Throughout history physical forms of money in the form of coins, bills and notes have slowly been replaced by more abstract means of exchange. Now virtual money in the form of cryptocurrencies is taking center stage, and the implications are far-reaching. In a world where almost everything is becoming digital, it’s only natural that money should follow suit. But how will it happen, and what are the risks involved? In The Future of Money: Cryptocurrencies and Their Implications, Tolani Senior Professor of Trade Policy Eswar Prasad explains how the world of cryptocurrencies is evolving. He also outlines the many ways that this new form of money could affect the global economy and what investors need to know about it. While most people are aware of the buzz around cryptocurrencies, few understand what they really are or how they work.
They’re essentially bits of computer code that are created and managed through the internet without any central authority. The underlying technology is called blockchain. The most famous example of a cryptocurrency is bitcoin, which was launched in 2009. Like other cryptocurrencies it is decentralized and offers the promise of lower transaction costs because users don’t need to trust centralized intermediaries such as banks. In addition, the blockchain system is designed to be secure and immutable. But cryptocurrencies are still in their infancy and have yet to demonstrate the full range of their potential benefits. Their value is volatile and they’re only accepted in limited amounts as a medium of exchange, partly because the cost of producing them is so high. This reflects the massive amount of energy needed to solve complex cryptographic puzzles that protect the transactions and ensure the integrity of the blockchain.
And in spite of their claims to be transparent, they remain susceptible to exploitation by unscrupulous management and market manipulation. In contrast, the international monetary system built on traditional fiat currencies is robust and resilient. It provides a common language for conducting business and exchanges and enables global flows of goods, services and capital that facilitate growth and prosperity. But it is not without its problems, especially the power imbalance between the United States and many other countries over the global financial system. The US dollar’s dominance gives the country unrivaled economic leverage and allows it to impose crippling sanctions on adversaries. But sanctioned states such as Iran and North Korea have found ways to circumvent these restrictions by using cryptocurrencies to fund terrorist activities and evade U.S. penalties.
The rise of cryptocurrencies is a significant challenge for the existing monetary system and will require regulators to develop rules that limit traditional financial risk while not stifling innovation. This is a tricky balancing act, and many fintech businesses will need to evolve quickly if they want to survive as the world moves away from cash. While the future is likely to involve some forms of virtual money, it is unlikely that cryptocurrencies will replace official currency controlled by independent inflation-targeting central banks. The technology is simply not ready to take on the full set of functions that money performs, including providing a store of value, a unit of account and a medium of exchange.
