IMF The Money Revolution Crypto CBDCs and The Future 1662742636

SEPTEMBER 2022
A new era for

money P.4
Regulating
crypto P.18
DeFi’s promise
FINANCE AND DEVELOPMENT and pitfalls P.33
The Money Revolution

Crypto, CBDCs, and the future of finance
I N T E R N A T I O N A L M O N E T A R Y F U N D
Contents
The era of
physical
currency is
drawing to
an end; the
age of digital
currencies
10 has begun.
THE MONEY REVOLUTION

4 A New Era for Money 20 Bullet Train
As bytes replace dollars, euros, and renminbi, some New tokens and platforms may transform cross-
changes will be welcome; others may not border payments—and potentially much more
Eswar Prasad Tobias Adrian and Tommaso Mancini-Griffoli
10 A Foundation of Trust 24 ‘DeFi’ and ‘TradFi’ Must Work Together
Central banks should harness crypto’s technical Decentralized and traditional finance can thrive
wizardry to enable a rich monetary ecosystem in tandem to fund renewable energy
Agustín Carstens, Jon Frost, and Hyun Song Shin Michael Casey
14 Making Sense of Crypto 27 The Superficial Allure of Crypto
Central banks and regulators need to take a Cryptocurrencies can’t deliver their claimed
differentiated approach to various crypto innovations benefits, and instead pose grave risks
Ravi Menon Hilary J. Allen
18 Regulating Crypto 30 Central Bankers’ New

The right rules could provide a safe space Cybersecurity Challenge
for innovation CBDCs may pose security risks, but responsible
Aditya Narain and Marina Moretti design can turn them into opportunities
Giulia Fanti, Josh Lipsky, and Ole Moehr
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FINANCE & DEVELOPMENT
A Quarterly Publication of the International Monetary Fund
September 2022 | Volume 59 | Number 3
DEPARTMENTS
38 People in Economics
Getting into People’s Heads
Marjorie Henriquez profiles Harvard’s Stefanie
Stantcheva, who uses surveys to uncover the invisible
48 Picture This
The Ascent of CBDCs
More than half of the world’s central banks are
exploring or developing digital currencies
Andrew Stanley
54 50 Back to Basics
Crypto’s Conservative Coins
Stablecoins are far from the revolutionary ideals of
ALSO IN THIS ISSUE crypto’s creators and are not without risk
Parma Bains and Ranjit Singh
33 DeFi’s Promise and Pitfalls
Decentralized finance could support a new financial 52 Café Economics
infrastructure if challenges are overcome
A Looming Food Crisis
Fabian Schär
FAO’s Maximo Torero Cullen discusses how
36 Digital Money 101 supply shortages could tip into a catastrophe
A brief guide to blockchain and crypto lingo 61 Book Reviews
42 Digital Journeys: Bali, India, Africa The Meddlers: Sovereignty, Empire, and the Birth of
Digital innovation is disrupting the status quo Global Economic Governance, Jamie Martin
Harry Jacques, Jeff Kearns, Ashlin Mathew, A Brief History of Equality, Thomas Piketty
and Chris Wellisz
The United States vs. China: The Quest for Global
54 Hall of Mirrors Economic Leadership, C. Fred Bergsten
A deeper understanding of how consumers think
about the economy would help policymakers 64 Currency Notes
control inflation Taking Digital Currencies Offline
Carlo Pizzinelli In many regions, internet-free access may be a make-
or-break feature for central bank digital currencies
58 The New Economics of Fertility John Kiff
People and economies will prosper if policymakers
help women combine career and family
Matthias Doepke, Anne Hannusch, Fabian
Kindermann, and Michèle Tertilt
38
September 2022 | FINANCE & DEVELOPMENT 1
EDITOR'S LETTER FINANCE & DEVELOPMENT
A Quarterly Publication of the
International Monetary Fund
EDITOR-IN-CHIEF:
Gita Bhatt
MANAGING EDITOR:
Maureen Burke
DEPUTY MANAGING EDITOR:
Peter Walker
SENIOR EDITORS:
Analisa R. Bala
Money,
Marjorie Henriquez
Nicholas Owen
ASSISTANT EDITOR:
Reimagined Andrew Stanley

DIGITAL EDITOR:
Kwabena Akuamoah-Boateng
THE FUTURE OF MONEY is undoubtedly digital. The question is, What is it
CREATIVE AND MARKETING:
going to look like? In this issue, some of the world’s leading experts try to Rose Kouwenhoven
answer this complex and politically charged question.
WEB EDITOR:
Of course, digital money has been developing for some time already. Rekia Ennaboulssi
New technologies hope to democratize finance and broaden access to PRODUCTION MANAGER:
financial products and services. A key goal is to achieve much cheaper, Melinda Weir
instantaneous domestic and cross-border payments. Eswar Prasad takes us COPY EDITOR:
on a tour of existing and emerging forms of digital money and looks at the Lucy Morales
implications for finance, monetary policy, international capital flows—even ADVISORS TO THE EDITOR:
the organization of societies. Ruchir Agarwal Mame Astou Diouf
Bernardin Akitoby Rupa Duttagupta
Not every form of digital money will prove viable. Cryptocurrencies like Celine Allard Davide Furceri
Bitcoin fail as money, says Singapore’s Ravi Menon, among others. Recently Steven Barnett Kenneth Kang
these tokens have lost two-thirds of their value. While they are actively Helge Berger Subir Lall
S. Pelin Berkman Raphael Lam
traded and heavily speculated on, prices are divorced from any underlying Oya Celasun Papa N’Diaye
economic value. Stablecoins are designed to rein in the volatility, but many Martin Čihák Mahvash Qureshi
have proved to be anything but stable, Menon adds, and depend on the Alfredo Cuevas Uma Ramakrishnan
Era Dabla-Norris Daria Zakharova
quality of the reserve assets backing them.
Still, journalist Michael Casey argues, decentralized finance (DeFi) and
© 2022 by the International Monetary Fund. All rights reserved.
crypto are not only here to stay but can address real-world problems such as For permission to reproduce any F&D content, submit a request
the energy crisis. Regulation is key. The IMF’s Aditya Narain and Marina via online form (www.imf.org/external/terms.htm) or by e-mail
Moretti call for global regulation to bring order to markets and provide a to copyright@imf.org. Permission for commercial purposes also
available from the Copyright Clearance Center
safe space for innovation. (www.copyright.com) for a nominal fee.
Meanwhile, central banks are considering their own digital currencies. Opinions expressed in articles and other materials are those of
Bank for International Settlements Chief Agustín Carstens and his coauthors the authors; they do not necessarily reflect IMF policy.
suggest that central banks should harness the technological innovations Subscriber services, changes of address, and
offered by crypto while also providing a crucial foundation of trust. Privacy advertising inquiries:
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Finance & Development
bank digital currencies, adds the Atlantic Council’s Josh Lipsky. PO Box 92780
It’s too early to tell how the digital landscape will evolve. But with the Washington, DC 20090, USA
right policy and regulatory choices, we can imagine a future with a mix Telephone: (202) 623-7430
Fax: (202) 623-7201
of government and privately backed currencies held safely in the digital E-mail: publications@imf.org
wallets of billions of people. Postmaster: send changes of address to Finance & Development,
International Monetary Fund, PO Box 92780, Washington, DC
GITA BHATT, editor-in-chief 20090, USA.
The English e dition is printed at Dartmouth Printing Company,
Hanover, NH.
SEPTEMBER 2022
A new era for

money P.4
Regulating
crypto P.18
Finance & Development is

DeFi’s promise
FINANCE AND DEVELOPMENT and pitfalls P.33
published quarterly by the

ON THE COVER
The Money Revolution
Crypto, CBDCs, and the future of finance
International Monetary Fund, 700

Digital currencies and other financial technologies are reshaping everything from 19th Street NW, Washington, DC
consumer banking to international payments. Illustrator Pete Reynolds uses a raised 20431, in English, Arabic, Chinese,
fist, symbol of social tumult, to show the power of this money revolution that is hidden French, Russian, and Spanish.
I N T E R N A T I O N A L M O N E T A R Y F U N D in plain sight. English edition ISSN 0145-1707
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A
NEW
ERA
FOR MONEY As bytes replace dollars, euros, and renminbi, some
changes will be welcome; others may not
Eswar Prasad

ART: PETE REYNOLDS

M oney has transformed
human society, enabling
commerce and trade even
between widely dispersed
geographic locations. It
allows the transfer of
wealth and resources across
space and over time. But for
much of human history, it
has also been the object of
rapacity and depredation.
Money is now on the cusp of a transformation
that could reshape banking, finance, and even the
structure of society. Most notably, the era of phys-
ical currency, or cash, is drawing to an end, even
in low- and middle-income countries; the age of
digital currencies has begun. A new round of com-
petition between official and private currencies is
also looming in both the domestic and international
arenas. The proliferation of digital technologies that
is powering this transformation could foster useful
innovations and broaden access to basic financial ser-
prices, and constraints to transaction volumes and
processing times, have rendered cryptocurrencies
ineffective as mediums of exchange. New forms of
cryptocurrencies called stablecoins, most of which
ironically get their stable value by being backed
by stores of central bank money and government
securities, have gained more traction as means of
payment. The blockchain technology underpinning
them is catalyzing far-reaching changes to money
and finance that will affect households, corpora-
tions, investors, central banks, and governments
in profound ways. This technology, by allowing
secure ownership of purely digital objects, is even
fostering the rise of new digital assets, such as
non-fungible tokens.
At the same time, central banks are concerned
about the implications for both financial and eco-
nomic stability if decentralized payment systems
(offshoots of Bitcoin) or private stablecoins were
to displace both cash and traditional payment
systems managed by regulated financial institu-
tions. A payment infrastructure that is entirely in
vices. But there is a risk that the technologies could the hands of the private sector might be efficient
intensify the concentration of economic power and and cheap, but some parts of it could freeze up in
allow big corporations and governments to intrude the event of a loss of confidence during a period of
even more into our financial and private lives. financial turmoil. Without a functioning payment
Traditional financial institutions, especially com- system, a modern economy would grind to a halt.
mercial banks, face challenges to their business In response to such concerns, central banks are
models as new technologies give rise to online contemplating issuing digital forms of central bank
banks that can reach more customers and to money for retail payments—central bank digital
web-based platforms, such as Prosper, capable of currencies (CBDCs). The motives range from broad-
directly connecting savers and borrowers. These ening financial inclusion (giving even those without
new institutions and platforms are intensifying a bank account easy access to a free digital payment
competition, promoting innovation, and reduc- system) to increasing the efficiency and stability
ing costs. Savers are gaining access to a broader of payment systems by creating a public payment
array of saving, credit, and insurance products, option as a backstop (the role now played by cash).
while small-scale entrepreneurs are able to secure A CBDC has other potential benefits. It would
financing from sources other than banks, which hinder illegal activities such as drug deals, money
tend to have stringent loan-underwriting and col- laundering, and terrorism financing that rely on
lateral requirements. Domestic and international anonymous cash transactions. It would bring more
payments are becoming cheaper and quicker, ben- economic activity out of the shadows and into the
efiting consumers and businesses. formal economy, making it harder to evade taxes.
Small businesses would benefit from lower trans-
Stability concerns action costs and avoid the hassles and risks of han-
The emergence of cryptocurrencies such as Bitcoin dling cash.
initially seemed likely to revolutionize payments.
Cryptocurrencies do not rely on central bank money Risk of runs
or trusted intermediaries such as commercial banks But a CBDC also has disadvantages. For one, it
and credit card companies to conduct transactions, poses risks to the banking system. Commercial
which cuts out the inefficiencies and added costs banks are crucial to creating and distributing credit
of these intermediaries. However, their volatile that keeps economies functioning smoothly. What if

households moved their money out of regular bank

accounts into central bank digital wallets, perceiving
If market forces are left to
them as safer even if they pay no interest? If com-
mercial banks were starved of deposits, a central
themselves, some issuers
bank could find itself in the undesirable position of of money and providers of
having to take over the allocation of credit, deciding
which sectors and firms deserve loans. In addition, payment technologies could
a central bank retail payment system could even
squelch private sector innovation aimed at making
become dominant.
digital payments cheaper and quicker.
Of equal concern is the potential loss of privacy. that issue them in digital form, also as mediums
Even with protections in place to ensure confidenti- of exchange. Still, privately intermediated payment
ality, any central bank would want to keep a verifi- systems are likely to gain in importance, intensify-
able record of transactions to ensure that its digital ing competition between various forms of private
currency is used only for legitimate purposes. A money and central bank money in their roles as
CBDC thus poses the risk of eventually destroying mediums of exchange. If market forces are left to
any vestige of anonymity and privacy in commercial themselves, some issuers of money and providers
transactions. A carefully designed CBDC, taking of payment technologies could become dominant.
advantage of fast-developing technical innovations, Some of these changes could affect the very nature
can mitigate many of these risks. Still, for all its of money—how it is created, what forms it takes,
benefits, the prospect of eventually displacing cash and what roles it plays in the economy.
with a CBDC ought not to be taken lightly.
The new technologies could make it harder for International money flows
a central bank to carry out its key functions— Novel forms of money and new channels for
namely, to keep unemployment and inflation low moving funds within and between economies
by manipulating interest rates. When a central will reshape international capital flows, exchange
bank such as the Federal Reserve changes its key rates, and the structure of the international mon-
interest rate, it affects interest rates on commercial etary system. Some of these changes will have big
bank deposits and loans in a way that is reasonably benefits; others will pose new challenges.
well understood. But if the proliferation of digital International financial transactions will become
lending platforms diminishes the role of commercial faster, cheaper, and more transparent. These
banks in mediating between savers and borrowers, changes will be a boon for investors seeking to
it’s unclear how or whether this monetary policy diversify their portfolios, firms looking to raise
transmission mechanism will continue to function. money in global capital markets, and economic
migrants sending money back to their home coun-
Currency competition tries. Faster and cheaper cross-border payments
The basic functions of central-bank-issued money will also boost trade, which will be particularly
are on the threshold of change. As recently as a beneficial for emerging market and developing
century ago, private currencies competed with economies that rely on export revenues for a sig-
each other and with government-issued curren- nificant portion of their GDP.
cies, also known as fiat money. The emergence Yet the emergence of new conduits for
of central banks decisively shifted the balance in cross-border flows will facilitate not just interna-
favor of fiat currency, which serves as a unit of tional commerce but also illicit financial flows,
account, medium of exchange, and store of value. raising new challenges for regulators and govern-
The advent of various forms of digital currencies, ments. It will also make it harder for governments
and the technology behind them, has now made it to control the flows of legitimate investment capital
possible to separate these functions of money and across borders. This poses particular challenges for
has created direct competition for fiat currencies emerging market economies, which have suffered
in some dimensions. periodic economic crises as a result of large, sudden
Central bank currencies are likely to retain their outflows of foreign capital. These economies will
importance as stores of value and, for countries be even more vulnerable to the monetary policy

Digital central bank money is only as strong and
credible as the institution that issues it.
actions of the world’s major central banks, which the large number of unbanked and underbanked
can trigger those capital outflows. households in developing economies and even in
Neither the advent of CBDCs nor the lowering of advanced economies such as the United States.
barriers to international financial flows will alone do As the recent cryptocurrency boom and bust have
much to reorder the international monetary system shown, regulation of this sector will be essential
or the balance of power among major currencies. The to maintain the integrity of payment systems and
cost of direct transactions between pairs of emerging financial markets, ensure adequate investor protec-
market currencies is falling, reducing the need for tion, and promote financial stability. Still, given
“vehicle currencies” such as the dollar and the euro. the extensive demand for more efficient payment
But the major reserve currencies, especially the dollar, services at the retail, wholesale, and cross-border
are likely to retain their dominance as stores of value levels, private-sector-led financial innovations could
because that dominance rests not just on the issuing generate significant benefits for households and
country’s economic size and financial market depth corporations. In this respect, the key challenge for
but also on a strong institutional foundation that is central banks and financial regulators lies in balancing
essential for maintaining investors’ trust. Technology financial innovation with the need to mitigate risks to
cannot substitute for an independent central bank uninformed investors and to overall financial stability.
and the rule of law. New financial technologies hold the promise of
Similarly, CBDCs will not solve underlying weak- making it easier even for indigent households to
nesses in central bank credibility or other issues, gain access to an array of financial products and
such as a government’s undisciplined fiscal policies, services, and of thereby democratizing finance.
that affect the value of a national currency. When However, technological innovations in finance,
a government runs large budget deficits, the pre- even those that might allow for more efficient
sumption that the central bank might be directed to financial intermediation, could have double-edged
create more money to finance those deficits tends to implications for income and wealth inequality.
raise inflation and reduce the purchasing power of The benefits of innovations in financial technolo-
central bank money, whether physical or digital. In gies could be captured largely by the wealthy, who
other words, digital central bank money is only as could use them to increase financial returns and
strong and credible as the institution that issues it. diversify risks, and existing financial institutions
could co-opt these changes for their own benefit.
Government’s role Moreover, because those who are economically
Central banks and governments worldwide face marginalized have limited digital access and lack
important decisions in coming years about whether financial literacy, some of the changes could draw
to resist new financial technologies, passively accept them into investment opportunities whose risks
private-sector-led innovations, or embrace the they do not fully appreciate or have the ability to
potential efficiency gains the new technologies tolerate. Thus, the implications for income and
offer. The emergence of cryptocurrencies and the wealth inequality—which has risen sharply in
prospect of CBDCs raise important questions about many countries and is fomenting political and
the role the government ought to play in financial social tensions—are far from obvious.
markets, whether it is impinging on areas that are Another key change will be greater stratifica-
preferably left to the private sector, and whether tion at both the national and international levels.
it can compensate for market failures, particularly Smaller economies and those with weak institu-
tions could see their central banks and currencies
swept away, concentrating even more economic and
financial power in the hands of the large economies.
Meanwhile, major corporations such as Amazon
and Meta could accrete more power by controlling
both commerce and finance.

Even in a world with decentralized finance built can work well in good times, confidence in them
around Bitcoin’s innovative blockchain technology could prove fragile in difficult circumstances. If
(which is likely to be its true legacy), governments the financial system is dominated by decentralized
have important roles to play in enforcing contrac- mechanisms that are not directly backed (as banks
tual and property rights, protecting investors, and are) by a central bank or other government agency,
ensuring financial stability. After all, it appears confidence could easily evaporate. Thus, decentral-
that cryptocurrencies and innovative financial ization might yield efficiency in good times and
products, too, work better when they are built rapid destabilization when economies struggle.
on the foundation of trust that comes from gov- Potentially big changes to societal structures are
ernment oversight and supervision. Governments also at hand. The displacement of cash by digital
have the responsibility to ensure that their laws payment systems could eliminate any vestige of
and actions promote fair competition rather than privacy in commercial transactions. Bitcoin and
favoring incumbents and allowing large players to other cryptocurrencies were intended to secure
stifle smaller rivals. anonymity and eliminate reliance on governments
and major financial institutions in the conduct
Central or fragmented of commerce. Yet they are spurring changes that
Financial innovations will generate new and as yet might end up compromising privacy. Societies
unknown risks, especially if market participants will struggle to check the power of governments
and regulators put undue faith in technology. as individual liberties face even greater risk.
Decentralization and its corollary, fragmentation,
cut both ways. They can increase financial stabil- ESWAR PRASAD is a professor at Cornell University and a
ity by reducing centralized points of failure and senior fellow at the Brookings Institution. This article draws
increasing resilience through greater redundancy. on his latest book, The Future of Money: How the Digital
On the other hand, while fragmented systems Revolution Is Transforming Currencies and Finance.
INSIGHTS & ANALYSIS ON

ECONOMICS & FINANCE
Blogs.IMF.org

A Foundation of Trust
Central banks should harness crypto’s technical wizardry to enable a rich monetary ecosystem
Agustín Carstens, Jon Frost, and Hyun Song Shin

W Any legitimate transaction that
hen people or companies make a pay-
ment, they are trusting in two things:
the money itself and the payment
system that executes the transaction. can be carried out with crypto
While often taken for granted, these two elements
are a crucial foundation of any economy. Every
can be accomplished better with
day, billions of times, households and businesses
put their trust in this system and the institutions
central bank money.
underpinning it.
Digital innovation is upending both money and
payments. Cryptocurrencies and decentralized And it must be open across borders, to support inter-
finance (DeFi) are built on the premise of decen- national economic integration. Today’s monetary
tralization, aiming to replace traditional financial system is generally safe and stable, but there is room
intermediaries (bankers, brokers, custodians) with for improvement in many areas (see table, page 13).
technological solutions. The remarkable rise of cryp- Cryptocurrencies and DeFi aim to replicate
tocurrencies has captured the popular imagination money, payments, and a range of financial services.
and offers a glimpse of new technical capabilities. They build on permissionless distributed ledger
These include the ability to program payments (pro- technology such as blockchain. This technology
grammability), combine different operations into allows for technical functions that can adapt to new
one transaction (composability), and generate a digi- demands as they arise, as well as for openness across
tal representation of money and assets (tokenization). borders. Yet crypto suffers from serious structural
Yet recent developments have underscored cryp- flaws that prevent it from serving as a sound basis
to’s failure to fulfill the requirements of a monetary for the monetary system.
system that fully serves society. Its shortcomings are First, crypto lacks a sound nominal anchor.
not just bugs but structural flaws. This is why we The system relies on volatile cryptocurrencies and
argue that the monetary system of the future should so-called stablecoins that seek such an anchor by
harness the new technical capabilities demonstrated maintaining a fixed value to a sovereign currency,
by crypto but be grounded in the trust central such as the US dollar. But cryptocurrencies are not
banks provide (BIS 2022). currencies, and stablecoins are not stable. This was
In other words, any legitimate transaction that underscored by the implosion of TerraUSD in May
can be carried out with crypto can be accomplished 2022 and persistent doubts about the actual assets
better with central bank money. Central bank digital that back the largest stablecoin, Tether. In other
currencies (CBDCs) and other public infrastructure words, stablecoins seek to “borrow” credibility
can underpin a rich and diverse monetary ecosystem from real money issued by central banks. This
that supports innovation in the public interest. shows that if central bank money did not exist, it
would be necessary to invent it.
Crypto’s structural flaws Second, crypto induces fragmentation. Money
Let’s start by looking at the requirements of a mon- is a social convention, characterized by network
etary system that can fully serve society. It must be effects—the more people use a given type of money,
safe and stable, with participants (public and pri- the more attractive it becomes to others. These
vate) who are accountable to the public. It must be network effects are anchored in a trusted institu-
efficient and inclusive. Users must have control over tion—the central bank—that guarantees the stabil-
their data, and fraud and abuse must be prevented. ity of the currency as well as the safety and finality
The system must also adapt to changing demands. (settlement and irreversibility) of transactions.

Because of these flaws, crypto is neither stable
Chart 1
nor efficient. It is a largely unregulated sector,
A fraying landscape and its participants are not accountable to society.
Ethereum congestion has led DeFi users to other blockchains. Frequent fraud, theft, and scams have raised serious
(percent of total assets locked)
concerns about market integrity.
100
Crypto has introduced us to the possibilities
of innovation. Yet its most useful elements must
75
be put on a sounder footing. By adopting new
50 technical capabilities but building on a core of
25 trust, central bank money can provide the foun-
dation for a rich and diverse monetary ecosystem
0
that is scalable and designed with the public
2021 2022
interest in mind.
Layer 1 networks:
Ethereum Terra Binance Avalanche Fantom Solana Tron
The trees and the forest
Other Layer 1 and 2 networks
Central banks are uniquely placed to provide this
core of trust, given the key roles they play in the
Sources: Boissay and others (2022); DeFi Llama; and Bank for International Settlements.
monetary system. First is their role as the issu-
ers of sovereign currency. Second is their duty
to provide the means for the ultimate finality of
Chart 2 payments. Central banks are also responsible for
Monetary flora the smooth functioning of payment systems and
Central banks can be seen as the solid trunks of trees in the global for safeguarding their integrity through regulation
monetary ecosystem. and supervision of private services.
Tokenized
assets
Tokenized
assets If the monetary system is a tree, the central
Smart Smart
bank is its solid trunk. The branches are banks
Autonomous Autonomous
contracts wallets Tokenized Tokenized wallets contracts
deposits deposits
Electronic
Retail
CBDC
Electronic
and other private providers competing to offer
services to households and businesses. Central
money money
Retail
fast
Open
banking
payment
systems
Open
banking bank public goods will support innovative ser-
Credit
cards Private sector
Wholesale
CBDC Private sector
Credit
cards
vices to back up the digital economy. The system
is rooted in settlement on the central bank’s
PSPs PSPs
mCBDC platform
Cash
balance sheet.
APIs Correspondent APIs Cash
banks
Central bank Central bank

Zooming out, we can see the global monetary
money (M0) money (M0)
system as a healthy forest (see Chart 2). In the
trees’ canopies, the branches come together and
Source: Bank for International Settlements.
Note: API = application programming interface; CBDC = central bank digital currency;
allow economic integration across borders.
mCBDC = multiple CBDC; M0 = monetary base; PSP = payment service provider. How can this vision be achieved? It will take
new public infrastructure at the wholesale, retail,
and cross-border levels.
Crypto’s decentralized nature means that it relies First, wholesale CBDCs—a superior represen-
on incentives to anonymous validators to confirm tation of central bank money for use exclusively
transactions, in the form of fees and rents. This by banks and other trusted institutions—can offer
causes congestion and prevents scalability. For new technical capabilities. These include the pro-
example, when the Ethereum network (a block- grammability, composability, and tokenization
chain widely used for DeFi applications) nears previously mentioned. Wholesale CBDCs could
its transaction limit, fees rise exponentially. As a unlock significant innovation that benefits end
result, over the past two years, users have moved to users. For instance, the buyer and seller of a house
other blockchains, resulting in growing fragmen- could agree up-front that the tokenized payment
tation of the DeFi landscape (see Chart 1). This and the tokenized title transfer must be simul-
inherent feature prevents widespread use (Boissay taneous. In the background, wholesale CBDCs
and others 2022). would settle these transfers as a single transaction.

Making the grade
The future monetary system can improve both on today’s monetary system and crypto.
High-level goals for money Today’s monetary Crypto universe Future monetary
and payments system (to date) system (vision)
1. Safety and stability

2. Accountability
3. Efficiency
4. Inclusion
5. User control over data
6. Integrity
7. Adaptability
8. Openness
Status: Policy goal broadly fulfilled Room for improvement Not generally fulfilled
Source: Bank for International Settlements.
Hands-on work by central banks is showcasing this can deliver faster, cheaper, and more transparent
and many other applications (see “Making Sense cross-border payments (Bech and others 2022).
of Crypto” in this issue of F&D). This can help migrants pay less for their remit-
Second, at the retail level, CBDCs have great tances, allow greater cross-border e-commerce,
potential, together with their first cousins, fast and support complex global value chains.
payment systems. Retail CBDCs would work Digital technologies promise a bright future for
as digital cash available to households and busi- the monetary system. By embracing the core of
nesses, with services provided by private companies. trust provided by central bank money, the private
Central-bank-operated retail fast payment systems sector can adopt the best new technologies to foster
are similar to retail CBDCs in that they provide a rich and diverse monetary ecosystem. Above all,
this common platform while ensuring that services users’ needs must be at the forefront of private
are fully connected. Both promise to lower payment innovation, just as the public interest must be the
costs and enable financial inclusion. Brazil’s Pix lodestar for central banks.
system was adopted by two-thirds of Brazilian
adults in only one year. Merchants pay a fee of AGUSTÍN CARSTENS is general manager of the Bank for
just 0.2 percent of a transaction’s value on average, International Settlements, where JON FROST is head of
one-tenth the cost of a credit card payment. Many economics for the Americas and HYUN SONG SHIN is the
central banks are currently working on inclu- economic adviser and head of research.
sive designs for retail CBDCs to better serve the
unbanked (Carstens and Queen Máxima 2022). References:
In conclusion, at the global level, central banks Bank for International Settlements (BIS). 2022. “The Future Monetary System.” Chapter
can link their wholesale CBDCs together to allow 3 in Annual Economic Report. Basel.
banks and payment providers to carry out trans- Bech, M., C. Boar, D. Eidan, P. Haene, H. Holden, and W. Toh. 2022. “Using CBDCs
actions directly in central bank money of multiple across Borders: Lessons from Practical Experiments.” BIS Innovation Hub, Bank for
currencies. This is made possible with so-called International Settlements, Basel.
permissioned distributed ledger technology— Boissay, F., G. Cornelli, S. Doerr, and J. Frost. 2022. “Blockchain Scalability and the
Fragmentation of Crypto.” BIS Bulletin 56 (June).
restricted to trusted parties. Work by the Bank for
International Settlements Innovation Hub with Carstens, A., and H. M. Queen Máxima of The Netherlands. 2022. “CBDCs for the
People.” Project Syndicate, April 18.
10 central banks shows that such arrangements

Making Sense of
CRYPTO
Central banks and regulators need to real asset, such as a work of art; or even something
intangible, like computing resources. The digital
take a differentiated approach to various asset ecosystem has three distinct features:
crypto innovations • Tokenization, which involves using software
programs to convert ownership rights over an
Ravi Menon
asset into a digital token that can be stored, sold,
C
or used as collateral.
entral banks and regulators cannot afford • A distributed ledger, or blockchain, which is an
to wait for clarity on how crypto-related immutable computerized record of the ownership
innovations will shape the future of and transfer of ownership of a token.
money and finance. These innova- • Cryptography, which uses advanced encryption
tions—including digital assets, cryptocurrencies, techniques to ensure that transactions in these
stablecoins, and central bank digital currencies tokens are secure.
(CBDCs)—are rapidly gathering momentum.
Some already pose risks that must be understood The digital asset ecosystem offers significant
and addressed. But they also present potential economic potential. It can facilitate more efficient
benefits worth harnessing. Central banks and transactions and unlock untapped economic value.
regulators around the world are developing frame- The most promising use cases of digital assets in
works that seek to balance risks and opportunities financial services are in cross-border trade and
judiciously. The frameworks need to evolve con- settlement, trade finance, and pre- and post-trade
tinually, as technologies, business models, and capital market activities.
market practices change. In cross-border payments and settlements, common
The Monetary Authority of Singapore (MAS), settlement networks using distributed ledger tech-
Singapore’s central bank and integrated finan- nologies are achieving reductions in settlement time
cial regulator, aims to develop an innovative and from two-to- three days to less than 10 minutes and
responsible digital asset ecosystem. It has looked at in transactions costs from 6 percent of transfer value
the various crypto innovations individually, taking to less than 1 percent. In trade finance, common
into account their specific risks and potential uses. ledgers that permit transactions to be traced have
achieved reductions in processing time for letters of
Digital assets credit from five to 10 days to less than 24 hours. In
MAS actively promotes the innovative and respon- capital markets, distributed ledgers are reducing the
sible use of digital assets. time to clear and settle securities transactions from
A digital asset is anything of value whose own- two days to less than 30 minutes.
ership is represented in a digital or computerized In Singapore, United Overseas Bank Ltd. has
form. It could be a financial asset, say a bond; a piloted the issuance of a S$600 million digital bond

on Marketnode’s servicing platform that facilitates

a seamless workflow through smart contracts.
Central banks and regulators around the
Smart contracts are computer programs embedded
in a distributed ledger that automatically execute
world are developing frameworks that seek
actions—for example, a coupon payout—when to balance risks and opportunities judiciously.
pre-set conditions are met. Marketnode is a joint
venture between the Singapore Exchange and the seamlessly without the need for intermediaries.
investment firm Temasek. Assets that can be tokenized and traded include
MAS itself has launched an initiative—called works of art, real estate, commodities, even live-
Project Guardian—to explore digital asset appli- stock. Not all tokenized assets make sense, but
cations in wholesale funding markets. Led by DBS those that do could help unlock hitherto untapped
Bank, JP Morgan, and Marketnode, the first pilot economic value.
involves creating a liquidity pool, comprising a In Singapore, OCBC Bank has partnered with
collection of tokenized bonds and deposits locked the digital exchange MetaVerse Green Exchange to
in a series of smart contracts. The aim is to achieve develop green financing products using tokenized
seamless secured borrowing and lending of these carbon credits. Tokenizing the carbon credits gen-
tokenized bonds through the smart contracts. erated from green projects such as reforestation and
The concept of tokenization to create digital placing them on a distributed ledger helps ensure their
assets has potential beyond finance. First, it can provenance and reduces the risk of double-counting
enable the monetization of any tangible or intan- of credits. Companies can buy these credits with
gible asset. Second, tokenization makes it easier to confidence, to offset their carbon emissions.
fractionalize an asset (that is, split up the ownership A digital asset ecosystem will need a tokenized
ART: ISTOCK / MF3D
of the asset, much as ownership of a company is medium of exchange to facilitate transactions. Three
split into shares of stock). Third, tokenization popular candidates are cryptocurrencies, stable-
makes it easier to trade the assets securely and coins, and central bank digital currencies (CBDCs).

Cryptocurrencies their stability depends on the quality of the reserve
Private cryptocurrencies—of which Bitcoin is assets backing the coins. The recent meltdown of
probably the best known—fail as money. They the stablecoin TerraUSD demonstrates the need for
perform poorly as a medium of exchange, as a store such quality backing. TerraUSD sought to achieve
of value, and as a unit of account. Many of the cryp- stability by relying on algorithms to control its
tocurrencies that are widely traded today are really supply through a complicated relationship with its
utility tokens that represent a stake in blockchain unbacked sister cryptocurrency, Luna, rather than
projects. But they have taken a life of their own through secure asset backing.
outside the blockchain. They are actively traded National authorities recognize the potential of
and heavily speculated on, with prices that are stablecoins and are developing proposals to regu-
divorced from any underlying economic value on late their issuance and circulation. The focus has
the blockchain. The extreme price volatility of been on governing the reserve assets that back the
cryptocurrencies rules them out as a viable form peg—the liquidity, credit, and market risks of the
of tokenized currency or investment asset. assets, the auditability of the reserves held, and the
Because users of cryptocurrencies operate through ability to redeem stablecoins at par.
e-wallet addresses or pseudonyms, cryptocurrencies But stablecoins are not without potential risks.
have made it easier to conduct illicit transactions, Being collateralized by financial assets means they
including money laundering. Cryptocurrencies are more closely intertwined with the broader
have also helped to fuel ransomware—one of the financial system than are unbacked cryptocurren-
fastest growing crimes in cyberspace. cies. If faced with liquidity stresses, a stablecoin
MAS has consistently warned the public of the issuer that holds financial assets in reserve could
hazards of trading in cryptocurrencies. It has also be forced into a fire sale of those assets, which
made it harder for individuals to have access to cryp- could have repercussions for the financial system.
tocurrencies—employing such measures as banning While the risk of such contagion to the financial
the advertisement or promotion of cryptocurrencies system is small at this point, appropriate regulatory
to the general public. MAS plans to impose further levers are being considered in case the risk becomes
restrictions on retail access to cryptocurrencies. significant. The Financial Stability Board (FSB)
and other international standard setting bodies
Stablecoins continue to update their guidance on this front.
MAS sees good potential in stablecoins, provided MAS will soon issue proposals to regulate stable-
they are well regulated and securely backed by coins in Singapore.
high quality reserves.
Stablecoins are tokens whose value is tied to another Wholesale CBDCs
asset—usually fiat currencies, such as the U.S. dollar. A CBDC is a direct liability and payment instru-
They seek to combine the benefits of stability and ment of a central bank. Wholesale CBDCs are
tokenization, thereby enabling them to be used as restricted to use by financial intermediaries and
payment instruments on distributed ledgers. are akin to the balances commercial banks now
Stablecoins are beginning to find acceptance place with a central bank. MAS sees a strong case
outside the crypto ecosystem. Some technology for wholesale CBDCs, especially in cross-border
firms have integrated popular stablecoins into payments and settlements.
their payment services. Visa and Mastercard allow Cross-border payments today are slow, expensive,
transactions to be settled using USD Coin. This and opaque. Payments have to go through multiple
can be a positive development if stablecoins can banks before they reach their final destination.
make payments cheaper, faster, and safer. The Directly linking instant payment systems across
competitive challenge that stablecoins pose to countries—such as between Singapore’s PayNow
established players can also spur improvements and Thailand’s PromptPay—achieves real-time
in traditional payments. payments and at considerably lower cost. But
But to reap the benefits of stablecoins, regu- settlement is still not instant. The goal is to achieve
lators must ensure that they are indeed stable. cheaper, instantaneous cross-border payments that
Being pegged to a fiat currency is not enough; settle round-the-clock in real time.

It is not unreasonable to imagine a future in which the digital asset

ecosystem is a permanent feature of the financial landscape.
Wholesale CBDCs on a distributed ledger have • setting minimum standards for speed, access,
the potential to achieve atomic settlement, or the and interoperability (to enable payments across
exchange of two linked assets in real-time. The different payment networks).
Bank for International Settlements Innovation
Hub has embarked on Project Dunbar to explore The use of regulations should, of course, be
a common multi-CBDC platform to enable atomic weighed against the possibility that regulations could
settlement across multiple countries. It is a partner- discourage new entrants to the payments system.
ship of the MAS, Reserve Bank of Australia, Bank Third, a retail CBDC could offer greater pri-
Negara Malaysia, and South African Reserve Bank. vacy and control over personal information and
transactions than provided by today’s electronic
Retail CBDCs payment system. But here too, enhancements to
The case for retail CBDCs— essentially digital cash regulations or legislation to protect users’ privacy
issued by a central bank to the general public—is and ensure sound data governance are possible
less strong. The unique attribute of a retail CBDC alternatives to issuing retail CBDCs.
relative to other regulated digital currencies (like MAS believes that the case for a retail CBDC
stablecoins or tokenized bank deposits) is that it in Singapore is not compelling for now, given
would be a liability of the central bank. well-functioning payment systems and broad finan-
Interest in retail CBDCs has risen sharply in cial inclusion. Retail electronic payment systems
recent years, with many central banks experiment- are fast, efficient, and cost nothing, while a residual
ing with them. There are three commonly cited amount of cash remains in circulation and is unlikely
arguments for retail CBDCs. to disappear. Nevertheless, MAS is building a tech-
First, a retail CBDC would preserve direct access nology infrastructure that would permit issuance of
to public money in a digital economy in which cash retail CBDCs should conditions change.
has disappeared. Members of the public may feel
that they have a right to digital money that is always Future state
stable and free of credit and liquidity risks—as they It would be foolhardy to be too definitive about how
do with cash today. But the differences between the these various innovations will pan out. Central
liabilities of central banks and commercial banks are banks and regulators must continually monitor
generally of little practical concern to most individ- trends and developments and adapt their polices
uals. As long as people trust that their money is safe and strategies accordingly.
and that central banks stand ready to backstop the But it is not unreasonable to imagine a future in
system during crises, direct access to public money which the digital asset ecosystem is a permanent
may not be necessary. feature of the financial landscape, co-existing with
Second, there may be a case for direct public today’s intermediary-based system. Traditional
provision of new digital money to act as a con- fiat currencies will continue to dominate, but
straint on any monopoly power exercised in the securely backed private stablecoins and wholesale
retail payment space by banks or e-wallet provid- CBDCs could be expected to play an important
ers. But there are other ways of enabling greater role in cross-border payment and settlement. Retail
competition and ensuring that payments systems CBDCs may well emerge as a small component
meet the required standards: of the monetary base—similar to the role played
• opening up retail payment systems to more par- by cash today.
ticipants, including non-banks;
• capping interchange fees that merchants pay on RAVI MENON is managing director of the Monetary
credit and debit sales; Authority of Singapore.

REGULATING
CRYPTO
The right rules could provide a safe space for innovation
Aditya Narain and Marina Moretti
C
rypto assets have been around for more and stakeholders is not globally harmonized. The
than a decade, but it’s only now that term “crypto asset” itself refers to a wide spectrum
efforts to regulate them have moved to of digital products that are privately issued using
the top of the policy agenda. This is partly similar technology (cryptography and often dis-
because it’s only in the past few years that crypto tributed ledgers) and that can be stored and traded
assets have moved from being niche products in using primarily digital wallets and exchanges.
search of a purpose to having a more mainstream The actual or intended use of crypto assets can
presence as speculative investments, hedges against attract at once the attention of multiple domestic
weak currencies, and potential payment instruments. regulators—for banks, commodities, securities,
The spectacular, if volatile, growth in the market payments, among others—with fundamentally dif-
capitalization of crypto assets and their creep into ferent frameworks and objectives. Some regulators
the regulated financial system have led to increased may prioritize consumer protection, others safety
efforts to regulate them. So too has the expansion and soundness or financial integrity. And there
of crypto’s many different products and offerings is a range of crypto actors—miners, validators,
and the evolving innovations that have facilitated protocol developers—that are not easily covered
issuance and transactions. The failures of crypto by traditional financial regulation.
issuers, exchanges, and hedge funds—as well as Entities operating in financial markets are typ-
a recent slide in crypto valuations—have added ically authorized to undertake specified activities
impetus to the push to regulate. under specified conditions and defined scope.
Applying existing regulatory frameworks to But the associated governance, prudence, and
crypto assets, or developing new ones, is challeng- fiduciary responsibilities do not easily carry over
ing for several reasons. For a start, the crypto world to participants, who may be hard to identify
is evolving rapidly. Regulators are struggling to because of the underlying technology or who
acquire the talent and learn the skills to keep pace may sometimes play a casual or voluntary role in
given stretched resources and many other priorities. the system. Regulation may also have to reckon
Monitoring crypto markets is difficult because data with the unwinding of conflicting roles that have
are patchy, and regulators find it tricky to keep tabs become concentrated in some centralized entities,
on thousands of actors who may not be subject to such as crypto exchanges.
IMAGE: ROGER BROWN/ PEXELS
typical disclosure or reporting requirements. Finally, in addition to developing a framework

that can regulate both actors and activities in the
Playing catch-up crypto ecosystem, national authorities may also
To complicate matters, the terminology used to have to take a position on how the underlying tech-
describe the many different activities, products, nology used to create crypto assets stacks up against

other public policy objectives—as is the case with fragmented global response neither assures a level
the enormous energy intensity of “mining” certain playing field nor guards against a race to the bottom
types of crypto assets. as crypto actors migrate to the friendliest juris-
In essence, crypto assets are merely codes that dictions with the least regulatory rigor—while
are stored and accessed electronically. They may or remaining accessible to anyone with internet access.
may not be backed by physical or financial collat- The international regulatory community has
eral. Their value may or may not be stabilized by not been sitting idle either. In the early years, the
being pegged to the value of fiat currencies or other major concern was preserving financial integrity
prices or items of value. In particular, the electronic by minimizing the use of crypto assets to facilitate
life cycle of crypto assets amplifies the full range money laundering and other illegal transactions.
of technology-related risks that regulators are still The Financial Action Task Force moved quickly
working hard to incorporate into mainstream reg- to provide a global framework for all virtual asset
ulations. These include predominantly cyber and service providers. The International Organization
operational risks, which have already come to the of Securities Commissions (IOSCO) also issued
fore through several high-profile losses from hacking regulatory guidance on crypto exchanges. But it
or accidental loss of control, access, or records. was the announcement of Libra, touted as a “global
Some of these might have been lesser concerns stablecoin,” that grabbed the world’s attention and
if the crypto asset system had remained closed. added a greater impetus to these efforts.
But this is no longer the case. Many functions in The Financial Stability Board began monitoring
the financial system, such as providing leverage crypto asset markets; released a set of principles
and liquidity, lending, and storing value, are now to guide the regulatory treatment of global sta-
emulated in the crypto world. Mainstream players blecoins; and is now developing guidance for the
are competing for funding and clamoring for a broader range of crypto assets, including unbacked
piece of the action. This is all leading to greater crypto assets. Other standard-setters are following
calls for the “same activity, same risk, same rule” suit, with work on the application of principles for
principle to be applied, with the necessary changes, financial market infrastructures to systemically
to the crypto world—piling pressure on regulators important stablecoin arrangements (Committee
to act. It is posing another conundrum for public on Payments and Market Infrastructures and
policy, too. How closely can the two systems be IOSCO) and on the prudential treatment of banks’
integrated before there is a call for the same central exposures to crypto assets (Basel Committee on
bank facilities and safety nets in the crypto world? Banking Supervision).
The regulatory fabric is being woven, and a pat-
Contrasting national approaches tern is expected to emerge. But the worry is that the
It’s not that national authorities or international longer this takes, the more national authorities will
regulatory bodies have been inactive—in fact, a get locked into differing regulatory frameworks.
lot has been done. Some countries (such as Japan This is why the IMF is calling for a global response
and Switzerland) have amended or introduced new that is (1) coordinated, so it can fill the regulatory
legislation covering crypto assets and their service gaps that arise from inherently cross-sector and
providers, while others (including the European cross-border issuance and ensure a level playing
Union, United Arab Emirates, United Kingdom, field; (2) consistent, so it aligns with mainstream
and United States) are at the drafting stage. But regulatory approaches across the activity and risk
national authorities have, on the whole, taken spectrum; and (3) comprehensive, so it covers all
very different approaches to regulatory policy for actors and all aspects of the crypto ecosystem.
crypto assets. A global regulatory framework will bring order to
At one extreme, authorities have prohibited the the markets, help instill consumer confidence, lay
issuance or holding of crypto assets by residents out the limits of what is permissible, and provide
or the ability to transact in them or use them for a safe space for useful innovation to continue.
certain purposes, such as payments. At the other
extreme, some countries have been much more ADITYA NARAIN is deputy director and MARINA MORETTI
welcoming and even sought to woo companies is assistant director of the IMF’s Monetary and Capital
to develop markets in these assets. The resulting Markets Department.

BULLET

T TRAIN
New tokens and platforms may transform cross-border
payments—and potentially much more
Tobias Adrian and Tommaso Mancini-Griffoli
ART: ISTOCK / HAKULE

W
e have all felt the frustration of sending money bridges allow money that Joe trusts on the one hand,
abroad. It takes time. It’s expensive. It’s cumbersome. and that Sally trusts on the other, to be exchanged.
And to some of us, it’s embarrassing—because our Across borders, bridges between trust networks
friends who know we’re economists always ask us are much harder to establish. There is no commonly
what is going on behind the scenes, and the truth trusted asset or network to settle transactions. To
is we don’t really know. It’s messy. make things worse, information is scarcer across
But we redeem ourselves by talking about what borders and legal recourse more difficult. So the
the future may hold. That, people always find inter- costs of establishing trust are higher.
esting, especially if the future promises to offer And yet cross-border transactions do happen,
cheaper and more immediate and convenient ways albeit with the drawbacks we routinely face. Again,
to pay. Here is what we envisage: platforms offering a there’s a trick, courtesy of specialized commercial
marketplace where digital money can be exchanged banks called correspondent banks.
and sent internationally. Imagine Sally and Joe live in different countries,
As with all good stories, it helps to start at the and Sally wants to send money to Joe. Sally’s bank
beginning. Once upon a time, there was money. contacts Joe’s bank through a messaging network
What is money? It’s essentially an IOU—a promise to and asks it to credit Joe’s account. Joe’s bank initially
pay—made by one party, like a bank, to another, like protests, as it doesn’t receive any funds in return. But
the holder of a savings or checking account. We lend Sally’s bank offers an IOU, suggesting that next time
funds to our bank, which in return offers us a means Joe’s bank needs to send a payment abroad, Sally’s
to buy goods and services. Modern money is credit. bank will reciprocate. It’s give and take. So Joe’s
As money is credit, its value lies in trust. We bank agrees to extend credit to Sally’s bank (accept
trust our bank to hold good-quality assets, and our the IOU) and in turn to credit Joe’s account. It’s
bank trusts us not to engage in money laundering this handshake between banks that know each other
and terrorism financing. Trust is a two-way street. well—that trust each other—that stands behind
Without trust, money is no longer a good store of today’s cross-border transactions.
value or a means of payment. In exchange for a good But banks are not willing to shake many hands.
that we sell, we accept only the money we trust. Establishing and monitoring trust is costly, as is
That is, money circulates only within an established dealing with the risks inherent in extending bilateral
network of trust. credit to another bank. Few banks can cover these
costs and still generate profits. So only a hand-
Enter central banks ful of very large institutions with strong bilateral
So if Joe and Sally are customers of the same bank, relationships control the correspondent banking
Joe should readily accept Sally’s money—both trust market. It’s no surprise our payments are costly,
the same issuer and are trusted by it. But what if they slow, and opaque.
bank with different institutions, albeit in the same
country? Joe (or his bank) does not necessarily know A radical transformation
or trust Sally’s bank. And yet transactions from one Things could change as money becomes tokenized;
bank to the other are common. We take these for that is, accessible to anyone with the right private
granted, but in fact the invisible mechanisms that key and transferable to anyone with access to the
make them possible were developed and refined same network. Examples of tokenized money include
over centuries. so-called stablecoins, such as USD Coin, and cen-
To cut the story short, the trick boils down to tral bank digital currency (CBDC), which some
banks trusting not each other, but the central bank. countries, such as The Bahamas and Nigeria, have
Joe’s bank does not receive or hold money from Sally’s already launched and an increasing number are
bank. It receives perfectly safe—and trusted—special actively evaluating.
central bank money called “reserves” from Sally’s Tokenized money introduces a radical transfor-
bank. Those reserves—accounts that banks hold at mation that breaks down the need for two-way
the central bank—and the network over which they trusted relationships. Anyone can hold a token,
are traded are two essential public goods provided by even without having a direct relationship with the
central banks behind the scenes. Central banks serve issuer. Joe can send Sally tokens he holds in his
as the bridges between trust networks. And these wallet, as long as Sally’s wallet is compatible. The

issuer of Joe’s tokens may not know anything about handshake was between two correspondent banks.
Sally—though her wallet will. But there is an alternative: the platform could take
This transformation greatly enhances the effi- in money such as CBDC from Sally’s bank, hold it
ciency of correspondent banking. How? First, risks in an escrow account, and issue a token against it for
are lower. Joe’s bank does not have to extend unse- settlement on the platform to Joe’s bank. In essence,
cured credit—which isn’t backed by any asset—to the platform would bring each participating institu-
Sally’s bank to process a payment. It will receive a tion’s money onto a single ledger. Think of that as
tokenized deposit in Sally’s bank—a concrete form taking in different monies, putting them in a basket
of money—that can be sold onward or potentially everyone recognizes, and seamlessly exchanging those
even redeemed for hard assets such as government baskets between participants and across borders.
bonds. The need for trust dissipates. Doing so could be extremely powerful. The plat-
Second, Joe’s bank will hold a liquid asset that it form’s ledger could be leveraged to write so-called
can sell, trade, or hedge more easily than an unse- smart contracts, which are essentially program-
cured IOU. And third, correspondent banking can mable transactions. For instance, a payment could
be made more competitive, which should improve be made only when another is received. Or firms
the quality of service—including speed—and reduce could automatically hedge foreign exchange risks of
fees. Sally’s bank does not have to deal exclusively transactions or pledge a future incoming payment in
with the correspondents it happens to trust. Any a financial contract. More is also possible. Auctions
bank or financial institution with a compatible wallet could be designed to encourage the exchange of
can receive Sally’s payment and issue a payment to currencies that typically are shunned, thus expensive,
Joe’s bank. Handshakes are no longer limited to in cross-border payments.
close friends. The possibilities are infinite. And that is precisely
the point—the private sector would be able to extend
A digital platform the uses of the platform by writing smart contracts.
But handshakes do need to be coordinated. And It would do so by leveraging two key public goods:
that’s where the platform comes in. The platform will a common settlement platform and a common
broadcast Sally’s payment order, collect participants’ programming language to write smart contracts that
bids for correspondent banking services, and ensure are compatible with one another. So the platform
payments are made in a timely fashion. would emerge as a tight public-private partnership.
A key question is, Which assets will be traded on The challenge will be to find the right governance
the platform? Tokenized bank deposits, as in the arrangements and to mobilize a sufficient number
previous example, are one option. Another is CBDC. of central banks to pull this off. The IMF, with its
In that case, Sally’s bank would first exchange its near universal membership, is a good place to start
reserves for CBDC, then transfer it to a willing cor- exploring these prospects.
respondent through the platform. The advantage is We will soon publish two papers on these topics
that more correspondents may be willing to engage, with coauthors Dong He and Federico Grinberg of
because holding CBDC is less risky, in most cases, the IMF; Rod Garratt of the University of California,
than holding the liability of a foreign private com- Santa Barbara; and Robert Townsend and Nicolas
pany. And from a social perspective, settlement in Xuan-Yi Zhang of the Massachusetts Institute of
a safe and liquid asset such as CBDC is preferable Technology. The papers will lay out an initial blueprint
because it will give rise to fewer disputes down the for such platforms in the hope of stimulating further
line. But other digital assets, such as well-regulated discussion on these important topics, which are likely
stablecoins, could also be exchanged on the plat- to shape the future of cross-border payments. Much
form. The real requirement is that a wide body of remains to be explored, debated, and eventually done.
counterparties trust the asset—not necessarily each The effort is certainly worth it, if anything to avoid
other—to be stable. embarrassing questions about what happens today
The platform idea goes further. Instead of merely behind the cloak of bilateral handshakes.
orchestrating payments (offering clearing services, in
the jargon), the platform could provide settlement TOBIAS ADRIAN is director of the IMF’s Monetary and Capital
services—the handshakes that move money from Markets Department, where TOMMASO MANCINI-GRIFFOLI
one owner to another. In the earlier example, the is division chief.

POINT OF VIEW
‘DeFi’ and ‘TradFi’ Must Work Together

Decentralized and traditional finance can thrive in tandem to
fund renewable energy and other pressing needs, but only with
clear standards and rules
Michael Casey
for the stewards of the global economy to explore
DeFi and crypto solutions to its many problems.
One area to focus on is the highly centralized
energy industry.
Consider the negotiations with Saudi Crown
Prince Mohammed bin Salman to boost oil pro-
duction and combat soaring global prices in the
aftermath of Russia’s invasion of Ukraine. That
world leaders must cater to the interests of a sole
unelected human being to solve an economic crisis
that affects all 8 billion of us is the epitome of a
centralization problem.
Another stark example: Germany’s dependence
on Russian natural gas, which constrains its capac-
ity to impose sanctions on the Kremlin. Or last
year’s shutdown of the Colonial pipeline, when
PHOTO: COURTESY OF MICHAEL CASEY
ransom-demanding hackers exploited the fact that

60 million people depend on the pipeline’s gasoline.
And one more: 2017’s Hurricane Maria, which after
knocking down a few high-voltage transmission
lines, left 90 percent of Puerto Ricans deprived of
power for months.
Vulnerability to outside events—which electric-
THE CRYPTOCURRENCY INDUSTRY is in the throes of ity system designers describe as a lack of “redun-
a crypto winter. dancy”—is as good a reason as any to advocate for
Tokens like bitcoin and Ethereum’s ether have lost renewable energy in response to the climate crisis.
three-quarters of their value while major crypto lend- We desperately need to decentralize our energy
ing and investing firms have collapsed into bankruptcy. model. Renewables such as solar, geothermal, and
But to be fair, it’s also pretty wintry in tradi- wind—or the recycling of waste heat and energy—
tional finance—or TradFi, as the crypto and DeFi are the answer. They are locally sourced and can
(decentralized finance) community refers to the function at wide ranges of scale.
financial and economic old guard. We have the But what does decentralized energy have to do
highest inflation in 40 years, a war that’s fractured with decentralized finance?
the international monetary system, an energy and It starts with recognizing that the world’s insuf-
commodity crisis sowing famine and political ficient response to our energy crisis is not a failure
unrest, and record temperatures exposing a massive of technology—it’s a failure of funding.
shortfall in investment to fight climate change. The Climate Policy Initiative, a San Francisco–
The reality is, both sides need each other. based think tank, estimates that the world invested
If they are to attain mainstream adoption, DeFi $632 billion in addressing climate change in
and crypto must integrate some of the regulatory and 2019–20, far short of the $4.5–$5 trillion it says
self-regulatory practices that have brought functional is needed annually to achieve net zero carbon
stability to TradFi. But there’s also an urgent need emissions by 2050.

It’s not for lack of desire—governments and com- community in Rwanda building a DeFi-funded
panies everywhere are committing to ambitious solar microgrid to power a new irrigation system
carbon reduction goals. It’s that investors can’t and you get an idea of the potential.
find enough projects in whose promised returns And then there’s the demand problem.
and impact they are sufficiently confident. Imagine that economies of scale require that, to
In most cases, two elements are lacking: first, be financially viable, the Rwandan microgrid must
reliable, rapidly actionable information with which have at least 2 megawatts of capacity, but the new
to measure and project outcomes, and second, a irrigation system needs only 500 kilowatts. How
source of persistent, flexible user demand that would a poor community with modest electricity
would make renewable energy production econom- needs make up the shortfall?
ically viable in places where it’s available. The answer lies in Bitcoin, which may seem
Both can be addressed by the financial innovation counterintuitive to anyone who has joined recent
spurred by the open-source developer communities crusades to ban “wasteful” proof-of-work mining
of DeFi and crypto. in New York and elsewhere.
Unlike other users of energy, Bitcoin mining is
Green funding potential geography-agnostic. Miners will operate anywhere.
The prospects for actionable information lie in They will happily absorb any community’s excess or
the technology’s ability to immediately convert otherwise wasted energy, so long as it is priced low
data into tradable assets, a result of its automated, enough to keep them profitable and competitive.
near-instant peer-to-peer settlement and its capacity
to define unique digital units of any size or value.
The efficiencies are potentially enormous when If we can’t regulate Bitcoin out of existence,
compared with, say, the analog world of green
bonds, which require many layers of bureaucracy then the objective should be to steer it
and are based on retroactive data that take months,
even years, to generate and verify. toward renewable sources.
Crypto technology allows plants fitted with
provably secure sensors and blockchain-based What is the cheapest form of energy? By defi-
tracking systems to verify they’re generating renew- nition, it’s renewables. Already, 53 percent of
able power and then instantly represent that infor- the Bitcoin network runs on renewable energy,
mation as unique one-off tokens. according to the Cambridge Center for Alternative
In a DeFi environment, those tokens can become Finance, not because miners are altruistic but
collateral for lenders. Incorporating programma- because they are profit-seeking.
ble cryptocurrencies, stablecoins, or central bank Now that bitcoin prices have plunged, and with
digital currencies, the model gives investors a Intel’s new Blockscale application-specific inte-
form of remote security. With governments and grated circuits (ASICs) poised to create a glut of
ESG-compliant companies ratcheting up demand cheap chips for miners, the presence of low-cost
for proven carbon-reducing assets, a giant pool of energy will become the main factor in any miner’s
liquidity could arise around these tokens, forging expansion plans.
the deep capital markets that climate action needs. As long as regulators don’t prevent them from
This approach could drive down financing forging relationships, renewable energy developers
costs for all kinds of projects. Imagine a remote will find miners to be willing, valuable partners.

POINT OF VIEW
They will agree to large energy contracts up-front We should avoid, however, applying the out-
that underwrite plant development and commit to dated regulatory models of the existing centralized
consuming excess energy production during peri- financial system to decentralized crypto projects
ods of low community consumption to smooth out that function very differently. By applying a cen-
the troughs and peaks in the grid. Mining can make tralized solution—for example, by trying to make
the economics of electricity predictable and viable. far-flung, leaderless groups of open-source devel-
To be fair, the other 47 percent of the Bitcoin opers accountable for users of the DeFi protocols
network is emitting a lot of carbon. The Cambridge they work on—we may introduce rather than
Center for Alternative Finance’s midrange esti- mitigate risks.
mate is that the total network currently consumes The three biggest sources of the recent finan-
around 84 terawatt hours of electricity annually, cial contagion were centralized “CeFi” services—
about 0.38 percent of total world consumption. Celsius, Voyager Digital, and Three Arrows
That’s because Bitcoin’s proof-of-work algorithm Capital—while the other big failure, the de facto
is highly energy-intensive. It’s why proponents of Ponzi scheme known as Terra Luna, was DeFi in
far less energy-intensive proof-of-stake systems name only. Real DeFi projects such as Aave and
advocate their usage for digital assets such as Compound have so far survived this intense stress
non-fungible tokens. test remarkably well.
Like it or not, however, Bitcoin is not going Yet there are other big risks in DeFi. Crypto
away. When mining is banned in one place, it security firm Immunefi estimates that $670 million
simply moves, as in 2021, when a ban in China was lost in the second quarter of 2022 from smart
prompted much of the industry to migrate to the contract breaches and hacks. If DeFi is to win
United States, Kazakhstan, and other places. over new followers, users will need much stronger
If we can’t regulate Bitcoin out of existence, then assurances that their funds are safe.
the objective should be to steer it toward renewable
sources—or away from fossil fuel sources. It’s time The trick is to find a balance
for sensible energy policies that remove subsidies Regulators should impose stricter fiduciary
for dirty power plants and entice Bitcoin miners to requirements on the managers of CeFi services—
provide long-term funding commitments to renew- treat them like brokerages or other regulated
able providers with minimum capacity thresholds financial institutions. But for DeFi operations,
for their communities. they should work with the industry to develop
The goal here is not just renewables expansion, self-regulatory solutions that tap its technological
but decentralization. Let’s not follow the lead of strengths and lean into its decentralized struc-
El Salvador, whose government is mining Bitcoin ture. Ideas include expanding the “bug bounties”
at a government-owned geothermal plant and that reward developers who identify and fix inci-
keeping the proceeds for itself. Rather, developing dents, mandating periodic software audits, and
economies should encourage partnerships between conducting frequent stress tests of leverage and
miners and community-based solar microgrids, collateral models.
spreading wealth and generation capacity to achieve Above all, we need consensus around what
both social goals and grid redundancy. constitutes a decentralized system and on whether
projects that intend to evolve in that direction are
Rethinking regulation appropriately doing so.
None of this is to say the crypto industry is without In short, all interested parties from both the DeFi
problems. The sector’s recent financial contagion and TradFi worlds must first agree on frameworks
highlighted the dangers of a speculation culture and a common lexicon, then establish standards
that spawned unfettered leverage and scams. The and rules. This is not easy—but it must be done.
use of anonymity to front-run markets through wash There is too much at stake.
trades and other pump-and-dump scams is especially
acute. Clearer, more effective regulation is needed. MICHAEL CASEY is chief content officer of the news site CoinDesk.

POINT OF VIEW
The Superficial Allure of Crypto

Cryptocurrencies cannot deliver their claimed benefits, and
instead pose grave risks that policymakers must curb
Hilary J. Allen
blockchain keeps promising to shift from proof of
work to the more energy-efficient proof of stake,
but this never seems to happen.
A crypto-based financial system would perpetuate,
and even magnify, many of the problems of tradi-
tional finance. For example, the amount of leverage
in the financial system could be multiplied through
a potentially unlimited supply of tokens and coins
serving as collateral for loans; rigid self-executing
smart contracts could deprive the system of the
flexibility and discretion so necessary in unexpected
and potentially dire situations. More generally, the
crypto ecosystem is extremely complex, and that
complexity is likely to be a destabilizing force (both
because complexity makes it hard to assess risks
even when there’s plenty of data and because the
more complex a system is, the more susceptible it
is to “normal accidents,” when a seemingly minor
PHOTO: BEN GEBO
trigger cascades into significant problems). So any

crypto-based financial system would likely be subject
to regular destabilizing booms and busts.
IN THE 14 YEARS since Bitcoin emerged, proponents Crypto’s complexity arises from attempts at decen-
have made promises that crypto will revolution- tralization—by distributing power and governance in
ize money, or payments, or finance—or all of the the system, there is theoretically no need for trusted
above. These promises remain unfulfilled and look intermediaries like financial institutions. That was
increasingly unfulfillable—yet many policymakers the premise of the initial Bitcoin white paper, which
have accepted them at face value, supporting crypto offered a cryptographic solution intended to allow
experimentation as a necessary step toward some
vague innovative future. If this experimentation were
harmless, policymakers could let it be, but the ills of
crypto are significant. Given these negative impacts,
Policymakers should not be swayed by
policymakers must train a more critical eye both on the dubious promises of decentralization
crypto assets themselves and on their underlying
databases (known as blockchains) to determine and democratization.
whether crypto can ever deliver on its promises.
If it cannot, or is even unlikely to, deliver, there payments to be sent without involving any financial
must be strong regulation to rein in the negative institution or other trusted intermediary. However,
consequences of crypto experimentation. Bitcoin became centralized very quickly and now
Among its negative impacts, the rise of crypto has depends on a small group of software developers
spurred ransomware attacks and consumed excessive and mining pools to function. As internet pioneer
energy. Bitcoin’s blockchain relies on a proof-of- and publisher Tim O’Reilly observed, “Blockchain
work validation mechanism that uses about as much turned out to be the most rapid recentralization
energy as Belgium or the Philippines; the Ethereum of a decentralized technology that I’ve seen in my

POINT OF VIEW
lifetime.” Although the Bitcoin white paper’s promise exchanges, wallet providers, and stablecoin issuers,
of decentralization did not deliver, the underlying for example, are all critical players in the crypto
complexity of the technology that tried to do so ecosystem. Many of these intermediaries are simply
remains—which is also true of crypto writ large. new (and often unregulated) equivalents of what
Over the spring and summer of 2022, we saw a already exists in traditional finance.
number of other purportedly decentralized crypto And so crypto users will always have to trust in
players stumble and fail—and as they did so, it people. These people are no less greedy or biased
became abundantly clear that there were intermedi- than anyone else—but they are largely unregulated
aries calling the shots. A stablecoin is a type of crypto (sometimes even unidentified), and in the absence of
asset designed to maintain a stable value, and as the consumer protection regulation, the crypto industry’s
Terra stablecoin lost its peg to the dollar in May claims of furthering financial inclusion take on a
2022, holders looked to founder Do Kwon’s Twitter more troubling cast. The crypto ecosystem is certainly
feed for guidance. Before Terra failed, it received an rife with hacks and scams that prey on users, but at
attempted rescue package of crypto loans from a a more fundamental level, the value of crypto assets
nonprofit established by Kwon. The loaned crypto is driven entirely by demand because there is no
was allegedly deployed to allow some of Terra’s largest productive capacity behind them, and so founders
holders—commonly referred to as “whales”—to and early investors can profit only if they can find
redeem their Terra stablecoins at close to par value, new investors to sell to. If they rely on traditionally
while smaller investors lost nearly everything. In underserved populations to make up that market,
the crypto market turmoil that followed the failure then the most vulnerable members of society—in
of Terra, multiple episodes showed the power of both developed and developing economies—could
founders and whales in platforms ostensibly admin- be left holding the bag.
istered by decentralized autonomous organizations. Even if the market for crypto assets were some-
Many crypto proponents were quick to criticize how sustainable, there are many reasons to doubt
the affected platforms, saying that they were never that crypto could democratize finance. For exam-
really decentralized in the first place and that only ple, crypto lending platforms demand significant
the “truly decentralized” deserved to survive. All of amounts of crypto collateral before they grant
crypto, however, is centralized to varying degrees. loans, so they won’t help those who lack financial
assets to begin with. And although stablecoins are
‘Decentralization illusion’ often touted as a better payment mechanism for
Voting rights in decentralized autonomous orga- underserved populations, the World Economic
nizations and wealth tend toward concentration in Forum concluded that “stablecoins as currently
crypto even more than in the traditional financial deployed would not provide compelling new ben-
system. In addition, decentralized blockchain tech- efits for financial inclusion beyond those offered
nology cannot handle large volumes of transactions by preexisting options.”
very well and does not accommodate transaction
reversal, so it seems inevitable that intermediaries Fixing finance’s flaws
will emerge to streamline unwieldy decentral- To be clear, financial inclusion is a real and pressing
ized services for users (especially because there are problem, and there are also many other problems
profits to be made by doing so). Without mincing with traditional finance that need to be solved. Part
words, economists at the Bank for International of the reason crypto firms, venture capitalists, and
Settlements concluded that there is a “decentral- lobbyists have been so successful in selling crypto
ization illusion” that is “due to the inescapable is their very lucid and compelling indictment of
need for centralized governance and the tendency our current financial system. The largest banks
of blockchain consensus mechanisms to concen- did perform terribly in the lead-up to 2008 (and
trate power.” And of course, many of the crypto some still do); lots of people are underserved by the
businesses that have emerged over the past decade current financial system; in the United States, in
make no pretense of decentralization: centralized particular, payment processing is too slow.

Applying laws and rules to centralized crypto intermediaries

would be relatively straightforward.
However, these are by and large political rather than autonomous organizations, for example—which
technological problems—and if the underlying politi- would be relatively easy to enforce against the
cal issues aren’t resolved, the new crypto intermediaries founders, venture capital firms, and whales who
that emerge will simply perpetuate existing problems. own the lion’s share.
Where technological upgrades to our current systems Ultimately, policymakers should not be swayed
are indeed necessary, there are often simpler, central- by dubious promises of decentralization and
ized technological solutions already (as is the case democratization; they should be proactive in
with real-time payments). What is often lacking stopping crypto’s negative impacts. The architects
is the political will to implement those solutions. of the future of finance have many problems to
In an era of growing political dysfunction, it solve and should come up with the simplest and
is understandable that policymakers might want most direct solutions. Trying to retrofit crypto
to believe that technology can fix things without assets and blockchains to solve those problems
their involvement. Unfortunately, crypto does will in all likelihood only make things worse.
not live up to its claims of decentralization, and
crypto’s booms and busts could have broad eco- HILARY J. ALLEN is a professor at American University’s
nomic consequences if it is integrated with the Washington College of Law. Her research focuses on the
traditional financial system and able to interrupt impact of new financial technologies on financial stability.
the flow of capital to the real economy.
To limit the fallout from crypto implosions and
protect the broader economy, regulators should
take steps to erect a firewall between crypto and
traditional finance.
As a first priority, banks should be prohibited
from issuing or trading any crypto asset, including
stablecoins (which are rarely used for real-world
payments; they mostly facilitate crypto invest-
ments). Such steps could be carried out within
existing banking law frameworks, often without
any new laws or rules. Policymakers should con-
sider enacting new laws or rules, though, that
target the crypto industry more directly. Given
crypto’s lack of benefits and negative impacts,
an outright ban may be appropriate; if policy-
makers don’t wish to implement a ban, crypto’s
negative impacts should be managed with more
targeted laws or rules. Applying laws and rules
to centralized crypto intermediaries would be
relatively straightforward (although jurisdictional
issues may arise); their application to nominally
decentralized players may face a few extra hurdles.
These hurdles are not insurmountable, though,
because no part of crypto is entirely decentral-
ized. People could be barred from holding gov-
ernance tokens in noncompliant decentralized

CENTRAL BANKERS’
NEW CYBERSECURITY CHALLENGE
Central bank digital currencies may pose security risks, but responsible design can
turn them into opportunities
Giulia Fanti, Josh Lipsky, and Ole Moehr
I
n the typically cautious world of central bank- But as more countries launch CBDC pilot proj-
ing, the idea of a central bank digital currency ects, concerns about cybersecurity and privacy
(CBDC) is moving at lightning speed. Atlantic loom large. Federal Reserve Chair Jerome Powell
Council GeoEconomics Center research recently listed “cyber risk” as his number one
shows that 105 countries and currency unions worry relating to financial stability, and a recent
are currently exploring the possibility of launch- UK House of Lords report specifically described
ing a CBDC, either retail—issued to the general cybersecurity and privacy risks as potential reasons
public—or wholesale, used primarily for interbank not to develop a CBDC.
transactions. That’s up from an estimated 35 as These concerns are not unfounded. CBDC vul-
recently as 2020. It is not just smaller economies nerabilities could be exploited to compromise a
that are interested, either; 19 Group of Twenty nation’s financial system. CBDCs would be able to
(G20) countries are considering issuing CBDCs, accumulate sensitive payment and user data at an
and the majority have already progressed beyond unprecedented scale. In the wrong hands, this data
the research stage. could be used to spy on citizens’ private transactions,

Technology enables central banks to ensure that both

cybersecurity and privacy protection are embedded in any
CBDC design.
obtain security-sensitive details about individuals and one place also increases security risk by making
organizations, and even steal money. If implemented the payoff for would-be intruders much greater.
without proper security protocols, a CBDC could However, the risks associated with centralized data
substantially amplify the scope and scale of many collection can be mitigated either by not collecting
of the security and privacy threats that already exist it at all or by choosing a validation architecture in
in today’s financial system. which each component sees only the amount of
Until recently, little work had been done pub- information needed for functionality. The latter
licly in the cybersecurity and central banking approach can be aided by cryptographic tools, such
world to actually understand the specific cyberse- as zero-knowledge proofs, which authenticate private
curity and privacy risks associated with CBDCs. information without revealing it and allowing it to be
Few have considered whether CBDC designs compromised, or cryptographic hashing techniques.
could mitigate risks or perhaps even improve the For example, Project Hamilton (a joint effort by
cybersecurity of a financial system. the Boston Federal Reserve and the Massachusetts
Our new research, published in the Atlantic Institute of Technology to explore a US CBDC) has
Council’s recent report, titled “Missing Key–The designed a system that separates transaction valida-
Challenge of Cybersecurity and CBDCs,” ana- tion into phases, and each phase requires access to
lyzes the novel cybersecurity risks CBDCs may different parts of the transaction data.
present for financial systems and makes the case These cryptographic techniques can be extended
that policymakers have ample options to safely even further to build systems that verify transaction
introduce CBDCs. There are many design variants validity with only encrypted access to transaction
for CBDCs, ranging from centralized databases details like sender, receiver, or amount. While these
to distributed ledgers to token-based systems. tools sound too good to be true, they have been
Each design needs to be considered before reach- tested extensively in privacy-preserving cryptocur-
ing conclusions about cybersecurity and privacy rencies such as Zcash and are based on significant
risks. These designs also need to be compared advances in the cryptography community. The
with the current financial system—the one that bottom line is that technology enables central
keeps Powell up at night—to determine if new banks to ensure that both cybersecurity and privacy
technology could deliver safer options. protection are embedded in any CBDC design.
So what are some of the main new cybersecu-
rity risks that could arise in a CBDC? And more Transparency vs privacy
important, what can be done to mitigate these risks? A common concern with privacy-preserving designs
(including those that use specialized cryptographic
Centralized data collection techniques) is reduced transparency for regulators.
Many of the proposed design variants for CBDCs Regulators generally require enough insight to
PHOTO: FUNTAP VIA GETTY IMAGES
(particularly retail CBDCs) involve the centralized identify suspicious transactions, enabling them
collection of transaction data, posing major privacy to detect money laundering, terrorism financing,
and security risks. From a privacy standpoint, such and other illicit activities.
data could be used to surveil citizens’ payment But even this is not an either/or decision.
activity. Accumulating so much sensitive data in Cryptographic techniques can be used to design

International standard-setting and more knowledge sharing
between banks is critical at this moment of rapid development
and adoption.
CBDCs that provide cash-like privacy up to a specific governments have many CBDC design options
threshold (for example, $10,000) while allowing gov- to choose from, including new variants that have
ernment authorities to exercise sufficient regulatory not yet been fully tested in current central bank
oversight. This kind of threshold is not so different pilots. These variants present different trade-offs
from the current system in the United States, which in terms of performance, security, and privacy.
allows reduced reporting for transactions under Governments should choose a design option based
$10,000. The reality is that in many ways, a new on a country’s needs and policy priorities. Based
CBDC system would not need to reinvent security on our evaluation of these trade-offs, CBDCs are
protocols but could instead improve on them. not inherently more or less secure than existing
Several countries have committed to or even systems. While responsible designs must take
deployed retail CBDCs whose underlying infra- cybersecurity into account, that should not pre-
structure is based on distributed ledger technology. vent consideration of whether to design and test
Nigeria’s eNaira, launched in October 2021, is a a CBDC in the first place.
good example. Such designs require the involve- One thing is abundantly clear in our research.
ment of third parties as validators of transactions. Fragmented international efforts to build CBDCs
This introduces a new role for third parties (for are likely to result in interoperability challenges
example, financial and nonfinancial institutions) and cross-border cybersecurity risks. Countries are
in central bank money operations. Critically, the understandably focused on domestic use, with too
security guarantees of the ledger would depend little thought for cross-border regulation, interopera-
on the integrity and availability of third-party bility, and standard-setting. Regardless of whether the
validators, over which the central bank may not United States decides to deploy a CBDC, as issuers of
have direct control. (Although it is possible to a major world reserve currency, the Federal Reserve
implement distributed ledger technology with all should help lead the charge toward development of
validators controlled by the central bank, doing global CBDC regulations in standard-setting bodies.
so largely defeats the purpose of using the tech- International financial forums, including the Bank
nology.) The associated risks can potentially be for International Settlements, IMF, and G20 have
mitigated through regulatory mechanisms such a similarly critical role to play.
as auditing requirements and stringent breach CBDCs’ cybersecurity and privacy risks are
disclosure requirements. However, there is not a real. But solutions to these challenges are within
clear blueprint for devising these regulations in a the grasp of technologists and policymakers. It
system as time-sensitive and closely interconnected would be unfortunate to preemptively decide the
as a distributed-ledger-based CBDC. This is why risks are too high before developing solutions that
the need for international standard-setting and could actually help deliver a more modern and
more knowledge sharing between banks is critical stable global financial system.
at this moment of rapid development and adoption.
GIULIA FANTI is a senior fellow at the Atlantic Council
Threat or opportunity? GeoEconomics Center and an assistant professor of electrical
Over the past 18 months some central banks and computer engineering at Carnegie Mellon University.
have prematurely decided that a CBDC poses too JOSH LIPSKY is the senior director of the Atlantic Council
many cybersecurity and privacy risks. We wanted GeoEconomics Center and a former IMF staff member.
to determine what is truly a threat and what OLE MOEHR is a fellow at the Atlantic Council
is actually an opportunity. We concluded that GeoEconomics Center.

DEFI’S
PROMISE
AND
PITFALLS
Decentralized finance could support a new financial infrastructure if challenges are overcome
Fabian Schär
D
igital innovation has brought major improvements to the financial
system. But the system’s architecture remains essentially the same.
It’s still centralized.
Decentralized finance (DeFi) offers an alternative. It uses public
blockchain networks to conduct transactions without having to rely on centralized
service providers such as custodians, central clearinghouses, or escrow agents.
Instead, these roles are assumed by so-called smart contracts.
Smart contracts are instructions in the form of computer code. The code is
stored on public blockchains and executed as part of the system’s consensus
rules. DeFi protocols can be designed in a way that prohibits intervention and
manipulation. All participants can observe the rules before they engage and verify
that everything is executed accordingly. State changes (for example, updates to
PHOTO: ISTOCK/ ANNA BLIOKH
account balances) are reflected on the blockchain and can be verified by anyone.
In the context of DeFi, smart contracts are used mainly to ensure the atomic
(simultaneous and inseparable) transfer of two assets or to hold collateral in an

escrow account. In both cases, the assets are subject of public blockchains with those of centralized
to the smart contract’s rules and can be released ledgers, they usually assume centralized entities
only if the predefined conditions are met. are benevolent, making it hard to see the benefits
Making use of these properties, DeFi can mitigate of decentralization.
counterparty risk and replicate numerous financial Public blockchains are transparent. Because
services without the need for intermediaries and they are not controlled by a single entity, they can
centralized platform operators. This can reduce provide a neutral, independent, and immutable
costs and the potential for errors. Lending markets, infrastructure for financial transactions. The code is
exchange protocols, financial derivatives, and asset stored and executed on an open system. All data are
management protocols are just a few examples. available and verifiable. This allows researchers and
Smart contracts can reference other smart con- policymakers to analyze transactions, run empirical
tracts and make use of the services they provide. studies, and compute risk metrics in real time.
If, for example, an asset management protocol Most important, access is not restricted. This
uses a decentralized exchange, incoming assets can has two implications.
be swapped as part of the same transaction. This First, the absence of access restrictions provides
concept, of actions across multiple smart contracts a neutral foundation that cannot discriminate
that can take place within a single transaction, is between use cases nor stakeholders. This is in
referred to as “intra-transaction composability” sharp contrast to permissioned ledgers, whose
and can effectively mitigate counterparty risk (the rules are set by a centralized entity. Because it’s so
likelihood that other parties will not fulfill their centralized, universally accepted standards may be
end of the deal). hard to achieve, and the rights to access and use
the infrastructure could easily be politicized. In
Benefits of decentralization anticipation of such problems, participants who
Many advantages usually attributed to DeFi—or feel that this may be to their disadvantage will
blockchains in general—can also be achieved via not use the centralized infrastructure in the first
centralized infrastructure. Smart contracts are place. Decentralized systems can mitigate these
not limited to decentralized systems. In fact, the holdups, potentially preventing the problem of
same standards and execution environments can no, or minimal, cooperation.
be used on centralized ledgers. There are countless Second, DeFi is built on a layered infrastructure
examples of the Ethereum virtual machine (a (see Schär 2021). A decentralized ledger does not
virtual machine that runs on all computers in the mean that everything deployed on top of it must
blockchain network and executes smart contracts) be equally decentralized. There may be good rea-
being employed alongside heavily centralized sons for access to certain tokens or financial pro-
consensus protocols. Similarly, the same token tocols to be restricted or subject to intervention.
standards and financial protocols can be used on These restrictions can be implemented at the smart
centralized platforms. Even composability can contract level without compromising the general
work on such systems. neutrality of the base infrastructure. However,
Moreover, well-managed centralized systems are if the ledger itself (settlement layer) were already
much more efficient than public blockchains. That centralized, it would be impossible to credibly
could lead to the conclusion that public blockchains decentralize anything built on top of it.
and DeFi are inferior to centralized systems. It is very likely that we will see a move toward
However, centralized systems rest on a very ledgers that combine payments, tokenized assets,
strong assumption: trust in intermediaries and and financial protocols, such as exchanges and
institutions that are largely opaque. But such trust lending markets. DeFi is the first example of this
should not be taken for granted. History provides development, but there will be similar develop-
countless examples of corruption and errors within ments in centralized infrastructure. The rationale
institutions. Yet, when economists discuss finan- is that intra-transaction composability works only
cial infrastructure and compare the properties if the assets and financial protocols are on the

Centralized systems rest on a very strong assumption:

trust in intermediaries and institutions.
same ledger. There are strong network effects, profits at the expense of the issuer of the original
and neither crypto assets nor central bank digital transaction. There are potential solutions that may
currencies would be particularly compelling if at least partially mitigate this problem, but they
deployed on a ledger with no other assets or finan- involve trade-offs.
cial protocols. It is possible to create composable Finally, the scaling of public blockchains cannot
centralized infrastructure with additional assets be done easily without compromising some of their
and financial protocols, but it would be risky and unique properties. Decentralized block creation
difficult to govern given the challenges associated inflicts severe costs. Hardware requirements to
with permissioned ledgers. This makes a strong run a node can’t be arbitrarily high, as this would
case for decentralization. price out many stakeholders and compromise
decentralization. This limits on-chain scalability,
Challenges and risks pushing up transaction fees. This trade-off between
There are many advantages to be gained from DeFi, security, decentralization, and scalability is usually
but there are challenges and trade-offs to be considered. portrayed as a trilemma. A potential solution is
First, there is the risk of deception, or “decen- so-called Layer 2s. These are designed to move
tralization theater.” What is generally referred to some of the burden away from the blockchain
as DeFi is, in fact, often heavily centralized. In while allowing participants to enforce their rights
many cases, DeFi protocols are subject to central- on the blockchain in case anything goes wrong.
ized data feeds and can be shaped or influenced This is a promising approach but, in many cases,
by people with “admin keys,” or a highly concen- still requires trust and various forms of centralized
trated governance token allocation (voting rights). infrastructure.
While partial centralization is not necessarily a DeFi still faces many challenges. However, it
bad thing, it is important to strictly differentiate can also create an independent infrastructure,
between true decentralization and companies mitigate some risks of traditional finance, and pro-
that claim to be DeFi when in fact they provide vide an alternative to excessive centralization. The
centralized infrastructure. open-source nature of DeFi encourages innovation,
Second, immutability can introduce new risks. and there are many talented people—academics
It might be harder to enforce investor protection, and practitioners alike—working on these chal-
and smart contract programming errors can have lenges. If they can find solutions without under-
devastating consequences. Composability and com- mining the unique properties at the core of DeFi,
plex token wrapping schemes (Nadler and Schär, it could become an important building block for
forthcoming) that resemble the rehypothecation the future of finance.
of collateral contribute to shock propagation in the
system and may affect the real economy. FABIAN SCHÄR is a professor of distributed ledger tech-
Third, the transparent nature of the blockchain nology and fintech at the University of Basel and managing
and decentralized block creation can be problem- director of the Center for Innovative Finance.
atic from a privacy perspective. Moreover, it allows
for the extraction of rents through generalized References:
front-running—a phenomenon known as miner/ Schär, Fabian. 2021. “Decentralized Finance: On Blockchain- and Smart Contract-
maximal extractable value (MEV). Those who Based Financial Markets.” Federal Reserve Bank of St. Louis Review 103 (2): 153–74.
observe a transaction that contains an order to https://doi.org/10.20955/r.103.153-74.
swap assets on a decentralized exchange can try Nadler, Matthias, and Fabian Schär. Forthcoming. “Decentralized Finance, Centralized
to front-run (or sandwich) this action by issuing a Ownership? An Iterative Mapping Process to Measure Protocol Token Distribution.”
Journal of Blockchain Research. https://arxiv.org/abs/2012.09306.
transaction of their own. The front-runner thereby

CENTRAL BANK DIGITAL CURRENCY
Potentially a new form of digital central bank money that can be
distinguished from reserves or settlement balances held by
commercial banks at central banks. It is a central bank liability,
denominated in an existing unit of account, which serves both as a
medium of exchange and a store of value. CBDCs are not cryptoassets.
FINANCIAL INCLUSION SECURITY TOKENS

Individuals and businesses have access to Crypto assets that meet the definition of
useful and affordable financial products and security in the jurisdiction where they’re
services that meet their needs—such as issued, marketed, transferred, exchanged
transactions, payments, savings, credit, and or stored.
insurance—and are delivered in a
responsible and sustainable way.
DIGI
STABLECOIN
A crypto asset that aims to
MON
maintain a fixed value
relative to a specified asset,
or a basket of assets.
DECENTRALIZED FINANCE (DEFI)

A set of alternative financial markets,
products and systems that use crypto
assets and software known as smart
BLOCKCHAIN
contracts that are built using distributed
ledger or similar technology. A distributed ledger
in which transaction
details are held in
UNBACKED blocks of information.
CRYPTO ASSET A new block is attached to the chain of
existing blocks via a computerized
Crypto assets that are neither
process that validates transactions.
tokenized traditional assets
nor stablecoins.

DIGITAL ASSETS
A digital instrument issued or
represented using distributed
ledger or similar technology. This
excludes digital representations of
fiat currencies.
DISTRIBUTED LEDGER TECHNOLOGY (DLT)

A means of saving information through a distributed ledger, such as a
repeated digital copy of data available at multiple locations. A database
a
that’s stored, shared and synchronized on a computer network. Data is
updated by consensus among the network participants. Blockchain is one
d,
example, but it doesn’t necessarily maintain its record using the same chain
of blocks architecture.
ITAL
1001
1010
NEY
CRYPTO ASSET
0101 Also known as cryptocurrency, a
0101
private sector digital asset that
depends primarily on cryptography
1001
and distributed ledger or similar
technology.
E-MONEY
A stored monetary value or prepaid product in which a record of the funds
or value available to the consumer for multipurpose use is stored on a
prepaid card or electronic device like a computer or phone, and which is
accepted as a payment instrument by other than the issuer (multipurpose
use). The stored value represents a claim enforceable against the e-money
provider to repay the balance on demand and in full.
UTILITY TOKENS
Crypto assets that give holders a right to access a current or prospective
product or service from the issuer or issuing network.

PEOPLE IN ECONOMICS
Getting into
PEOPLE'S
HEADS
Marjorie Henriquez profiles Harvard’s Stefanie Stantcheva,
who uses surveys and experiments to uncover the invisible
PHOTO: TYLER SMITH
in traditional economic data

PEOPLE IN ECONOMICS
A
fter studying taxation for several years, economists have studied for close to 100 years with
Stefanie Stantcheva came to a daunting much yet to learn. The field examines how to design
conclusion: people have complex and taxes that maximize social welfare by reflecting soci-
deep-rooted views that are hard for econ- ety’s choices between equality and efficiency.
omists to understand. When crafting policy advice
with a social objective in mind, like reducing inequal- Taxation as a powerful tool
ity, economists don’t have enough data to guide them Stantcheva was 11 years old in 1997 when inflation in
on what people know, believe, and consider to be her birth country of Bulgaria surpassed 2,000 percent
fair, she found. on an annual basis. Although she and her family had
Stantcheva, an economics professor at Harvard already left the country, the episode helped shape
University, wants to change that. “The goal is really her eventual decision to study economics.
to get into people’s minds and try to understand By the time she started undergraduate studies at
how they reason, what their perceptions are, their the University of Cambridge, Stantcheva had already
attitudes, their knowledge on various economic lived in East Germany, witnessing pay disparities with
policy issues,” she says. the West, and in France, where she was troubled by
Using large-scale social economic surveys and the level of inequality.
experiments, often in several countries, she has been “Having lived in such different countries as a child
able to get a glimpse into why people support some made me witness a lot of very different economic
policies and not others, on issues ranging from redis- and social systems,” she says. “When I understood
tribution to trade to environmental taxes. that there was a field called economics that deals
“These surveys uncover what is invisible in tradi- with these things I was interested in, it was clear
tional economic data and bring economics closer that I wanted to study that.”
to other social sciences such as psychology, sociol- After Cambridge, she returned to France, where
ogy, and political science,” says Emmanuel Saez, she studied master’s level economics and finance
director of the Center for Equitable Growth at the at the École Polytechnique, ENSAE, and the Paris
University of California, Berkeley, and coauthor of School of Economics. When she began thinking
the Paris School of Economics’ World Inequality about a doctorate, she focused on taxation to help
Report. “This line of work could be a game changer address the inequalities she had seen growing up.
for the economic profession as it will force a reeval- “I realized that taxation is a super powerful tool
uation of the most standard assumptions about that governments have and that can be applied to
rational economic behavior.” many different areas,” Stantcheva says. “There is so
Since earning her PhD from the Massachusetts much that actually relies on taxation. It is extremely
Institute of Technology (MIT) in 2014, Stantcheva, potent in that it can have a lot of cascading effects,
36, has become one of the world’s leading young which could be very good or could be terrible if you
economists. Among a boatload of awards and honors, get it wrong.”
she won the 2020 American Economic Association’s One focus is the effects of taxes on various activi-
Elaine Bennett Research Prize, which recognizes ties, with an emphasis on those that take place over
outstanding research by a woman within the first long periods. Her 2017 study, “Optimal Taxation
seven years of receiving her PhD. She was the first and Human Capital Policies over the Life Cycle,”
woman to join the editorial board of the influential broke new ground by analyzing in unprecedented
Quarterly Journal of Economics. detail how tax and human capital policies, such
Early in her doctoral program, Stantcheva stood as investment in higher education, interact over a
out for being drawn to questions at the center of person’s life span.
economic research and public policy discussion. She was interested in addressing the widespread
“Stefanie is fearless in the questions she asks,” says problem of high student debt. Is there a system
James Poterba, her doctoral advisor at MIT. “From her where people can pay for higher education—not just
first year in graduate school, it was clear that she was once but over a lifetime—without going into debt
thinking about the unanswered questions, the topics and exacerbating inequality? Stantcheva found that
for future research, as much as the well-resolved ones.” income-contingent loans can provide such a solution.
Stantcheva has also made important contributions “It’s thinking jointly about the whole system—
to research on optimal taxation theory, a subject financing education and then taxing the income

PEOPLE IN ECONOMICS
generated throughout life in a way that balances US—and found large gaps between reality and
the decision to acquire human capital against the perceptions. In all countries, respondents greatly
disincentives that taxes create,” she says. overestimated the number of immigrants. They also
Under this system, a person would take out a perceived immigrants to be economically weaker,
government loan for education. As individuals earn more unemployed, and less educated than they
more as a result, they pay a higher share of their really were. This, in turn, led survey participants
incomes through taxes, which flow into the gov- to say they thought immigrants paid less in taxes
ernment’s common pool for education. Conversely, and received a much larger share of government
when people are down on their luck and their transfers than was actually the case.
income takes a hit, they pay less. “These misperceptions are largest among people
Although nine or so countries, including with lower education, in lower-paid jobs, working
Australia, New Zealand, and the UK, have adopted in sectors that employ many immigrants,” she says.
some form of income-contingent loans, they protect “And, across all countries, among people on the
the borrower during bad times but fail to collect right of the political spectrum.”
more during good times. For the common pool to Just making people think about immigration
remain funded and be truly optimal, Stantcheva before asking them about redistribution policies,
found, it must work both ways. they found, makes them less likely to support redis-
tribution. “The two biggest predictors of reduced
The Social Economics Lab support for redistribution are the perception that
“As I was studying these issues of taxation, it became immigrants ‘free-ride’ and do not put in hard work,
very clear that something that is often missing—but and the perception that immigrants are economi-
that is really critical—is how people think about tax cally weak,” Stantcheva says.
and other policies,” Stantcheva says. “Ultimately, Through her research in other areas, she has
what they consider to be the right social objective, discovered that facts and explanations of how a
what they consider to be fair.” policy works are often effective in helping people
This led Stantcheva to create the Social Economics understand it and sometimes come to support it
Lab at Harvard in 2018, where she and a team of more. However, giving people facts about immi-
about 20 research fellows, including graduate and grants, such as their numbers or origins, doesn’t
undergraduate students, are uncovering these invis- shift views on redistribution, Stantcheva found.
ible data through rigorous large-scale surveys and Narratives, on the other hand, do.
experiments, the results of which in some cases “One of the most effective ways to counter peo-
debunk standard theory. ple’s misperceptions of immigrants is to actually tell
The median-voter theory, for example, predicts them a story about a very hard-working immigrant
that wider inequality should lead to increased that counters the free-rider narrative,” she says.
demand for redistribution from high-income to
low-income earners as policymakers cater to the Notion of fairness
median voter. Data collected by the lab, how- While economists have traditionally relied on argu-
ever, suggest that the existence of inequality alone ments about economic efficiency to garner support
doesn’t really lead people to support redistribution. for redistribution policies, Stantcheva has found
Instead, perceptions are what shape their backing that what appears to really matter to people is who
for most policies. the winners and losers are.
Stantcheva, along with Harvard colleagues “Everybody cares about fairness, but it means dif-
Alberto Alesina and Armando Miano, set out in ferent things to different people,” she says. Someone
2018 to find out whether and how perceptions on the left who is less tolerant of income inequality,
about immigration affect support for redistribution for instance, might think it only fair that a high
policies. They focused on two key considerations: earner share his or her income through higher taxes,
who people think benefits from redistribution—in she says, and someone on the right is more likely
this case, is it immigrants?—and to what extent to consider that unfair.
people think that is fair. Such notions of fairness are more likely to shape
They surveyed 22,000 people in six countries— people’s views than arguments about efficiency,
France, Germany, Italy, Sweden, the UK, and the her studies show. In the case of immigration and

PEOPLE IN ECONOMICS
redistribution, people who think that immigrants In the past couple of years, Stantcheva has taken
are not hard workers and are free-riding are also on an unexpected role. In May 2020, her Harvard
likely to expect that immigrants will unfairly benefit colleague, mentor, and Social Economics Lab col-
from redistribution. laborator Alesina died suddenly at the age of 63. The
Stantcheva reports seeing similar results in a Italian-born professor was one of the world’s most
current project, a study of attitudes concerning influential economists and was widely considered
climate change across 20 countries. Survey data a pioneer of modern political economy, the study
from the project already show that people’s views of how economics and political systems are linked.
are shaped by who they think will bear the burden “Stefanie in a very natural way has stepped up
of paying for climate change. to the role that Alberto used to have for many of
“People think it’s unfair that the lower- or us,” says Pierfrancesco Mei, a Harvard student
middle-income class bears a disproportionate and research fellow at the lab. “One of the most
burden through environmental taxes or other special things she has done is to keep Alberto’s
sacrifices, when they have the perception that legacy alive.”
higher-income people don’t bear as much of the
burden,” Stantcheva says. Helping people make better decisions
At the onset of the COVID-19 pandemic, French Stantcheva is currently studying how the general
President Emmanuel Macron tapped Stantcheva, property tax in the US shaped economic develop-
who is a member of the French Council of Economic ment in the 19th century and the impact of France’s
Analysis, to join an international commission to wealth tax on tax evasion and wealth. In addition
assess long-term challenges beyond the pandemic to her project on perceptions of climate policy, she
and come up with proposals. She and the Harvard will continue extending her research on how people
Kennedy School’s Dani Rodrik, a professor of form views on key economic policies, she says.
political economy, were assigned to look into the Stantcheva is often asked to present her findings
challenge of inequality. to policymakers. They are curious and are slowly
A number of their proposals reflected what becoming aware of the power of survey methods
Stantcheva’s surveys in France showed about peo- for understanding how people think, she says. She
ple’s perceptions. For instance, knowing that many just published a note for the French Council of
in France blame globalization and outsourcing Economic Analysis on French people’s attitudes
for the lack of jobs, they urged policymakers to about climate policies.
pay attention to how trade policies affect local “The gilets jaunes crisis [the “yellow vest” pro-
labor markets. tests that started in 2018 over economic unrest]
“Under our proposal, it would be possible—after has traumatized policymakers in France and else-
an appropriately deliberative and broadly participa- where in Europe, so her research, based on very
tory domestic process—to restrict imports that are rich surveys on the acceptability of these policies, is
produced under conditions that violate labor rights discussed with great interest,” says Philippe Martin,
abroad and threaten jobs or working conditions at professor of economics at the Paris Institute of
home,” they said in an opinion piece published by the Political Studies and chair of the French Council
international media organization Project Syndicate. of Economic Analysis.
Stantcheva says she ultimately hopes her research
Carrying on a legacy will give economists and policymakers a greater
While she devotes considerable energy to the chance to build consensus around social policies
rigors of her research and often speaks at more that improve people’s lives. More important, she
than one conference in a day, Stantcheva ada- says, she hopes that by understanding how people
mantly makes a top priority of teaching and of process information, economists will be able to pro-
coaching graduate and undergraduate students. vide the tools people need to make better decisions.
“I love teaching students, seeing them grasp “Our goal is to find what explanations are useful
new concepts, have lightbulb moments, experi- to improve people’s understanding of core policies
ence the world through a new lens,” she says. Her that really shape their daily lives,” she says.
colleagues say they admire the way she interacts
with and cares for students. MARJORIE HENRIQUEZ is on the staff of Finance & Development.

Tokocrypto, an Indonesian affiliate of
Binance, has a large presence in Bali.
DIGITAL JOURNEYS
BALI’S CRYPTO
SUMMER ENDS
The Indonesian island became a base for crypto entrepreneurs, but few priced in the crypto winter
Harry Jacques
A
short stroll from a clutch of Balinese beach other districts in Bali—flush with remote workers as
clubs a group of blockchain professionals pandemic restrictions eased halfway through 2022.
mingles poolside in a villa owned by a Many cryptocurrency speculators with an instinct
swimwear entrepreneur. Millennial enthu- for arbitrage were drawn to the possibilities of Bali’s
siasts and more seasoned finance professionals take crypto summer, with high-end amenities at far lower
turns staking chips on village-fete-style games set up cost than in San Francisco or Singapore.
in the garden around frangipani trees and an open bar. “You can have the quality of life in Bali while
The event in May was thrown by a Singapore-based earning the salary of a Western country,” said Paul,
finance firm in Bali to mark the launch of its ESG— 19, a self-taught developer, who arrived in Bali to
environmental, social, and governance—“legacy spend one month remotely coding a blockchain
token.” The company, which holds concession rights platform for a retailer in Paris.
to an estimated 150,000 troy ounces of gold beneath Few appeared to have priced in the emergence
a forest in Ontario, Canada, has proposed the token as of a crypto winter—Bitcoin fell from an all-time-
an innovative mechanism to leave the gold unmined. high above $68,000 in November 2021 to below
Energetic ideas founded on blockchain technology $20,000 in June as some exchanges paused with-
sprang up quickly around Canggu, Seminyak, and drawals and alternative assets collapsed.

Like Paul, many new arrivals find a network a devastating two-year blackout caused by the pan-
stone’s throw from the beach at T-Hub, a coworking demic. Tens of thousands of tourism workers had
space operated by Tokocrypto, an Indonesian affiliate their working hours cut or lost their jobs entirely
of Binance, the world’s largest crypto exchange. as the travel industry collapsed around them.
“There are people who are not in the mood to In April 2019 almost half a million people
talk about crypto,” said Antria Pansy, who runs arrived at Bali’s Ngurah Rai International air-
community engagement for Tokocrypto in Bali. port—this year in April, with restrictions begin-
“But there have been winters in the past.” ning to ease, the total was barely one-tenth that
Tokocrypto claims to have tens of thousands (although there were signs of a stronger recovery
of registered users in Bali, an order of magnitude in May and June).
increase over just one year. Pansy said this breakneck Young professionals newly released from lockdowns
growth could be the result of tens of thousands of in Europe and elsewhere appear eager to choose Bali as
newly unemployed tourism workers searching for a base, although some say challenges with paperwork
income during the pandemic and of media coverage have curbed enthusiasm for longer stays.
of cryptocurrencies in Indonesia that began a couple “I think it’s very nomadic here,” said Gabrielle,
of years ago. who organizes crypto networking events in Dubai
and Singapore.
Silicon Bali In 2021, Thailand announced it would issue
At discussion groups in July attendees pondered 10-year work permits to foreign nationals earning
the emergence of “Silicon Bali” for crypto and more than $80,000 a year. This year Indonesia’s
blockchain and brainstormed how best to link tourism minister, Sandiaga Uno, unveiled similar
foreign visitors with Indonesian talent. plans for a five-year visa for Bali targeting the rise
An event that month packed about 30 people into in remote workers.
T-Hub. Aaron Penalba arrived in a T-shirt embossed
with a Nike Swoosh and the words “Just HODL Cautionary tales
It”—Hold on for Dear Life—a mantra among those Tales of scams are common among Bali’s crypto
who believe that Bitcoin’s utility and finite stock traders and are a fresh priority for regulators keen
herald wealth. on restricting the influence of advertising and
A young crowd listened to Penalba explain the irresponsible social media influencers.
basics of minting and staking and the nuances of The Commodity Futures Trading Regulatory
royalty fees for those who want to begin trading in Agency, part of Indonesia’s trade ministry, assumed
non-fungible tokens (NFTs), forms of digital data oversight of cryptocurrencies in 2018. It currently
stored on a blockchain ledger. permits trading in 229 assets.
Penalba, who describes himself as a full-time NFT Cryptocurrency transaction volume in Indonesia
trader, was an early adopter in what became frenzied grew from Rp 64.9 trillion in 2020 to Rp 859.4 tril-
trading in digital art collections such as Bored Ape lion in 2021, the agency head said at a parliamentary
Kennel Club. (“Basically, it’s dogs,” he explains.) hearing in March. By February this year, the number
Digital artist Mike Winkelmann famously sold of participants transacting in cryptocurrencies in
his NFT artwork through auction house Christie’s Indonesia had more than doubled, to 12.4 million,
for $69 million in May 2021 as NFT transactions compared with just 10 months earlier.
PHOTO: HARRY JACQUES; ART: ISTOCK / SUKSUNT SANSAWAST
soared to about $17 billion that year. Blockchain developer Paul guesses that most
“At first it was just being there—getting in early,” people in Bali’s cryptocurrency community are
said Penalba. simply speculating on rising prices, with only a
But sales of digital art, music, and other NFTs fraction working on technology that proponents
crashed by about 92 percent from January to hope will cut costs for everything from agriculture
May 2022 as sentiment changed, according to to migrant worker remittances.
NonFungible, a blockchain data company estab- “You can make a lot of money,” said Penalba during
lished in 2018. his presentation. “If you are lucky.”
Statistics agency data show that Indonesia’s main
tourism destination is still finding its feet after a HARRY JACQUES is a journalist based in Southeast Asia.

Shop in New Delhi, India, with a QR
code for Paytm displayed prominently.
DIGITAL JOURNEYS
INDIA EMBRACES
MOBILE MONEY
The central bank has played a key role in the country’s digital payment boom
Jeff Kearns and Ashlin Mathew
T
he Reserve Bank of India’s headquarters, UPI for feature phones (older devices with buttons
opened in 1981, is a high-rise building instead of touchscreens) that can potentially connect
clad in white towering over Mumbai’s Fort 400 million users in distant rural areas.
district, a few blocks from the waterfront. The UPI system was introduced in 2016, just
The RBI is also a pillar of the country’s rapidly before the end of RBI Governor Raghuram Rajan’s
growing digital payment network and a lesson in term. The shock of the demonetization initiative
cooperation between a central bank and private firms. followed near the end of that same year, when
India’s digital payment volume has climbed at high-denomination banknotes were withdrawn
an average annual rate of about 50 percent over from circulation.
the past five years. That itself is one of the world’s UPI was a response to the nation’s patchwork of
fastest growth rates, but its expansion has been rules and paperwork for payments. The goal was to
even more rapid—about 160 percent annually—in make transfers easier and safer by allowing multiple
India’s unique, real-time, mobile-enabled system, the bank accounts on the same mobile platform for indi-
Unified Payments Interface (UPI). Transactions more vidual and business use alike. It rapidly came of age.
than doubled, to 5.86 billion, in June from a year The UPI network’s genesis traces back even fur-
earlier as the number of participating banks jumped ther, to 2006, when the RBI and Indian Banks’
44 percent, to 330. Values nearly doubled in the same Association jointly formed the National Payments
period. In addition, the RBI in March introduced a Corporation of India (NPCI).

The goal was to be an umbrella institution for With the memory of cash reliance already rapidly
digitalization of retail payments, and it was incor- fading since the beginning of the smartphone era,
porated as a nonprofit company intended to provide the pandemic helped further accelerate the embrace
India’s people a public good. This public good of contactless digital transactions, especially for
approach to providing digital financial infrastruc- small amounts, as people tried to protect themselves
ture is relevant for all economies, whatever their from the virus.
stage of development, researchers at the Bank for
International Settlements wrote in a 2019 paper. Unique digital infrastructure
This transition piggybacked on another unique
Going cashless domestic innovation, the India Stack, a digital
Growth for individual digital payment users is identity and payment system built on an open appli-
set to triple in five years to 750 million, accord- cation programming interface, or API. It has been
ing to NPCI Chief Executive Officer Dilip Asbe; a force for greater financial inclusion by making
merchant users could double to 100 million. The services easier for consumers to access, including
central bank fosters a varied ecosystem of payment by incorporating the national identity program,
systems, he said, including RuPay, a debit and Aadhaar, with 1.3 billion users.
credit card issuer with a large market share, the Open-stack technology is the foundation of
National Financial Switch cash machine network, UPI, which transformed India’s digital payments,
and a payment system using the national identity said Dinesh Tyagi, CEO of CSC e-Governance
program to bring banking to underserved areas. Services India, the government’s operator of centers
“RBI was determined that a country our size for electronic public services in villages and other
needs multiple payment systems so citizens can remote areas.
choose from multiple payment options,” he said. “The government promoted open-stack tech-
“A system like UPI cannot come into any country nology so that people can try to integrate very
unless the central bank and the government of that quickly,” he said. “We also promoted private fin-
country are keen to bring in such an innovation, tech companies, in addition to traditional public
which democratizes the payment system to the sector banks, which is what [allowed] quicker
smallest value and the most reasonable cost. UPI adoption of these technologies. These services are
is nearly free today for consumers in India, and the also available at no cost to the citizen, and that is
government is providing incentives for promotion the uniqueness of India’s digital transformation.
of UPI merchant payments.” Meanwhile, policymakers are planning another
With a burgeoning cashless society, the old ways big bet on the future of digital money, with even
are increasingly forgotten by the country’s hundreds more far-ranging effects on the economy. The
of millions of young people. It is they who have RBI is exploring a central bank digital currency
helped swell the ranks of users of Paytm, one of the (CBDC) designed to meet monetary policy objec-
world’s largest mobile money services providers, to tives of financial stability and efficient currency
more than 400 million. and payment operations.
Anjchita Nair, an entrepreneur and cofounder RBI Deputy Governor Rabi Sankar, who oversees
of the New Delhi–based arts and culture organiza- payment systems and financial technology, said
tion Culture, uses Paytm for sales and Razorpay’s achieving such an advance would have advantages
platform for online transfers. For personal use for currency management, settlement risk, and
she prefers Google Pay, another of India’s most cross-border payments.
PHOTO: SAJJAD HUSSAIN / AFP VIA GETTY IMAGES
popular platforms. He said in a June address at an IMF event on

“Monetary transactions can be done quickly and digital money that a digital rupee would have big
conveniently,” she said. “The younger generation implications for crypto assets: “CBDCs could
are more and more using cashless methods such actually be able to kill whatever little case there
as UPI and wallets, and we wanted to make trans- could be for private cryptocurrencies.”
actions easier for them. We also have small-value
transactions happening for some of our products, JEFF KEARNS is on the staff of Finance & Development.
and it reduces the hassle of handling cash.” ASHLIN MATHEW is a writer based in New Delhi.

A truck leaves the border post at
Machipanda, Mozambique.
DIGITAL JOURNEYS
FREEING FOREIGN
EXCHANGE IN AFRICA
The continent seeks to ease cross-border payments in a bid to boost trade
Chris Wellisz
M
aking payments from one African currency transactions for companies doing busi-
country to another isn’t easy. Just ask ness in Africa.
Nana Yaw Owusu Banahene, who lives Cross-border payments are just one of the many
in Ghana and recently paid a lawyer barriers to trade in Africa. Others range from high
in nearby Nigeria for his services. tariffs and cumbersome border procedures to diver-
“It took two weeks for the guy to receive the gent commercial regulations and congested roads.
money,” Owusu Banahene says. The cost of the A trade agreement that went into effect in 2021
$100 transaction? Almost $40. “Using the banking aims to lower some of those hurdles and create a
system is a very difficult process,” he says. vast trading area from Casablanca to Cape Town,
His experience is a small example of a much bigger encompassing 1.3 billion people. In its first phase,
problem for Africa’s economic development—the the African Continental Free Trade Area (AfCFTA)
expense and difficulty of making payments across agreement would gradually eliminate tariffs on 90
borders. It is one reason trade among Africa’s 55 percent of goods and reduce barriers to trade in
countries amounts to only about 15 percent of their services. In later stages, it would harmonize poli-
total imports and exports. By contrast, an estimated cies on investment, competition, e-commerce, and
60 percent of Asian trade takes place within the intellectual property rights.
continent. In the European Union, the proportion The AfCFTA’s backers say lowering trade barriers
is roughly 70 percent. will supercharge commerce, attract foreign direct
“When the payments are unlocked, invariably investment, and boost economic growth. A recent
you are unlocking trade between African coun- World Bank study estimates that the deal, if carried
tries,” says Owusu Banahene, the Ghana country out in full, would raise real income by 9 percent and
manager for AZA Finance, which handles foreign lift 50 million people out of extreme poverty by 2035.

Working in tandem with the agreement will be Naryshkine, the operations manager for Kuza Africa,
the Pan African Payment and Settlement System which exports avocado seedlings from Tanzania.
(PAPSS), a project of the AfCFTA secretariat and “We have sold seedlings in Angola and have had
Cairo-based Afreximbank, which specializes in trade to wait for payment simply because the central bank
finance. The system aims to link African central in Angola didn’t have enough dollars for people to
banks, commercial banks, and fintechs into a net- settle their trade,” he says. Delays and uncertainty
work that would enable quick and inexpensive trans- make it difficult to decide when to plant avocados,
actions among any of the continent’s 42 currencies. he says, and put a damper on business.
As of 2017, only about 12 percent of intra-African One of his customers is Lourenço Rebelo, com-
payments were cleared within the continent, accord- mercial director of FertiAngola, a dealer in agricul-
ing to the Society for Worldwide Interbank Financial tural products ranging from seedlings to tools. Rebelo
Telecommunication (SWIFT). The rest are routed says delays in getting access to foreign currencies
through overseas banks, mostly in Europe and North mean some shelves stay empty, resulting in lost sales.
America. As a result, an African currency must first “We’re a one-stop shop,” he says. “So if I’m out
be exchanged for dollars, pounds, or euros and then of fertilizers, for instance, [customers] will not come
swapped a second time for a different African cur- in, and the other stuff will not be selling.”
rency. That adds an estimated $5 billion a year to the PAPSS aims to solve such problems by settling
cost of intra-African currency transactions. transactions in local African currencies, obviating
Owusu Banahene says his $100 payment to his the need to convert them into dollars or euros before
lawyer was relatively straightforward, because banks swapping them for another African currency. In
in both Ghana and Nigeria have correspondent bank- essence, PAPSS would eliminate costly overseas
ing relationships with overseas counterparts that use intermediaries. The system aims to complete trans-
dollars in foreign currency transactions. But in the actions in less than two minutes at a low though
case of Ghana and Côte d’Ivoire, transactions involve unspecified cost.
two overseas banks—because Ivoirien institutions “This will be a game changer for trade on the
have ties to banks that use the euro. African continent,” says Wamkele Mene, secretary
Most of the cost of Owusu Banahene’s transaction general of the AfCFTA.
consisted of the standard $35 fee charged by SWIFT. Still, PAPSS faces hurdles of its own. The cen-
As a proportion of the amount of the transaction, tral banks at the heart of the system will have
costs are typically much lower, though still consid- to reconcile differences in national regulations,
erable, amounting to as much as 4 to 5 percent. infrastructure, and oversight systems. Deciding
Still, the cost of small-value transactions can be a how to settle transactions among a number of
barrier to the small cross-border traders who account volatile currencies could also prove difficult.
for a significant portion of intra-African commerce. Formally launched in January 2022, the system
Many of them don’t have bank accounts to begin had yet to complete a single commercial transac-
with, and even those who do often exchange money tion as of midsummer. It has integrated six central
on the black market, which can involve the risk banks, with more on the way, and 16 commer-
of being robbed or receiving counterfeit currency, cial banks, says John Bosco Sebabi, deputy chief
says Richard Adu-Gyamfi, senior advisor at the executive officer of PAPSS.
AfroChampions Initiative, which seeks to nurture Sebabi concedes that awareness of the system is
African multinational enterprises. low in the business community. He says Afrexim
There are other obstacles. One is the volatility of and PAPSS have a joint marketing campaign
African exchange rates. In the case of Ghana, it took under way, although he says he cannot pro-
PHOTO: GIDEON MENDEL / CORBIS VIA GETTY IMAGES
about ¢6 to buy a dollar in mid-July 2021; a year vide details.

later, the cost was ¢8, a depreciation of 25 percent. “While implementing a project of this magni-
Volatility increases the risk, and therefore the cost, tude, there are always glitches along the way,” he
of foreign currency transactions. says. “However, we are set to have commercial
Another hurdle: some African central banks, seek- bank transactions very soon. We cannot say today
ing to support the value of their currencies, ration or tomorrow, but very soon.”
dollars and other hard currencies by holding regular
auctions. This has been a source of frustration for Sasha CHRIS WELLISZ is a freelance writer and editor.

PICTURETHIS
PICTURE THIS
THE ASCENT OF CBDCs

THE ASCENT OF CBDCs
More than half of the world’s central banks are exploring or developing digital currencies.
More than
Central bankhalf of thecurrencies
digital world’s central
(CBDCs)banks
are arebanked
exploring or developing
populations digitalthan
across more currencies
30 of its
digital versions of cash that are issued and regulat- inhabited islands was a primary driving force.
CENTRAL
ed by centralBANK DIGITAL
banks. CURRENCIES
As such, they are(CBDCs)
more secure are populations
Beyond across more thanfinancial
promoting 30 of its inhabited
inclusion,
digital
and versionsnot
inherently of cash that are
volatile, issued
unlike and regulated
crypto assets. CBDCswas
islands cana primary
create greater
drivingresilience
force. for domestic
by While
central some
banks.may assume
As such, theythat CBDCs
are more areand
secure a payment
Beyond systems
promoting andfinancial
foster more competition,
inclusion, leading
new concept,
inherently notthey haveunlike
volatile, in factcrypto
been assets.
around for which may
experts argueleadthattoCBDCs
better access
can maketo money,
domesticincrease
pay-
three
Whiledecades.
some may In 1993,
assumethe thatBank
CBDCs of are
Finland
a new efficiency
ment in payments,
systems more resilient andandin turn
fosterlower transac-
competition,
launched
concept, they the Avant
have insmart card,around
fact been an electronic
for three tion costs.
which may CBDCs can also
lead to better improve
access transparency
to money, increase
form of cash.
decades. Although
In 1993, the of
the Bank system
Finlandwaslaunched
eventuallythe in money flows and could help
payment efficiency, and lower transaction reduce currency
costs.
dropped in the early 2000s, it can be considered
Avant smart card, an electronic form of cash. Although substitution
CBDCs (when transparency
can improve a country uses a foreign
in money flows
the
theworld’s
system was firsteventually
CBDC. dropped in the early 2000s, currency
and couldinhelpaddition
reduceto, or instead
currency of, its own).
substitution.
But not until
it can be considered the recently
world’shasfirst research
CBDC. into Whilea CBDC
While a CBDC may havemay many
have potential
many potential
benefits
CBDCs proliferated globally, prompted
But not until recently has research into CBDCs by benefits on paper, central banks
on paper, central banks must first determine will first need
if thereto
technological advances and a decline
proliferated globally. Central banks all over the in the use of determine if there is a compelling case
is a compelling case to adopt them, including if there to adopt
cash. Central banks all over the world are now them in their jurisdictions, including if there will
world are now exploring their potential benefits, will be sufficient demand. Some have decided there
exploring their potential benefits, including how be sufficient demand. Some have decided there is
including how they improve the efficiency and is not, at least for now.
they improve the efficiency and safety of payment not, at least for now, and many are still grappling
safety of payment systems.
systems. And,
with issuing
this CBDCs comes with risks that central
question.
As
As ofofJulyJuly2022, therethere
2022, were nearly 100 CBDCs
were nearly 100 banksAdditionally, issuingUsers
need to consider. CBDCs might withdraw
comes too
with risks
in research or development
CBDCs in research or development stages stages and two and
fully much money from banks all at once
that central banks need to consider. Users might to purchase
two fully launched: the eNaira in Nigeria, whichin
launched: the eNaira in Nigeria, unveiled CBDCs,
withdrawwhichtoo muchcouldmoney
trigger from
a crisis. Central
banks all atbanks
once
October
was launched 2021, lastand theand
year, Bahamian
the Bahamiansand dollar,
sand will
to purchase CBDCs, which could triggermanage
also need to weigh their capacity to a crisis.
which debuted October 2020.
dollar, which made its debut in October 2020. risks posed
Central by cyberattacks,
banks will also need while also ensuring
to weigh data
their capaci-
Countries
Countrieshave havedifferent
differentmotives
motives forfor
exploring and
exploring privacy and financial
ty to manage integrity.
risks posed by cyberattacks, while
issuing
and CBDCs,
issuing CBDCs, butbut
in the casecase
in the of The
of TheBahamas,
Bah- also ensuring data privacy and financial integrity.
the need
amas, to serve
the need unbanked
to serve unbanked andand under-banked
under- ANDREW STANLEY is on the staff of Finance & Development.
Gaining currency
CBDC research and development have exploded in the past few years, with 15 pilots ongoing across the world and 15 more in an advanced research stage.
100
Launched
Pilot
80
Proof of concept
60
40
Research
20
Canceled
0
2014 2015 2016 2017 2018 2019 2020 2021 2022
Source: CBDC Tracker (cbdctracker.org). The chart shows the status of CBDCs worldwide by month. Proof of concept = advanced research stage.
44 FINANCE&&DEVELOPMENT
48 FINANCE DEVELOPMENT | | September
September2022
2022
PICTURE THIS
PICTURE THIS
CBDC cultivation
Central banks are going through various stages of development to assess the benefits and risks of CBDCs and to consider how best to deploy them.
(CBDC development status by country for stated period)
July 2018
Launched (0)
Pilot (1)
Proof of concept (3)
Research (15)
19
July 2020
Launched (0)
Pilot (7)
Research (25)
39
July 2022
Launched (2)
Pilot (15)
Research (65)
97
Source: CBDC Tracker (cbdctracker.org).

Note: The map shows both retail and wholesale CBDCs.
A country can have multiple CBDCs; the map shows the status
of the most advanced stage of development in each country.
The boundaries, colors, denominations, and any other
information shown on maps do not imply, on the part of the
IMF, any judgment on the legal status of any territory or any
endorsement or acceptance of such boundaries.
BACK TO BASICS
Crypto’s Conservative Coins

Stablecoins are far from the revolutionary ideals of crypto’s creators and are not without risk
Parma Bains and Ranjit Singh
of assets. These assets could be a monetary unit

of account such as the dollar or euro, a currency
basket, a commodity such as gold, or unbacked
crypto assets. This stability can be achieved only
if a centralized institution is in charge of issuing
(minting) and redeeming (burning) these crypto
assets. Another centralized institution (a custodian)
must hold corresponding reserves (typically fiat
currency issued by governments) that back each
unit of stablecoin that is issued.
Centralizing finance
This evolution is at odds with the original vision.
Rather than decentralizing finance, many stable-
coins have centralizing features. Instead of moving
away from fiat currencies, most types of stablecoins
are fundamentally reliant on those currencies to
stabilize their value. Rather than disintermediating
markets, they lead to new centralized intermediaries,
such as stablecoin issuers (who hold data on their
users), reserve managers (usually commercial banks),
WHEN IT WAS LAUNCHED IN 2009, the crypto revolu- network administrators (who can change the rules
tion was about much more than just finance. The of the network), and exchanges and wallets (that
financial crisis shook people’s trust in banks and can block transactions). In fact, given the transpar-
the governments that bailed them out. For those ency of blockchains and the need to comply with
wanting to shun traditional institutions and find anti-money-laundering rules, stablecoins may offer
alternative means to make payments, Bitcoin and the less privacy than existing payment rails.
innovative blockchain technology that underpins it If stablecoins oppose elements of the initial vision of
promised to decentralize and democratize financial Bitcoin, why do they exist and what purpose do they
services. Power would be placed in the hands of the serve? Stablecoins are used primarily to permit users
people—this remains a compelling vision. to remain in the crypto universe without having to
The problem was that speculators soon piled into cash out into fiat currency. They’re used to purchase
the market. Instead of spending bitcoins and other unbacked crypto assets as well as access and operate in
crypto assets, speculators simply hoarded them in decentralized finance (DeFi). They were a key element
the hope that prices would rise ever higher. Crypto in the growth of the crypto asset and DeFi markets.
assets struggled to prove their potential as a pay- In some emerging market and developing economies,
ment instrument and instead became a speculative dollar-denominated stablecoins could become popular
punt. The creation of thousands of other volatile “alt- as a store of value and a hedge against inflation and
coins”—many of them nothing more than schemes currency depreciation. From the users’ perspective, this
to get rich quick—made it even more problematic so-called cryptoization provides an avenue to protect
to use crypto assets for transactions. After all, how financial interests in the face of macroeconomic pres-
ART: ISTOCK / RASTUDIO
do you pay for something with an asset that is not sures and weak financial institutions. Where they are
a stable store of value or a trusted unit of account? not regulated, stablecoins can circumvent controls on
A stablecoin is a crypto asset that aims to maintain free capital movement while complicating macroeco-
a stable value relative to a specified asset, or a pool nomic management by the central bank.

BACK TO BASICS
For some, stablecoins represent the future of pay- Regulation challenges

ments. After all, in many economies most money Finally, regulatory barriers may arise. Regulators of
in circulation is not central bank money but pri- domestic payment systems may not allow stablecoins
vately issued commercial bank money. Furthermore, to serve as a payment instrument for purchases of
blockchains have the potential to increase the speed goods and services and integrate with domestic pay-
and reduce costs for services traditionally offered by ment systems. In addition, stablecoins (and the wider
banks, in particular cross-border remittances. An crypto universe) are not yet regulated for conduct and
argument can be made that stablecoins will be the prudential purposes in many jurisdictions. Although
privately issued money of the future. some anti-money-laundering rules might apply, users
aren’t protected if something goes wrong. Users could
Unstable coins face large losses without recourse to compensation if,
This vision comes with some challenges. First, sta- for example, fraudulent stablecoins were issued, issuers
blecoins are not all stable. In fact, most stablecoins claimed their stablecoins were backed but were not,
fluctuate around their desired value rather than stablecoins were stolen, or users couldn’t access their
sticking rigidly to it. Some stablecoins can devi- stablecoins or redeem them at par.
ate significantly from their desired value. This is
particularly true of algorithmic stablecoins. These
tokens aim to stabilize their value through an algo-
rithm that adjusts issuance in response to demand
Stablecoins permit users to remain in the
and supply, sometimes combined with backing crypto universe without having to cash out
through unbacked crypto assets. However, these
tokens are extremely risky. They are susceptible to into fiat currency.
de-pegging in the event of a large shock that becomes
self-perpetuating once it starts, as the TerraUSD Given the risks they pose, some authorities have
experience shows. looked to regulate stablecoins in a manner similar
This stablecoin suffered a peg failure in mid-2022 to traditional financial institutions, with different
after bank-like runs by users. The collapse of rules according to their business models, economic
TerraUSD, then the third-largest stablecoin, trig- risks, and economic functions. For example, where
gered significant ripple effects across the entire crypto stablecoins are not issued by banks and are used for
market. Similar contagion in the future could go payments on a small scale, issuers might be subject
well beyond crypto markets: many stablecoins hold to adjusted payment regulations. Where stable-
reserves in traditional financial instruments, and coins have less liquid reserve assets and are used
exposure to crypto assets among traditional financial for investment purposes, issuers might be subject to
market participants has increased. requirements similar to those applied to securities.
Second, the distributed ledger technology that One of the proposals floated by many authorities is
underpins stablecoins has not been tested at scale to apply bank-like regulations to stablecoins, particu-
from a payment perspective. These technologies larly if they become more widely used for payments.
could make cross-border remittances and wholesale Should this happen, stablecoins will themselves become
payments somewhat more efficient, but they may the banks that crypto assets were meant to replace.
not offer sizable advantages over domestic payment Any innovation that provides people with more
systems, especially in advanced economies. choice, reduces the power of institutions that are too
While financial inclusion is often touted as a ben- big to fail, and increases access to financial services
efit of stablecoins, most users are educated, relatively should be explored. With the right regulation in
young, and already have bank accounts. Unless trans- place, stablecoins could grow to play a valuable role
actions are conducted outside the blockchain—taking in delivering these benefits, but they won’t be able to
stablecoins further away from the traditional crypto do so alone. And they are far from the revolutionary
ideals of transparency and decentralization—they vision of crypto’s creators.
can at times be more expensive than alternatives such
as mobile or electronic money. These non-crypto PARMA BAINS is a financial sector expert and RANJIT SINGH
alternatives raised financial inclusion in Kenya from an assistant to the director in the IMF’s Monetary and Capital
14 percent to 83 percent between 2006 and 2019. Markets Department.

CAFÉ ECONOMICS
A Looming Food Crisis halted the exports of fertilizers, that drove up

the prices—which were already high before the
war—creating a significant problem for farmers.
FAO’s Maximo Torero Cullen discusses So the impact on food-importing countries is
how global food supply difficulties could tip twofold—they face a steeper food import bill and a
higher cost of fertilizers. That is our major concern
into a full-blown catastrophe today. Because the cost of fertilizers has in some
cases quadrupled, many farmers cannot afford them
BECAUSE OF HIGH NATURAL GAS PRICES rising food anymore, and that will be affecting the harvest this
prices could make the difference between life or year and next year.
death for millions of people around the world.
Organizations such as the United Nations Food and F&D: What is the impact on vulnerable economies?
Agriculture Organization (FAO) are closely tracking MTC: In the case of Africa, the key net food importers
the effects of price hikes on global food security. are northern African countries—more than 50 per-
In an interview with F&D’s Bruce Edwards, cent of their wheat imports come from Russia and
Maximo Torero Cullen, FAO’s chief economist, says Ukraine. Sub-Saharan Africa is different, as it doesn’t
wheat and fertilizer supply shortages have driven have wheat as a main staple. They have cassava and
up prices and increased food import bills for the rice. However, maize and wheat are used for feedstock.
most vulnerable countries by more than $25 billion, In the 62 most vulnerable countries in the
putting 1.7 billion people at risk of going hungry. world, we are talking about a roughly $25.4 bil-
lion increase in the food import bill compared to
F&D: We know the war in Ukraine is affecting last year. And this is affecting 1.7 billion people.
food supply in some parts of the world. What
other factors are at play? F&D: What are your main concerns if the war
MTC: The main driver behind the food price problems in Ukraine continues?
we are facing is conflict; most of the countries in food MTC: If the war continues, in 2022 and 2023 we
crisis have internal conflict. The second is economic could potentially have a food access problem cou-
downturns; COVID-19 is one of the major reasons pled with a food availability problem, because
most poor countries are facing significant challenges. Ukraine and Russia would significantly reduce
PHOTO: COURTESY OF FAO; IMAGE: VALERIA MILLER/PEXELS
And the third, of course, is climate change. their exports, including fertilizers. This is a sit-
The war in Ukraine has exacerbated the problem, uation we have to avoid. Under the current con-
as it stopped exports from two key exporters of ditions, we estimate Ukraine could reduce their
cereals: Ukraine and Russia. Around 50 countries exports of wheat and maize by around 40 percent,
depend on these two exporters for at least 30 per- and Russia might do something similar.
cent of their cereal imports. For about 20 of these We are also observing that, because of the increase
countries, it’s more than 50 percent. in the cost of fertilizers, rice production has been
Another factor is that Russia is the world’s lead- affected for next year, and prices are starting to rise.
ing exporter of nitrogen, the second of potassium, In addition, a poor monsoon season is potentially
and the third of phosphorus fertilizer. When it affecting rice sowing in India. These developments

CAFÉ ECONOMICS
pose risks because rice is a key staple around the it take to help producers find alternative means
world, including in sub-Saharan Africa. to increase agricultural output?
If I had a say in which countries should have access MTC: Climate change has two potential impacts. One
to fertilizers, the key exporters of rice would be a is extreme situations, like droughts or flooding, and
priority, because they will supply the rice we need the other is variability. What we can do with farmers
to minimize food access problems in the next year. is to increase their resilience. One way is to insure
them. In developed countries, farming insurance
F&D: Your research shows that conflict accounts is highly subsidized. Poor countries, on the other
for 72 percent of the increase in food insecurity hand, don’t have the resources to provide this level
since 2016. How do you ensure that countries of subsidies or adequate information for insurance
in conflict have access to food? companies to calculate losses properly.
MTC: Countries in conflict are the most vulnerable We need innovative mechanisms to help insur-
because they are net food importers, in addition to ance companies lower their cost. For example,
having balance of payments problems. We are propos- Mexico started to implement weather index insur-
ing a food import financing facility, which we hope ance, initially with a significant subsidy. Now, com-
the IMF will operationalize. Why is this so critical? panies compete, and the subsidy has been reduced
Because it’s an issue that affects 1.7 billion people. to a minimum. Also, figuring out the science—for
What we are observing in these conflict coun- example, knowing what the more weather-resilient
tries is, first, they are not importing what they need. seeds are—will help farmers determine what to
Second, some are importing foods with low calorie plant to avoid crop losses.
content, which could create significant problems.
Third, they don’t have access to finance because they F&D: How do we prevent the current crisis from
are already too indebted. I am referring to Afghanistan, becoming a full-blown global humanitarian disaster?
Burkina Faso, Burundi, the Central African Republic, MTC: I wouldn’t say we are in a food crisis right now.
the Democratic People’s Republic of Korea, Eritrea, I think we have a very serious food access problem.
Ethiopia, The Gambia, Guinea, Liberia, Mali, If things get worse, and we have a food access and
Mozambique, Niger, Rwanda, Sierra Leone, Somalia, a food availability problem, then we will be in a
South Sudan, Sudan, Syria, Togo, and Yemen. very bad situation.
We believe a food import financing facility could We recommend, of course, continued support
help support these countries immediately by sup- of the humanitarian response. But we need to link
plementing their balance of payments, so they can that to the provision of inputs and cash to maintain
import what they need this year and minimize critical production systems and support the supply
the risk of social unrest, which could exacerbate chains of countries in deep emergencies, which
the situation. They can later repay the cost of the includes Ukraine.
import gap, which is $24.6 billion. For the whole system, the first urgent step is to
help countries cover the gap in the food import bill.
F&D: What are countries doing that may be Then we have to accelerate the process of efficiency
worsening the situation? gains. We need to keep trade open; the level of
MTC: Since these commodities are concentrated in key export restrictions we have right now is extremely
exporting countries, export restrictions are extremely risky. We need to increase transparency of infor-
damaging. More than 20 countries put in export mation, and that is where our Agricultural Market
restrictions by end-July, and we have 17 percent of cal- Information System comes into play. Then we need
ories being trade-restricted. The duration of this export to increase efficiency in the use of fertilizers.
restriction level is longer than what we had in 2007–08, We also need to identify where the new hot spots
when trade-restricted calories were 16 percent. of food insecurity are so that social protection
If we have rice shortages, many countries will programs can be retargeted to be more effective
start imposing export restrictions, and that will and efficient.
only make things worse.
This interview has been edited for length and clarity.
F&D: Given so much dependence on rain-fed Listen to the full conversation at https:/apple.co/
agriculture in food-crisis regions, what would 3zFdVnd.

HALL OF
MIRRORS
A deeper understanding of how consumers
think about the economy would help
policymakers control inflation
Carlo Pizzinelli
W
ith inflation rising to levels unseen
in decades, households across the
world are asking themselves how
much more they can expect to pay
for gasoline, groceries, and other necessities. Their
answers may help them make important personal
financial decisions. Should they go ahead and buy that
new refrigerator, rather than wait until later and risk
seeing the price go up? Should they ask their boss for
a raise to make up for the loss of purchasing power?
The answers won’t affect just individual house- Powell’s statement explains why policymakers care-
holds but the economy as a whole. The reason: cen- fully monitor households’ and firms’ inflation expec-
tral bankers and academic economists view inflation tations, measured through regular surveys, at different
partly as a self-fulfilling prophecy. If consumers time horizons. In particular, increased forecasts for
believe prices will rise at a faster pace, they may inflation in three to five years signal that expecta-
behave in ways—buying a refrigerator or asking for tions are becoming unmoored and that an interest
a raise—that will fuel more inflation. More money rate increase may be needed to keep inflation under
chasing a fixed number of refrigerators will drive up control. This also explains why central banks try to
their price, and more people asking for a raise will shape the public’s expectations of future develop-
prompt employers to mark up the prices of goods or ments by explaining their current and future policies.
services they sell to make up for higher labor costs. Indeed, the success of policymakers’ actions crucially
Federal Reserve Chairman Jerome Powell expressed relies on their ability to convey the intended effect to
that concern at a recent press conference, when he households and steer their expectations accordingly.
announced a half-point increase in the Fed’s key
interest rate: “We can’t allow a wage-price spiral Coffee, gasoline
to happen,” he said. “And we can’t allow inflation All this raises an important question for academics
expectations to become unanchored. It’s just some- and policymakers alike: How well do we understand
thing that we can’t allow to happen.” households’ expectations? Over the past decade, a

large body of behavioral economics research has dug as experts? Knowing the answers to these questions
deep into this question. The main findings are that would help policymakers better guide consumers’
households hold very disparate views on inflation expectations regarding the effects of their actions.
and tend to perceive it as higher and more persistent In a recent paper, my coauthors and I set out to
than it usually is. Consumers also tend to disagree search for answers (Andre and others 2022). We
on the outlook for inflation more than experts do, conducted surveys to measure people’s beliefs about
they change their view less often, and they often rely the effects of economic shocks on unemployment and
on a few key products they consume regularly—such inflation. From 2019 to 2021, we collected answers
as coffee and gasoline—to extrapolate changes in from samples of 6,500 US households broadly repre-
the overall cost of living. Furthermore, individual sentative of the population. Separately, over the same
expectations are strongly correlated with demographic period, we surveyed 1,500 experts, including staff at
characteristics including sex, age, education, and central banks and international financial institutions,
political orientation. For instance, women and people professors and PhD students, and financial sector
with less education or lower incomes tend to expect economists. For the samples of the survey collected
higher inflation. Finally, past experiences—such as during the COVID-19 pandemic, we adjusted the
living through the Great Depression or the 1970s questionnaire to ensure that the respondents’ expec-
Organization of the Petroleum Exporting Countries tations referred to how the economy functions in
(OPEC) oil embargo, which drove inflation sharply “normal times” rather than during the exceptional
higher, can strongly shape people’s perceptions of circumstances of the pandemic.
inflation for the rest of their lives (Malmendier
and Nagel 2016; Weber and others, forthcoming; Hypothetical shocks
D’Acunto, Malmendier, and Weber, forthcoming). We used the survey to shed light on how people
While these results characterize the richness and think about the way the economy works—or in the
complexity of households’ expectations, they do not language of economists, their “subjective models.”
quite break down how those expectations are formed. We asked respondents to consider four hypothetical
When nonexperts read news about monetary and shocks to the US economy: a sharp increase in crude
fiscal policy or economic events, how do they factor oil prices as a result of falling world supply, a rise in
ART: ISTOCK / FRANCESCOCH
that information into their expectations for inflation income taxes, a federal government spending increase,
and other key indicators? Is it safe to assume, for and a rise in the Federal Reserve’s target interest
effective policymaking and for theoretical models, rate. These shocks are widely studied in macroeco-
that laypeople form expectations in the same way nomics but are also conceptually understandable by

nonexperts. To make sure that all the respondents households and within the two groups. Part of the
based their answers on the same information, we disagreement seems to arise because respondents
provided current figures for the rates of inflation and think the shocks work through different transmission
unemployment and asked them to give their forecasts channels—in particular, demand- versus supply-side
for the two variables over the following year. We then mechanisms. Using a set of multiple-choice ques-
provided news about one of the four hypothetical tions and open text boxes, we asked respondents to
shocks and asked them to make new predictions for describe what they were thinking when they made
inflation and unemployment. their predictions. We found that these associations
Their responses showed that beliefs about the explained a substantial part of the differences in
effects of economic shocks were widely dispersed, forecasts. Unsurprisingly, experts were most likely to
with large differences within our samples of house- rely on their technical knowledge, using frameworks
holds and experts and between the two groups. In taken from their everyday toolkits and often making
some cases, households and experts even disagreed direct reference to theoretical models or empirical
on whether a particular shock had a positive or studies. By contrast, households drew on a broader
negative impact on inflation and unemployment. range of approaches in making their predictions.
Most strikingly, households on average believed They were more likely to rely on personal experi-
that a rise in the central bank’s policy interest rate ences, be influenced by political views, or simply
and a rise in income taxes would increase inflation, guess how a given shock might affect the economy.
contrary to predictions of a decrease by experts and Moreover, when households think of specific shock
many textbook models (Chart 1). propagation mechanisms, they often come up with
In the second part of the survey, we investigated very different channels than experts. This in turn
the origins of disagreement between experts and partly explains why their predictions for some shocks
differ so markedly from those of experts. For instance,
households more often thought about the impact
Chart 1 of higher interest rates on firms’ costs of borrowing
Divergent views capital, which are passed on to consumers via higher
Households’ predictions for the economy often differ from those of experts. prices. On the other hand, experts mostly considered
(average forecasts for the impact of macroeconomic shocks on inflation and the unemployment rate) the canonical demand-side channel, which predicts
a decline in inflation in response to higher interest
General population Experts rates as consumers spend less and save more (Chart 2).
Government Federal Contextual cues

Oil price spending funds rate Income taxes
0.75 pp Are these results bad news for central bankers? If
the general public interprets an interest rate hike
0.50 pp
as a harbinger of higher inflation, might central
0.25 pp banks find it more difficult to succeed at keeping
0.00 pp
inflation at bay? One final result from our exer-
cise points to effective communication of policy
–0.25 pp actions as a solution. Contextual cues can shape
–0.50 pp which propagation channels individuals think of
∆π ∆u ∆π ∆u ∆π ∆u ∆π ∆u and thereby which forecasts they make. We saw
that households that were prompted to think about
demand-side channels before making their forecasts
Source: Andre and others (2022). were more likely to predict an effect of monetary
Note: The figure displays the average forecasts of the effects of macroeconomic
shocks on the inflation rate (π) and the unemployment rate (u). Error bars represent 95 policy shocks in line with that of experts.
percent confidence intervals, using robust standard errors. pp = percentage point. Encouragingly, while central bankers have long
been aware of the power of their carefully crafted

Chart 2
Changing channels
Households and experts see shocks working in different ways.
(thoughts about the channels through which a Federal Reserve rate increase affects the economy)
Households Experts
statements to guide market expectations, it seems they
are now focusing more on making their communi- Supply (-)
cation accessible to a wider audience. For instance, Raise firm prices due to
Gardt and others (2021) show that, as part of a broader higher interest rates
Reduce labor demand due
strategy to expand the reach of their message, in recent to higher interest rates
years the European Central Bank has built a presence
Demand (-)
across social media platforms and has used simpler
Lower product demand
language in speeches and monetary policy statements. due to lower income
The results of our study also provide some empir- Invest less due to
higher interest rates
ical guidance in a different but related direction. Lower product demand due
Canonical macroeconomic models crucially hinge to higher interest rates
on the assumption of “rational expectations,” Reduce labor demand due
to lower demand
according to which households base their individ- Reduce firm prices due
to lower demand
ual decisions—on how much to save, consume,
and work—on expectations about the uncertain Other
future state of the economy. These expectations in Raise firm prices to
maintain firm profits at
turn are consistent with the way the economy even- lower product demand
0% 20% 40% 60% 80% 0% 20% 40% 60% 80%
tually evolves. The assumption does not mean that
households have perfect knowledge of the future. Frequency
But it does imply that if households see the central
bank raising interest rates unexpectedly, and they
Source: Andre and others (2022).
believe this will lower inflation, their subsequent Note: This figure shows which propagation channels are on respondents’ minds when
actions will ultimately lead to a decline in inflation. they make their predictions. Respondents can select the channels from a list. Error bars
While this approach to modeling expectations has display 95 percent confidence intervals.
often been criticized as too strict or unrealistic,

deciding the appropriate way to depart from it is not
straightforward. To be meaningful, any departure potential to fundamentally shape both theoretical
from this pillar of modern macroeconomics must macroeconomics and real-world policymaking in the
realistically reflect how households actually form years to come, and it will most likely find a key role
expectations. Our study thus provides a preliminary for communication in influencing expectations.
direction for macroeconomic models to incorporate
behavioral aspects of households’ expectations that CARLO PIZZINELLI is an economist in the Research
are grounded in empirical evidence. Department of the IMF.
A growing research effort—spearheaded by prom-
inent academics in the field—aims to use insights References:
from behavioral economics to embed behavioral Andre, P., C. Pizzinelli, C. Roth, and J. Wohlfart. 2022. “Subjective Models of the
features of the way households form expectations Macroeconomy: Evidence from Experts and Representative Samples.” Review of
in macroeconomic models and depart from clas- Economic Studies, February 9.
sic rational expectations assumptions. This field, D’Acunto, F., U. Malmendier, and M. Weber. Forthcoming. “What Do the Data Tell Us about
known as behavioral macroeconomics, is expand- Inflation Expectations?” Handbook of Subjective Expectations.
ing fast but faces some significant challenges. It is Gardt, M., S. Angino, S. Mee, and G. Glöckler. 2021. “ECB Communication with the Wider
Public.” ECB Economic Bulletin 8:122–42.
math-intensive, which may limit its immediate use in
everyday policy work. Moreover, it relies crucially on Malmendier, U., and S. Nagel. 2016. “Learning from Inflation Experiences.” Quarterly
Journal of Economics 131 (1): 53–87.
empirical evidence of how households reason about
the macroeconomy and form expectations, which Weber, M., F. D’Acunto, Y. Gorodnichenko, and O. Coibion. Forthcoming. “The Subjective
Inflation Expectations of Households and Firms: Measurement, Determinants, and
behavioral economists can solidly build only through Implications.” Journal of Economic Perspectives.
numerous and careful studies. However, it has the

THE NEW ECONOMICS
OF FERTILITY
People and economies will prosper if policymakers help women combine career and family
Matthias Doepke, Anne Hannusch, Fabian Kindermann, and Michèle Tertilt
F
ertility in high-income countries has been force participation and income. Economists have
declining for a hundred years, with few excep- proposed two main explanations.
tions, and in many areas, it is now extraor- The first is known as the quantity-quality trade-off.
dinarily low. In Germany, Italy, Japan, and It suggests that as parents get richer, they invest more
Spain fertility has been well below 1.5 for more in the “quality” (for example, education) of their
than two decades—lower than the average of just children. This investment is costly, so parents choose
over two children per woman needed to maintain to have fewer children as incomes rise. Historically
a stable population size. This means that each new fertility and GDP per capita are strongly negatively
generation is less than three-quarters the size of related, both across countries and over time.
the preceding one. Such ultralow fertility makes The second explanation acknowledges how
for a rapidly rising older population and poses time-consuming it is to raise children. As wages
challenges for governments, economies, and the increase, devoting time to childcare—time that could
sustainability of social security systems. otherwise be spent working—becomes more costly
Substantial economic research on individual fer- for parents, and especially for mothers. The result is
tility decisions has naturally focused on the perva- a decline in fertility and greater female labor force
sive trends associated with this demographic tran- participation. There is in fact historically a strong
sition—primarily negative relationships between negative association between female labor force par-
fertility and income and between female labor ticipation and fertility over time and across countries.

New fertility facts and children is now the exception rather than the
The data show that these relationships are no norm. Most women today want the option of both
longer universally true. Despite a continued neg- a fulfilling career and a family. From a historical
ative income-fertility relationship in low-income perspective, we can interpret this shift as a con-
countries (in particular in sub-Saharan Africa), vergence of women’s and men’s overall life plans
it has largely disappeared both within and across after a long period of sharply divided gender roles.
high-income countries. The same is true for the
relationship between fertility and female labor Chart 1
force participation. In a recent survey (Doepke
Births and economic growth
and others 2022) and a VoxEU column (June 11, In just 20 years, the relationship between per capita income and fertility rates
2022), we outline these new empirical regularities changed dramatically.
and discuss the key factors that explain fertility (total fertility rate [births per woman] and GDP per capita in selected OECD countries)
outcomes in recent decades. 1980 2000
For a long time, high per capita income in a
country reliably indicated low fertility. In 1980, 2.4 2.4
PRT ESP USA
fertility was still well above two children per woman 2.0 FRA AUS USA 2.0 FRA
in poorer countries, such as Portugal and Spain, but AUS NOR
JPN ITA NORSWE CAN PRT FIN NLD
just 20 years later, fertility in the same set of coun- 1.6
FIN DEU NLD
1.6 CAN SWE
tries had changed substantially (Chart 1). In fact, in JPN DEU
1.2 1.2 ESP ITA
2000 the United States, the second-richest country
in the sample, exhibited the highest fertility rate. 8.8 9.0 9.2 9.4 10.0 10.2 10.4
The fertility pattern across families in high-income Log of per capita GDP Log of per capita GDP
countries (such as France, Germany, and the United
Source: Doepke and others (2022).
States) has changed as well. Historically, the relation- Note: OECD = Organisation for Economic Co-operation and Development. Data labels
ship between female education and fertility is clearly use International Organization for Standardization (ISO) country codes.
negative, consistent with higher wages increasing the
opportunity cost of raising children. Yet this nega-
tive relationship is weaker for US women of recent
birth cohorts (Chart 2). Although highly educated Chart 2
women with more than 16 years of schooling had Education and fertility
the lowest fertility rate in 1980, this no longer held Highly educated US women with more than 16 years of schooling had the lowest
true in 2019 (see also Hazan and Zoabi 2015). fertility rate in 1980, but by 2019 this no longer held true.
(normalized hybrid fertility rate, births per woman)
Career-family compatibility
The recent empirical regularities point to fertility 1.0
behavior in high-income countries today that is
driven by factors not immediately captured by 0.9
the quantity-quality trade-off nor the opportunity
cost of time. Researchers across disciplines had to 0.8
contemplate alternative mechanisms responsible
for within- and across-country fertility patterns in 0.7 2019
2010
high-income countries (see Rindfuss and Brewster 2000
0.6
1996 and Ahn and Mira 2002 for early contribu-
ART: ISTOCK/LAYLABIRD, RIDOFRANZ, LECHATNOIR
1990
tions). A common theme has emerged from this 0.5 1980
broad scholarly discussion: the compatibility of
< 12 12 13–15 16 >16
women’s careers and families.
There has been a fundamental economic trans- Years of schooling
formation: in many high-income countries women
Source: Doepke and others (2022).
now participate in the labor force for much of their Note: The normalized hybrid fertility rate (HFR) was obtained by dividing all HFRs by the
lives. The earlier pattern of a woman entering the HFR for the lowest education group in each decade.
labor market but dropping out following marriage

Cheap and easily available childcare
frees up women’s time and allows them Finally, labor market conditions also affect
career-family compatibility. In Spain, for example,
to combine motherhood with a career. a country with a two-tier labor market where jobs
are often either temporary or for a lifetime, women
tend to postpone childbearing in hopes of landing
While the shift in women’s career plans is shared a stable job first. Such labor market conditions
across high-income countries, there is still substan- naturally dampen fertility. More generally, when
tial variation in how compatible women’s careers unemployment is high, temporary jobs are common
and families really are. Four factors explain the and permanent jobs are hard to obtain—even taking
variation in career-family compatibility across temporary leave to start a family can have long-term
countries: family policies, cooperative fathers, repercussions for women’s labor market prospects.
favorable social norms, and flexible labor markets. Fertility rates may consequently be lower than in a
A key determinant of career-family compatibility setting where secure, long-term jobs are easy to find.
is women’s access to affordable alternatives to the
time devoted to caring for children, time historically Policy implications
provided exclusively by mothers. In some countries, For policymakers concerned about ultralow fertility,
such as the United States, these alternatives are the new economics of fertility does not offer easy,
largely organized in private markets, while many immediate solutions. Factors such as social norms and
European countries offer publicly provided child- overall labor market conditions change only slowly
care. Cheap and easily available childcare frees up over time, and even potentially productive policy
women’s time and allows them to combine moth- interventions are likely to yield only gradual effects.
erhood with a career, which ultimately increases Yet the clear cross-country association of fertility rates
fertility. In countries such as Sweden and Denmark, with measures of family-career compatibility shows that
where public childcare is widely available for children ultralow fertility and the corresponding fiscal burden
of all ages, female employment and fertility rates are not inescapable, but a reflection of a society’s poli-
today are higher than in countries where child- cies, institutions, and norms. Policymakers should take
care is sparse. Not surprisingly, these countries also note and take a career-family perspective. Investing in
spend a larger fraction of their GDP on public early gender equality—and especially the labor market pros-
childhood education. Other policies that influence pects of potential mothers—may be cumbersome in
career-family compatibility include parental leave the short run, but the medium- and long-term benefits
policies, tax policies, and the length of the school day. will be sizable, for both the economy and society.
Fathers can of course care for children as well.
Although historically fathers have spent little time MATTHIAS DOEPKE is a professor of economics at
caring for children, the data show an increase in Northwestern University. ANNE HANNUSCH is an assistant
recent decades. The division of childcare between professor of economics at the University of Mannheim.
parents has important implications for fertility when FABIAN KINDERMANN is a professor of economics at the
parents contemplate the decision to have children. University of Regensburg. MICHÈLE TERTILT is a professor
Doepke and Kindermann (2019) show that in coun- of economics at the University of Mannheim.
tries where fathers engage more in childcare and
housework, fertility is higher than where such labor References:
falls disproportionately on women. Japan, where Ahn, Namkee, and Pedro Mira. 2002. “A Note on the Changing Relationship between
men share little in caring for children, bears this Fertility and Female Employment Rates in Developed Countries.” Journal of Population
out: fertility there continues to be ultralow. Economics 15 (4): 667–82.
A third influence on modern fertility deci- Doepke, Matthias, Anne Hannusch, Fabian Kindermann, and Michèle Tertilt. 2022.“The Economics
sions is social norms regarding a mother’s role at of Fertility: A New Era.”CEPR Discussion Paper 17212, Centre for Economic Policy Research, London.
home and in the workplace. Low fertility can be Doepke, Matthias, and Fabian Kindermann. 2019. “Bargaining over Babies: Theory, Evidence,
and Policy Implications.” American Economic Review 109 (9): 3264–306.
a result of traditional social norms. For example,
the characterization of a full-time working mother Hazan, Moshe, and Hosny Zoabi. 2015. “Do Highly Educated Women Choose Smaller
Families?” Economic Journal 125 (587): 1191–226.
as a Rabenmutter (bad mother) is still common
in Germany and imposes an implicit penalty on Rindfuss, Ronald R., and Karin L. Brewster. 1996. “Childrearing and Fertility.” Population and
Development Review 22:258–89.
mothers who aspire to both family and career.

BOOK REVIEWS
Governance,
Assistance, and
Interference
THE GUARDIANS OF THE GLOBAL ECONOMY may be
established fixtures today, but their roots in Allied Jamie Martin
supply management during World War I were The Meddlers:
once controversial. Sovereignty, Empire,
That’s the starting point for Jamie Martin’s com-
and the Birth of Global
prehensive history of the formation of international
financial institutions, which opens at the close of Economic Governance
the Great War, a quarter century before Bretton Harvard University Press,
Woods. His book is a deeply researched contextu- Cambridge, MA, 352 pp., $39.95
alization of what led to the 1944 New Hampshire
conclave that birthed the IMF and World Bank.
Martin, an assistant professor of history and for everything from arms to autos. Martin illumi-
social studies at Harvard, is critical, but global nates production and trade controls as “the final
economic governance supporters and detractors interwar innovation in economic governance,”
can learn from his tracing of predecessors like the regulating tin markets in colonies and countries.
League of Nations and Bank for International The arrangement, a precursor to the Organization
Settlements (BIS), created amid war and depression. of the Petroleum Exporting Countries, endured
He begins with wartime supply councils, and until 1985.
the questions they raised about autonomy for The final chapter frames the IMF origins as part
governments. The London-based Nitrate of Soda of the reversal of global apex power. Washington’s
Executive, for example, was a body led by a British Lend-Lease Act provides London with warships in
merchant and staffed by government representatives exchange for eased “imperial preference” in trade
of European allies and the United States. It was across territories—and even wheat production
formed to dominate buying of a key ingredient of controls—while the international monetary insti-
explosives and fertilizer from neutral Chile, the tution proposed by John Maynard Keynes ends up
world’s main supplier. more like the vision of his overshadowed American
The League of Nations Economic and Financial counterpart Harry Dexter White.
Organization, prohibited from interfering in Martin emphasizes unequal sovereignty, which
member nations’ domestic affairs, gained the suggests that tweaks to existing bodies like the
ability to do so in the 1920s with new types of IMF and World Bank “may be insufficient to
conditional lending, Martin writes, detailing the produce a more stable reconciliation of global
resulting resistance from Albania to Austria. As the governance and democratic politics,” and that
global Depression loomed, the creation of the BIS “ambitious thinking” can supersede 20th century
fueled dispute over sovereignty itself, and whether institutions and imperial legacies. His answer may
governments or supposedly apolitical financial be a future book, as it isn’t revealed.
bodies should control monetary policy. “Governing the world economy needs to be
A thorough account of what are, ultimately, dramatically rethought if it is to be made fully
bureaucracies could be tedious, but Martin isn’t. compatible, for the first time, with real economic
Instead, he brings alive forgotten figures who self-determination and democratic self-governance,”
shaped our world—and links future IMF chief Martin concludes, “and for all states, regardless of
(1956-63) Per Jacobsson and top economist Jacques their histories of sovereignty and imagined stand-
Polak to their earlier work at the League. ings in a hierarchical global order.”
One fascinating chapter revolves around tin,
mined mainly in British colonies such as Malaya JEFF KEARNS is on the staff of Finance & Development.

BOOK REVIEWS
Making Progress in the face of economic shocks—expenditures

that disproportionately benefited lower- and
THE LONG MARCH of progress is marked by revo- middle-class people.
lutions, struggles, economic crises, liberations, This “leap forward” was made possible by
injustices, and regressions—the “turning points unprecedented revenue mobilization: from less
where social conflicts are crystalized and power than 10 percent of national income in 1910 to
relationships are redefined,” explains Thomas between 30 and 40 percent by the century’s middle
Piketty in his surprisingly optimistic account of decades. Progressive taxation lowered the massive
human progress toward equality. Building on his concentration of wealth and economic power at
previous works and drawing on the sweeping his- the top, leveling both pre- and posttax inequalities
torical record, Piketty brings his larger argument and garnering collective acceptance for the new
about the origins of inequality and the political, social and fiscal contract.
social, and institutional contexts of its evolution Piketty calls this an “anthropological revolu-
into sharp relief. He shows that human societies tion,” occurring as it did during the gradual ero-
have moved toward measurable improvements in sion of exclusive control by the dominant political
the quality of life and fairer distribution of income classes. Universal suffrage and electoral competition,
and assets, but that it will take novel solutions to spurred by an independent press and the labor union
address today’s inequities. movement, he notes, were instrumental in ensuring
majoritarian prosperity. In addition, the liquidation
of colonial assets and cancellation of public debts
accumulated during the interwar periods freed up
resources for reconstruction and redistribution.
The sharply rising concentration of incomes
and wealth since the 1980s and persistence of
inequity in all its forms speak to the urgency of
the need for transformation. Piketty questions
the centrality of growth to economic prosperity,
arguing that financial liberalization, deregulation,
and loopholes in the international tax system have
favored the largest fortunes to the detriment of
others, including in the global South. The result
is a system where political power and economic
resources have increasingly coalesced.
Thomas Piketty
His proposed solutions include a return to
A Brief History of Equality greater fiscal progressivity: significantly steeper
Translated by Steven Rendall income tax rates on high earners, a global wealth
Belknap Press, Cambridge, MA, 2022 tax on the well-off, basic income programs, and
274 pp., $27.95 cancellation of debts. Progress would be marked
by publicly financed elections, worker involve-
ment in the management of large enterprises, a
The two world wars and the dislocation of the welfare state that extends beyond national borders,
Great Depression are the backdrop of Piketty’s and revision of global treaties to address climate
“great redistribution”—the dramatically reduced change and the unequal distribution of wealth.
income and wealth inequalities across much of the Past experience, Piketty notes, offers hope that
Western world between 1914 and 1980, thanks to such “a profound transformation of the world
the rise of the welfare state and progressive taxation economic system” is possible.
of income and wealth. The welfare state boosted
equality of access to education and health care, ERA DABLA-NORRIS, assistant director, IMF Asia and
transportation, old-age pensions, and insurance Pacific Department

BOOK REVIEWS
Leading the Way

CHINA’S DRAMATIC GROWTH and its implications
for the world economy have fueled new books at a
pace commensurate with the subject. A recent wave
includes an important book by C. Fred Bergsten,
founder of the Peterson Institute for International
Economics and an established Washington elder, C. Fred Bergsten
on global economics. The United States vs.
Bergsten focuses on what China’s growing role China: The Quest for Global
in the international economy means for US lead-
ership in the post–World War II global economic
Economic Leadership
Polity Press
order, whose pillars are cooperative international
Cambridge, UK, and Medford, MA, 2021
institutions (including the IMF), avoidance of
362 pp., $29.95
beggar-thy-neighbor policies, and reliance on mar-
kets and the rule of law.
Bergsten argues that the United States inevita-
bly will have to share global economic leadership obligations and requirements. He discusses several
with China. He rejects as fanciful such notions relevant questions for the Fund, including its
as “containing” China or persuading China to location, governance, and the role of the IMF’s
adopt Western views. The relevant question is Special Drawing Rights (SDRs) in global finance.
which shape a sharing of leadership may take. Bergsten supports US integration into China-led
Bergsten proposes an approach he calls “conditional institutions (such as the Asian Infrastructure
competitive collaboration,” comprising collabora- Investment Bank) and vice versa, and—perhaps
tive US-China leadership on key global economic presciently—a complementary rather than con-
issues, conditional on each country’s fulfilling its frontational approach to projects such as the Belt
obligations in the international economic system. and Road Initiative.
The countries should consult closely on systemic The book calls for domestic reforms to underpin
matters involving global public goods (such as the outward orientation of US economic policy and
climate change), be flexible about the balance of its global economic role, including stronger social
leadership on specific issues (with China having safety nets and mechanisms to address the inequal-
greater sway on development finance, for example, ities associated with globalization, which provides
and the United States on international financial large aggregate gains but distributes them unequally.
and monetary issues), and differentiate between Bergsten’s book is important for its breadth of
the global and regional arenas. perspective and depth of knowledge. While it
Bergsten recommends the United States seek to deals extensively with foreign policy and history,
uphold, with other major countries, the collabo- it is on international economic issues that it is
rative international economic system. Economic most insightful and perhaps most relevant for
leadership should be decoupled from issues such as F&D readers. A caveat is that the issues are seen
national security and values, traditional alliances from an essentially US perspective. The lay of the
should be restored to strengthen the international land may look different when viewed from China
consensus on key global matters, and a multilateral or, for that matter, Europe, Japan, or elsewhere.
trade reform package should be completed with There is much to learn from the literature that
China involved in writing the rules. has emerged around the world on these issues by
Regarding international financial institutions Yukio Hatoyama, Robert Kagan, Yan Xuetong, and
and cooperation, Bergsten envisions a need even- others, and Bergsten’s book is a good addition.
tually for broad equivalence between China and
the United States at the IMF, including on quotas VIVEK ARORA, deputy director, IMF African Department, and
and voting parity, with countries accepting related former IMF senior resident representative in China

CURRENCY NOTES
Taking Digital Currencies Offline

In many regions, internet-free access may be a make-or-break
feature for central bank digital currencies
John Kiff
AS THE WORLD’S CENTRAL BANKS RUSH to develop in places like China and Sweden. Central banks
digital currencies, almost all the research and trials don’t want to leave billions of transactions in
focus on internet-based technology. What will the hands of internet payment platform oper-
happen when the web goes down in a war or a ators. And it’s an issue of financial inclusion
natural disaster? And what about the 75 percent for millions of people who can’t afford to use
of the world’s adult low-income population that the conventional banking system or don’t have
doesn’t even have internet access (World Bank internet access.
Findex Database)?
That’s where a little-noticed but long-running Offline digital currencies
push to develop offline digital payment systems Offline digital payment systems could verify avail-
comes in. Some of this work goes back 30 years, to ability of funds and validate transactions with-
a time long before smartphones. In fact, the future out the need to check in with an online ledger.
of offline central bank digital currencies (CBDCs) They could use old-tech, non-internet-driven
may lie in the technological past. mobile phones or something like a souped-up
But wait. Why do central banks in developing stored-value card.
economies like Ghana or Uruguay want to give Back in 1993, the Bank of Finland launched
people some fancy digital currency to replace their its Avant stored-value card. It was capable of
cedis or pesos? offline payments using a custom-made card
There are several compelling reasons. One is reader device, but it never caught on and was
better risk management as digital currencies may dropped in 2006. National Westminster Bank in
be harder to steal than bales of paper money. the United Kingdom tested a similar stored-value
Much of the world’s consumer commerce already payment platform called Mondex in 1995. Avant
takes place digitally—well over 90 percent of it and Mondex showed that the technology worked,
but not enough merchants acquired the required
point-of-sale devices. And even though both
allowed peer-to-peer transactions, users had to
access it through special devices.
Recently, several enterprises have launched
PHOTOS: COURTESY OF WHISPERCASH; URBAN COW GETTY IMAGES
updated versions of the Avant and Mondex con-

cepts that are capable of handling offline pay-
ments. Users send and receive funds by exchanging
multi-digit authorization codes, either manually
or using near-field communication (NFC) con-
nections. Some require intermediary devices such
as mobile phones or online connections to fully
settle transactions, but that is to keep the device
costs down and eliminate the need for internal
battery power.
For example, the 170-year-old German banknote
WhisperCash’s credit-card-sized device: The company is the first to develop a battery-powered card for offline company Giesecke+Devrient is testing an offline
CBDC payments. CBDC platform with the Bank of Ghana based

on a stored-value card. It is configured to allow like limits on transaction amounts and balances,
for unlimited consecutive offline transactions but need to be protected because modifying them
uses an intermediary device. The eCedi can be could allow the misuse of funds. Such limits
used by anyone with either a digital wallet app or also play a role in enforcing financial integrity
a contactless smart card that can be used offline. regulations. On-device analytics or periodic
The People’s Bank of China has reportedly been synchronization with a trusted verification ser-
experimenting with similar hardware wallets as vice could be used to allow identification of
part of its trials of the digital yuan. suspicious transactions.
The cost of some of these devices may put them The Bank of Canada is exploring such uni-
out of practical reach for many people. For exam- versal access devices intended to incorporate
ple, the fintech company WhisperCash offers a attributes of cash and prevent the interruption
sophisticated battery-powered credit-card-sized of digital transactions in case of an infrastruc-
device for conducting digital currency transactions ture failure. In its exploratory work on a digital
that costs about $70. euro, the European Central Bank is considering
But the company has also rolled out an offline functionality.
offline platform that piggybacks on text-based, Whether any of these ideas will go into full oper-
non-internet-enabled mobile phones. Known as ation is an open question, but it does seem that in
“feature phones,” they can be had for as little as many regions offline access may be a make-or-break
$5. The WhisperCash system involves a $2 device feature for central bank digital currencies.
that’s attached to the phone’s SIM card.
Even in low-income countries, 66 percent of JOHN KIFF is a retired IMF senior financial sector expert
adults own at least such a phone. In 2017–18 the focusing on fintech and digital currencies. Now he works as a
Central Bank of Uruguay conducted a successful consultant to central banks; his clients include WhisperCash.
six-month test of a CBDC that users could access
using feature phones (Sarmiento 2022). Reference:
Offline devices typically rely on tamper-resistant Sarmiento, Adolfo. 2022. “Seven Lessons from the e-Peso Pilot Plan: The Possibility of a
hardware to maintain integrity. Policy constraints, Central Bank Digital Currency.” Latin American Journal of Central Banking 3 (2): 100062.

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IMF The Money Revolution Crypto CBDCs and The Future 1662742636

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SEPTEMBER 2022

A new era for

The Money Revolution

THE MONEY REVOLUTION

18 Regulating Crypto 30 Central Bankers’ New

Subscribe at www.imfbookstore.org/f&d Read at www.imf.org/fandd Connect at facebook.com/FinanceandDevelopment

Reimagined Andrew Stanley

A new era for

Finance & Development is

published quarterly by the

International Monetary Fund, 700

2 FINANCE & DEVELOPMENT | September 2022

CAPITAL CONTROLS CUSTOM QUERIES

Scan to access now

4 FINANCE & DEVELOPMENT | September 2022

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6 FINANCE & DEVELOPMENT | September 2022

households moved their money out of regular bank

September 2022 | FINANCE & DEVELOPMENT 7

8 FINANCE & DEVELOPMENT | September 2022

INSIGHTS & ANALYSIS ON

September 2022 | FINANCE & DEVELOPMENT 9

10 FINANCE & DEVELOPMENT | September 2022

September 2022 | FINANCE & DEVELOPMENT 11

Central bank Central bank

12 FINANCE & DEVELOPMENT | September 2022

1. Safety and stability

September 2022 | FINANCE & DEVELOPMENT 13

14 FINANCE & DEVELOPMENT | September 2022

on Marketnode’s servicing platform that facilitates

September 2022 | FINANCE & DEVELOPMENT 15

16 FINANCE & DEVELOPMENT | September 2022

It is not unreasonable to imagine a future in which the digital asset

September 2022 | FINANCE & DEVELOPMENT 17

typical disclosure or reporting requirements. Finally, in addition to developing a framework

18 FINANCE & DEVELOPMENT | September 2022

September 2022 | FINANCE & DEVELOPMENT 19

20 FINANCE & DEVELOPMENT | September 2022

ART: ISTOCK / HAKULE

September 2022 | FINANCE & DEVELOPMENT 21

22 FINANCE & DEVELOPMENT | September 2022

September 2022 | FINANCE & DEVELOPMENT 23

‘DeFi’ and ‘TradFi’ Must Work Together

ransom-demanding hackers exploited the fact that

24 FINANCE & DEVELOPMENT | September 2022

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26 FINANCE & DEVELOPMENT | September 2022

The Superficial Allure of Crypto

trigger cascades into significant problems). So any

September 2022 | FINANCE & DEVELOPMENT 27

28 FINANCE & DEVELOPMENT | September 2022

Applying laws and rules to centralized crypto intermediaries

September 2022 | FINANCE & DEVELOPMENT 29

30 FINANCE & DEVELOPMENT | September 2022

Technology enables central banks to ensure that both

September 2022 | FINANCE & DEVELOPMENT 31

32 FINANCE & DEVELOPMENT | September 2022

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34 FINANCE & DEVELOPMENT | September 2022

Centralized systems rest on a very strong assumption:

September 2022 | FINANCE & DEVELOPMENT 35

FINANCIAL INCLUSION SECURITY TOKENS

DECENTRALIZED FINANCE (DEFI)

18 Regulating Crypto 30 Central Bankers’ New