What do camera manufacturers and banks have in common? They have both made the transition to the digital world, but they are being challenged by disruptive technologies. The smartphone has already destroyed the still camera market. Now the smartphone is in the process of replacing even better camera models.
We’re not quite there in finance, but this process is emerging here too. Decentralized finance, which relies on crypto technologies, began with a modest offering of betting services, financial swaps, and other financial products that did not require interaction with the physical world.
You can’t buy a house that way – not yet. But technology and services are evolving quickly. The big crypto advance this year was the rise of the non-fungible token, a crypto asset that can be used to sell digital works of art – and so much more. Think of it as an automatically enforced digital copyright.
You might be wondering, “What does this have to do with me?” The answer is, the disruptive technologies of the 21st century are going where you are – in governments, in finance, in the media, and even in universities .
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The decentralized financial system, called Defi in technical jargon, is on the way to displacing parts of the financial sector. It’s the great disintermediation, what the supermarkets did with the mom and pop shops. Specialized segments of the financial sector will continue to thrive.
The beginning of the end of fiat money
Universities are a particularly vulnerable target. It is far from clear that they are the best places to learn about the rapidly evolving technologies of the 21st century. Some try to keep up. But the most modern crypto and machine learning technologies are not primarily developed by university researchers, but by companies like Google, Apple and their Chinese competitors, as well as by countless computer geeks in their basements.
Do you know who Sakoshi Nakamoto is? Nakamoto is the pseudonym of the author who wrote the so-called Bitcoin White Paper in 2008, a technical document that formed the basis of the Bitcoin blockchain. Nakamoto can be a man, a woman, or an organization. He may have been a university professor or worked in the private sector.
Some evidence in the paper suggests that the way central banks reacted to the global financial crisis in 2008 may have been a trigger for the creation of the bitcoin. Nakamoto’s genius was to bring together existing technologies in a really original way.
Bitcoin will not replace fiat money – the means of payment set by a government – any more than Defi will replace the entire financial sector. Nakamoto designed Bitcoin as a transactional currency that should be independent of governments. Nakamoto did not claim that Bitcoin would perform all of the functions of money, including a store of value or a unit of account.
But it could be the beginning of the end of fiat money. If central banks fail to control the endemic instability caused by the deregulation of financial markets and asset purchases by central banks, global demand for unofficial money as a store of value will increase.
The late Paul Volcker once joked that the only financial innovation he saw in his lifetime was the ATM. Creating a hack-proof, unofficial transaction currency is likely next. It has already spawned countless other innovations, most notably Ethereum, the blockchain that enables decentralized financial applications.
Bitcoin is volatile because we relate its value to the dollar
The complacent world of central banking and the economy has long denied the threat of cryptocurrency and crypto-financing. This is mainly due to a way of thinking that confuses what must not be with what cannot be. In the world of cryptocurrency, there are no monetary policy bodies, no advisory committees. If you’re an economist, this is a world that works without you.
Central bank digital money is not the answer to cryptocurrencies. You are, so to speak, the hybrid car in a world in which electric cars will soon dominate. If you want to work with digital money in the future, you will likely want the real money and not a digital version of fiat money.
Central bankers view cryptocurrencies as a bubble that will dissolve on its own. There have been cases of bitcoin exchanges crashing, but the bitcoin blockchain has worked without interruption since its inception. Bitcoin is a volatile asset for sure, but keep in mind that this volatility only exists because we relate the value of a bitcoin to the dollar. There is only ever volatility in relation to a reference.
As a longtime observer of the fragile European monetary union, I also wonder whether it is possible that the euro will be called into question by parallel crypto currencies. During the sovereign debt crisis in the euro area, economists in Greece and Italy toyed with the idea of a parallel currency disguised as a short-term debt instrument. In Italy they were called minibots. It was a clever idea, but ultimately doomed because of institutional support and legal restrictions.
A parallel cryptocurrency would be a much more flexible tool. For example, a government could allow taxes to be paid in cryptocurrencies and use the proceeds to pay suppliers. The crypto market would offer some financial services, including fully secured loans. He would offer unregulated savings instruments. Fiat money will not go away, but it will lose its monopoly status. When that happens, the central bankers will find that they are no longer in control. Nobody has to leave the euro – or the EU.
Interaction with politics
At the technological level, the battle is currently not between digital and analog, but between digital and digital. Kodak made the transition from analog to digital sensors, but couldn’t keep up with the competition. Canon and Nikon have switched from analog to digital cameras, but are now being superseded by purely digital smartphones with advanced computer photography.
Another example comes from financial mathematics. The pricing of financial derivatives is based on mathematical models based on profound theories of stochastic processes. They, too, are increasingly being used by machine learning algorithms.
The first generation of translation software was based on clever language algorithms from mathematical linguistics. The experts at the time never took Google seriously because they smugly believed that statistical translation could never compete with their superior knowledge of the structure of the language. The advocates of Artificial Intelligence won the battles.
I suspect that the greatest upheaval will come not only from technology, but also from its interaction with politics. Growing distrust of official institutions, including central banks, has created a demand for an alternative to paper money.
Cryptocurrencies were used for money laundering, but also to finance opposition movements against autocratic regimes. They exist because there is a demand for them. You are a political creature. They exist because capitalist societies have not produced stability and because pseudo-democratic regimes have emerged. And they thrive because they are underestimated by those who are most threatened by them and who do not know how to contain them.
The author is the director of www.eurointelligence.com
More: Political Predictions: Why Analysts Keep Getting Wrong.