Cryptocurrency: Bonfire of the Currencies, WarOnCash, CBDCs

grarpamp grarpamp at
Mon Nov 1 01:38:34 PDT 2021

Two recent books by renowned economists have set the stage for today's
great debate over the future of money in a digital age. In particular,
public and private moneys are entering into a sustained rivalry, with
far-reaching implications for markets and politics.

Eswar S. Prasad, The Future of Money: How the Digital Revolution Is
Transforming Currencies and Finance, Harvard University Press, 2021.

Kenneth S. Rogoff, The Curse of Cash: How Large-Denomination Bills Aid
Crime and Tax Evasion and Constrain Monetary Policy, Princeton
University Press, 2017.

Ready or not, the financial world is being forced to face the
possibility of a future without traditional notes and coins. Is cash
going the way of the dodo? Should the prospect of its extinction be
welcomed or feared? And what would its disappearance mean for domestic
and global markets and politics?

Two recent books by renowned economists have set the stage for the
coming debates, highlighting two questions in particular. The first is
whether cash should disappear. The second is whether it actually will
disappear. Kenneth Rogoff of Harvard University and Eswar Prasad of
Cornell University have much to say on both issues.

For Rogoff, cash is a curse. Paper currency, he argues, “lies at the
heart of some of today’s most intractable public finance and monetary
problems,” and thus should be phased out as quickly as possible. He
highlights two big problems. On one hand, by permitting large
recurrent and anonymous transactions, cash facilitates tax evasion and
other crimes. High-denomination bills like US “Benjamins” ($100 notes)
or Switzerland’s 1,000 franc note play a starring role in a broad
range of criminal activities, from drug trafficking and money
laundering to racketeering and extortion.

On the other hand, cash handicaps monetary policy. The availability of
currency effectively sets a “zero lower bound” on interest rates.
Returns on Treasury bills or other fixed-income securities cannot fall
much below zero so long as people have the option of holding paper
money, which at least pays zero interest. Cash therefore ties central
bankers’ hands, inhibiting negative-interest-rate policies.

The Curse of Cash represents the culmination of a campaign that Rogoff
has waged for more than two decades, and he pulls no punches in his
advocacy of a “less-cash” economy. Written in accessible if somewhat
colorless language, it is a clarion call for action – in effect, a
manifesto for our times. The sense of urgency is palpable.

Prasad, by contrast, is more in the forecasting business. He believes
we are in the midst of a financial revolution that is being driven by
“FinTech” – the ongoing wave of innovations in financial technologies
that are dramatically disrupting traditional ways of doing business.
In the vanguard are cryptocurrencies, a new class of financial
instruments that threaten to displace conventional notes and coins.
“The era of cash is drawing to an end,” Prasad declares, though he
hesitates to offer any firm predictions concerning what will come

Prasad’s text is relatively easy to read, showing flashes of humor
despite the complexities of the subject. Its analysis, however, is
ultimately inconclusive, because most of its discussions end
cautiously (and rather unhelpfully) with words like “seem,” “may,” or
“could.” In a book that aspires to be virtually encyclopedic in its
coverage, Prasad’s takeaway message is that there remain “many
unanswered questions.”

Cryptocurrencies have become one of the hottest sectors in finance,
led by Bitcoin, which is barely a decade old. New cryptocurrencies
have since proliferated like dandelions; according to the
International Monetary Fund, there are around 9,000 digital tokens
listed on various exchanges today. Earlier this year, the market value
of all crypto assets surpassed $2 trillion – a tenfold increase in not
much more than a year.

The roots of the crypto boom go back to the dawn of the digital age in
the last years of the twentieth century. Traditional notes and coins
are creatures of an analog world, physical in nature and reliant on
face-to-face interactions. Cryptocurrencies, by contrast, are digital
– that is, based on encrypted strings of zeros and ones – and
transferable through vast electronic networks.

Once computers and the internet came to be part of our daily life,
smart operators realized that it might be possible to create units of
purchasing power that would be fully usable through cyberspace. The
race was on to produce “virtual” money that could be employed as
easily as conventional paper money or coins to acquire real goods,
services, or assets.

The earliest attempts to achieve this, going back to the 1990s, aimed
simply to facilitate the settlement of payments electronically. These
initiatives, which The Economist once playfully labeled “e-cash
version 1.0,” included diverse card-based systems as well as
network-based systems. Operating on a principle of full pre-payment by
users, each scheme functioned as not much more than a convenient proxy
for conventional cash – in effect, something akin to a glorified
traveler’s check. Few caught on with the general public.

Subsequent models, “e-cash version 2.0,” were more ambitious, aspiring
to produce genuine substitutes for traditional notes and coins.
Examples included Flooz (using the comedienne Whoopi Goldberg as a
spokesperson) and Beenz. But the impact of these schemes, too, was
limited, because most were offered as a reward for buying products or
services from designated vendors – constituting, in effect, updated
electronic versions of ancient scrip. Vendor-specific media live on in
airline mileage programs and the like; but they failed to provide a
direct substitute for traditional currency. Most disappeared after the
brief downturn in financial markets at the turn of the century.

Then came Bitcoin, a revolutionary innovation introduced in 2009 by a
person (or persons) who remains anonymous. Bitcoin could be called
“e-cash version 3.0.” Designed as a decentralized payments system
independent of governments and private financial institutions, the
currency has soared in popularity. Since Bitcoin’s unheralded
inception, its price has skyrocketed from $1 per unit to as much as
$66,000 earlier this month.

Many other digital currencies, including increasingly well-known
rivals such as Ether, Litecoin, and Ripple, have followed in its wake,
especially over the past year. Prasad calls Bitcoin the “granddaddy”
of cryptocurrencies. Digital money is now an established part of the
global financial ecology, and has been declared legal tender in two
countries, El Salvador and Cuba.

Prasad finds it hard to conceal his enthusiasm for Bitcoin, which he
describes as “truly ingenious and innovative.” Words like “magic,”
“genius,” and “elegant” are liberally sprinkled throughout his
discussion. For anyone who really wants to understand how the currency
works in all its technical splendor, there is no better introduction
than Prasad’s fourth chapter, which dwells on the Bitcoin revolution
in elaborate detail.

There you will find a step-by-step tutorial on the currency’s
underpinnings – the so-called blockchain technology that enables
Bitcoin to function without any trusted central authority to manage
it. No government agency or private institution is needed to validate
transactions. Instead, blockchain relies exclusively on a public
consensus mechanism managed through a peer-to-peer network that alerts
participants to every exchange in real time. A publicly shared ledger
of transactions is created and maintained in a decentralized network.

The ledger is called a blockchain because once transactions coming
into the network are grouped into blocks of data and validated, the
blocks are then chained together. The “magic” comes from delegating
trust and verification to the public square. As Prasad breathlessly
puts it, “This is people power, backed up by computing power, at its

People power to manage money is obviously attractive to libertarians
and others who, taking inspiration from the Austrian economist
Friedrich von Hayek, have long argued for the “denationalization” of
currency. Governments, driven by politics, all too frequently abuse
their control of “state” money, sooner or later generating runaway
inflation. In recent years, we have seen that ruinous process
devastate countries like Venezuela and Zimbabwe.

Cybercurrencies, by contrast, are designed to rely on market forces to
keep the growth of money supply in line with real economic activity.
Inflation, crypto enthusiasts contend, will be contained by the wisdom
of crowds.

But there are also downsides, and they are not insignificant. First
and most obvious is the danger that competition among cybercurrencies
could lead their sponsors to take ever greater risks. Many of the
thousands of digital tokens currently available are backed by nothing
more than flimsy promises. Even so-called “stablecoins” like Tether or
USD Coin, which in principle are fully backed by conventional
reserves, are in practice often quite lacking in transparency.

Observers frequently liken today’s cybercurrencies to the private bank
notes that circulated in the United States during the co-called
free-banking era of the nineteenth century. But that system was
fragile and frequently subject to “runs,” owing to the ebb and flow of
public trust. Crowds did not always show the greatest wisdom. Why
should we expect today’s cybercurrencies to be any less prone to
panics and wild price fluctuations? Just in the last year, Bitcoin has
traded up and down by over 50%. Prasad calls it “wacky ... a wild
roller-coaster ride.” Others might call it a bubble that could burst
any time.

Second, the prospect of unfettered price volatility limits
cybercurrencies’ usefulness as a medium of exchange. Who wants to
accept payment in a currency whose value might drop through the floor
tomorrow? Admittedly, there will always be some market actors,
particularly criminal elements, who might value cryptocurrencies’
supposed anonymity enough to take the risk.

It stands to reason, then, that Rogoff’s complaints about the role of
cash in facilitating tax evasion and other nefarious activities apply
to cybercurrencies as well. But Rogoff himself suggests that the real
threat from cybercurrencies lies elsewhere. “Yes,” he says, “digital
currencies raise important questions for the future, but more as
competitors for other financial instruments and institutions, not so
much for paper currency.” Prasad agrees, suggesting that the allure of
digital currencies for illegal activities is wearing off. Some
scholars, however, estimate that criminal activities still account for
as much as 50% of Bitcoin transactions.

Moreover, the legitimate business world does not appear to be
attracted to the quotidian use of cybercurrencies. Instead,
cybercurrencies have primarily become a vehicle for risk-loving
investors, serving as a class of speculative assets reminiscent of the
seventeenth-century tulip mania in the Netherlands, when a single bulb
sold for the equivalent of a mansion on the Amsterdam Grand Canal. In
a sense, the “cybercurrency” label is a misnomer, because none of
these new creatures actually perform all three of the traditional
functions of money: medium of exchange, unit of account, and store of
value. They are, at best, liquid quasi-moneys.

Looming over the entire incipient debate is the possibility of a real
threat to state authority in monetary affairs. The more that ordinary
transactions come to be conducted in cryptocurrencies, the more
difficult it will be for monetary authorities to manage existing
payments systems via traditional interest-rate policy or open-market
operations. If traditional cash becomes largely extinct, so, too, does
much of the power of central banks.

That is why we now see mounting interest around the world in the
development of central-bank digital currencies (CBDCs). As Prasad
points out, there is nothing mysterious about central-bank digital
money. It is simply an existing fiat currency that is issued by a
monetary authority in digital form as a complement to or in place of
conventional notes and coins. For a clear guide to the merits and
risks of such an innovation, readers could do worse than to consult
Prasad’s sixth chapter, which provides a careful point-by-point
examination of the case for CBDCs.

The rationale for CBDCs is simple: fight fire with fire. If
conventional paper money really is going the way of the dodo, monetary
authorities should create a more attractive alternative. In any
competition with privately issued rivals, CBDCs would have the
advantage of being firmly backed by the full faith and credit of their
sovereign governments. One country, the Bahamas, has already created a
CBDC of its own – the sand dollar – and others like Sweden and Uruguay
are quickly moving in the same direction.

Who will prevail? Writing some five years ago, before the
cryptocurrency craze really took off, Rogoff expressed confidence in
governments’ ability to fend off any competitive threat from the
private sector. This is not the first time, he points out, that
currency innovations have emerged from the private sector to leapfrog
ahead of publicly issued money, at least for a time.

In every previous instance, he insists, innovations were either tamed
by regulation or appropriated by governments, which have broad
advantages in providing a safe guaranteed asset. Some governments,
most notably China, have already begun cracking down on
cryptocurrencies. “If the private sector comes up with a much better
way of doing things,” Rogoff observes, not without a touch of
cynicism, “the government will eventually adapt and regulate as
necessary to eventually win out.”

But Prasad is not so sure. Writing more recently, he notes that
cryptocurrencies have come a long way in the last half-decade. Yes, he
concedes, central banks are likely to remain central. But that does
not rule out sustained rivalry between the private and public sectors.
Privately issued digital currencies have competitive advantages of
their own, including faster, lower-cost transactions and broader
access to financial products and services. A “glorious future”
beckons, Prasad concludes – before adding, “perhaps.”

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