The financial industry has never stopped innovating. However, throughout history, most financial innovations have served as specialized tools for commercial institutions rather than the general public. The average person visiting a bank isn’t there to open a letter of credit or trade oil futures. Even into the first decade of the 21st century, ordinary people’s interactions with the financial system were largely limited to deposits and mortgages. A relatively small portion of the population ventured into the stock market as an alternative investment channel to real estate.
But things began to change. In modernized societies—and even in some less developed countries—financial innovations that reached the masses began to emerge. Mobile payments and online wealth management, now commonplace for many in China, are prime examples of fintech. In countries with more relaxed regulations, cryptocurrencies continue to thrive, with markets experiencing significant volatility yet never falling completely silent. Meanwhile, the more formal concept of central bank digital currencies (CBDCs) has captured the attention of policymakers in major economies over the past decade. Several nations have launched research and development initiatives, with pioneers like China already conducting pilot programs, introducing this new form of official currency beyond physical banknotes and coins into daily life.
The potential benefits and risks of these developments, along with their broader social impact, deserve serious consideration by both policymakers and the public. In The Future of Money: Digital Revolution’s Impact on Currency and Finance, renowned monetary expert and Cornell University economics professor Eswar Prasad offers a comprehensive exploration of these issues, blending detailed knowledge with insightful analysis for the general reader.
The Rise of Financial Technology
Like many newly coined terms, “fintech” lacks a precise definition. Limiting it to financial business models that have emerged in the last decade due to the spread of the internet and digital devices seems overly narrow. The shift from paper ledgers to computer-stored accounting data in the banking sector during the latter half of the 20th century was, in itself, a milestone in financial technology. While banking customers may not have noticed this change much, another technological product became very familiar to the public: the automated teller machine (ATM).
Yet, it’s hard to argue that these two innovations radically transformed daily life. Credit cards and the payment networks behind them introduced far more significant changes. For people in developed countries during the last century, the convenience and security of using credit cards for payments—both domestically and abroad—were unprecedented and remained unmatched by other payment methods for a long time.
In low- and middle-income countries, credit card services were not entirely absent, but they were accessible only to a minority. Banks, aiming to minimize losses from defaults, had to assess applicants based on income, profession, and other factors to determine creditworthiness. Until the early 2000s, by traditional banking standards, most people in developing countries did not meet the criteria for obtaining a credit card. Many didn’t even have debit cards linked to deposit accounts and relied almost entirely on cash. This gap created an opportunity for new technologies to revolutionize payment methods.
Of course, we now know that the combination of mobile internet and smartphones became a powerful tool to fill this void. Alipay, which started as an online payment service for e-commerce on computers, naturally evolved into a mobile payment tool on smartphones. WeChat Pay quickly followed. The rest is well-known history. What is less known is that China’s major payment platforms not only handle extremely high volumes of concurrent transactions but also maintain exceptional risk control systems, keeping fraud rates remarkably low. As a result, China has become the country with the most extensive and deeply integrated use of mobile payments. In the United States, services like Apple Pay and Venmo have gained significant traction, and companies like Stripe have emerged as back-end payment technology providers primarily serving businesses. In India, the government has established public digital infrastructure that includes biometric identity verification and a unified payments interface, allowing approved payment service providers to offer services to the public.
However, mobile internet and smartphones are not absolute prerequisites for mobile payments. In 2007, Kenya introduced a mobile banking service based on feature phones and SMS. Launched by the country’s largest mobile operator, M-PESA allowed users to open accounts and deposit funds at partner agents, using their phone numbers as account identifiers, with deposits protected by insurance. By sending a specially formatted SMS to another phone number, users could transfer money to the recipient, eliminating the need to visit a bank or rely on the internet. Non-cash payments quickly became popular in Kenya, with people using M-PESA to receive salaries and pay utility bills, avoiding long queues. A decade after its launch, less than 20% of Kenyans had internet access, but nearly every household used M-PESA. Financial service coverage in Kenya rose from 27% before M-PESA to 83% by 2019, representing a dramatic improvement in financial inclusion.
For payment service providers, cross-border payments pose the greatest challenge. Sending money abroad has long been known for high fees and long processing times. This is because cross-border fund transfers must comply with regulatory requirements in multiple countries, often involving several financial institutions. Each step in the process requires repeated checks for anti-money laundering, counter-terrorism financing, and foreign exchange controls, often taking several days to complete. Exchange rates fluctuate during this period, and to protect themselves from potential losses due to these fluctuations, institutions charge higher fees as a form of insurance. Workers from less developed countries who send earnings back to their families sometimes pay fees as high as 8%. New institutions have emerged to address these challenges. Some have created standardized payment protocols and network platforms, inviting banks from different countries to join, enabling international payment settlements between member banks in as little as a few seconds. Others hold reserves in multiple foreign currencies, acting as market makers to bypass traditional foreign exchange intermediaries, reducing both time and foreign exchange risk, thereby lowering costs. Still others focus on niche markets, such as streamlining tuition payments for international students through batch processing.
Beyond payments, fintech also assists borrowers who cannot obtain credit from traditional banks, including small businesses and individuals. Banks, responsible for public deposits, face strict regulatory requirements. Due to their operational models, banks cannot afford to spend excessive resources assessing the repayment capacity of borrowers who generate relatively low returns per loan, nor can they efficiently monitor these borrowers after issuing loans. Therefore, banks typically require loan applicants to provide sufficient collateral or other guarantees. If applicants cannot provide collateral but have decent credit records, banks may offer very limited loan amounts. Those with poor credit records are usually denied.
New financial institutions armed with technology target these underserved borrowers. Unlike traditional banks, these institutions often operate without extensive branch networks, significantly reducing overhead costs. Some are licensed banking institutions that primarily accept deposits online; others do not take public deposits at all, instead funding loans through private investors and institutions. Their common approach relies on big data and machine learning algorithms to assess borrowers’ default risk and make approval decisions. Such institutions have emerged not only in Europe and the United States but also in emerging markets like India. In China, MyBank, under Ant Group, is a prominent example. Leveraging the vast data accumulated from Alibaba’s e-commerce and payment businesses, MyBank has provided loans to tens of millions of small and micro enterprises. Its approval process is several times faster than that of traditional banks, with some applications being evaluated entirely by algorithms without human intervention, delivering results in under a second. Despite this efficiency, MyBank’s non-performing loan ratio remains significantly lower than that of traditional banks. Ant’s consumer credit product, Huabei, synergizes with Alipay, Taobao, and Tmall, using big data and algorithms to extend small credit lines to individuals, also achieving high market penetration and low default rates.
The insurance industry, already rich in data, has naturally adopted big data and artificial intelligence technologies. In addition to incorporating new types of data from payments and other areas to enhance actuarial accuracy, and using machines to automate underwriting and claims processing, some companies offer clients the option of lower premiums in exchange for sharing more data through specified devices, effectively addressing information asymmetry.
A common saying in finance is that regulation always lags behind innovation. This often holds true for fintech. However, some regulators have begun to take a proactive approach by establishing “regulatory sandboxes.” These allow new business models not yet covered by existing regulations to operate on a small scale without jeopardizing overall financial stability. After evaluating the sandbox trials, formal regulations are developed, and operations are expanded.
Understanding Cryptocurrencies
The story of cryptocurrencies has been retold many times since Bitcoin’s emergence 15 years ago. Some voices in the media declare them the future, while others predict they will burst like the historical tulip bubble within a few years. Fairly speaking, neither the most extreme optimistic nor pessimistic predictions have come true. In the dense forest of cryptocurrencies, Bitcoin remains dominant, repeatedly nearing collapse only to rebound to new highs.
Bitcoin’s resilience leads its supporters to hope it will become the future of global money, as Satoshi Nakamoto envisioned and as the title of Prasad’s book suggests. However, after the early hype, observers have developed a more sober view: theory and reality suggest this is highly unlikely.
First, a global monetary system must handle hundreds of millions of transactions daily from market participants worldwide. But Bitcoin’s cumbersome “proof-of-work” design allows it to process a mere seven transactions per second on average—a laughably low number. And this already consumes more electricity than some small countries. The fee required to incentivize the network to confirm a transaction is substantial, fluctuating with network congestion and Bitcoin’s price, sometimes reaching tens of dollars.
Second, any currency widely adopted voluntarily must maintain relatively stable value, whether measured against a consumer price index or another stable currency. No one wants their salary’s purchasing power to unpredictably swing by dozens of percentage points each pay period. Bitcoin, with its wild price fluctuations against any major world currency, fails this basic requirement. Countless other cryptocurrencies have crashed and never recovered, with many involved in fraud.
Third, the “advantages” Bitcoin enthusiasts celebrate—decentralization, independence from the existing financial system, and freedom from manipulation by any state or financial institution—may not benefit ordinary people much and could instead create significant inconveniences. Precisely because they are regulated and guaranteed by banks, lost debit or credit cards can be reissued, unauthorized charges can be disputed, and balances in a deceased person’s account can be inherited. In contrast, users alone are responsible for safeguarding the private keys to their Bitcoin wallets. If the storage medium is damaged or lost, the associated Bitcoin is irretrievably gone. Researchers estimate that millions of Bitcoin have already been lost this way, representing a loss worth hundreds of billions of dollars at recent prices. Additionally, Bitcoin transactions are irreversible, meaning there is no recourse if an account is hacked or a transaction goes wrong. While many people store Bitcoin on exchanges, this merely transfers the risk to the exchange rather than eliminating it. Bitcoin’s history includes several instances of exchanges being hacked and cryptocurrencies stolen.
Finally, the anonymity touted by Bitcoin and many other cryptocurrencies is largely theoretical; in practice, real-world use almost inevitably leads to identification. Consider using Bitcoin for online shopping. However reliable the platform, the buyer must provide a delivery address, linking this personal information to their Bitcoin wallet address. If Bitcoin is stored on an exchange or other intermediary used to pay for the order, the identity exposure simply shifts to that intermediary. In reality, most Bitcoin holders today don’t use it for shopping; many hold accounts on exchanges to convert between Bitcoin and fiat currencies. Transfers from external bank accounts to these exchanges create another link between real identity and Bitcoin wallets. Given that all transactions are permanently recorded on the blockchain and are infinitely traceable, even if a user miraculously avoids leaving any trace in the real world, once their identity is revealed through other means, it cannot be undone. Transferring funds to a new wallet only shows the new wallet is connected to them. Thus, the features promoted as Bitcoin’s “advantages” either aren't truly advantageous—or are even disadvantageous—or are peculiar solutions looking for problems they don’t effectively solve within the traditional financial system.
After Bitcoin’s issues became apparent, new cryptocurrency designs emerged aiming to address one or several of these problems, such as replacing proof-of-work with less resource-intensive “proof-of-stake” to increase transaction throughput. However, no cryptocurrency appears to have achieved comprehensive success, and most solutions introduce new problems themselves.
Among the various imperfect cryptocurrencies, stablecoins—which peg their value to fiat currencies like the U.S. dollar to reduce volatility—have gained popularity recently. Issuers typically claim to hold reserves of the fiat currency or safe assets like government bonds in a 1:1 ratio or higher, using them as collateral to issue their branded stablecoins. Prasad argues that stablecoins are not true money but merely a medium of exchange, lacking the standard functions of a unit of account and store of value, which are still ultimately provided by the underlying fiat currency. Some stablecoins have also faced market skepticism regarding whether they truly hold sufficient reserves.
If stablecoins or other cryptocurrencies gain sustained use as a medium of exchange, and if the underlying blockchain technology supports it, participants could use programmable smart contracts. These could automatically execute based on predefined conditions without needing a third party to adjudicate and enforce penalties. However, because blockchains cannot directly interact with real-world events, the usefulness and scale of smart contracts remain limited.
Beyond their inherent flaws, the most significant challenge for cryptocurrencies is government regulation, particularly concerning their anonymity features. Countries require banks to monitor fund flows to prevent financing for terrorism, criminal activities, or money laundering—adhering to “Know Your Customer” (KYC) principles. Anonymity fundamentally contradicts this requirement. Using cryptocurrencies can, in principle, bypass intermediaries entirely, operating completely outside regulatory oversight—a core design principle of Bitcoin. So far, several countries have imposed varying degrees of control on cryptocurrencies. China has banned cryptocurrency trading, and India is considering similar measures. Major developed countries have taken a more lenient stance but still mandate that market institutions holding cryptocurrencies as financial assets comply with tax, anti-money laundering, and counter-terrorism financing regulations. The U.S. shut down the Silk Road dark web market for its use in illegal drug transactions. In 2019, Facebook’s stablecoin project, Libra (later Diem), faced collective opposition from regulators in major economies because its design, based on a basket of currencies rather than a single national currency, threatened to enable cross-border flows bypassing regulation, posing a risk to monetary and regulatory sovereignty. The project was eventually abandoned. A few countries have launched their own blockchain-based official cryptocurrencies, but these seem more like publicity stunts than practical solutions.
Burdened by these numerous issues, the future of cryptocurrencies is unlikely to be as glorious as their proponents envision.
Central Bank Digital Currencies (CBDCs)
Money and the state have always been closely intertwined throughout history. Although unofficial mediums of exchange have emerged spontaneously within small groups during特殊 periods, widely circulating money possessing all three functions—medium of exchange, unit of account, and store of value—has invariably involved state power. Official coinage in the era of precious metals is an example; the current monetary system, comprising central banks and chartered commercial banks, is even more so. Cryptocurrencies launched privately attempt to break the state’s monopoly on money issuance背后 (behind) fiat currency. Most countries with stable monetary sovereignty therefore do not offer official support, at most tolerating their existence. On the other hand, many central banks are not just reacting passively; they have proactive strategic designs, namely central bank digital currencies (CBDCs).
If one interprets CBDCs literally as digital forms of official currency issued by central banks, then wholesale CBDCs already exist in the form of reserve balances held by banks. New developments like the digital yuan fall under retail CBDCs.
Retail CBDCs can be simply understood as digital cash. In an era where most people own smartphones, holding CBDCs could be more convenient than physical banknotes or coins, while still being central bank money. Compared to bank deposits or balances held in fintech products, CBDCs reside directly on the central bank’s balance sheet, eliminating concerns about the issuing institution’s safety. Retail CBDCs can promote financial inclusion, allowing citizens who have difficulty opening bank accounts due to remoteness or other reasons access to modern financial services. If commercial payment networks fail, CBDCs could serve as a backup payment method, swiftly expanding use to help keep the economy running.
Economists have discussed the potential macroeconomic policy uses of CBDCs. According to modern macroeconomics, the optimal policy interest rate during a recession could be negative. Indeed, during the last global financial crisis, central banks in the eurozone and Japan implemented negative interest rates for financial institutions. However, because people can hold physical cash, which effectively carries a zero interest rate, negative rates struggle to transmit to the real economy. If CBDCs widely replace physical cash, negative interest rates could, in principle, be implemented directly by periodically deducting small amounts from CBDC balances rather than adding interest. But this would likely be political poison. Reducing people’s savings数字 (digitally) would be unpopular even in normal times; doing so during a recession when people are already tightening their belts would likely cause public outrage. Therefore, implementing negative rates via CBDCs is probably not a good idea. Conversely, CBDC accounts could undoubtedly be used to disburse various subsidies directly to citizens. This could not only save administrative costs but also help prevent corruption and fraud.
Given these benefits, it might seem that retail CBDCs should be vigorously promoted across society immediately. However, monetary authorities in major economies have not rushed ahead. The digital yuan, publicly launched five years ago, remains in the pilot phase. The U.S. Federal Reserve, the European Central Bank, and the Bank of Japan have also been researching for years but have yet to adopt a clear stance for practical implementation, maintaining a cautious wait-and-see attitude. The reasons for this careful approach are complex and include country-specific considerations, but a common and important factor is the fear of triggering financial disintermediation. In other words, central banks are reluctant to see CBDCs rapidly and completely replace bank deposits as the primary place for people’s savings, which could sharply impact banks’ balance sheets in the short term and颠覆 (overturn) the existing financial order.
In retrospect, the area likely to see significant breakthroughs in the foreseeable future is wholesale CBDCs. As mentioned earlier, cross-border payments are a major pain point, primarily due to the lack of mutual trust regarding regulation and security for each specific transaction between various official and commercial institutions across different jurisdictions. The current multi-step,处处 (everywhere) verification approach sacrifices time and cost for security and compliance. Since no cross-jurisdictional central arbiter exists, if parties want to shorten the payment chain to improve efficiency, they must achieve secure mutual trust through other means. CBDCs incorporating decentralized blockchain technology could provide a novel solution. The book mentions the “m-CBDC Bridge” project, a collaboration based on this concept initiated in 2019 by the Hong Kong Monetary Authority and the Bank of Thailand, joined in early 2021 by the People’s Bank of China and the Central Bank of the UAE. Since the book’s publication, this project has progressed further, with multiple commercial banks from participating countries completing pilot tests involving real peer-to-peer transactions using several CBDCs, including the digital yuan—a world first. These transactions were completed in as little as seven seconds, with costs reduced by at least half.
The development of CBDCs shows that innovation is not monopolized by commercial institutions; official bodies can also contribute. It is indeed an exciting era of significant financial innovation. However, while innovation promotes financial inclusion and efficiency, it also challenges the financial order. Market competition has intensified, and traditional financial institutions, impacted by new rivals, are forced to learn and adapt. Regulators face complex trade-offs, wanting neither to stifle innovation nor jeopardize financial stability. Rapid financial innovation in large countries can cross borders via the internet. An increasing number of smaller nations will find that some of their citizens are already using these innovations to bypass regulations or physical barriers, accessing financial services overseas, including but not limited to using international currencies like the U.S. dollar. For people in poorly governed countries suffering from severe inflation and other problems, this represents a last resort for economic self-preservation. For governments of smaller countries that seek to legitimately control harmful activities like illicit fund flows, it presents an increasingly difficult challenge. Addressing the inequality between pioneers and latecomers in financial innovation will require institutional innovation within future global governance frameworks.
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Frequently Asked Questions
What is the main difference between cryptocurrency and a CBDC?
Cryptocurrencies like Bitcoin are typically decentralized, private digital assets not backed by any government. A CBDC (Central Bank Digital Currency) is a digital form of a country's official fiat currency, issued and regulated by the central bank, making it a sovereign digital currency with state backing.
How can CBDCs improve financial inclusion?
CBDCs can provide direct access to central bank money via digital wallets on phones or other devices. This allows individuals in remote areas or those without access to traditional banking infrastructure to participate in the digital economy, make payments, and store value securely without needing a commercial bank account.
Are stablecoins a safe alternative to volatile cryptocurrencies?
Stablecoins aim to reduce volatility by pegging their value to assets like the U.S. dollar. However, their safety depends heavily on the issuer actually holding sufficient, high-quality reserves. They are not immune to risks like regulatory changes, issuer insolvency, or technological failures, and they lack the deposit insurance protections of traditional bank accounts.
What are the biggest risks associated with using cryptocurrencies?
Key risks include extreme price volatility, the irreversible nature of transactions (leading to loss if sent to wrong addresses or if private keys are lost), susceptibility to hacking on exchanges, use in illicit activities, and evolving regulatory scrutiny that could restrict their use or value in various jurisdictions.
Could CBDCs completely replace physical cash?
While technically possible, it's unlikely in the near future. Complete replacement raises significant concerns regarding privacy, access for digitally excluded populations (like the elderly or those without smartphones), and resilience during power outages or cyber incidents. Most central banks considering CBDCs envision them as a complement to, not a immediate replacement for, physical cash.
How do smart contracts work in finance?
Smart contracts are self-executing contracts with terms written into code on a blockchain. They automatically execute actions (like releasing funds) when predefined conditions are met. In finance, they could automate processes like insurance claims payments, trade settlements, or loan disbursements, reducing paperwork, time, and the need for intermediaries, though their applicability is still limited to scenarios with clear digital triggers.