In the 13th century, Kublai Khan, grandson of Genghis Khan, created the first fiat currency, money that derives its value from the state declaring it to be of value. It was not the first paper money – Chinese merchants had used certificates of deposit since the 7th century. It was, however, the first not supported by any kind of commodity, like gold, but only by state power. Indeed, anyone who did not accept the tokens risked being put to death. It was the birth of money as most of us know it today.
Now, according to Eswar Prasad, we are in the midst of a new revolution, this time started by private innovation. The spark came with bitcoin in 2009, the first digital currency that did not need any trusted third parties, whether it was a government, a commercial bank or a payment processor such than Visa. While the libertarian ideal of its creators – a financial system without state power – will be frustrated, he argues, the decentralized record keeping that underpins cryptocurrencies will bring cheaper and more efficient payments.
In The future of money, Prasad envisions an era of monetary separation between the state and the private sector. While modern money consists primarily of bank deposits, commercial banks depend on central banks to provide the reserves that support them and to administer the interbank payments system. New technologies will break this partnership. While state money will provide a store of value, private currencies will often be used to make payment.
Take Facebook’s alluded to cryptocurrency, now known as Diem. This could, according to Prasad, transform the creaky and expensive world of international payments. Today, cross-border payments move from bank to bank, adding fees at every step and repeating costly anti-money laundering checks. Instead, transfers could all take place by buying and then sending Diem. This would save often poor migrants from having to hand over much of the remittances they wish to send home to the financial sector.
Diem is believed to be a “stablecoin” – a private cryptocurrency backed by a reserve of fiat money, such as the US dollar. These are the only cryptocurrencies that actually work like cash, claims Prasad. The technology behind bitcoin makes cheaper payments easier, but the currency is far too volatile to make the payment – it soars one day and plunges the next.
Counterintuitively, the elasticity of fiat money offers more stability than the artificial scarcity of bitcoin. This makes fiat money a much more attractive prospect for businesses who can be assured that when times are tough the central bank can step in and print more.
This means that central banks will remain, as Prasad says, central. Decentralized payment systems may become more mainstream, but the stablecoins built on them will be tied to fiat money, leaving the role of central banks in macroeconomic management intact. Whether central banks are creating their own digital currencies is also a question of whether – the Bahamas has already launched its digital sand dollar, while major central banks such as the European Central Bank are still exploring their options.
The combination of the digital currencies of national central banks and international stablecoins will both increase and reduce the state power embodied in money since the era of Kublai Khan. State-run digital currencies have enormous potential as a monitoring tool. In many ways, that could be good – Prasad points out that in his native India, bribery usually involves handing over an envelope of money – but it could, without proper safeguards, mean loss of privacy.
On the other hand, the new international currencies will limit the ability of governments to keep funds inside or outside through capital controls and provide an alternative to circumvent US sanctions. The dollar will remain preeminent, he argues, thanks to the large amount of safe assets – US government debt – available. Cryptocurrencies cannot offer such a depth of reliable store of value, nor can they offer the same ease of trading that is vital in a crisis. However, new competitors will weaken the dominant position of the dollar.
The book is comprehensive at a fault and an essential manual for anyone looking to understand how finance evolves. The styling, however, can be quite dry and the language, often, too academic. And if the author’s vision for the future is, in many ways, plausible, is this really as new an era as he suggests? Stablecoins are very similar to existing bank deposits. Indeed, the United States is considering regulating cryptocurrencies like banks. From a consumer’s perspective, the future may look quite similar even though behind the scenes payment systems work differently.
Prasad’s prediction that the monetary balance of power will shift to the private sector will not depend on the effectiveness of decentralized registries, but on the state’s willingness to tolerate the challenge. The “free banking” eras in Scotland and the United States, when banks issued their own banknotes, similar to stablecoins, ended in the mid-19th century not because of better technology. , but because the state asserted control.
Indeed, since The future of money has been written, the regulatory decline has intensified. China, in particular, has cracked down on bitcoin, banning foreign exchanges from selling into the country. It humiliated Ant Group, the financial services company run by Jack Ma. The government forced it to separate, including handing over its user data to a partially state-owned joint venture. Facebook’s Diem has also been overlooked by Western regulators. Bitcoin may have sparked a revolution, but like so many revolutions, the circle may now be complete.
The future of money: How the digital revolution is transforming currencies and finance by Eswar S Prasad Harvard, $ 35 / Belknap, £ 28.95, 496 pages
Gavin jackson is a leading FT writer
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