The future of money and… public institutions, regulators and policymakers
The evolving nature of money will require central authorities to adapt. The implications are significant, including issues of monetary policy, sustaining financial stability, maintaining trust, ensuring fair customer treatment, establishing updated global standards and adapting to new ways of administering core functions like tax collection and fighting financial crime.
Faith in financial institutions has come under strain since the 2008 global financial crisis. This strain has worsened in some quarters as a range of international economic, political, societal and military upheavals bring further volatility. It is perhaps one reason behind the rising interest in, and adoption of, decentralised cryptocurrencies. However, far beyond providing a decentralised alternative to central bank currencies, we believe digital assets have the potential to reinvigorate confidence in institutions.
While incidents such as the high-profile collapse of crypto-exchange FTX in 2022 have exposed worrying weaknesses in the current system of digital assets, they have also concentrated minds. Indeed, the FTX saga has focused attention on the risks and misunderstandings that exist around digital assets. If this incident and others spur investors, businesses, consumers, and perhaps most importantly, regulators to examine and better understand the issues at hand, as well as the associated risks, that can only help future adoption. Likewise, better practical judgements may come as the market improves its ability to distinguish good from bad.
For public institutions, regulators and policymakers, the path to the future of money must be anchored on trust. The task will be difficult as a result both of embedded suspicions and a lack of common understanding around digital assets and the technologies that underpin them. After all, while cryptography-based blockchains are designed to protect privacy, one person’s privacy is another’s secrecy and distrust, and herein lies a conundrum. Data must be held securely and with appropriate confidentiality yet, if it is locked away completely, it cannot be used to improve the efficiency of financial systems or supply the benefits it has the potential to deliver.
What businesses, regulators and consumers do broadly agree on is that personal data, including payments data, must be secure and be seen to be secure. With concerns over data breaches and cybercrime on the rise, governments around the world are increasingly looking for ways to ensure that personal data is properly protected, and as a result the confidence of citizens and businesses is both maintained and improved.
So, in order to thrive, digital assets and currencies will have to demonstrate the highest standards of data security and privacy. This is a tricky balance to strike as many of the cost and efficiency benefits will only accrue if financial and other personal data can be shared to support improved risk management, for example fraud and financial crime intelligence sharing, and enhanced, personalised products and services for customers. The hurdles are not insurmountable. Advances in technology will increasingly improve our ability to strike the right balance, and comfort with data sharing may well improve when there is trust in the checks and balances, and genuine value can be seen. Building this trust and supporting value creation will need to be at the core of regulation.
Transnational questions of personal privacy also loom over the big technology firms. As well as being guardians of data, they have the potential to create currencies beyond the reach of central authorities, although recent attempts to do so have struggled to gain traction. In the future of money, data protection will only be as robust as the algorithms used by the blockchain, or similar systems storing that data. This has led some to ask, if the financial system is decentralised: can it be held to account? And importantly, if so, how?
If public institutions, regulators and policymakers conclude that trust can be digitised and appropriately governed, the financial services industry will be able to cross a significant hurdle. Cryptographic security, ledger immutability and ‘programmable’ money could provide more secure and efficient mechanisms for establishing trust between buyers and sellers, as well as reducing the role of intermediaries. This could have a transformative effect on the payments landscape and financial services more broadly, where intermediaries currently account for a significant proportion of complexity and cost generated by transactions between businesses and individuals.
On a similar note, public institutions, regulators and policymakers also have a big stake in the security of the systems they oversee. As the digital attack surfaces of institutions grow, regulatory expectations of financial institutions’ defences will similarly increase. Scrutiny and oversight of cybersecurity measures taken by institutions will adapt accordingly, and financial institutions will need to keep pace. Models based around threat prediction rather than damage limitation are becoming ever more critical. Effective prevention and predictive models will enhance institutions’ abilities to understand unseen and prospective threats, allowing corresponding protection measures to be put in place ahead of time, further bolstering confidence in the system.
Assuming trust can be maintained, and in some cases rebuilt, how then will central authorities manage the future of money? Central banks will want to retain control of monetary policy, particularly in the knowledge that cryptocurrencies and wider DeFi movement may erode their position of primacy over time in some areas. They will want to control monetary conditions through the tightening and easing of the money supply. However, such activities could be limited in a scenario that includes numerous other decentralised forms of money.
Digital assets may therefore usher in a ‘new economics’, requiring a new set of levers to control the macro environment and some degree of recalibration on the part of regulators, central banks and governments. The outcome, however, may be similar in scope to the status quo. In essence the rules and the rule-setters will be the same, with the shift being more practical in nature as tokens evolve from fiat currencies to new cryptographic equivalents.
Above all though, governments and central banks will want to ensure that the quality and quantity of money in an economy is appropriately matched to sustainable demand. Such controls are essential to ensure the health of economies and the wider societies depending on them.
For reasons of financial stability, it will also be important for central banks and regulators to provide clear signals concerning the balance sheet treatment of digital assets as they become more ubiquitous. Would it be, for example, wise to treat reward coins as quasi-currencies for use in specific, non-systemic settings? That, together with myriad other specific points of difference, will need to be debated and settled as the market evolves.
Global consensus will also be needed as the nature of money itself becomes more complex and the mechanics of foreign exchange evolve. In addition, should cryptocurrencies become commonly used for payments, investments and savings, authorities will need to rewrite long-standing principles of accounting to accommodate a future dominated by digital assets. The implications for central monetary authorities therefore are substantial, as will be any decisions concerning the adoption of international standards for digital assets. Without comprehensive international co-operation, digital currencies will likely remain fragmented and cost and efficiency benefit potential will be reduced. Successful global regulation will require collaboration from recognised supranational agencies, such as the World Bank, the International Monetary Fund (IMF), the Bank for International Settlements (BIS) and the Organisation for Economic Co-operation and Development (OECD).
Such issues will need to be tackled for the opportunities connected with the future of money to flow freely. For example, many governments will be attracted by the enhanced capabilities offered by digital assets to track and trace transactions, especially in the context of tax evasion and fighting illicit finance flows. Tax collection could also become cheaper, easier and fairer for governments to administer, with streamlined collaboration across agencies improving the tracking and tracing of wealth. Evasion activities, meanwhile, could also prove to be more difficult in the longer run as cryptographic ‘money with memory’ enables easier forensic investigation.
A summary of some of the challenges and opportunities faced by governments and regulators, along with potential responses are set out in the table below.
For institutions, regulators and policymakers, the stakes are high. Our base case view though is that, while traditional markets will likely be disrupted by new entrants and progressive incumbent providers, central authorities will retain their crucial position in the system, albeit in a new, adapted state.
Coming next: We consider the ways in which the future of money could support a more sustainable and eco-friendly future for all. A large-scale migration to greener consensus mechanisms is needed to address the energy intensity of much of some of today’s new blockchain- based systems. But, down the road, we anticipate the broader adoption of digital assets will deliver a range of eco-friendly benefits.
