SPEAKER: This is a production of Cornell University Library.
TOM OTTAVIANO: Hello, everyone. I'm Tom Ottaviano, the business and economics librarian at Mann. And I'm delighted to be welcoming you all today to today's Chats in the Stacks book talk with Dr. Eswar Prasad.
Today's book talk opens Mann's book talk series for the fall 2021 semester. We'll be hosting several more this semester, with other unit libraries in the Cornell University Library system hosting several of their own. For a look at the lively range of speakers and titles featured, please visit the book talk link that my colleague has posted in the chat.
Due to ongoing COVID-19 infection mitigation efforts at Cornell, all library book talks for the fall semester will be virtual webinars. They all include opportunity for questions, which audience members can pose via the chat function in your webinar view. Please feel free to submit your questions via chat at any time during today's presentation, and I will present them to our speaker in the Q&A portion of the webinar.
I will introduce questions by using the asker's first name, unless anonymity is specifically requested. If you would like captions for this presentation, they can be toggled by clicking on the CC Live Transcript button at the bottom right in the Zoom interface.
Before proceeding to my introduction for Professor Prasad, I'd like to include an acknowledgment that Cornell University is located on the traditional homelands of the Gayogohono, Cayuga Nation. The Gayogohono are members of the Haudenosaunee Confederacy, an alliance of six sovereign nations with a historic and contemporary presence on this land.
The Confederacy precedes the establishment of Cornell University, New York state, and the United States of America. We acknowledge the painful history of the Gayogohono dispossession and honor the ongoing connection of Gayogohono people, past and present, to these lands and waters.
And now to our speaker. Dr. Eswar Prasad is the Nandlal P. Tolani Senior Professor of Trade Policy and professor of economics at the Charles H. Dyson School of Applied Economics and Management at Cornell University. He is also a senior fellow at the Brookings Institution, where he holds the New Century Chair in International Economics, and a research associate at the National Bureau of Economic Research.
He was previously chief of the Financial Studies division in the IMF's research department and before that, was the head of the IMF's China Division. Professor Prasad's research has spanned a number of areas, including labor economics, business cycles, and open economy macroeconomics.
Through a publishing and engagement record that is both distinguished and extensive, his impact on research, policy-making, and education in national and international finance and financial sector reform has been broad and consequential. He has authored, co-authored, and edited several books and monographs on financial globalization, China, and India. His articles have appeared in numerous collective volumes and top academic journals.
Through op-ed articles and appearances on various major national and international news media, he has helped make a better understanding of current issues in international finance and development possible for a wide global public. On multiple occasions, he has testified before the Senate Finance Committee, House of Representatives Committee on Financial Services, and the US-China Economic and Security Review Commission.
Dr. Prasad's current research interests include the macroeconomics of globalization, the structures of the international financial and monetary system, and the Chinese and Indian economies. His newest book, The Future of Money, which has been described as "a single-volume masterpiece with all one needs to know about an amazing turning point in monetary policy," shows us where his recent work has led him. Please join me in giving Professor Prasad a warm welcome.
ESWAR PRASAD: Thank you, Tom, for that introduction. And thank you, also, to your Mann Library colleagues who have put together this event. It is really a pleasure to be with all of you. And this is truly a Cornell book in the truest sense of the term.
Because in addition to Cornell being my home, there are many Cornell students who actually helped me with the background research for this book-- many undergraduates and some graduate students, as well, who helped in my thinking on these issues. And of course, many of my academic colleagues, both in the Ithaca Campus and at Cornell Tech, including some of our colleagues in the Initiative for Cryptocurrencies, have been really helpful in sharpening my thinking about some of these issues.
So when I started this book, my objective was really to think about central bank digital currencies, which I will talk about during this talk. And this came about because I hang out with central bankers a lot. And about three or four years ago, I started getting questions about digital currencies and what they might mean for finance and monetary policy.
I didn't have many good answers to this, so I decided to go out and read up on this. And it turned out that there wasn't very much to read up on because this was all fairly new. So I decided to start thinking in a more structured way about this.
And soon, it became apparent to me that, as I thought about central bank digital currencies-- that is, digital forms of what we now know as currency-- one needed to think about the broader development in financial markets that come under the rubric of this term "fintech." And that led me into thinking more about cryptocurrencies and having to learn about them, which is a very exciting and intellectually demanding process, and then thinking about how all of these changes might affect things that matter to us, things like the global financial system but also more basic concepts of money, banking, and finance.
So that's the broad overview. But of course, it's worth thinking about what set off this entire technological revolution that we're going to talk about today. In economics and finances and everything else, getting the timing right is really crucial. And let me take you back to those dark days of September 2008, where the global financial crisis got started.
September 15, 2008 was a particularly dark moment in US and, indeed, global financial history. That's the date referred to as the "Lehman moment," when Lehman Brothers essentially went under and threatened to take the entire financial system in the US and abroad down with it.
So this was a period right after all of this happened when it seemed like there was declining trust in both government and commercial financial institutions, especially the large banks. So the time was ripe for something that happened right about six weeks after the Lehman moment.
So in late October of 2008, this blog post appeared on a particular chat group. And what is important is the date here-- October 31, 2008. And it's by this person with the digital identity Satoshi Nakamoto who says very modestly, I've been working on a new electronic cash system that is supposed to be fully decentralized, peer to peer, with no trusted third party.
And this paper turned out to be the beginning of the revolution. The first version of Bitcoin was actually released in January. And again, the time was ripe for something to come up. And the objective of Bitcoin was really to set up a payment system that would allow electronic payments to be conducted but, crucially, without relying on central bank money or a bank or other financial institution.
So this sounds like magic. How on earth are you going to be able to do it, especially because Bitcoin promised that not only could you do this magic but could do it without revealing your true identity-- that is, just using your digital identities, a concept referred to as pseudonymity?
So I'm going to tell you a little bit about how Bitcoin achieved this marvelous objective. It turns out that Bitcoin is, in fact, not great at doing what it was supposed to do. But the technology turns out to have really remarkable effects.
Now, where does cryptography enter into this? Because when you hear about cryptocurrencies, you might assume that a lot of this stuff is based on cryptography. It turns out that Bitcoin is actually remarkably transparent.
There is an element of cryptography that enters into this. And that is in the form of cryptographic systems that generate pairs of keys-- public and private digital keys-- which are crucial to the operation of Bitcoin. And you can think about this as analogous to your bank account, where your account number might be shareable with other people but they can't do anything with it unless you know the password, which is really a private key.
There are also other elements from cryptography that are relevant here. And one of the building blocks is something called a hash function. What a hash function basically is is a cryptographic tool that takes any random block of text or numbers and translates it into a particular format that makes it very difficult to break the code very easily. And I'll explain this a bit more in a second.
And another element is something called distributed ledger technology. So a hash function basically is something that you take any input, it gives you an output in a standardized format. Now, I have a very simplified hash function that's shown here. And what is important to note is that if you make even the slightest change to the input, the output changes completely.
And it turns out that hash functions used in Bitcoin, for instance, are much more complex, of course. And what is crucial is that you cannot back out from the hash function what the input was. So this property turns out to be very important in being able to identify, for instance, transactions. So if you take certain key elements of a transaction-- what the digital identities of the transacting parties are, who is paying whom, what the amount of the transaction is-- and then run that information through a hash function, you can get a digital fingerprint of that transaction which is unique to that transaction.
Distributed ledgers are an interesting development, as well, that predate Bitcoin. But Bitcoin uses them in a very effective way. So typically, one can think about accounts being maintained by a centralized party. It could be a commercial bank or another financial institution.
But distributed ledgers are maintained on multiple computers around the world, and they are synchronized in real time. So each ledger has exactly the same information. But in addition, they are transparent.
So distributed ledgers don't necessarily have to be transparent, but Bitcoin, as I'm going to show you, is remarkable that, in fact, while you might think it's very secretive, in fact, all Bitcoin transactions are publicly available for anybody to see. And this radical transparency turns out to be crucial.
So the challenges that Bitcoin tries to solve are really remarkably complicated ones. How do you validate transactions without a trusted party? How do you achieve consensus in a decentralized network that certain transactions are valid? How do you verify them? And how do you make sure that if people have digital money in their account that they don't double spend that money-- that is to say, use it for multiple transactions?
And the way the Bitcoin algorithm solves this problem is through what is called a consensus protocol. That is, everybody in the community of all the computer nodes that are acting as validators have to agree that certain transactions are valid. And the way this works is a very interesting process called mining.
Essentially, what happens is the Bitcoin network throws up a completely randomly generated numerical problem that can only be solved by brute computing power. And whoever solves that problem first gets to have the privilege of validating that block of transactions and confirming that they are, in fact, valid transactions. And what happens then is that you have the settlement of these transactions by essentially having the account balances of all the people who are using Bitcoin updated on the network.
And why do Bitcoin miners do all of this? Because, after all, computing power does cost real money. You have to pay for energy. You have to pay for computers. The answer is that they get rewarded with Bitcoin. And it turns out this process of mining not only validates transactions but also is the process by which new Bitcoin are generated.
So this is a simple graphical conceptual description about how Bitcoin works. People who have Bitcoin and want to transact with it, either paying for goods and services or transferring that money to somebody else on the network, post those transactions in the network. These are collated into blocks. Those blocks are validated. And then these blocks are chained together, using computer algorithms, to all the previous transactions.
This is where the term blockchain comes in. So blocks of transactions are recursively linked to each other. So now you have a very long and complex distributed ledger complex, not because of the complexity of the information but because of the amount of information in there.
So this information is distributed to computers on the network that then maintain this in a synchronized fashion. So every Bitcoin transaction in history is available for you out there to see, so long as you know where to look.
So this radical transparency actually provides some security. Because now when you have some malevolent actors who try to tamper with certain transactions, they can be very quickly identified. And those illegitimate transactions then get kicked out.
Now, Bitcoin has not worked very well as a medium of exchange, which was its ostensible function. As you probably heard, Bitcoin is a very unstable value so you can't really use it very effectively. And it also has very slow processing time. The number of transactions that can be handled on the network is very limited. So it's failed in its basic purpose.
There has been some concern that Bitcoin fuels illicit activities, although it turns out that this digital anonymity is not as secure as one might expect. Certainly, there have been ransomware attacks where those attackers have demanded payment in Bitcoin. But it takes a fair bit of technological sophistication to hide your trades, even using Bitcoin.
And then I talked about those digital private keys. If you lose your password to your bank account, you can go to your bank and retrieve the password. With Bitcoin, you lose your private key, and it's gone. And it has happened to a lot of people.
So curiously, Bitcoin has become a speculative financial asset now that people hold on to. Why do people think that Bitcoin has value given that it doesn't seem to have any intrinsic value? Among Bitcoin adherents, there seems to be this token of faith that, unlike dollars that can be printed at will by the Federal Reserve, Bitcoin actually is a scarce commodity.
There are going to be at most 21 million bitcoins that can be created. About 18 and 1/2 million have been created so far. So scarcity is believed to be an underpinning of Bitcoin's value.
But to an economist, this is a very dubious proposition. After all, something that doesn't have any intrinsic value, just because it's scarce, is probably not going to retain value. So I don't hold any bitcoin, and I would recommend you don't, either.
Another problem is this validation process of transactions is really environmentally very destructive. Right now, there are very specialized machines called ASICs, or Application-Specific Integrated Circuits, that are devoted just to cryptocurrency mining. And this is a picture of a cryptocurrency mine with zillions of these ASICs chained together. This takes up a huge amount of energy. There are some estimates that somewhere between 1/2% to 1% of global electricity consumption is consumed by Bitcoin mining. And of course, you generate a lot of computer detritus. So Bitcoin has really not been good for the environment.
But what has transpired as a result of the technology side of Bitcoin is that you now have new cryptocurrencies that try to fix many of the flaws of Bitcoin. Unstable value is a major problem. And there are new stablecoins that try to get around this problem by essentially being backed up by reserves of fiat currencies.
So for instance, there is a stablecoin called Tether that is ostensibly backed up by dollar-denominated assets, including Treasury securities. There are alternative ways of validating transactions that are much more environmentally friendly and are also much more efficient.
There are new cryptocurrencies that offer much more anonymity, which one might worry can be used, again, for illicit activities. But these are somewhat more cumbersome to use, somewhat thankfully. And then, of course, Facebook plans to issue its own cryptocurrency called Diem, as though Facebook doesn't control enough of our social lives as it is.
But they are trying to meet a real need, or at least that's what Zuckerberg tells us, that this Facebook-backed cryptocurrency coin would essentially be backed up by reserves of dollar instruments. And it would provide a way of giving access to low-cost digital payments, both within and across countries, to people who want that.
And then, of course, you have meme coins like Dogecoin, which are even more out there. But certainly, the fact that you have all these cryptocurrencies together having a value of somewhere in the range of $2 and 1/2 trillion is suggesting that we can't likely dismiss cryptocurrencies as a phenomenon.
But what I think is far more interesting is the technological revolution that Bitcoin has set off. And it is creating the basis for something called a decentralized finance. And decentralized finance is built like Bitcoin on decentralized blockchains. But it allows a broad range of financial transactions to be conducted without these third parties, or trusted intermediaries.
One example is that of smart contracts, which actually allow certain transactions to take place-- for instance, buying a house, buying a car, or just exchanging a financial instrument-- without a real estate attorney or a broker being present. And remarkably enough, this crazy-sounding future is already here.
This is a pictorial description of a very simple smart contract. In fact, smart contracts have functionality that is way beyond this. So basically, the way it works is you have computer code that sets it up such that two parties who want to exchange something-- let's say one of them wants to sell a corporate bond or maybe some other financial asset to another person. They both agree to this contract, which is all embedded in computer code.
And then the computer code essentially becomes the escrow account. That is, one party deposits a financial asset. The other party deposits a payment. And the smart contracts make sure that those conditions are met. And when those conditions are met, it executes a contract.
And the contract can then be settled by the money being transferred to the account, the digital wallet, of the person who had the bond. And the bonds ownership gets transferred to the person who is buying the bond. And this is, again, a very simple version of the remarkable functionality that smart contracts actually have.
Now, decentralized finance sounds, at one level, a bit crazy. But in fact, it has a number of advantages. Because you have this distributed ledger system, you essentially don't have a single point of failure, which actually makes these systems more resilient and more resilient not just to failures but also to attacks. And it turns out that one malevolent institution-- and some people think the government may be a malevolent institution-- cannot really control this, and the governance is by the community.
So it is permissionless. That is to say anybody can use it. Nobody can stop you from using it. And anybody can verify the execution of a transaction. And DeFi actually has given way to remarkable financial products. So it turns out that it actually allows you to combine different modular projects. So it has been described as financial LEGOs because you can sort of stick them together and create completely new products.
I have given you an example, again, of a product that already exists. It's of people essentially using whatever cryptocurrencies they may have to put it into a sort of deposit account so that those cryptocurrencies can be used by other people who want the liquidity. And then multiple people who put their deposits into these accounts then enter a lottery game where the winner of that lottery gets the prize, which is the interest rate that each person would have got.
So everybody who put their money into this contract gets the original principle back. The winner gets the principal back plus the interest that everybody would have gotten. So it gives more of an incentive for people to participate. Again, this sounds crazy, but it already exists.
So there are many other products coming along. Of course, the notion that technology can solve all problems is something we should worry a little bit about. In principle, regulatory compliance tools can be plugged in.
But there are a variety of risks that emerge, especially because these are new and innovative products. And there are obviously huge incentives for hackers, who have to be very sophisticated to break these systems, to actually try and make off some money. So there are some vulnerabilities to be thought about.
Now, amid all of this, what is happening to central banks, who, after all, play very big roles in creating money? These are four of the major central banks around the world. They haven't been sitting quietly. Recognizing these remarkable changes that are taking place and the possibilities that have been created by these innovations, they are moving forward, as well, with thinking about digital versions of their fiat currencies.
So I will refer to this as Central Bank Digital Currencies, or CBDC. Why are central banks considering CBDC? It turns out that there are very good reasons. Cash is a payment mechanism, but many of us now use digital payments. You just use your swipe of your phone when you go to Ithaca Bakery or to Mann Café to pay for your beverages or food.
But it turns out that there is a large part of the population in many developing countries, and even in a country like the US, where to use Apple Pay, you need to be able to link it back to a credit card or a bank account, which many people do not have. So a central bank digital currency, especially if it was set up in the form of an account that you could have with the Federal Reserve or the Central Bank-- and in fact, the technology now exists for each of us to be able to have an account with the Central Bank and for the Central Bank to be able to manage this-- then we might have everybody having easy access to a very low-cost digital payment system. So you could have better payment system.
But also, in countries such as Sweden, where the private sector is doing a perfectly fine job of creating very good payment systems that people use, there is the concern that maybe if the entire payments infrastructure is in the hands of the private sector, it creates some vulnerabilities. If people start getting a little worried about the financial stability of those payment providers, the entire economy could freeze up.
So Sweden is undertaking a trial of CBDC and e-krona because they want to have a backstop to the private payments infrastructure. And in some countries, there is also a desire to maintain the relevance for central bank money at the retail level that is in day-to-day transactions.
So CBDC have many benefits, in addition to those I already spoke about, such as broadening financial inclusion and enabling the shift to digital payments. A lot of corruption, a lot of illegal activities, are intermediated through cash. So eliminating cash and having digital forms of payments will create digital traces for every financial transaction.
This is not going to eliminate corruption or illicit commercial activities, but at least it means that central bank money cannot be used for that anymore. And it will bring a lot of economic activity out of the shadows. And some of this could be perfectly legitimate activity-- paying your babysitter or your gardener with cash that may not get reported for tax purposes, either by you or by the gardener or babysitter.
And these are small amounts, and maybe it doesn't matter that much. But the less cash is used and the more you have digital payments, the more activity is going to come into the tax net. Of course, an increase in tax revenues may not necessarily be seen by everybody as a good thing, as it may help the government grow and perhaps do good things.
There are other advantages, as well. During the early stages of the coronavirus pandemic, the US government sent out coronavirus stimulus payments. Those who had direct deposit information on file with the IRS were able to get that money right away. But others got prepaid debit cards, checks in the mail, some of which got lost, some of which got misappropriated.
So if each of us had an account at the central bank, it would be much easier for the central bank to undertake what are called helicopter drops of money-- that is, all qualified people could easily get money deposited into their accounts. You could also have, in desperate circumstances, where the government is trying to encourage consumption and investment, you can actually have something that is infeasible in an economy with cash, which is negative nominal interest rates.
Cash has a zero nominal interest rate. $100 bill today is $100 bill two years from now. Certainly, inflation may eat away its purchasing power. But in nominal terms, that dollar is still worth the same.
At a time of huge financial peril, when an economy is collapsing, a government may want to have negative interest rates so that rather than saving up their money, businesses will go out and invest, consumers will go out and spend. And in fact, in the years after the financial crisis, many countries around the world, although not the US, did try to put in place negative interest rates.
Now, these are admittedly very desperate policy tools for desperate circumstances. And I would not suggest that any central bank would consider using them lightly. But it's good to know that with a CBDC, such possibilities exist if we were to face really perilous economic times again.
But a CBDC has risks, as well. If we all had access to central bank accounts, we might decide that, especially in difficult economic times, we want to move our money from commercial banks, even if our deposits are insured there, and move them to central bank accounts. This could cause the banking system to collapse.
And even in normal times, if the government provided a low-cost digital payment system, that could block private agents from creating their own payments innovation. After all, who can compete with an entity such as the government?
Plus, there are concerns, of course, about potential hacks of our central bank accounts, as well as loss of privacy. After all, any transaction that leaves a digital trace, there is a concern that you might lose some privacy and confidentiality in your transactions.
So there are some real risks. But it turns out that there are experiments being undertaken by many countries which suggest that there might be ways using technology and good design choices to mitigate, if not entirely eliminate, these risks.
For instance, China's experiment with its digital currency suggests that there might be a way to set up different types of digital wallets. So you could have very low-value digital wallets that you could use for very low-value transactions where the government may not collect much information on those transactions. But once a transaction value crosses a certain threshold, then the government may want to make sure, that it knows that its money is being put to good use.
What about the flight of deposits into the banking system? It turns out that the Bahamas, which has issued the first nationwide central bank digital currency, has found a simple solution to this, which is you cap the amount of money that can be kept in a central bank digital currency account. So there are ways around this.
And with these technological and design choices, many countries are beginning to move forward. I already mentioned the first nationwide CBDC that has been rolled out in the Bahamas, the sand dollar. There are trials in progress around the world. China, Sweden, and Japan have already initiated central bank digital currency trials.
Many countries are in the planning stages of the trials. And the US Federal Reserve, our very own central bank, is planning to release some research on the technical design and prospects of a digital currency any day now.
So I think as we look at the broad landscape, there are certain things that are pretty clear in terms of the future of money. One is that cash is on its way out. Now, there are certainly some segments of the population-- maybe the elderly, the less technologically savvy-- who still view cash as very important.
In fact, there are many states and cities in the US that are trying to pass legislation-- some have already done so-- that businesses cannot deny customers the ability to pay in cash. I still pay my Uber drivers their tips in cash because the tactile element of cash and the personal connection, to me, is very important.
But the reality is that as we move towards low-cost and efficient digital payments, both for consumers and businesses, there are many advantages. Many businesses find it a real hassle to deal with cash. It's prone to theft. It's prone to loss. It's prone to damage.
So for businesses, so long as they can get access to low-cost digital payments, they're going to start moving in that direction. And businesses around the world are already doing so. And this provides channels for financial inclusion through the new technologies.
And we're going to see more and more channels of direct financial intermediation between savers and borrowers, between businesses and consumers, between consumers and consumers. The other day, I asked in my class about how many of my students use Venmo. And virtually every hand shot up.
But this is going to create some challenges, especially to the existing banks and financial institutions. And we may not love our banks too much, but they play a very important role in finance. We think about central banks creating money.
But it turns out that most money creation in modern economies, when we think about the money that facilitates consumption, that facilitates buying a house, a car, or businesses taking loans to make investments, those are really fueled by money created by commercial banks. So in modern economies, commercial banks are really crucial to the creation of money. So some of these challenges may have larger ripple effects.
There are also potentially ripple effects in terms of international finance. So as you look at the landscape of currencies-- and my two previous books were about the two currencies depicted here, the US dollar and the Chinese renminbi-- so there are questions also about whether the international monetary system is going to be affected, as well. And there, too, there are changes coming.
These new technologies are going to make international payments a lot easier. Right now, international payments are even more complex than domestic payments because you have to deal with multiple financial institutions, multiple currencies, multiple regulatory regimes. So international payments right now tend to be very cumbersome, very slow, difficult to track in real time.
The new technologies spawned by Bitcoin are really making these payments a lot more efficient. And this is going to benefit exporters and importers for their trading activities. It's going to benefit migrants sending remittances back to their home countries. So I think there is a lot of change in prospect in areas where there are lots of inefficiencies in financial markets right now.
There are going to be some challenges, not just for central banks in the large economies but especially for smaller countries and less developed economies. And one can well conceive of a digital version of the dollar or a digital version of the Chinese renminbi if it was easily available abroad, or even Facebook's stablecoin Diem. If that were easily available abroad, that could be trusted much more than the currencies of some of these economies.
So you might have currency competition develop on an international scale and essentially wipe out the currencies of some of these smaller and less developed economies. But my view, at least, is that, even though there might be some more intensified currency competition, the dollar is likely to remain the dominant store of value for a long time to come.
Because ultimately, when you think about stores of value, as opposed to a currency for making payments, it's the institutional framework that matters as much as economic size and depth of financial markets. And what is that institutional framework? It includes an independent central bank, the rule of law, an institutionalized system of checks and balances.
And admittedly, each of these institutions came under attack in the last few years. But they seem to have stood up, at least moderately well so far. And in international finance, you don't have to be perfect. You just have to be better than everybody else. And this combination of economic and financial might, plus institutional framework, that the US has, I think, is going to keep the dollar in its position as the predominant currency for a long time to come.
But in the long arc of history, we are in a really fascinating period right now. Because we had a long time ago, when money was first created, private currencies emerging, issued by merchants or small financial institutions, including money lenders. And then you had government currencies competing with private currencies.
The establishment of central banks, which were given the task of maintaining faith in money, they essentially wiped out private currencies. But now we are coming back to a time where private currencies and fiat currencies issued by central banks may actually compete once again, at least in the medium of exchange function, although perhaps not in the store of value function. And as an economist, I think competition is a good thing, so long as it is kept within bounds.
But finally, I want to draw your attention to the point that as we think about these big issues that are much broader issues that come to play and that we need to consider very seriously, one of these is about the government's appropriate role in financial markets, as well as in the economy. As I mentioned, countries are moving forward with issuing central bank digital currencies.
This could make central banks and governments far more important in our economic and financial lives. And whether we really want central banks to be in this position, where they might end up getting a lot of deposits from households and businesses and end up being in the position of having to allocate credit or, at a minimum, where they're going to have a window into a lot of our financial transactions, it is a serious question whether we want to live in that world.
On a more micro scale, one may also think about what sort of regulation the government can put in place. Because ideally, you want a government to be playing a role where it is facilitating innovations by the private sector. And there are fantastic innovations underway right now in finance.
But at the same time, you want to make sure that regulators are on the ball in terms of preventing us from having to deal with the risks that emanate from all these innovations. So striking that balance is a challenge that every regulator, every government, is having to deal with. And this challenge is only going to intensify.
And while technology is a wonderful thing, I think there are some real concerns about whether these innovations, like many of those we've seen in the past, might end up worsening certain economic and social problems that we're already confronted with. We've seen certain new innovations, like easy access to trading platforms, like the Robinhood platform, drawing in a lot of relatively naive retail investors.
And the problem is that if you were to try to buy Bitcoin now or to join in one of these speculative frenzies at the tail end of the party without being aware of the risks and getting caught up in the technological razzle dazzle, you may end up being the one who suffers the largest losses. So I think there are lots of issues here related to making sure that there is sufficient investor protection. And that has to be largely done through increasing financial literacy and also making sure that people don't get left out of this transformation because they do not have digital access.
So there are some underlying problems, such as inequities in digital access and financial literacy, that may mean that these new technologies end up actually exacerbating, rather than dampening, the existing problems. So as the title of my last chapter in the book suggests, a glorious future beckons, but only perhaps. Thank you.
TOM OTTAVIANO: Thank you so much for a fascinating talk. We welcome any questions to come into the chat box now. We already have two questions. I'll start with one from Wayan. And please forgive my pronunciation if that's incorrect. "How would a 100% rollout and adoption of a CBDC impact private banks?"
ESWAR PRASAD: So first of all, I should make clear, in case I didn't earlier, that every central bank that is contemplating a CBDC is thinking about CBDC as co-existing with cash. But I think the reality is that cash will organically disappear because people will find digital payments much easier to use.
Wayan's specific question was about whether, if we all had CBDC accounts, that could end up with disintermediation of the banking system. I think there are safeguards that can be put in place. I gave you an example of what the Bahamas has done.
But what Sweden and China are doing, which might end up becoming the template for other countries, is creating what is called a dual-tier approach, or a two-layer approach. Essentially, the central banks in these countries provide the digital tokens, which is the form that the CBDC takes, and they provide the payment infrastructure.
But then, the front end-- that is, the digital wallets-- in which CBDC balances are maintained are actually maintained by the commercial banks. So the commercial banks maintain these non-interest-bearing CBDC wallets in parallel with their interest-bearing accounts, which are largely digital, of course.
So this keeps commercial banks in the game. It allows commercial banks also to undertake regulatory compliance functions, such as know your customer to make sure that these central bank digital wallets are really assigned to parties whose bona fides are checked. And with limits on the central bank digital currency wallets, I think the disintermediation can be managed.
And this dual-layer approach has another attraction, as well, which is that because the central bank just provides the tokens and the platform on which these payments can be made, you can now have private payment providers that innovate in how efficiently those tokens can be used. So you accomplish a number of objectives.
You have a low-cost digital payment system, but you keep the commercial banks in the game still. You don't threaten them entirely. And you still allow for private sector payments innovation. So it seems like the experiments underway right now are showing us ways in which some of these risks can be mitigated.
TOM OTTAVIANO: Wonderful. Thank you. And we have several questions coming in. This one is from Jonathan. "Can you say a bit more about the ideological underpinnings of Bitcoin? Is there an anti-government libertarian bias at work?"
ESWAR PRASAD: There is a hugely libertarian angle at work here. Because the whole point of Bitcoin was to create a form of conducting transactions that did not require reliance on a third party, such as a government, a central bank, or, indeed, a financial institution.
And that is the great hope of the decentralized finance community, as well, that a key aspect of decentralization is the community comes up with the rules and governs itself. And the community has a lot of self-correcting mechanisms in place so that malevolent actors do not end up dominating the system.
So that is the objective. But I think the irony here is that if you think about stablecoins, for instance, they are cryptocurrencies, but they are not decentralized in the form that Bitcoin is because you will have a particular company that we'll undertake the validation of the transactions. But they get the stability of their value because they are backed up by central bank-issued fiat currencies.
So that is one of the ironies. And the other irony is that cryptocurrencies, including Bitcoin, seem to actually benefit from the veneer of legitimacy that is given to them by governments. So in the US, for instance, the IRS treats Bitcoin and other cryptocurrencies as financial assets. So in principle, you're supposed to report capital gains and financial assets.
And I've actually, in the course of research for the book, found people saying that if the government thinks it's OK and wants me to report it, then maybe they think it's OK. So curiously, I think, this role of the government may actually lead people into believing that Bitcoin is somehow OK. But of course, the whole point of cryptocurrencies was to sidestep the government and existing, or traditional, financial institutions.
TOM OTTAVIANO: In a related question from Liam, "Do you expect corporate currencies to encounter significant regulation from governments?"
ESWAR PRASAD: There is a lot of concern about cryptocurrencies or stablecoins issued by private corporations. Now, I should nuance something I said about Facebook. It's not exactly Facebook that will be issuing this cryptocurrency called Diem. Facebook is one of the companies that created this association which is now called the Diem Association. It used to be called Libra.
And Facebook claims that it's the association that will be claiming it. But it's not hard to imagine that Facebook is the real money and power behind this association. So it is really seen as a Facebook currency. And given the enormous reach of Facebook and given its extensive financial cloud, it's not hard to imagine that people, especially in many countries where there are no trusted currencies, might view a Facebook-issued currency as a much better way to conduct financial transactions.
And this creates a lot of concerns for the government about whether Facebook will, as with many other things, wash off its hands and say that if this cryptocurrency, Diem, is used for illicit transactions, that is really not up to it to police. There are also concerns that cross-border illicit activities could be financed through this and, ultimately, that it might become a financial risk.
Because even though it's supposed to have a stable value and it's supposed to be backed up by reserves of either holdings of dollars or dollar-denominated securities, there are questions about who is going to verify this and whether, if many people try to change their Diem back into US dollars at the same time, that might cause a run on Diem, so to speak, which might end up causing financial problems that spread to other parts of the financial system. So almost certainly, regulation is coming.
TOM OTTAVIANO: We have about a dozen questions in here, so I'm going to try to rapid fire them. It's a question from Zhao. "Is it a possibility that embracing a cryptocurrency could increase the appeal of a currency as a global reserve currency?"
ESWAR PRASAD: Not quite. I think a digital form of a currency is not going to change the currency status as a global reserve currency. And taking the Chinese example, for instance, certainly if an eCNY was widely available outside China, I can well imagine it being used as a payment currency for trade and financial transactions. But are investors going to trust it as a safe asset? Probably not.
There is this interesting experiment of Ecuador, which recently declared Bitcoin to be legal tender. And that is, to me, an exercise in desperation. Because Ecuador has a failing government, a central bank that is not very credible. For a long period, they've essentially abandoned their currency and have been using US dollars.
So I think what Ecuador is trying to do is shake off what they view as dollar hegemony and perhaps also try to ride the Bitcoin wave. Because after all, if Ecuador were to acquire a large number of bitcoins right now and the value of Bitcoin were to rise in the future, that might give Ecuador a lot of money to work with to plug the gaps in its government finances. I don't think it's going to work very well.
TOM OTTAVIANO: This is an anonymous question. "Do you think that POS cryptos will replace POW cryptos?"
ESWAR PRASAD: OK, that's an arcane question about the consensus protocols that I spoke about. Bitcoin uses Proof Of Work, which, as I mentioned, has a lot of inefficiencies. POS is Proof Of Stake, which is an alternative consensus protocol. The second-most important cryptocurrency, Ethereum, is going to move to proof of stake relatively soon. And there is talk that someday, perhaps, even Bitcoin will.
That is a more efficient protocol and certainly will allow for scalability of transactions to a level that Bitcoin is not capable of right now. So in the medium of exchange function of cryptocurrencies, shifting to proof of stake would definitely set up a cryptocurrency in a position much better capable of being able to discharge that medium of exchange function.
TOM OTTAVIANO: Here's a question from Ari. "Do you see the possibility of a future in which money creation is taken over by decentralized finance instead of banks?"
ESWAR PRASAD: I think decentralized finance is going to have a lot of potential in terms of matching savers and borrowers. Now, one of the questions is whether the money creation that we see in modern economies through commercial banks can be replaced adequately by decentralized finance.
And this has a couple of components-- whether decentralized finance can be scaled up to the extent to which you have normal financial activities mediated by commercial banks, and, second, whether you can have these fundamental functions of a banking system, which is maturity transformation, transforming short-term deposits into long-term loans and getting around information asymmetries, can be managed through a decentralized process. On the latter, I suspect the answer is yes. On the former, I'm a little less sure.
Certainly, one can think about Uber essentially solving a spatial coordination problem. And money helps to solve a intertemporal coordination problem. And after all, time is just another dimension. So maybe we just need to find the right technology that allows for better matching on the intertemporal dimension, as well.
But again, the tricky part here is that if you look at the broad monetary aggregate, such as M2, which includes currency created by the central bank but also commercial banks, in most economies, it's really commercial banks doing the creation of money. So I haven't come to grips quite yet with this question about whether money creation can be undertaken by a decentralized financial system, even if it can conduct financial intermediation quite efficiently.
TOM OTTAVIANO: A question from Mark. "Is there an analogy of NFTs to Bitcoin?"
ESWAR PRASAD: So NFTs are certainly a remarkable new development, the fact that you have digital objects that people seem to be willing to put down so much money for. And certainly, there is a parallel in that objects such as Bitcoin and NFTs are largely digital objects.
So if you own a bitcoin, it's sort of like owning some other digital object. And the question then, again, becomes, what is the intrinsic value? If you think about NFTs related to a piece of art, digital art, maybe the owners get value, some sort of psychic value from having that.
For Bitcoin, that value is supposed to come from its function as a medium of exchange. But it seems that people seem to view it as a speculative asset. So there is a parallel here in terms of how investors' faith, more than anything else, seems to prop these up. And the amount of faith out there seems to be enormous.
TOM OTTAVIANO: Here's a question from Eric. "What are your opinions on the future use cases for non-CBDC stablecoins-- for example, Tether, USDC-- in a world where CBDCs are prevalent?"
ESWAR PRASAD: So what stablecoins are trying to meet is a real need for digital payment systems that are very easily accessible to the masses without having to rely on financial institutions. So when Facebook talks about Diem, at least it is couched in very noble terms of providing easy financial access to a lot of the world's population.
So the need is there. And the question is whether stablecoins issued by private corporations, or private entities of any sort, are going to have a viable existence if central banks issue their own digital currencies. I suspect it's going to be hard to maintain a user case for privately issued stablecoins if central banks are able to effectively issue CBDCs.
But again, one might argue that we might see technological innovations taking place on the top of the CBDC architecture. So again, as an economist, I see competition as good. And I might take the let a thousand flowers bloom approach to this.
If stablecoins building on CBDCs can provide even more easy digital access to the underserved and underbanked parts of the population here in the US, and especially in low-income and developing countries, so be it. But it's going to be a lot harder to make that use case for stablecoins if CBDCs are really rolled out efficiently and at scale.
TOM OTTAVIANO: Cyrus asks, "Bitcoin wastes an enormous amount of energy. You mentioned that other digital currencies are better in this respect. How much better are they?"
ESWAR PRASAD: A lot better. The proof of work protocol is really extremely energy-intensive. The proof of stake protocols use a small fraction of the proof of work consensus protocol. And there are other consensus protocols being developed, including by some of our colleagues at the Initiative for Cryptocurrencies at Cornell. They're doing fantastic work in terms of thinking about more efficient consensus protocols, efficient not only from an algorithmic sense but also from an environmental perspective. So that is coming soon.
TOM OTTAVIANO: Nicholas asks, "Governments are notoriously protective of their monopolies on production of national currencies. Which would be the first with a large-scale gov coin, and what will it look like?"
ESWAR PRASAD: As I mentioned, many countries are undertaking creation of central bank digital currencies. And they have different motivations. But again, I would draw your attention to the observation that money creation and modern economies is not really dominated by central banks. In the US, if you take this monetary aggregate of M2, only about 10% of it represents money creation by central banks that is currency, as opposed to money created by commercial banks.
But certainly, central banks want their money to retain a role and for people to have easy access to a low-cost digital payment system. And I think central banks are bowing to the reality that cash is not likely to be around much longer.
Cash has lasted for a long time. The first paper currency came out many centuries ago. The first paper currency was actually in the seventh century in China. And then, in the 13th century, you had the first fiat currency issued by the government of Kublai Khan, the first unbacked legal tender. So now we're coming again in the long arc of history to a time when the demise of cash might end.
And there is an interesting symmetry. Because the first paper currency appeared in China. The first central bank was the Swedish Riksbank. And those two countries right now are at the forefront of the move towards switching over to central bank digital currencies.
TOM OTTAVIANO: Lourdes asks, "Do cryptos threaten CBDCs or the other way around?"
ESWAR PRASAD: I think they're going to coexist, although, again, having a government-issued digital currency is going to make it much harder for privately issued digital currencies, either stablecoins or cryptocurrencies, to be as viable as they are right now. But I think they're going to remain, for the foreseeable future, speculative assets.
Now, this is, again, built on a very fragile foundation of faith based largely on scarcity. But when I was asked four to five years ago, will Bitcoin be a store of value, I emphatically said no. And certainly, it's had a pretty long run.
But there have been many speculative bubbles in history that have had very long runs, and it seemed like they might go on. And one day, they crumbled. I don't know if Bitcoin will crumble or not. I suspect that it may not be very long in the tooth.
But I think the real legacy that we should be thankful for is the technology that Bitcoin has bequeathed, which, as I already said, is a marvel and has given birth to, I think, an entire financial ecosystem that is going to have many advantages.
TOM OTTAVIANO: We're at 5 o'clock, and out of respect of time, I'm going to cut it to two more questions, one from Samuel. "In countries like India and Nigeria, what could be some externalities that could arise from a transition to digital currencies? I ask this considering that there exists a large number of unbanked populations in those countries."
ESWAR PRASAD: Yeah, in those countries, financial inclusion really is a key imperative. India has actually gotten a head start with something called the Unified Payments Interface. And I think India-- and I discuss this extensively in my book-- might be a good template for many other countries to follow in terms of what role the government should play.
India has set up a public payments infrastructure but then provides easy access to at all payment providers. So payment providers can basically innovate on top of that layer.
And it is interoperable, meaning that because the government provides the payment infrastructure, the different payment systems can then talk to each other. Plus, India has a biometric identification scheme for its population called Aadhaar, which has brought a lot more people into the financial net by giving them easily verifiable electronic identities.
And India is also approaching the use of data in a very sensible manner. There is legislation on the table to make it clear that users whose data are used by private payment providers all the data and data users get to determine how the data can be employed by the private sector or, perhaps, even by the government.
But financial inclusion is really a key imperative in these middle-income economies. And India's UPI, plus India's CBDC and Nigeria's CBDC, may pave the path towards greater provision of financial services.
TOM OTTAVIANO: OK. And the final question from [INAUDIBLE]. "How can I be appropriately positioned to capitalize on the gains of CBDCs?"
ESWAR PRASAD: I think you just need to sit back and wait for these developments to take place. But one thing you can certainly do is contribute to the intellectual and design development of this entire new financial ecosystem. And as I mentioned, there are many students and faculty at Cornell.
In addition to the Initiative for Cryptocurrencies, there is the Cornell FinTech Initiative, as part of the Johnson College of Business. So William Cong and others are leading the work on that front. So there are many ways in which, whether or not you profit from it, you can certainly intellectually contribute to the development of the technology and the ideas right here at Cornell.
TOM OTTAVIANO: Thank you again for coming to our book talk today. We very much appreciated sharing this hour with you to learn a bit more from Dr. Prasad about what promises to be one of the most potent developments of modern finance in our century. To find out more about The Future of Money, I encourage you to visit the publication's website noted on this slide.
Mann's next book talk will feature Professor Phil McMichael of Cornell Global Development, who will be presenting his book, Development and Social Change-- A Global Perspective, on Tuesday, November 2. For details on that talk and all the other book talks lined up by Cornell University Library for the fall, please visit the link to the book talk schedule posted to the chat. Thank you, and have a wonderful evening.
ESWAR PRASAD: Thank you, Tom. Thank you to all your Mann colleagues and to all those of you who took the time to be present for my talk.
SPEAKER: This has been a production of Cornell University Library.
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The concept of money is about to be fundamentally redefined, says Eswar Prasad, the Tolani Senior Professor of Trade Policy at Cornell University. In a virtual Chats in the Stacks book talk on his new book, "The Future of Money: How the Digital Revolution Is Transforming Currencies and Finance," which was hosted by Mann Library in October 2021, Prasad explains how this transformation will impact corporations, banks, states, and individuals. Changes may lead to improvements in efficiency, personalization of services, and market access for the unbanked, but they may also bring instability, lack of accountability, and the erosion of privacy. The Future of Money explains how to maximize the best and prepare against the worst, as businesses, governments, and individuals embrace new financial technologies that have the power to fundamentally change our lives. Prasad is also a senior fellow at the Brookings Institution and previous chief of the financial studies division in the International Monetary Fund’s research department.