The Future of Money, Eswar S. Prasad

"While it is premature to assume that traditional central banking activities are on the verge of major disruption, it is worth considering whether the looming changes to money, financial markets, and payments systems will have significant repercussions for the operation of central banks and their capacity to deliver on key objectives such as low inflation and financial stability."


"This much, at least, is clear. Cash is on its way out. In many small advanced economies, from Singapore to Sweden, as well as in developing economies such as China, cash is playing a smaller role in economic transactions. For a major currency such as the US dollar that is used extensively beyond the borders of its issuing country, change is likely to come more slowly. But no currency, even one so mighty as the US dollar, is immune to the winds of change that will affect the stature of cash."

p. 11

"Meanwhile, the introduction of CBDCs could alter the role and scope of central banks' activities. There are thorny questions about whether a CBDC that inherently carries an official imprimatur could stifle private sector-led financial innovations and perhaps even decimate traditional commercial banks by drawing deposits away from them. Central banks, which already grapple with multiple and often conflicting mandates, are far from eager to take on additional functions and responsibilities even as they try to take measures to remain relevant and maintain financial stability. After all, a central bank should ideally stay out of areas in which the private sector can provide services satisfactorily and where competition can produce innovations and efficiency gains. Attempts to resolve such tensions will bring into sharp relief perennial questions about the appropriate role and functions of a central bank."

p. 21

"In summary, the shadow financial system can be viewed as a parallel system--one that is complement to and not a substitute for traditional banking. For policymakers, this implies a delicate balancing act between attaining the benefits of shadow banking and controlling the risks, especially those that may seep into other parts of the financial system. Some of the Fintech players and developments discussed later in this book raise similar questions--are the benefits of innovations that might lie outside the ambit of traditional regulatory frameworks worth the risks?"

p. 53

"Even more salient transformations might be on the horizon, although perhaps only in the distant future. Consider two areas. The first is the issue of maturity transformation, which is harder to get around using only data and technology because things get more complicated once there is a time dimension involved. It may, however, be possible to improve on this using technology as well. Uber allows matching of riders and drivers along the spatial dimension; perhaps a similar matching technology is possible along the time dimension. Second, is it possible for banks to do their banking without money? Uber is the world's biggest taxi company but does not own a single taxi. Airbnb now has more rooms on offer across the world than any major hotel chain, but it does not own a single property that is rented out by the company through its website. In fact, one could argue that peer-to-peer lending platforms are already out front on both these issues, so these transformations might be on our doorstep."

p. 98

"These public and private digital keys constitute the essential elements of anonymous digital payment systems. A digital coin is stamped with the public key of its owner; it would also be associated with the owner's private key to ensure that it has only one owner. Thus, each digital coin is identified by two attributes--a public key and the corresponding private key. To transfer the coin, the owner signs the coin (digitally, of course) using their private key together with the public key of the next owner: the person to whom they are making a payment. Anyone can (electronically) check the public keys of both the sender and the recipient to verify the chain of ownership."

p. 111

"The cap would have some negative implications, however, if Bitcoin enthusiasts' dreams of its rivaling fiat currencies were to come true. The supply cap means that Bitcoin is intrinsically deflationary. Consider an economy that used only Bitcoin as a currency. What would happen as the economy grew and produced increasing volumes of goods and services? The fixed supply of Bitcoin means that the prices of those goods and services in Bitcoin would fall over time. Falling prices might sound good but in fact they create as many, if not more, problems than rising prices (inflation). Expectations of lower prices in the future could cause people to put off purchases and firms to hold off on investments, thereby driving demand and prices down further, setting off a downward economic spiral. Fortunately, there is no risk that cryptocurrencies are about to displace fiat currencies, but more on that later."

p. 126

"In short, while mining blocks on a blockchain under the Proof of Work protocol offers creative solutions to some real-world problems, it also uses a large amount of real-world resources. Mining requires ongoing purchases of hardware and an immense amount of energy consumption, both of which are harmful for the environment. Moreover, the mining process requires hardware to be running constantly on a full load, wearing out machines sooner than under more normal operating conditions. Since ASICs are designed for just a single application, they also face rapid obsolescence and cannot be repurposed for other uses. The constant turnover of equipment thus creates a massive stockpile of obsolete parts."

p. 142

"The bottom line is that the notion of true anonymity seems a mirage. A transaction using any sort of digital technology might never guarantee the level of anonymity and privacy in financial transactions, not necessarily only to hide the tracks of illegal activities. Both official and nonofficial digital currencies will have to grapple with finding the right balance among these conflicting demands of the use community--anonymity, ease of use, and security. The trade-offs are linked to the degree of centralizations of the validation mechanism (for instance, more centralization typically means less anonymity), although such trade-offs exist even among fully decentralized cryptocurrencies."

p. 159

"One might consider this case of trying to make a virtue out of a shortcoming. After all, one clear takeaway from this chapter's discussion is that while each cryptocurrency can boast the blend of stability, efficiency, privacy, and safety that would allow it to dominate central bank money. The prospect of Facebook issuing a stablecoin has, however, shaken the complacency of central bankers. Diem is unlikely to dent the prominence of major reserve currencies, but it could become a viable competitor to the fiat currencies issued by many other economies, especially smaller ones and those that lack strong, independent, and credible central banks. And even major central banks seem to have been put on notice about a medium of exchange that could become too big to fail and that might someday be delinked from and compete with fiat money."

p. 189

"A CBDC, if properly designed, thus makes monetary policy more potent in general, particularly under difficult circumstances when an economy faces collapsing growth and spiraling deflation. In principle, the same is true if an economy is facing the opposite circumstances--the risk of overheating in the presence of high inflation. In those circumstances, conventional monetary policy tools such as raising interest rates would work better, although operations such as raising interest rates on CBDC accounts could help as well.

There is, however, one major risk to be confronted. A central bank's forays, through actions such as helicopter drops of money, into what are essentially fiscal policy operations could blur the line between a government and an independent central bank. There are good reasons for fiscal and monetary policy to be pulling in the same direction, especially amid a deep recession or financial crisis. Nevertheless, the longer-term costs of becoming seen as an agent of government policies might undercut the very features that have made central banks effective--their independence, credibility, and willingness to take actions not swayed by shifting political winds."

p. 209

"Some studies make the point that cash (along with checks) constitutes a psychologically more painful form of payment than debit and credit cards or other forms of electronic payments. Credit cards, in particular, lead to increased willingness to pay more for purchases on account of transactional decoupling. Credit cards provide immediate gratification from purchasing goods and services without the psychological pain associated with spending one's money. After all, the bill comes due only days or weeks later, and actual payment can be put off even longer. Paying with cash forces a more immediate evaluation of the costs and benefits of a purchase, which has a dampening effect on all purchases and on impulse purchases in particular. Perhaps, though, this is equally why a government eager to boost consumption, as it encourages economic activity and thereby brings in higher tax revenues, might want to dissuade consumers from using cash."

p. 235

"Perhaps these considerations are excessively paranoid. A CBDC is after all just a digital tool. The notion that a malign government could twist its digital currency in a way that perverts the neutrality of that currency and makes it a weapon against its own people seems an absurd notion. It is as though someone were to build a digital platform to connect people, allowing family and friends to stay in contact no matter where in the world they may be. And for that platform to someday become a tool to spread misinformation, foment conspiracy theories, subvert democracy, and . . . oh."

p. 238

"The upshot is that, for all its incompetence and economic mismanagement, the Venezuelan government managed to create the world's first official cryptocurrency with explicit backing of the state. The Petro is unlikely to meet the government's goals of circumventing US financial sanctions, creating a new source of revenue, or avoiding hyperinflation. Like any other currency, it is only as strong and trusted as the government that stands behind it. And the new currency will hardly shake up the "hegemonic" international monetary system. Even if the Petro, as is likely, suffers the same fate as the bolivar, losing value and the confidence of its country's citizens, it still represents a milestone--albeit a peculiar one--in the evolution of digital currencies."

p. 262

"Investors in fact exhibit extensive home bias--they tend to heavily favor investments in their domestic stock markets rather than diversifying their portfolios. In principle, they could do far better to improve the risk-return trade-off of their portfolios through international diversification. In plainer language, judiciously buying stock in companies around the world, or simply investing in financial products that track other countries' stock market indexes, would allow investors to attain higher average returns over a long period for a given degree of risk. Or, if they were targeting a particular average rate of return, they could reduce the riskiness of their portfolios through such diversification."

p. 290

"One of the next frontiers in the Fintech evolution is likely to be the intermediation of capital flows at the retail level, enabling less-wealthy households and smaller firms in both rich and poor economies to more easily gain access to global financial markets. Diversifying one's portfolio should become easier as stock markets around the world open up to foreign investors and as the costs of transacting across national boundaries fall. Fintech firms that lower information barriers, reduce costs and other frictions in international capital movements, and create new saving and financial products are likely to experience significant demand for their services. As is often. the case during shifts in financial market structures, there will be risks and stumbles in this process, and regulators will face the usual trade-offs between facilitating innovations and managing those risks. In fact, the capital flows themselves pose risks not just to individual investors but also to entire economies."

p. 291

"One important requirement of a store of value currency is depth. That is, there should be a large quantity of financial assets denominated in that currency so that both official investors such as central banks and private investors can easily acquire those assets. There is a vast amount of US Treasury securities, not to mention other dollar-denominated assets, that foreign investors can easily acquire. Another characteristic that is important for a store of value, and one that is very much related to its depth, is its liquidity. That is, it should be able to easily trade the asset even in large quantities. An investor should be able to count on there being sufficient numbers of buyers and sellers to facilitate such trading, even in difficult circumstances. This is certainly true of US Treasuries, which are traded in large volumes."

p. 299

"The two objectives--low and stable inflation (along with low unemployment) and financial stability--and the tools to achieve them have come to be seen as inextricably linked. For instance, financial instability can lead to gyrations in economic activity that make it harder to maintain stable inflation. But the lines between the two policies on occasion blur and get tangled up, making policy decisions less straightforward. There are periods of low inflation and decent growth when the stock market might show signs of rising too fast. In such cases, monetary policy might seem on track to hit the inflation mandate, but if it ignored frothy stock prices, it could forgo the opportunity to let some air out of the stock market rather than standing by while it soars and perhaps ultimately crashes. Tightening monetary policy by raising interest rates would cool off the stock market, but this could, on the other hand, come at the price of restraining growth."

p. 317

"Decentralized finance hardly eliminates the need for government, which will retain important roles in enforcing contractual and property rights, protecting investors, and ensuring financial stability. After all, it appears that even cryptocurrencies and innovative financial products work better when they are built on the foundation of trust that comes from government oversight and regulation, even if only at arm's length. Governments have the responsibility of ensuring that their laws and actions promote fair competition, rather than favoring incumbents and allowing large players to stifle competition from smaller ones."

p. 360