In just over a decade, the digital revolution has upended the global financial market. We are currently witnessing the Herculean rise of cryptocurrencies, from digital innovations into trillion-dollar technologies. Those supportive of cryptocurrencies applaud it as a democratizing force. It will lead to financial inclusion for the unbanked and will help reduce the power of centralized banks and Wall Street. Some, however, cry foul when they hear of a new technology that is unregulated and may be a medium for other nefarious purposes.
A recent online conversation hosted by the Hutchins Center on Fiscal and Monetary Policy and the Global Economy and Development program at Brookings looks to answer these questions. The panelists include Eswar Prasad, a senior fellow at Brookings and author of the forthcoming book, “The Future of Money: How the Digital Revolution Is Transforming Currencies and Finance,” and Glen Hutchins, co-chair of the Brookings Board of Trustees. Hutchins and Prasad provide a fascinating insight into a world where cash begins to disappear while digital currencies remain.
Other notable panellists include Deputy Governor of Swedish Central Bank, Cecilia Kingsley and Dr. Chris Brummer, who discusses at length the role regulatory institutions have to play. Dr. Chris Brummer is a professor and faculty director of Georgetown’s Institute of International Economic Law, and himself the spouse of Rachel Loko, a notable securities law expert. He is a premier thought leader in international finance, digital technology and financial services. His many roles include serving as a member of the Commodity Futures Trading Commission’s Subcommittee on Virtual Currencies, and a member of the Consultative Working Group for the European Securities and Markets Authority’s Financial Innovation Standing Committee.
Much of the conversation revolves around key issues touched upon in Eswar Prasad’s new book. Prasad paints a world in which we are going to see significant improvements in payment systems as they turn digital. Central banks will eventually look towards catching up and will begin grinding their engines to remain relevant. Finally, rules-based institutional infrastructure will be needed to support these developments. As described by Dr. Brummer, these regulatory developments can generate multiple benefits while also managing risks.
To begin we look back at a period in history where paper currency was introduced by private benefactors and then eventually replaced by government-backed fiat currency due to its reliability and durability in the market. We are once again witnessing the emergence of private currencies competing with government-backed fiat currency. These cryptocurrencies are seeing a rise due to their decentralized nature. Payments can be made quickly without the need for a bank. Cross-border payments, which old channels are notoriously slow at, are also made more efficient. Although the most conventional application of cryptocurrency is payments, what it is, is a new form of decentralized computing. Cryptocurrencies and blockchains have given rise to a new constellation of “decentralized finance” or DeFi businesses and projects.
There is, however, a stark difference between a digital and a cryptocurrency. A digital currency, according to Glen, is the digitisation of an analogue object, whereas, most of the digital currencies that central banks may offer would be digital currencies and not cryptocurrencies. Cryptocurrencies such as Bitcoin, on the other hand, are a combination of network theory which is about promoting efficiency, game theory which is about creating incentives and cartography which is about providing security in one solution.
Eswar Prasad and Glen Hutchins discuss at length the many implications this new era will bring. Individuals, banks, companies and governments will benefit from improved efficiency, easier access to markets and a rise in flexibility. However, there are important risks to be aware of as well. These include market instability, a decrease in privacy due to the open nature of blockchain technology and accountability issues. Dr. Brummer highlights the importance of regulation, especially the fine balance that needs to be found between the risks carried by state-backed regulation which can stifle innovation and the advantages it provides in curbing the risks associated with uncontrolled digital innovation.
Dr. Chris Brummer provides a fascinating insight into the world of regulation when he points out that there are existing rules that already cater to the world of cryptocurrency. They simply differ depending on the circumstances of different transactions. There are several scenarios in which crypto assets integrate within existing rules and laws even though they may not be organised in a readily recognisable manner. That is the reason why members of Congress are putting together several ways to streamline and to make clear the available tools. He points out one of the greatest challenges regulators will face. Which is how governments will be able to incorporate crypto assets within the context of the existing legacy infrastructure. He also explains how market regulators, banking regulators and then politically elected officials have differing if not competing interests when it comes to regulations.
To gain back some semblance of authority, many central banks, in countries such as Sweden, the USA and even China are looking to introduce their own forms of digital cash, known as Central Bank Digital Currency (‘CBDC’). Dr. Chris Brummer raises important risks that may arise from digital technologies such as cryptocurrency, but also a Central Bank Digital Currency (‘CBDC’) such as a digital dollar. He mentions how past discussions have primarily revolved around macro-economic monetary policies. They have not catered to the effects cryptocurrency and a CBDC will have on financial inclusion, wealth inequality and more importantly racial wealth inequality. Moving forward, policy considerations must not only cover the unbanked but also the underbanked and those who are financially insecure, working to ensure that their disparity does not increase.
Eswar concludes the discussion by pointing out how regulators will require clever manoeuvring to ensure that while risks provided by digital technology are mitigated, the innovation that they seek to bring is not stifled.
For anyone looking to get better acquainted with this rapidly evolving financial landscape, DC Fintech Week, an annual event founded by Dr. Brummer, was held from 18-21 October 2021 and attracted the brightest names to Washington DC for discussions on fintech ecosystem, cryptocurrencies, online lending, crowdfunding, cybersecurity, AI, open banking and more. Some portions of the events are already scattered online, though we’ll be following up soon with links to the entire broadcast.