2022 Homer Jones Memorial Lecture

Economists are storytellers at heart. So I have for you today a story, a story of remarkable technological innovation, some unfulfilled promises, and unintended consequences. The story, of course, revolves around money, which makes it especially apposite that I'm giving this lecture here today and am very privileged to be following in the footsteps of many distinguished people. And thank you, Jim, for the privilege of delivering the Homer Jones Memorial Lecture, which after all, is to honor somebody who had a great deal to-- a great deal to do with the development of monetary economics and thinking about how money affects us.

So the story I have for you today is going to revolve around how money is going to be reshaped in the way we think about it, the way we relate to it, and the way it helps us organize our economic activities. And it's going to go through a lot of terrain. We'll start by thinking a little bit about basic financial innovations then delve into the world of cryptocurrencies, including Bitcoin and much more; then talk about the possibility that we might have digital versions of the paper currency we are all used to; but then think about what all of this means, really, for financial markets and institutions, for central banks such as the Fed and, indeed, for the international monetary system. But it's not just going to be about finance and economics. It's ultimately going to have some implications for thinking about how we organize society and our day-to-day interactions.

So let's start at the beginning by thinking about this broad term that you may have heard about called "fintech" or financial technologies. Now, financial innovation is nothing new. Money itself is a wonderful financial innovation that allowed us to do a variety of things. I think of money as really enabling us to transform resources or transfer them across time and across space.

So it plays a very powerful role in the way societies are organized and in the way economies are organized. But, of course, the creation of paper currency in China, which took place in the seventh century was another innovation. You didn't have to carry around huge amounts of commodities or big chunks of stone around with you.

So what's new about the new wave of innovation? I will argue that there is something fundamentally important and distinct about this wave, which is that it is built on digital technologies. And that has two very important implications. One implication is that it means that you have much easier entry of financial services and providers who can bring new innovations, more competition, and thereby make the provision of financial services and financial intermediation more broadly, more efficient.

The second aspect is that these products and services can now be provided much more easily at scale on digital platforms because the marginal cost of servicing an additional client, even if that happens to be a very low-net worth, low-income client, is still viable using the digital technologies. And we are beginning to see the transformative effect of fintech, especially in the emerging market world.

Now, one reason why emerging markets seem to be leapfrogging is that there was a much greater need in countries like China, India, even in low-income economies like Kenya, for better services, better payment services, better banking products and services. So we are beginning to see these gain traction. And you've all seen these images of farmers in Kenya, who may have very low levels of literacy or even numeracy, being able to participate in the financial system through mobile payments.

Now, this is very important, not just in terms of making finance work better. I think that the fintech revolution has broader consequences for society. It's when people feel more vested in the financial system, in the economy, in the success of their economy that they are willing to endure the disruption, the pain that economic reforms invariably involve because any reform that you think about that is going to lead us to a better place in the short-term has a dislocative effect. And the reason why many of them don't work very well is simply because people don't feel that they are going to gain the benefits of those changes.

So I think fintech, really, has promise not just in the organization of finance but in terms of thinking about the evolution of economic and even broader reforms that could lead us to a better place. And we've seen transformative effects, especially in the context of payments. And this issue of payments is something that I will keep coming back to. Because ultimately, if you think about economic transactions of any sort, be they related to trade, buying a piece of fruit, undertaking a financial transaction, payments are really an essential lubricant. And this is one area where technology is really having a transformative effect.

So in countries such as China and India, hardly anybody uses cash or physical currency anymore. Because in these economies, the ability to get easy access to very low cost, very efficient digital payments is now proliferating. So this is all very good. So we are beginning to see a world where domestic payments in particular are becoming much more efficient.

But it's not just payments. It turns out that the sort of revolution that we are seeing even in low-income countries is providing a portal for basic banking products and services for households, for individuals to manage credit, savings risk, and so on. And these are things that were not easily accessible to low-income consumers, in particular, in developing economies and even in advanced economies like the U.S.

So I think the basic elements of fintech are already putting in place an architecture that is going to have important consequences. And then, of course, on the stage entered with impeccable timing a new wave of revolution. In finances and everything else, timing is everything. And Bitcoin's timing was impeccable.

You may all recall the dark days of September of 2008, September 15, of 2008, in particular, the Lehman moment, when this iconic investment banking firm Lehman Brothers went down and looked like it might take the entire U.S. and perhaps global financial system down with it. Six weeks later, this very modest sounding proposal appeared on the internet. The Bitcoin white paper was released. And what it promised was something remarkable.

The notion that Bitcoin suggested it could accomplish was to allow transactions to be conducted between individuals who did not even need to reveal their true identities. They just needed to use their digital identities. And they could conduct payments without relying on central bank-provided money or a trusted intermediary such as a commercial bank or a credit card or another services provider.

This sounds mind-boggling. How on Earth can you use a purely digital medium of exchange that is not issued by a trusted party and that you don't even need to reveal your identity to? It turns out-- and this is the magic of Bitcoin-- it did come up with a way to do this. I say it because it's not clear to this day who actually came up with Bitcoin.

Having written this book, I go to a lot of cryptocurrency conferences. And at one of the conferences, I was seated in the panel next to a gentleman who claimed he was the true Satoshi Nakamoto who had invented Bitcoin. Who knows? He was half credible, not fully credible.

Whoever it was, it is a remarkable invention. The ability to do this relies on principles that are borrowed from cryptography but use them very effectively with a variety of tools. And at one level, what makes Bitcoin work is what I think of as radical transparency, that every transaction ever undertaken with any Bitcoin and the digital identities of the transacting parties are all posted on these digital ledgers that are placed on multiple computers around the world and synchronized in real time.

And, again, mind-boggling as this sounds, it actually works. And there is a decentralized procedure whereby people with computing power that they are willing to devote to this process are able to validate these transactions. Now, when you think about a $20 bill, when I go up to the cafe here at the sixth floor, buy a latte with it, I hand over a $20 bill. Immediately, my account balance is updated. And the account balance of the cashier still is updated. This is what settlement of a transaction is about.

So it turns out when you're thinking about purely digital money, there is a complication. I might use that money to buy Jim a cup of coffee. I might decide to go out and then use that same digital unit to go out and buy Kevin a cup of coffee. How do you prevent double spending?

It turns out Bitcoin came up with this way of essentially validating transactions and posting them on these public digital ledgers, blockchain as it's called, in a way that is very difficult to override. And once people in the system have an incentive to make sure that the system doesn't fall apart and the trust in the system is maintained actually turns out to be viable. So this is really cool technology.

There is only one problem. It doesn't work. But it doesn't work in a very specific sense. It turns out it works in what it was supposed to do. But it cannot be scaled up. If I was to try to buy Jim a cup of coffee with a Bitcoin, first of all, the transaction fees are very large. It turns out it takes about 10 minutes for a transaction to be added to the blockchain and validated in that block of transactions.

So it's expensive. It's slow to process. So the cup of coffee would probably cool in Jim's hands before I could actually complete the payment. So this is not a very viable transaction medium. So Bitcoin has become what it was never meant to be. It has become an effect of pure speculative financial asset. And the value of that asset seems to come from its scarcity and nothing more.

There is a hard-coded element of the algorithm that they will ultimately only have about 21 million Bitcoins in existence, about 19 million have been created so far. And the sense that people who own Bitcoin seem to have is that since it is scarce compared to the fiat currency that Governor Bullard and his colleagues would go ahead and print essentially in infinite quantities, not literally print, but conceptually print, surely, something that is scarce must hold value better.

To an economist, this is a dubious proposition. Just because something is scarce, it's not obvious it should have value. But there are true believers out there. But I worry about those who seem taken in by the razzle dazzle of the technology and are investing in Bitcoin. But whatever Bitcoin's failings, it's left us with the technology, the blockchain technology, that I think is going to be lasting in many ways. And it has catalyzed a very important revolution.

And there are many elements to this that I will touch upon. One element is that there are new cryptocurrencies now that try to make up for Bitcoin's failings. In addition to the constraints that I mentioned in terms of processing time, processing volume, and so on, it turns out one of the fundamental problems of Bitcoin as a medium of exchange is that it has unstable value. If I walk into a coffee shop with a fraction of a Bitcoin, one day, if I can walk out the door with half a dozen croissants and a couple of lattes, and the next day, I can get just a small cup of coffee with it, it's not a very viable medium of exchange.

So there are new cryptocurrency, stablecoins, that have come up precisely to deal with this problem. Stablecoins are ostensibly backed up by stores of fiat currencies or financial instruments such as treasury securities that are seen as very solid instruments. So essentially, stablecoins provide a more effective way, or this is the way they are marketed, of using fiat currencies by providing them in digital form. And they are underpinning some new revolutions in finance.

So there is an element that Bitcoin set off on the blockchain that has allowed the creation of new products and services in a way that is not within the realms of traditional finance. Now, this notion of decentralized finance built on blockchains is at one level a very appealing one because the notion of decentralization has three important aspects to it.

One is decentralized architectures. So you have these digital ledgers or blockchains being maintained on multiple computers. So there isn't a single point of failure. Then there is the decentralized validation or consensus protocols. So there is no institution in charge of issuing or validating or managing this process. And then there is decentralized governance, that there is no institution or agency that determines the rules of the game. The community has a vested interest in determining the rules of the game.

And the idea here is that maybe this will underpin the democratization of finance, making it easier not just for the big bad banks. Maybe there are a few big bad banks in this room. But the idea is to give space to new financial services providers to compete on a level playing field and more importantly for even the common man to be able to have easy access to these products and services because these new technologies make it possible to do one thing that right now is not financially viable.

Right now, if I walk into the door of Goldman Sachs and Morgan Stanley, if I have a couple of million bucks in my pocket, they welcome me. If you walk in with $10,000, they don't give you the time of the day. The idea is that you could perhaps democratize finance by making it easy for anybody at very low cost to have access to these products.

This is an appealing vision. But here again, there is a bit of a gap between the principle and the reality. The parts of decentralized finance that seem to work well are actually the ones that are quite centralized. I referred to stablecoins. They give up all of the elements of decentralization inherent in something like Bitcoin. A stablecoin is a centralized issuer. Validation is undertaken by the stablecoin issuer. And you have essentially the governance determined by the stablecoin issuer.

Likewise, what we have seen so far in this realm of decentralized finance is a lot of financial engineering. We've seen a lot of products being offered that seem to help in democratizing finance but in fact are making people take on much more risk that they don't fully understand or accept. So I worry a little bit that all the potential benefits that could be gained by decentralized finance, in fact, are being subverted to a world of greater centralization.

So there is promise here yet. But it's not been realized yet. And I worry, again, that it might lead us to the wrong direction rather than the true democratization of finance.

Amidst all of this, central banks have been taking notice. They've been taking notice of one fact, which is that the currency that they supply is much less viable than it used to be in terms of retail transactions, in particular. So if you look at certain countries like China and India, the use of cash is plummeting. In a country like Sweden, less than 2% of transactions are conducted using cash. Why? Because we all have gotten used to the convenience of digital payments.

But, again, there are many people left out of this revolution. Even in the U.S., about 5% of households are unbanked or underbanked. So you and I can easily use Apple Pay, Google Pay. But you have to connect that to a bank account or a credit card. What about those left out of this element of having easy access to digital payments?

So central banks are thinking about whether or not to issue CBDCs, central bank digital currencies, which would essentially be like the physical currency you and I have right now, or at least some of us still have in our bill folds. But this would be an electronic or purely digital form. Why is central banks doing this?

It turns out that even if a central bank stopped issuing currency altogether, it could perfectly well conduct its business of managing monetary policy by affecting the cost of funds. So it's not existential for a central bank. Why is central banks doing this? It turns out there is a range of motivations at play.

In developing countries, the idea seems to be to use a CBDC as a way of broadening financial inclusion. Where the private sector does not provide these services, maybe the central bank can provide a payment mechanism. In a country like the Bahamas, which has issued the world's first nationwide CBDC, the sand dollar, this seems to be the main objective.

In a country like Sweden where the private sector is doing a very good job of providing digital payments at scale, the Riksbank seems to view a financial stability imperative as leading them to create a CBDC, which will essentially serve as a backstop to the private infrastructure in terms of payments. The idea being that the private payments infrastructure might be vulnerable to confidence or other issues. So you want to have a public backstop.

Then there is China. China, as in everything else, is unique. In China, Alipay and WeChat Pay have dominated the payments space. They give very easy access to merchants, to households. You can literally buy a dumpling on the streets of Beijing or a piece of fruit. And it's economical for both the merchant and the consumer.

But the government is concerned that these two payment giants are dominating the payment space and they've also been gathering up troves of data, which until recently they were not willing to share with the government. So the Chinese Central Bank talks about wanting to maintain the relevance of its money at the retail level and essentially create a payments infrastructure that other payment providers could build upon.

So countries like China, Japan, Sweden, Brazil are already experimenting with CBDCs. There are many others that plan to introduce CBDCs at some stage. But all of them seem to be moving towards an architecture, where, essentially, the central bank would provide a payments infrastructure. And on top of that, it would then provide the digital tokens, much like it provides currency to commercial banks right now in exchange for reserves. And the commercial banks can go out and distribute their currency to their customers who could be merchants, who could be households.

So the idea is that you would have a digital liability of the central bank that would work in a very similar way. But there are risks. There are significant risks that, in fact, if you could offer digital wallets that allow you to hold central bank money in digital form, that could lead to a flood of deposits away from commercial banks into these digital wallets.

And commercial banks are still very, very important in the creation of money in modern economies. They create credit. The disintermediation of commercial banks is a risk. And another issue is that you may not want the central bank to provide payment services which could outcompete the private sector. Nobody wants the central bank to be doing things which the private sector can do perfectly well.

So there are ways through conceptual and technical design choices where these risks can be mitigated but not entirely eliminated. The Bahamas, for instance, has put a cap on the amount of money that can be held in a CBDC account to prevent wholesale flight of deposits from the banking system. That cap may fall apart at a time of financial turmoil when people are clamoring to put their money in what is seen as a safer place. After all, what place can be safer than the central bank?

So even central banks that are contemplating CBDCs have to deal with a variety of risks. And then there is the broader question about whether we as a society want to live in a world where any financial transaction might be visible because it is in digital form. Either to a central bank or to a private payments provider.

Now, to those of us in this room, privacy might still mean something. To my kids' generations, maybe privacy is a chimera right now. They seem to be willing to accept being tracked in every dimension. But I think it is an important discussion to have because it's not just that you can think about a CBDC being used to track your transactions. Digital things can be subverted in different ways.

You could think about potentially making monetary policy more effective by issuing units of currency, say, in the middle of a pandemic, which has an expiry date on it. This would incentivize people to go out and spend, which is exactly what the government wants to do. But then you might have different units of central bank money floating around that could trade on secondary markets at different values.

So now, you create a situation where the integrity of central bank money starts coming into question. You could even think about a government deciding that its central bank digital currency cannot be used for certain purposes like maybe buying illicit drugs or pornography or weapons. So you could end up with social policy being directed through the CBDC.

Now, this is a very dark picture I'm painting. Central banks that talk about CBDC talk about it just as being a digital equivalent of cash with no programmable features. But I worry. We've seen many, many instances where technology was to lead us into better places, give us all much easier ways of staying in touch with friends and family, and look where that got us. So I think we should be a little cautious about taking technology at its word.

Then there is the international aspect, which is also worth thinking about. International payments are beset by frictions. They involve multiple currencies, moving money across different financial institutions in different jurisdictions. They are slow, expensive, difficult to track in real time. This is where technology can really have benefits. And it is beginning to have benefits already.

If you can reduce the frictions related to international payments, that could be very good in terms of bringing the world closer together. Economic migrants sending remittances back to their home countries could do it more cheaply and quickly. If you think about small and medium enterprises and even developing economies trying to get access to a global pool of capital, that might be easier the lower the frictions there are. If you think about savers looking for international portfolio diversification opportunities, that becomes easier.

But, again, as with anything else, there are potential problems. So if you think about an emerging market country that is already beset by the whiplash effect of capital flows-- so foreign investors put money into the country when they think it's doing well, pull that money out when it's not doing well. Once the barriers to capital flows start declining, those capital flows could become even more volatile, creating not just capital flow and exchange rate volatility. For mature economies, it's not that much of a problem dealing with capital-- or capital flow or exchange rate volatility. For emerging markets, it's a real problem.

There is also potential for some changes to the international monetary system. As you're all well aware, the dollar still remains dominant in international finance in practically every dimension in terms of denominating trade transactions, settling those transactions, and also as a reserve currency. I think we're going to see some changes. Some of these related to the developments I've talked about today. But there are other developments that work already with countries around the world building up their own payment systems.

China has built up the cross border interbank payment system, which allows its commercial banks to more directly communicate with commercial banks in other countries, including as it happens, Russia, which makes it easier to trade between pairs of emerging market currencies without having to go through a vehicle currency such as the dollar. Right now, it's difficult to directly transact between the renminbi and the rupee or the renminbi and the ruble. Those barriers are beginning to fall.

So I think the reality is that over time, we're going to see the role of the dollar as a vehicle currency perhaps declining. But there are counterbalancing forces at work. I spoke about stablecoins. They could play bigger roles in international payments in particular. But what stablecoin is likely to get the most traction in international finance, I'd bet on a stablecoin backed up by U.S. dollar reserves. That is still the currency of the world at large. So we might actually move to a world where indirectly the dollar starts gaining even more prominence as a payment currency.

The Chinese are moving forward with their digital currency. Is that going to threaten the dollar's prominence as a reserve currency? I think most emphatically not. In my last two books, which are about the dollar and the renminbi, I made this point that what is really important for a reserve currency status is not just economic size, not just financial market debt and liquidity, although both of those are very important, but ultimately, the institutional framework that inspires the trust of domestic and foreign investors.

And that institutional framework includes an independent central bank. It includes the rule of law, by which even the government has to play by the rules, and an institutionalized system of checks and balances. And despite all the knocks the institutional framework in the U.S. might have taken, the good thing is that in international finance, it's all relative.

And relatively speaking, if you think about the U.S. economy size, the size of its financial markets and its institutional framework, it's hard to see a serious rival to the U.S. dollar as a reserve currency. In particular, I don't think the renminbi, although it has accounted for about 2 and 1/2 percent of global foreign exchange reserves, is going to be a major rival to the U.S. dollar.

There is a shakeout coming, though. That shakeout is for currencies of countries that are relatively small, that have central banks that are not credible. I can well see that if a digital dollar or digital renminbi were easily available around the world, you could well end up in a situation where those currencies might be preferred to the domestic currencies.

And you could even think about stablecoins issued not just by the sort of issue as I mentioned, but major corporations, perhaps like Amazon or maybe Meta reviving its stablecoin project one day. Those currencies might well be seen as much more trustworthy than the currencies of some of these smaller economies. So I think there could be a real shakeout in terms of the relative importance of currencies in different functions but potentially existing threats for certain currencies.

So the broad theme in all of this, I think, we are very entering a very interesting era of competition in money, but competition that has a domestic as well as international analog in one very specific dimension, which is the use of money as a transaction medium, as a medium of exchange. In the domestic sphere, I can see a world in which we have digital payment systems, perhaps stablecoins, perhaps even a CBDC coexisting and providing alternative means of payment.

But in all of this, including in the context of stablecoins, the fundamental store of value remains the fiat currency. Likewise, if you think about the international monetary system, I can well see certain currencies, including emerging market currencies, becoming more important in terms of international payments. But as stores of value, as a reserve currencies, I think there is unlikely to be a major change in the configuration. So more currency competition but in a circumscribed way.

As one thinks about the broader implications, though, it is, I think, worth contemplating that all of this technology is going to solve certain problems in terms of giving people more access to financial markets, broader financial inclusion, which could have certain beneficial effects. But leaving technology by itself to fix many of our underlying problems, I think, is not going to be the answer.

If you take issues like inequality, there is a sense right now that the democratization of finance perhaps will also lead to a less unequal world. I worry that what we are seeing right now is something quite the opposite. What we are seeing in terms of people who are undertaking investments in these crypto assets, there are wealthier people for whom this is a roll of the dice. They are willing to take on more risk. They can afford to take on more risk.

On the other hand, you have many people who are putting their life savings. And God knows I've met many of these at the crypto conferences I go to. And I worry about them. They don't quite know what risk they're taking on. And it is quite worrying.

And there is this broader prospect that we might be shifting to a world where the promise of decentralization and not greater anonymity of transactions does not play out. But, in fact, what we end up with is much greater centralization and in a worrying way if you were to move to a world with purely digital currencies, a world where central banks, governments, major financial, and nonfinancial institutions all become much more intrusive into our daily economic, personal, and social lives.

So I leave you with just one final thought, which is the title of the last chapter of my book, which I think sums it all up, a glorious future beckons, perhaps. Thank you.

[LAUGHTER]

[APPLAUSE]

Good evening. Let's go ahead and get going here. I have a few prepared remarks for you. Welcome to the 31st Homer Jones Memorial Lecture. It's been more than two years since the 30th lecture, which was held here at the Bank on March 4, 2020, very shortly before the onset of the pandemic. Although the pandemic delayed the return of our annual lecture, we couldn't be happier to resume the lecture series now and to welcome our speaker and to all of you in our auditorium this evening. So, thank you, and welcome back.

[APPLAUSE]

It's great to see so many friends with us at the Bank this evening. But I'd like to take just a moment to recognize one of our old friends, Professor Phil Dybvig from the Olin Business School at Washington University in St. Louis. As I'm sure many of you know, Phil was recently awarded the Nobel Prize in economics along with Ben Bernanke and Douglas Diamond, for their pioneering work on financial intermediation and the economy. Phil--

[APPLAUSE]

Phil and Doug Diamond wrote one of the classic papers in economics, quote, "Bank Runs, Deposit Insurance and Liquidity," published in the Journal of Political Economy in 1983. Phil has had an outstanding and distinguished career. And he's a longtime friend of the Bank and visitor to the Bank. And we're glad he's joining us this evening. So, congratulations to Phil.

One of the other Nobel laureates, Ben Bernanke, has given this lecture in the past. And Phil Dybvig has also given this lecture in the past. So, Eswar, things are looking up for you--

[LAUGHTER]

--to possibly also get a Nobel Prize.

The Homer Jones Lecture honors the memory and institutional contributions of a former St. Louis Fed Research Director. Homer Jones and his legacy are probably well known to those of you with ties to the St. Louis Fed who have attended these lectures in the past. But for many of those who may be attending the lecture for the first time, it might be useful to provide a brief background on the professional life of Homer Jones.

Homer Jones taught at Rutgers University in the early 1930s. Arthur Burns, who later chaired the Fed's Board of Governors in the 1970s, was also on the Rutgers faculty at the same time. One of their students was a young man named Milton Friedman. Because of his interest in mathematics, Milton planned to become an actuary.

However, Homer introduced Milton to the Chicago School of Economics and made it possible for him to attend the University of Chicago for graduate studies. To make a long story short, the University of Chicago-- at the University of Chicago, Friedman helped found the important branch of monetary economics known as monetarism and eventually also won a Nobel Prize in economics. In an unusual twist, Homer Jones also matriculated to Chicago where he completed his Ph.D. under Friedman's tutelage. Thus, Homer was both a teacher and a student of Milton Friedman.

Homer eventually joined the St. Louis Fed as its research director and was instrumental in starting the Bank's own monetarist tradition. It boggles the mind to think how different monetary economic history, let alone the monetarist legacy of the St. Louis Fed, would have been if Homer Jones hadn't succeeded in encouraging Milton Friedman to become an economist rather than an actuary.

As director of research, Homer Jones built the St. Louis Fed into the powerhouse of monetary economics that it remains to this day. Homer had a two-pronged approach-- rigorous research using economic and monetary data, and public dissemination of that data. Jerry Jordan, who began his career at the St. Louis Fed under Homer and was later president of the Cleveland Fed, said that Homer's philosophy was very much aligned with the Show Me State ethos of "prove it." Said Jordan, "His philosophy essentially was, if the people see it often enough, they'll come to believe it whether they understand it or not."

[LAUGHTER]

In time, the St. Louis Fed and its many publications played no small role in the economic and policy debates of the 1960s and 1970s. To this day, the Bank remains strongly committed to macroeconomic and monetary policy research and to disseminating economic data and information to the public. We've followed a formula started by Homer that has proved quite successful. As one example, the Bank's FRED, Federal Reserve Economic Data, and family web services garnered more than 20 million visits last year. That's nearly 55,000 visits a day.

Shortly after Homer Jones' death, several of his colleagues, friends and academic acquaintances in the St. Louis community organized the first Homer Jones Memorial Lecture in 1987. The lecture has continued in large part because of the past support of many organizations and people, many of whom are represented here tonight. These have included the St. Way Gate-- St. Louis Gateway Chapter of the National Association for Business Economics, St. Louis University, Southern Illinois University at Edwardsville, University of Missouri at St. Louis, and Washington University in St. Louis. The St. Louis Fed has continued this tradition by hosting and sponsoring the lecture for many years now.

This year's speaker is Eswar S. Prasad. Dr. Prasad is the Tolani Senior Professor of Trade Policy and professor of economics 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. Dr. Prasad is the author of many professional journal articles and three books. His latest book, published in 2021, is the subject of today's talk, The Future of Money: How the Digital Revolution Is Transforming Currencies and Finance.

As most of you undoubtedly know, digital currencies, whether named Bitcoin, Ethereum or something else, have become prominent components of the financial landscape with increasing mainstream acceptance. Just recently, for instance, the oldest bank in the United States, the Bank of New York Mellon, announced that it would begin offering digital asset custodial services. Some central banks have even issued or contemplated issuing a digital currency. So, in the best Show Me State spirit of Homer Jones, Dr. Prasad is going to tell us if digital currencies are hype, hope or history. Please join me in welcoming Dr. Prasad.

[APPLAUSE]

Thank you.

Prasad: I think you had your hand up first, please.

Audience member: How do I do this?

Just press the button on top.

It's on the bottom, right at the bottom. [INAUDIBLE]. Go on

Got it. So what are the features of the digital currencies that you hear a lot about now is the tremendous amount of fraud that's sort of involved in the system. And obviously, that's probably a little bit sort of a shakeout of the weaker players. But when you talk to people, it seems like people who are very bullish on digital currencies refused to acknowledge the fact that some parts of it are hackable. Like if the consensus mechanism in Bitcoin, it can be hacked so that the nodes all, actually, aren't the same. You didn't really mention that. Is this is that just sort of an early feature of the bugs getting worked out? Or, does the solution to that problem and eventually take away some of the decentralization? How do we think about that?

Prasad: So interpret your question in two ways. First, the use of cryptocurrencies for fraudulent transactions, and that was a concern in the early days of Bitcoin when it was powering the dark. It's become a little less of a concern right now because it turns out that Bitcoin is not as anonymous as we thought it was. And, of course, new cryptocurrencies that come up with stronger anonymity provision. So that's one part of it.

And then there is a question about the security of the system. It turns out that Bitcoin is quite cleverly designed. You could potentially, with enough computing power, create a fork in the blockchain. But it's very difficult to undo the entire blockchain because the validation mechanism requires, literally, for you to do proof of work. That is, you have to show that you have done actual computing work, and the mechanism can pick this up.

So in order to double spend and create a fork in the blockchain. So the blockchain is essentially a digital record of all the digital ledger of all the transactions that have taken place using Bitcoin. So you could create an alternative reality, but you can't go very deep into the blockchain. So this is why, for instance, if you have a very high value transaction, it becomes secure only when it is about six blocks deep in the blockchain.

Each block is about 2000 transactions and takes about 10 minutes to be validated. The idea is in order to create a blockchain that the entire community will accept as the authentic blockchain that is forkable six blocks back, would already take an enormous amount of computing power. So it's hard to imagine it being done. So there are less mature cryptocurrencies where this becomes more of an issue.

You may have heard about the second largest cryptocurrency moving to a different validation protocol called proof of stake, which is much more efficient, which is much less environmentally destructive. There were some concerns that proof of stake might, in fact, be less secure than proof of work. It turns out, there is some truth to that, again, for very new cryptocurrencies, but not for mature cryptocurrencies where the blockchain or the electronic ledger is sufficiently long.

So the entire blockchain has not been hacked, and it would be quite difficult, although not impossible, to hack. So the sorts of hacks you've heard about are typically people hacking into the centralized exchanges that custody, that is hold people's cryptocurrency accounts. And so on those are very vulnerable. The exchanges which are centralized are also vulnerable. Jim.

Bullard: So maybe related to that issue a little bit is, the technology is going to continue to evolve and computing is going to continue to evolve. And so you could build up a big system, but then you have quantum computing coming along, as I understand it, at least five years away, maybe 10 or 15 years away. But how would that change-- since a lot of this is built on computing power, how would that change the calculus?

Prasad: So my Cornell colleagues who are on this, tell me that quantum computing is probably at least a couple of decades off in terms of attaining its potential. So it turns out right now, the sort of basic quantum computing mechanisms that we have out there, even if they were developed a good bit further the existing encryption algorithms and the cryptographic techniques used in what are called hash functions, are sufficiently robust, that they are going to be OK.

But the National Security Agency which created a lot of the hash functions-- hash functions are essentially one wave functions which take an input and create an output in a deterministic way. And those are very important in cryptography, and in the use of this entire technology. Right now, the function that is used to something called SHA-256, which is 2 to the power 256.

So as you can imagine, that is an extraordinarily large number, which would require all the computers in the world right now running for millions of years to crack it. With quantum computing, in 20 years from now, that would be crackable. But there is progress already, in terms of developing new encryption algorithms, new hash algorithms. Bitcoin already has this thing hardcoded. So the entire Bitcoin community would have to agree on a new mechanism.

But it turns out that by 2040, there'll be no more Bitcoin to be mined because as I told you, there is a specific cap on the amount of Bitcoin. And that cap, given that one Bitcoin is mined every 10 minutes, we know exactly when that cap will be reached. How will Bitcoin survive beyond that? It turns out that because Bitcoin is not very efficient at processing transactions, you can append a transaction fee to it.

So if I really desperately wanted to send you a Bitcoin right now, I would attach a transaction fee to that. So the person who validates that block of transaction would not only get the Bitcoin reward, but also get the transaction fee. When there are no more bitcoins to be mined, there will only be transaction fees. So the blockchain will still exist, it will still go on.

We might be able to develop new hashing mechanisms, but the use of these hash functions for, right now, creating Bitcoin, that will decline. So this is a very long way of saying yes, it is going to be a concern at some point, not in the foreseeable future, and there are forces at play to already make this less of a concern. Please

Audience member: I'll say right off the bat. I will say right off the bat that I believe this is a solution in search of a problem. But two comments you made that were somewhat disconcerting to me. One is you-- at the end, you said there's competition and money. But money has to be generally acceptable. So I think of this as more as competition in different means of transactions, not necessarily competition about money.

The other thing was that early on in your presentation, you talked about the Bitcoin just coming in at the right time. All right. So the recession began in December of 2007. Lehman Brothers declared bankruptcy in September 15 of 2008, and the recession ended in June of 2009. So are you kind of implying that Bitcoin had something to do with this easy end to the recession? I believe it's something else.

Prasad: Oh, no, no, no. I should have been clearer about this. And thank you for both questions. On the latter question, my point was that trust in traditional institutions such as central banks, commercial banks was at an all-time low. So it was a very fertile time for this medium of exchange to appear--

Audience member: But the reason it is, that people were holding toxic assets, which means they had no idea the value of the assets.

Prasad: Yes

Audience member: That was the problem. Bitcoin ain't never going to solve that problem.

Prasad: Bitcoin was, again, not designed to solve that problem. As I mentioned, it was designed just as a medium of exchange. But the point is, that was the time when people had less trust in central bank money, Jim and his colleagues were printing a lot of that money. And the idea was that at that time, maybe you could see a future where that value of that money would be debased because of the amount being created.

So Bitcoin, given its scarcity, was seen by some as potentially holding value better because of its scarcity. This is not the way it played out, of course, and this is not what it is intended to be. And about the competition issue, that's an interesting question. As I argued, we are seeing a bifurcation of the roles of money with Bitcoin, stablecoins, and so on. Some of them are viable mediums of exchange, some of them are not.

But ultimately, I think the faith in the central bank money is going to be dominant, so I'm certainly not writing off central banks. I think this ecosystem will move on its own, it will create some interesting innovations. I don't see it as long-lasting in terms of a value proposition. But in terms of a proposition and creating new financial technologies, I think it does have some legs. Yes, please. Do you want to go ahead, ma'am? And then--

Audience member: Oh, sure. Thank you.

Prasad: And then I take your questions?

Audience member: Help me understand. You talked about digital transformation, and that it's had such a huge impact on payments in India in Kenya. Don't you have to have either a computer cell service, internet, or a cell phone in order to execute those digital transactions? And if that's the case, what happens in this country where there's a great swathe of America that doesn't-- the places in rural America that don't have access to those things? Then how does that become a viable payment scheme, likewise, for the unbanked?

Prasad: Yeah, that's a very important issue. I think if cash were to disappear, there is a question about whether you get disenfranchisement of those who are technologically not sophisticated, who are poor, who are illiterate or just fearful of technology. It turns out that the technological requirements are actually quite minimal. If you think about the Kenya example, you don't need smartphones. It turns out you can implement a lot of this technology on simple mobile phones.

The mobile phone penetration rate in Kenya among adults is about 99%. And this M-Pesa scheme was actually created by a telecommunications company, which found that people were basically trading mobile credits instead of money. So they said, "Why don't we just set up a payment system where we can formally let people use it to transact?"

And it turns out that about 94% of people in Kenya, and this is a low-income country with very low levels of literacy, even low levels of numeracy, and it's working. This is what is used by a very wide swathe of the population. So I think we need to keep in mind the concerns you're raising, but they're not as big constraints as you might think.

Audience member: Maybe they have better cellphones?

[LAUGHS]

[AUDIENCE CHATTERING]

Prasad: Maybe that's the issue to be solved. We let Elon Musk solve it. I'm going to take this question-- maybe I'll take both of these questions and answer them jointly.

Audience member: Earlier, you mentioned the possibility of issuing a digital currency with an expiration date, and I understand how that creates an incentive to spend it. What's the incentive to accept it?

Prasad: OK. The other question, please. Yeah.

Audience member: Do you have any data of say, living in China, where if you speak out against the government and you want to buy something or go home or travel, your digital currency doesn't work, it's invalidated? I mean, is it not a high-risk that a if all of your resources are in this digital token and there's some issue that you may say something you didn't even intend to say, that you can't get into your apartment or can't buy groceries or can't travel?

Prasad: So both of these questions are clearly related. And these are about whether a CBDC, in particular, can be corrupted to accomplish certain non-economic objectives. And the first case, one can think about something like a coronavirus stimulus payment where if you don't have the cash and the government sends you some money, saying that you better spend it by a certain date, it might work. In fact, again, it just happens that I'm using China for this example.

In China, they did send out coupons that you could use to buy durable goods, white goods in particular, because they wanted to bump up consumption of certain durable goods at the time. But this gets into a tricky issue because once central bank money starts getting involved in fiscal policy, I mean, fiscal policy and monetary policy are related. But once a central bank starts being seen as an agent of the government, either the finance ministry or the government more broadly, as in the case that you pointed at, data, I think, is really dangerous for a central bank.

And in fact, in all of this discussion, I talked a little bit about monetary policy, and it's going to be a more complicated monetary policy environment as commercial banks face a variety of threats. Because the one thing we sort of understand, or at least I understand, maybe Jim understands better, is how monetary policy gets transmitted to real activity and inflation. We understand the banking channel, somewhat. If banks become less important, if non-bank institutions shadow banks start becoming more important, we don't quite know their responsiveness to interest rate changes.

And then on the social front, this is worrying because you could, certainly-- I mean, there are ways that you can create at least some degree of transactional privacy. But that may not be a credible promise because no central bank wants to issue money, digital or physical, that is used for illegitimate purposes, drug trafficking, terrorism financing, and so on. And with something digital that is inevitably going to leave a trace, you could use it for benevolent purposes. But it could, again, be subverted.

This is why we're going to have a conversation as a society before we move forward with a digital dollar, if at all. What is the value proposition in a CBDC? And do we, as a society, feel that we're comfortable moving to this world? It could be a much better world but it has some risks. Yes, sir. I'll take yours, [INAUDIBLE].

Audience member: You had talked about generational biases to adoption and such. Can you comment more about how you see the younger generation's view of the use of such currency and such, because they have very different views and values on how they approach it?

Prasad: And I think, one last question. And after that, I will have to--

Audience member: The gentleman in the front talked about fraud being an issue. And then it seems, to me, and so we're in the securities business, and one of the biggest challenges is money laundering. And so I just don't see how you control that in terms of giving it-- allowing or disallowing the bad people to trade money in this format.

Prasad: Yeah. So I'll wrap up with one comprehensive answer to these two questions. So on the younger generation, one of the very interesting things to me about the cryptocurrency revolution, is how it's brought youngsters out of the video games and so on. And I go and talk to many 12-year-olds, 14-year-olds, who are busy learning about money. They come and tell me their views about what money actually is. They're writing programs to find ways to exploit financial opportunities in the cryptocurrency space.

So it's creating an interesting new generation of people who are getting more interested in these economic concepts. But again, they seem to view this as interesting. But the sense that they don't really have a strong expectation of privacy is something I can sense as well. And that, again, worries me a great deal because to all of us, maybe privacy matters a little more. But the new generation, my kids seem to have given up any expectation of this.

And on the very last issue, I think one of the interesting challenges that we now face, is the intersection between this new finance or decentralized finance, in particular, in traditional finance. There are potentially some opportunities. We're already beginning to see traditional financial institutions adopt some of these technologies, or co-opt some of them to provide services at scale to customers that they could not efficiently service in the future.

But there are risks. And I think there are risks, not just to financial institutions. But even to existing financial markets securities markets. Stablecoins seem very safe because after all, they're backed up by stores of treasury securities and fiat currencies. But if you have a run on a stablecoin that could create problems in the underlying securities' markets, then there is the issue of fraud.

How do you make sure that fraud or nefarious activities in the decentralized finance ecosystem don't spill over into traditional finance? The problem is you don't have traction on the decentralized dimension. You can get traction only in terms of institutions that Jim and his colleagues regulate. But that tension and how to manage that while still recognizing that there are some benefits to this technology, that I think is the real and interesting challenge. Well, I could talk till the cows come home about this, but I suspect all of you have other things to do. So thank you.

[APPLAUSE]

Bullard: Well, thanks very much for a fascinating talk. Please join us for some Q&A afterwards here, and thanks so much for your lecture today.

[APPLAUSE]