What role do digital currencies play in the future of money?

FNA founder and CEO, Kimmo Soramäki, argues that while cryptocurrencies dominate the headlines, the real future of money is far more complicated

by | June 29, 2022 | bobsguide

For the global financial system, ‘the future of money’, including digital currencies, is about more than just rhetoric. There is a very tangible need to understand the impact of changes both big and small. The last financial crisis showed us just how interconnected the industry is – and the catastrophic impact of one false move in one corner of the market.

So, when considering the complex network guiding how money moves across the globe, it can be a daunting prospect to make even marginal gains.

In truth, banks struggle to get a single, bird’s eye view. It appears as a tangled web. But after the financial crisis, banks were asked to upgrade their IT systems and meet new regulations. As a result, they are starting to get a greater understanding and it is simulation technology that makes this possible.

Only once these systems are tracked and visualised, is it possible to start doing scenario analysis, getting data-driven insight into how certain changes (whether regulatory, financial, or technological) will affect the financial system as a whole. All of this combines to help shape the very nature of the financial system in the coming decades.

What will the future of money look like?

We know that the future is digital – and money is no different. Cryptocurrencies certainly dominate the headlines, but they are an interesting phenomenon. They have unquestionably helped accelerate change, but they alone are not going to shape the future of money. Indeed, it is entirely possible that they will not even be a part of it. They’ve been a catalyst for change on a technology level, showing it is possible to do something truly ground-breaking, but the race now is about how to make a tangible difference, rather than simply a theoretical one. The more appropriate battleground is establishing whose money we will use in the future. It’s pretty safe to say that it won’t be the cryptos, as Governments have such a vested interest in money to be pushed to one side.

The common problem, then, is around how any new innovation will impact upon the various institutions that make up the global financial system. The future of money must consider all parties, or find itself doomed to life on the fringes.

Rather than cryptos, it is central bank digital currencies (CBDCs) that are growing in importance. There are more than 60 different nations actively pursuing their own version, intent on retaining control of the future of money. But it is a risky business, as no one truly knows what introducing a CBDC will do to the broader economy. Fundamental to the strategy of any central bank is to reduce risk, by gathering actionable insight into what the impact of any new innovation, CBDC or otherwise, might be. Here, simulation is proving the difference between guesswork and informed decision making. Risk may be the starting point, but there are opportunities as well. Simulations help organisations think things through at a much deeper level, understanding how the financial system connects to drive not just innovation, but efficiency as well.

What about cash?

Much like cryptocurrencies are unlikely to drive the future of money, nor will cash ever truly become obsolete. Compliance requirements are the primary reason for this. Certain technologies (and that includes the invention of cash) never die, but they do become marginalised. Monetary policy rests on the idea that people will always be confident that they can get to the bank and take out money.

This premise gives the banks their legitimisation because customers can always draw out their cash if they want it. Interestingly, because of the pandemic there is more cash out there than ever. According to data from the Fed, almost 20% of all US dollars in circulation has been created in the past year, which shows cash has been used to try to kickstart the economy throughout the pandemic.

We have been there before with large value payment systems, working with banks to help them design how they send money, we help central banks understand the impact of introducing a CBDC – and how that might affect other players such as commercial banks.

What risks must we be aware of?

Firstly, security is the ever-present and rising risk vector that sits at the forefront of many simulation models. Cybersecurity is one of the largest threats to the future of money, so ensuring banks are prepared for the scenarios that might happen is of paramount importance.

For financial institutions, central and commercial banks, national security is a consistent talking point particularly as there are regular reports into attacks made against critical national infrastructure (CNI) and assets. If cyber criminals, or state-sponsored actors seized control, they can literally hold an entire countries economy to ransom.

Interestingly, political pressure comes into play here. In the past year we saw Joe Biden effectively tell President Putin that attacks against CNI were off the table. For financial institutions, they must be prepared for these threats, and anticipate what the consequences of attacks might be for the economy, and market fluctuations.

Read more: Walking the tightrope on crypto regulation

Conclusion

Ultimately, the future of money is intrinsically linked to simulation, and the capability to predict, anticipate and understand challenges along the way. Financial organisations will continue to modernise, but they simply cannot afford to do so without information and insight. Fail and they will risk more than just the bottom line, but their future entirely.

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