks to society and surveillance
- Authoritarian risk: a digital central bank currency could be used to surveil a population.
- Social policy risk: even benevolent governments might use digital money to restrict uses deemed not “socially beneficial,” turning money into an instrument of social policy and undermining central bank credibility.
Key findings and recommendations
- Findings:
- Digital payments are making cash increasingly obsolete in many settings.
- Bitcoin’s volatility and operational limits hinder its use as a daily medium of exchange.
- Stablecoins can improve payment efficiency but pose liquidity, redemption, and illicit-finance risks.
- CBDCs can improve financial inclusion and payment operations but risk crowding out private providers and disintermediating commercial banks.
- Emerging markets face particular vulnerabilities from increased cross-border digital currency access and private stablecoin issuance.
- Institutional credibility (rule of law, central bank independence, checks and balances) remains crucial for a currency’s international standing.
- Policy recommendations and scenarios:
- Pursue global coordination on cryptocurrency and stablecoin regulation.
- Consider dual-tier CBDC designs where central banks provide infrastructure and commercial banks operate wallets to mitigate bank disintermediation.
- Assess CBDC user cases country by country; consider targeted domestic payment system reforms (e.g., FedNow) as alternatives or complements.
- Monitor and manage potential for digital currencies to enable surveillance or unconventional social policy uses.
Source: Interview with Eswar S. Prasad, F&D Magazine, March 2022.
Content in this bundle
- ثورة العملة
- La monnaie : une révolution en marche
- Prasad
- Валютная революция – Финансы и развитие – Переосмысление бюджетных основ – март 2022 года
- Una revolución monetaria ● Finanzas y Desarrollo ● Marzo de 2022
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