The future of money: how the digital revolution is transforming currencies and finance. 2021. Eswar S. Prasad. The Belknap press of HArvard University Press.
Today, you cannot turn on the television or the radio without hearing an advertisement for cryptocurrencies or crypto exchanges. Many celebrities are touting 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 transform the economic and financial landscape? What are some of the pros and cons of digital currencies? Who will benefit from these new currencies?
Eswar S. Prasad attempts to answer these questions in The future of money: how the digital revolution is transforming currencies and finance. Prasad, Tolani Senior Professor of Trade Policy at Cornell University and author of several books on currencies, offers an interesting and insightful exposition on the changing landscape from traditional paper notes to digital currencies.
Prasad begins his discussion of the future of money with a quote from Cecilia Skingsley, Deputy Governor of Sweden’s central bank: “If you extrapolate current trends, the last note will have been returned to the Riksbank by 2030. Skingsley isn’t the only government official who sees a big future for digital currencies. China is another country moving away from paper money. In the United States, President Biden, recognizing the importance of new digital assets, signed an executive order to ensure the responsible development of digital assets in March 2022.
The book is divided into four parts. Part I, “Laying the Pedestal”, examines the future and promise of digital currencies and provides an introduction to finance for those with little experience. Part II, “Innovations”, 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, “Implications,” examines the potential implications for the international monetary system.
The “Innovations” section of the book begins with a chapter titled “Will Fintech Make the World a Better Place?” Here, the author takes us through the history of fintech, which he says is a catch-all term for new financial technologies. It was first invented in 1993 with Citicorp’s creation of the Financial Services Technology Consortium. However, some innovations, such as ATM, have become so ubiquitous that we forget they were once new technologies. The story includes an interesting look at the most recent innovations, such as M-PESA, which enabled individuals in Kenya to bank via mobile phone, as well as peer-to-peer lending, crowdfunding and lending. on-demand insurance. Many of these new services will pose challenges for traditional financial services companies.
Today, fintech is more 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 business areas, including securing medical records, non-fungible token (NFT) markets, and supply chain and market surveillance. logistics.
Most investment professionals are 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 underlying the system. The term “blockchain” is associated with a variety of cryptocurrencies. However, the protocols used to validate transactions differ for different blockchains. In addition, each protocol has advantages and weaknesses. Will many alternative protocols continue, or will one emerge as the industry standard?
Bitcoin uses a “proof of work” protocol to validate transactions, which requires block creators, called miners, to solve a randomly generated cryptographic problem. The approach makes it possible to validate transactions without a trusted third party. However, this method is computationally intensive, which requires large amounts of electricity to power the computers. Another disadvantage of this approach is that it only allows a relatively small number of transactions to be validated simultaneously.
Ethereum uses a “proof-of-stake” protocol. Proof of Stake was created to address some of the inefficiencies of the proof of work approach. Here, the privilege to validate a block is based on the amount that has been “staked” by competing nodes. However, as Prasad points out, this less resource-intensive approach is not without flaws.
Prasad debunks some of the myths of crypto and other digital currencies. For example, many view the use of cryptocurrencies, such as bitcoin, as a way to maintain anonymity. The reality is that, unlike cash, digital currencies require credentials for consumers to receive goods purchased with digital currencies, which removes anonymity. Blockchain has also been considered a secure technology. Although this technology offers greater security than other methods, Prasad outlines how individuals can hack the various protocols.
Like all new technologies, the fintech revolution has brought a whole new language to define new offerings, including hashing, security token offerings (STOs), smart contracts, initial coin offerings (ICOs) , hash-time-locked (HTLC) contracts, and stablecoins. The future of money allows investors to learn the new vernacular of this field and examine which innovations may offer the greatest investment opportunities.
Reading the book is unlikely to provide insight into how to value cryptocurrencies or how digital currencies, such as bitcoin, are likely to replace government-issued money as store of value, medium of exchange or unit of account. However, Prasad offers insight into the potential of digital currencies in the chapter “The case of central bank digital currencies”. He argues that CBDCs can improve efficiency on the wholesale side by improving how central banks distribute 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.
Although these chapters may seem more interesting to monetary economists and central bankers than to investors, Prasad provides some insights that investors can benefit from. It summarizes a study that analyzed how policies in some European countries aimed at reducing the use of cash reduced the underground economy and increased tax revenues. The savvy investor might wonder which investments will benefit from these increased tax revenues. Will the additional revenue be used to fund infrastructure spending? Will countries use the windfall to fund alternative energy projects? Perhaps countries led by conservative lawmakers will choose to return the money to citizens and businesses through tax cuts. If so, which industries are likely to benefit?
Innovations produce winners and losers by creating new opportunities and challenges for incumbents. Financial sector innovations are no different. Understanding some of the current and potential future changes will allow analysts to better determine which companies and industries are likely to prosper and which are likely to suffer. The future of money provides readers with a window into some of the opportunities and challenges facing the financial industry.
If you liked this article, don’t forget to subscribe to the Enterprising investor.
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 the CFA Institute or the author’s employer.
Professional Learning for CFA Institute Members
CFA Institute members are empowered to self-determine and report Professional Learning (PL) credits earned, including content on Enterprising investor. Members can easily register credits using their HGV tracker online.