The Future of Finance

There are three things that are important in finance: Money; Time; and Risk. If you understand how those three things fit together you understand finance. Of course … things are a bit more complicated than that.

Take the notion of ‘money’ for example. Most people think that they understand what money is. They do have a working knowledge of what money is – they know how it works, but not why it works.

Throughout human history money has been made up of objects and rules. The rules are fairly easy; money must be a medium of exchange, a unit of account, and a store of value. Ideally money should be a stable store of value – this is the Holy Grail of monetary economics. Historically those objects that met these three rules have tended to become ‘money’.

There is no need for money to be a physical object – it can be digital too. In fact, most money is digital and not physical. Money is computer code … and has been for a long time. Whether money as an object is physical or digital – it requires trust.

Historically we trusted money because it was gold or silver, or because it had the emperor’s head stamped on it. Now we trust cash because it has a whole lot of anti-counterfeit technology embedded into it. We trust digital money because we trust the banking system that holds our money. We trust the government that issues cash and regulates the banking system.

Wait … what … did I say we trust the banking system? Or the government?

It turns out that banking and financial crises are quite common. Worse governments have been known to divert the operations of financial markets to benefit themselves – Niall Ferguson has written about the warfare state and George Selgin and Larry White argue financial markets are distorted towards the fiscal needs of the state.

It was at the height of the global financial crisis that the pseudonymous Satoshi Nakamoto launched Bitcoin – a ‘money’ that did not rely on individuals having to trust the banking sector or government. Bitcoin is not just a ‘digital’ money, it is a crypto money. Rather than having to trust the banking system or government, here we trust the code.

Like many other innovations the real story here isn’t the new type of money, but rather the technology that supports the money. The Blockchain that supports Bitcoin is itself remarkable. It is a ledger that keeps track of commerce.

One of the biggest problems in modern finance is asymmetric information – the fact that some market participants have more information than others. In particular, the problem being that they could and would take advantage of that information power imbalance (through insider trading, front running, or other fraudulent behaviour). Many of the institutions and mechanisms that we see in finance exist to either reveal information or economise on the use of information. This is where trust becomes so important.

In a blockchain world, however, the problems of asymmetric information are minimised (but not eliminated) and as such many of the familiar mechanisms and institutions of finance are now redundant. Going forward this means much less complication in finance, more financial products aimed at niche markets, and more people being able to access (previously complex and sophisticated) financial products.

One of the core ingredients of finance – money – has been revolutionised. It is unsurprising then that we should see finance itself being revolutionised.

Author:

Sinclair Davidson is Professor of Institutional Economics in the RMIT Blockchain Innovation Hub.

27 September 2021

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The Future of Finance