The Future of Money: a balance of fintech, cryptocurrencies, and CBDCs
And all three trends will change the landscape in which the FCDO works
(Written together with colleagues from FCDO)
Technology is changing rapidly. Advances in digital, biological and materials technology are changing economies and societies. Emerging technologies such as Artificial Intelligence, Engineering Biology and Quantum Computing are potentially transformative and are the focus of strategic thinking by nations and businesses. These technologies have the potential to change our lives, they also have the potential to change the context in which FCDO seeks to meet its objectives.
Understanding how technology might change the landscape in which FCDO operates plays an important role in making sure the FCDO is prepared for these changes. Therefore, the FCDO’s Technology and Innovation Unit are working with the Frontier Tech Futures team to explore the world of 2030 and, over the last several months, we have been looking at the future of money.
Money and the financial system play an integral role in directing the course of economies and societies. Financial institutions and financial infrastructure are not simply neutral intermediaries between economic agents like companies and investors: they play an active role in determining real world outcomes. Unsurprisingly, this has meant that actors in the financial system are constantly innovating and looking for an edge. From laws on loans and interest in ancient Babylon to the first official national government bonds issued by the Bank of England in 1694, the financial system has been constantly evolving leading to a complex global web of financial markets.
This evolution has continued in the information age with the financial sector readily adopting innovations in computing, the internet, and cryptography. Advances in digital technology have been rapid. The cost of hardware, software, and connectivity is falling whilst the performance of hardware, software, and connectivity is increasing. The semi-conductor industry has been following Moore’s law, the doubling of transistors in an integrated circuit, for about 50 years. 25 doublings are about a factor of 34 million. The ITU estimates that approximately 4.9 billion people are using the Internet in 2021 (this still leaves 2.9 billion people still offline).
This means that digital technology is becoming more available, affordable, and useful, and this has led to the picture we see today where economies are becoming increasingly cashless and where some of the world’s biggest companies are e-commerce platforms (e.g. Amazon and Alibaba). Covid has also accelerated this trend, with one study showing a 35% drop in cash transactions in the UK.
It is likely that we will see significant further innovation in the financial sector by 2030. The three innovation trends we picked out were continued expansion of the role of fintech, cryptoassets, and central bank digital currencies.
Fintech
Fintech is, broadly speaking, any technology enabled financial innovation. In that sense, it also encompasses cryptocurrencies and central bank digital currencies. The fintech sector is likely to see substantial growth with emerging technologies (such as Machine Learning, Natural Language Processing, Robotic Process Automation, Blockchain, and Internet of Things) becoming standard. Developed economies will become increasingly cashless and most developing countries will have developed a mature mobile infrastructure for finance. There is likely to be intense competition between fintech companies and traditional banks, with fintech companies better leveraging and analysing customer data and exploiting network effects to compete against the incumbents. A large increase in the power of tech companies and their data-focused business models relative to traditional banks is likely to lead to increased concerns around surveillance and privacy. Since the majority of big tech companies are based in the US or China, this could also lead to concerns about data sovereignty and ‘data traps.’ The plus side is that we are likely to have access to much more efficient and personalised financial services.
Cryptoassets
Cryptocurrencies are digital currencies in which transactions are verified and records maintained by a decentralized system using cryptography, rather than by a centralized authority. They are sometimes described as crypto assets as they are generally held as investments rather than as a means of payment. There are over 13,000 cryptocurrencies ranging from bitcoin, with a current market cap of over $1 trillion, to those that are worthless. One important subset are stablecoins which aim to avoid the large price volatility of other cryptocurrencies by being pegged to a stable asset e.g. the US dollar or gold. The trajectory of cryptocurrencies until 2030 is uncertain as there are many decisions by both government and the private sector that could influence it. Current trends suggest that we will see significant growth. New DeFi (Decentralised Finance) business models could enable greater efficiency, transparency, flexibility and reliability. Seeking a hedge against inflation and due to their increasing value, investors, especially in high inflation countries, could look to cryptocurrencies as a safer investment. Countries with weak financial infrastructure, poor local investment opportunities or a high demand for remittances could also see a large increase in the adoption of cryptocurrencies.
Since El Salvador recognised Bitcoin as legal tender we could see other countries following suit. Whilst significant growth in cryptocurrencies could lead to better investment opportunities and increased financial inclusion in many countries it could also lead to several international level risks such as an increase in the circumvention of governments’ financial oversight and an increase in money laundering, terrorist financing and tax evasion. Growth in cryptocurrencies could also lead to increased risk of a financial crisis as major financial institutions become heavily leveraged through both regulated and unregulated crypto-derivatives. This would enable a crash in cryptocurrencies to have significant knock-on consequences as those major financial institutions become bankrupt or are forced to sell large amounts of other financial assets putting pressure on the liquidity within financial markets.
Central Bank Digital Currencies
A Central Bank Digital Currency (CBDC) is a digital form of central bank money that could be used by households and businesses to make payments and there are many different architectures e.g. retail vs wholesale, account vs token, direct vs indirect. There is significant interest in CBDC’s from many central banks, many pilots in progress (most notably in China) and a couple of countries which have launched a CBDC (Bahamas and Cambodia). China aims to conduct a large test of the digital yuan at the Beijing Winter Olympics in February but the timetable for broad adoption by a large economy is not yet clear. One likely reason for Chinese interest in CBDCs is as a route towards an alternative to the US dollar dominated cross-border payments system.
Another reason for initial interest in CBDCs by several other major economies was Facebook’s announcement of the planned launch of Libra (now Diem) which led to concerns that a private, multi-fiat stablecoin could threaten monetary policy.
There are a number of potential benefits to CBDCs such as faster, cheaper, more resilient payments, and greater capability to tackle tax evasion or financial crime. There are also risks such as the disruption of commercial banking and data privacy concerns. It is not clear how this will play out in 2030 but we could see increasing Chinese dominance in this space and, as emerging economies start to test their own CBDCs, they could start looking to China for lessons.
The most likely future will contain a mix of these three trends; growth in fintech, cryptocurrencies, and CBDCs. In the utopian vision of 2030, we manage to realise the full potential of all these technologies whilst managing to minimise their risks. This means creating the space for innovation and channelling it towards tackling issues around financial inclusion, transparency, usability, regtech, efficiency, and privacy whilst preventing that same innovation from moving too fast and breaking too many things. Whatever direction the future on money and the financial sector takes, it is highly likely to have wide ranging social, economic, and geopolitical consequences. Ensuring that the FCDO has a voice in that future requires the capability to understand the diplomatic and technical challenges, the ability to leverage UK leadership in fintech, and international collaboration to build the necessary digital standards and legal, regulatory, and ethical frameworks.
Read more about the Future of Money on the Frontier Tech Hub’s website.
