Paper currency is disappearing. Covid has hastened its demise, but the trend was already clear. Within a few decades, dollar bills will likely join gold coins as numismatic collector items. But while the disappearance of paper currency is the most visible implication of the digital revolution in money, it may not be the most important one.

The nature of money raises profound questions of private and public ordering—of liberty and the state. The digital revolution is intensifying the tensions between these forms of private and public ordering by making possible both digital private currencies in the form of cryptocurrencies, such as Bitcoin and Ethereum, and digital fiat currencies in the form of Central Bank Digital Currencies (CBDCs).

In The Future of Money: How the Digital Revolution is Transforming Currencies and Finance, Eswar S. Prasad considers both private and public crypto in our new digital world. As an economist, he weighs the costs and benefits of both private and public digital currency, but he is far more skeptical of private varieties and more optimistic about the public kind.

Prasad nicely helps readers understand why private cryptocurrency like Bitcoin has been widely heralded as a libertarian moment. The geniuses who devised these technologies wanted an alternative to state-controlled money. Their idea, as explained by Prasad, is that the trust needed to make money a store of value does not need to be provided by the state. Instead, Bitcoin, for instance, creates trust by requiring a consensus of people with computers—called miners—to verify all transactions. It thus cuts out banks as intermediaries, the institutions which currently keep the ledgers to verify our financial transactions.

The Bitcoin algorithm also puts a limit on the number of Bitcoins that can ever be “minted.” That limit creates trust in the long-term value of the currency because the inflation that decreases value is not possible. Finally, Bitcoin generates trust from the part of its algorithm that pays current miners in Bitcoin for verifying transactions—thus giving them a stake in its long-run value.

By contrast, the dollar’s value depends on trust in the state. It is the Federal Reserve’s responsibility in the first instance, but the Federal Reserve exists at the sufferance of the federal government. And while the Federal Reserve is independent in the sense that its leaders cannot be dismissed at will, its appointees are still selected by the President and therefore reflect his vision for monetary policy, which affects the value of the currency. Presidents and Federal Reserve appointees, after all, may have priorities that diverge from those of the individual currency holder—that the dollar maintains its value and thereby his own wealth. As citizens of Venezuela and Argentina know all too well, it is impossible to separate a public currency from the politics of the nation that issues it. Prasad recognizes that public control creates private risks for citizens, because the government may inflate the currency, harming savings and economic growth.

Skepticism of Private Crypto

Prasad is nevertheless skeptical about private crypto because he believes it fails in the fundamental requisites of a currency, being neither a good mechanism of exchange nor a sound store of value. For instance, Bitcoin, the cryptocurrency with the largest market capitalization, can process only seven transactions per second because of the inherent limitations on the capacity of the process by which it reaches consensus on updating its ledger. As a result, it is used in only a very small percentage of the total financial transactions on any given day. Credits cards, banks, and other financial intermediaries dwarf it in size. Thus, for all of Bitcoin’s technical innovation, the dollar remains the principal medium by which goods are bought and sold.

Prasad also argues that Bitcoin is not a good store of value given its much greater price volatility compared to major currencies like the dollar or the euro. Risk-averse citizens thus continue to hold most of their wealth in these traditional currencies. Moreover, it prevents the government from using the currency to pursue a beneficial monetary policy. Indeed, because there will only be a limited amount of bitcoin ever minted, Prasad argues, relying on it would be damagingly deflationary: as the gross product of the world increased, the nominal value of goods and services measured in bitcoin would decrease. Many economists believe that deflation is damaging because companies must pay back debt in dollars that have become more valuable. They might then react by cutting production and employment, thus decreasing demand in the economy.

There are reasonable responses to all of these criticisms, however. It is true that Bitcoin itself has capacity limitations. But it is a mistake to think of cryptocurrency simply as a set of separate, individual denominations. It is instead an ecosystem where some currencies will specialize in certain tasks. Because of its widely distributed and therefore very trustworthy system of verification, Bitcoin will specialize in being used for long-term holdings. Other cryptocurrencies will have better capacity for short-term transactions. Different cryptocurrencies will give consumers power in different situations even if Bitcoin becomes the one cryptocurrency to rule them all.

It is true that Bitcoin is volatile. But it has become less volatile over time. It needs to continue to gain in price not only to attract investors, but also to lessen volatility to attract those who would like to hold it as a means of payment. If Bitcoin comes to enjoy steady growth and demand, it will likely be able to attain an acceptable level of volatility, while at the same time reaching a broader market. Here is one plausible scenario: as it replaces less trustworthy currencies (like the Venezuelan Bolivar) and becomes a better hedge against inflation than gold, it is likely to become more stable.

It is true that if Bitcoin became the world’s reserve currency, it would be deflationary, because its increase in the money supply would not match economic growth. But there is a plausible argument that deflation is only a substantial problem if it is unexpected. If deflation is expected, companies can plan their borrowing accordingly and will not be forced to unexpectedly cut production. And with Bitcoin, deflation would be as predictable as worldwide economic growth, because its value would increase in line with that growth.

Confidence in State Crypto

Because of his doubts about private crypto, Prasad is a booster of digital competitors—primarily central bank digital cryptocurrency (CBDC). Cryptocurrency does not necessarily need to be private. Governments could issue their own digital currency: dollars, euros, and renminbi could all become digital and eventually exclusively so. The rise of CBDCs would provide a dramatic counterpoint to the libertarian vision of cryptocurrency.

Prasad’s defense of public cryptocurrency reflects his skepticism of the private forms. He regards the government’s role in currency as essential because it is only the government that can guarantee the stability of the currency and protect against ruinous runs on banks. Even this basic assumption is open to doubt. For instance, private currencies flourished in eighteenth-century Scotland, and were crucial to that nation’s rapid development. They were successful both as a medium of exchange and as a store of value until the national Bank of England decided to squash a competitor.

Prasad also believes that central banks will adopt cryptocurrencies available to consumers because they have other advantages over paper money. For instance, they allow governments to track the use to which the money is put, because the government keeps the ledger of transactions. As a result, they inhibit black markets and criminal activity facilitated by cash.

CBDCs also permit central banks to break through the “zero rate interest boundary.” Currently, central banks cannot create negative interest rates easily because if banks are forced to charge consumers for holding their money, they will take their money out of banks. But if all currency is digital, the central bank can itself reduce the absolute value of people’s money over time by varying the algorithm that creates the money.

According to Prasad, CBDCs would also allow government to target economic stimulus more effectively. The government could distribute money with an algorithm that will make it valueless unless it is spent within a certain time or for certain kinds of transactions.

But simply stating these “advantages” shows how government digital cryptocurrencies provide enormous new powers to the state. The central bank could track all your purchases. It could reduce even the nominal value of your money. It could tell you what you are permitted to buy. The state would become a monetary panopticon and a potential central controller of a citizen’s economic life.

The Paradox of CBDCs

A CBDC thus confirms the worst libertarian fears of those who launched private cryptocurrency. Given that a CBDC would give the government so much more power, CBDCs would require even more trust in government—a trust that is hard to justify. Even the past performance of the Fed has made many people wary of giving it power. For instance, the current value of the dollar is only three percent of what it was when the Federal Reserve began. Moreover, trust in government in general is falling and that decline also affects the Fed.

As a result, there may be a paradox in the introduction of CBDCs. They are being conceived in large measure to mirror and compete with private cryptocurrencies. But because they may threaten to empower the state in ways that many individuals fear, their effect may cause citizens to flee from fiat currency to private crypto. They improve the prospects that private rather than government cryptocurrency will ultimately govern our monetary world.

Ultimately, Prasad’s case for the advantages of public over private crypto is not persuasive, but he does show that we are likely to witness a grand competition between government and private cryptocurrency. The digital age has not guaranteed a victory for private currency so much as set up another fierce battle between private and public ordering, between the collective force of the state and the innovation of human genius.