Cryptocurrencies could lead to financial instability, author warns

• Cryptocurrency enthusiasts say the digital money will democratize finance.
• Economist Eswar Prasad has some more unsettling predictions.

By redistributing power away from the government and Wall Street and to the people, cryptocurrency will democratize finance, enthusiasts of the digital money say.

Economist Eswar Prasad, however, foresees a more complicated and, at times, dangerous reality.

In Prasad's telling, bitcoin is likely one long-lasting bubble, and digital money could leave the government with more control than ever, while making wealth inequality much worse. He sees other risks, too.

"Cryptocurrencies may contribute to monetary and financial instability, especially if they were to spawn a large and unregulated financial system that lacks investor protection," he said.

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CNBC spoke with Prasad, an economics professor at Cornell University and a research associate at the National Bureau of Economic Research, about the predictions in his new book, The Future of Money, published by Harvard University Press. The exchange has been edited and condensed for clarity.

Annie Nova: What does the emergence of cryptocurrencies tells us about what we want from money?

Eswar Prasad: There's a sense that the way the financial system is set up right now favors those who are already wealthy, that a lot of the investment opportunities are only available to them. And I think there is a desire to level the playing field. Cryptocurrencies could allow you to undertake transactions without, say, having to go to a financial institution. And how much money you have doesn't matter, at least in principle.

AN: What do you think will happen to cash?

EP: I think the convenience of digital payments will win out over cash. It's already happening: There are rich countries like Sweden where cash is barely used anymore. Likewise, in China and India, the use of cash is plunging very fast.

AN: You write about how Facebook is soon coming out with its own cryptocurrency, Diem, and then there's already Amazon Coins. What are some of the concerns about private companies issuing their own money?

EP: There are many. Maybe Facebook will just say, "Well, I don't need to have my currency backed up by U.S. dollars anymore. I can just start issuing it." And then you could have privately issued currencies in direct competition with the U.S. central bank's money. Then we get into all sorts of worrying terrains because now Facebook would have, you know, visibility not just into our social lives, but all aspects of our financial lives.

(Editor's note: Facebook did not respond to a request for comment.)

AN: A lot of people talk about bitcoin as a bubble, but it's been around since 2009. That seems like a long bubble.

EP: History gives us many, many examples of speculative manias that have lasted for a long time. And it's worth remembering that while bitcoin has been around since 2009, the real jump in its value took place only in the last three to four years. But whatever happens to bitcoin's value, I think it's going to leave a very important legacy. It's stoking a fire under central banks to start issuing their own digital currencies.

AN: You write that digital money could give the government an additional instrument of control over citizens. How so?

EP: I think central bank digital currencies are the way of the future. But every central bank will want to make sure that its money is not used for illicit purposes, so transactions will be auditable and traceable. And if every payment you make, including for a cup of coffee or for a sandwich, can be seen by a government agency, that's an uncomfortable proposition. You could, in a more dystopian world, have the government deciding what sort of goods and services its money can be used for.

AN: How could cryptocurrencies widen economic inequality?

EP: Cryptocurrencies and their underlying technology hold out the promise of democratizing finance by making digital payments and other financial products and services easily accessible to the masses. But because of existing inequalities in digital access and financial literacy, they could end up worsening inequality. In particular, any financial risks arising from investing in cryptocurrencies and related products might end up falling especially heavily on naïve retail investors.

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