The Rise of Crypto | Campbell Harvey and Neha Narula

Itay Goldstein: Hello, everyone. I am Itay Goldstein, professor of finance at the Wharton School. This is the Future of Finance series. This is our second season. We did the first season and talked about different dimensions of the future of finance, including fintech and AI in finance and banking and meme stocks. In the second season, we are hoping to dive deeper into the issue of cryptocurrencies, digital assets, decentralized finance. We’re going to talk more generally today about the rise of crypto and digital assets.

For this, we have two perfect guests. They are perfect for this particular purpose because they have been early movers in the direction of crypto and digital assets. I would say they identified the potential of this early on, about a decade ago, and stuck with it. I’m happy to start with Cam Harvey, who is a professor of finance at Duke University. Cam and I overlapped at Duke for three years, which was my first academic job. He was already a senior professor at the time. He was starting to think about crypto and digital assets at least a decade ago, and I remember having some early conversations with him on this at the time. Hello, Cam.

Cam Harvey: Hello, thank you for inviting me.

Goldstein: It’s great to have you. Our second guest is Neha Narula, who is the director of MIT Media Labs Digital Currency Initiative. She also identified the movement towards crypto early on, and her TED Talk from 2016 about the future of money has over 2.5 million views on the TED Talk website. Hello, Neha, it’s great to have you.

Neha Narula: Hi. It’s great to be here.

Goldstein: We have a lot to discuss, so let’s dive right in. I would like to start from the big picture. When we are thinking about digital assets and cryptocurrency, we are thinking about a potential change in the financial system, how the financial system works, and what we should expect from the financial system going forward. In your view, what do you think are the main gaps in the traditional financial system that crypto is trying to fill?

Harvey: I think the key word is gap. Change, just for the sake of change, might not be that useful. You need to be solving problems, and this new technology offers the potential to solve many problems. Looking at the original Satoshi Nakamoto paper, it was about transactions and the inefficiency of the current transaction system. The cost of transferring money, the cost of transferring money to different countries, the wait that’s necessary to do a simple transfer, the middle people that are involved in a sort of transfer.

It’s not just about money transfer. In our system of equities at the time of the foundational work in crypto, it took three days to settle a stock transaction. You think you buy it instantly, but to actually get ownership took three days. Now we’ve improved to one day. And one day is not impressive for me. It should be a matter of seconds.

The last thing I’ll say — and there’s a long list of issues — is that our current financial system is very exclusive. There are 4 billion people in the world right now that are unbanked, and many that are underbanked. This idea effectively allows people to become banked in a different way. Your smartphone is your bank, and you can participate in the global financial system. So. this is is really about inclusion and, fundamentally, economic and financial democracy. In this space, everybody is a peer. So there’s no banker and customer, institutional investor, or retail investor. People are peers, and we play on the same level ground.

I think those are some of the gaps that crypto has attempted to bridge. We’re not there yet, but we are moving in a positive direction.

Goldstein: Neha, where do you see the big gaps that we are trying to fill?

Narula: Echoing that, maybe just summarizing, I think three major things. No. 1, you can’t settle 24/7, 365. You can’t settle money, you can’t settle equities. You just can’t do that today with the existing financial system. Second, you can’t really make programmable payments. It’s really difficult to marry software with the movement of money. And then third, the fees are way too high. In the United States, merchants mostly bearing the cost, which they’ve passed on to consumers, up to 3%. But everywhere, we’re paying way too many fees. Especially, unfortunately, for things like remittances and cross-border transactions.

The thing that I want to emphasize is that I really think what crypto and blockchain technology is addressing is not a technology problem, it’s a market structure and incentive problem. It’s not that we didn’t have the technology to settle 24/7 on the old technology stack, or it’s not that we didn’t have the ability to reduce fees. It’s that the existing players didn’t want to deploy better technology. They didn’t want to change. Whether it’s based on regulation or whether it’s based on incentives, we weren’t getting that change.

If you look inside any of the major banks today, they’re using software that was developed in the 1960s. It’s not that they couldn’t upgrade that software to modern software. They just don’t want to. What happens is that when you have a whole new tech stack, a whole new platform, you get these new properties, and you get new opportunities. You get new opportunities for new players to come in and to experiment and to build. That’s what we’re seeing in the cryptocurrency blockchain, is this new opportunity,

Goldstein: In your TED Talk, you basically talk about money as a collective fiction. I believe that Yuval Noah Harari was also using similar terms to talk about money and how it helps communication and coordination among people. When we are thinking about that, we are thinking about crypto as the next step in that process of evolution. So, where do you think crypto is going to fit into that story, and what kind of collective fiction are we going to get?

Narula: The idea of the collective fiction is that, if we look at this rich history of objects that have been used as money — shells, beads, coins — it’s certainly the case that there are properties of these objects that make them good at being money. It’s also the case that there are institutions, whether public or private, that stand behind the objects. But it really comes down to, will someone accept payment in this currency? Do I have faith that this currency will be usable tomorrow, that anyone will take it, that it will be roughly worth the same amount?

This faith is part of the fiction. Even when we’re thinking about it as objects, money is not something you can eat or use. It’s not actually useful in and of itself, outside of this faith in context. It’s even more obvious when you get beyond the objects to things like ledgers and accounts that we use to mark who has what. Oftentimes, it’s just digital bits and databases. It’s markers for our collective belief.

I’d say that crypto is not so much reshaping that story as much it is the next iteration of that story. Something that’s coming out of it that’s really interesting is that it’s revealing the set of underlying assumptions behind something that we very much took for granted: the global monetary system. The global monetary system as it exists today is mostly just bits and databases. With the advent of cryptocurrency, people are asking questions like, “Wait, what do these bits actually mean? Who vouches for them? Why can’t you write over them? Why do people believe in them? Why do they have value?” I think what’s happening is that with the advent of cryptocurrency, it’s really illuminating a lot about our monetary system that your average person maybe didn’t necessarily think about or understand. Or they really took it for granted before.

Harvey: I agree, but I want to push this a little further. I agree fundamentally that something has got value because people believe it’s got value. In my book, I tell the story of the Iraqi Swiss dinar, which was printed with Swiss printing plates in England. When sanctions were put on Iraq, they needed a plan B, so they started printing Saddam dinars. You had to trade your Swiss dinars in for the Saddam dinars, or the Swiss dinars would go to zero. Well, it turned out that Saddam undertook massive inflation, and the new dinars were pretty well useless, but people still used the old ones, especially in the north. It wasn’t backed by anything. But they believed that it was useful in terms of transactions.

This is an important lesson that we’ve had, kind of historically, that you have to have faith. We live in a fiat currency sort of system. The U.S. dollar has value because it is, No. 1, legal tender. No. 2, you need to pay taxes in U.S. dollars. No. 3, you could be incarcerated if you don’t pay your taxes. So, there are intangible values from the U.S. dollar. But in the end, you can’t redeem it for gold, like you could have before August of 1971. It is based upon belief that it’s got value.

Crypto introduces something different. We could think of a stable coin that’s linked to the U.S. dollar as just a more efficient mechanism for dealing with the fiat currency. But in general, we’ve got the ability in this space to tokenize anything, and when we tokenize anything, this idea of money becomes very fuzzy. I can go, let’s say, to pay for groceries, and I usually pay in U.S. dollars. But in the future, I can pay with a token that’s linked to something else. I can pay in gold if I want. I can pay in Apple stock. I can pay in real estate.

The whole idea of money, I think, fundamentally changes. Indeed, in my book, the first sentence is, “We’ve come full circle.” And that’s referring to the origins of trade being decentralized, the very inefficient barter system. Where crypto takes us is a totally new direction, where we have a host of things that we can use to pay. Effectively, it is a more efficient barter system. And that changes things fundamentally. It means that monetary policy is not as important. It means that fiat inflation could be, in 15 years, a historical relic. This does structurally change what we will look like in the future.

Goldstein: Both of you mentioned faith and trust, and this is indeed crucial for the success of a financial system, the success of a monetary system. I wanted to connect back to your book, Cam, DeFi and the Future of Finance. I think one of the points that you’re making there is that this did not happen as a coincidence, but rather, this is an outcome of the global financial crisis that we had in 2008 that maybe led to breaking the trust that we had in the financial system. Can you elaborate on this a little more? Do you see a direct connection, indeed, to the global financial crisis?

Harvey: Yes, but it goes even before the global financial crisis. Indeed, the global financial crisis was the last straw, and certainly most people know that the very first block in the bitcoin blockchain makes a reference to a second bailout from a headline in The Times of London. So, there is a link.

But this idea of some sort of digital money goes back well before. Indeed, there was active research going on in the 1980s. There were hundreds of initiatives in terms of digital currency. The problem was that it was a very difficult problem, because just like you can make a digital copy of a document or a picture or a video, that causes problems for currency. Perfect counterfeiting. And most of these initiatives failed.

However, when Satoshi Nakamoto published their 2008 paper, the game changed. Because this was a way to avoid the so-called double spending or counterfeiting problem. That movement that he was involved with had a number of people, so-called cypherpunks — kind of libertarian- based. Very suspicious [about] big government monetary policy and the current financial institutions.

The last straw was the financial crisis. I remember being in Davos in 2005 and having an audience with the chair of the Senate Banking Committee, Richard Shelby, and telling him he needed to do the basic due diligence on the big banks because I saw extreme leverage. I saw these banks acting as hedge funds. I certainly hoped, if there was a crisis, that they would not be bailed out. But they needed to investigate the risk, to at least know the risk.

Those suggestions were ignored, and then you get the situation where these banks that were operating under extreme leverage were bailed out. And that seemed very, very pungent to many people, including me, and I think that was kind of the impetus for the first wave of interest in bitcoin.

Goldstein: Neha, you also mentioned incentives and the fact that we had the big players using old technologies, not having the incentive to change. As a result, the progress was stifled. What do you see as the big trigger that led us to where we are now?

Narula: I think definitely it was the case that we had projects that were trying to do digital money in the past. Ecash is one of the most famous examples. There were attempts to commercialize Ecash, to turn it into a product that people could use. The big, big, big problem with all of these services was that they relied on a centralized intermediary, so they used cryptography. They had really interesting properties. They provided a lot of privacy, but they relied on some kind of intermediary custodying the funds and being at the center of everything to solve the double-spend problem.

The real innovation behind bitcoin, the first cryptocurrency, was that they figured out how to solve the double-spend problem, not entirely, but in a decentralized way. That was the key part of that. That meant you didn’t need a bank. The problem with all of the Ecash projects is that they all got shut down. They were kind of skirting around the edges of the law. It was very hard for them to find banks that wanted to offer this as a product. Without a bank, it wasn’t legal.

But with bitcoin, it didn’t require a bank. It didn’t require any financial institution. It just required a group of people to start running software. That was it. I think that was the really key innovation. The really key difference there was the fact that you could bootstrap these systems with just a group of people with computers. You didn’t need to get a financial institution on board to custody money to plug into the financial system. Of course, when it started, nobody really wanted any bitcoin. It wasn’t really worth anything. But we’ve seen how that story plays out, right? Now today, as we’re recording this, bitcoin’s worth over $120,000 a coin. So, it was realizing that you could bootstrap the platform in the system, and then let it figure out how to attain value over time. You didn’t have to plug into the existing financial system immediately. That was really the key idea.

Harvey: Just to emphasize that the situation that we’re in right now with our financial system is really not that different than 12 or 14 years ago. I was at a discussion that was sponsored by a multitrillion-dollar asset manager with senior people. I asked the question, “What happens within the next few minutes if the SWIFT system goes down?” This is the messaging system that we use to transfer funds around the world. People started looking at each other, and it was very awkward. Finally, the most senior person in the room answered, “Well, we’ll give people the day off.” Everybody chuckled. And I’m saying, “Wow, I just can’t believe that.”

That means a fundamental lack of risk management. You need a backup, and currently there is no backup. What the crypto space provides is a backup, an alternative that does not rely, as Neha said, upon a centralized system. It’s decentralized. I think that this is not just about making payments more efficient and lower cost. It’s about having a system that is also more secure.

Goldstein: Let me put the skeptic hat on for a minute. Because so far, you have been emphasizing mostly the positive aspects of decentralized finance and crypto and bitcoin. But I think a lot of people who are looking at it from the outside might say, “Well, we haven’t really seen any of this progress so far.” I think the promise about bitcoin initially was that this is going to be a new means of payment, and if not bitcoin, then other cryptocurrency. But we haven’t really seen that taking off as fast as some people promised. Then we started talking about other rationales, other narratives for cryptocurrencies. That it’s going to be a store of value, it’s going to be a hedge, and other things like that.

When we are seeing this shifting narrative, and we haven’t seen a use case that was fully established yet, is this a sign that things are not going as planned? That it’s not as good as we thought? Or maybe this is just a learning process, and we are going towards a much better place in the end?

Narula: I think the answer is a little bit both. There legitimately was a tremendous amount of overpromising and underdelivering, and there’s been a lot of trying on different narratives and seeing what fits. I think this is actually pretty normal for any new, innovative, risky technology. It’s just that this particular case was about something as fundamental as money and our global monetary system, so it had a lot of attention very early on. There were a lot of eyeballs. There were a lot of expectations. There was also an incentive to create a lot of hype, because there was a lot of money to be made. So definitely overpromising, underdelivering. Not clear to me it was more so in this space than it was in other technologies. I think there were just more eyes on it. But we could debate that, absolutely.

I think that as we iterate, as we go through these cycles, more and more of what doesn’t work gets flushed out. That’s what we’re seeing happening, is that the people who overpromised and underdelivered, the people who were outright scammers or were perpetuating fraud, they’re getting flushed out of the system. And this is good. This is what should be happening. You know, in venture capital, a very small percentage of startups actually succeed. We should expect to see the same thing here. There’s going to be a lot of projects that try to do a lot of grand things, and they’re not going to succeed. But there will be a few that do really, really well.

I think, given the stage we’re at right now, there are two things I see that are really promising and that are doing really well. No. 1, bitcoin has found product market fit as a potential for new digital gold. We are seeing that happen day after day. We are seeing countries decide to hold it as an asset. We’re seeing public companies put it on their balance sheet. We’re seeing people kind of adopt the narrative around bitcoin. Bitcoin has found product market fit, or is finding it — it’s still in the early stages — as digital gold.

I think the second major use case that we’ve seen is stablecoins for cross-border transactions and for international transactions, and also as a hedge against inflation. We are seeing a lot of use for stablecoins and bitcoin in the Global South, in countries that are experiencing high inflation. People really want these things. Merchants and economies are slowly starting to develop around them.

Those are the two areas where I think we have seen actual success and real evidence of product market fit. Of course, the really interesting question is, what’s going to be the thing in the next few years? You know, real world assets. Are they going to be tokenized and move around, primarily on blockchains, instead of on traditional exchanges? Is it going to be more about payments? Is it going to be more about a platform for the internet, digital goods? These are the questions that we’re still trying to answer.

Goldstein: Cam, I know that you are very optimistic about it. What do you have to add to that?

Harvey: I’m not sure optimism is the right word. Kind of implies a bias. I think I’m realistic about it. I do think it’s important to look at the history of innovation. This is a very significant innovation. It happens to be occurring at the same time of other disruptions, which is interesting. Historically, we’ve never had, for example, decentralized technologies competing with AI and quantum technologies all at the same time. That’s very interesting because we’ve never had a situation like this.

But with any innovation, it’s hard to guess the timing of how it plays out. You always want it to happen faster than it actually does. And with any innovation, there’s risk. Some things will work and some things will not work. One of the great things in this space, especially — I spend most my time in the ethereum space rather than bitcoin— is this idea that you can very quickly innovate by literally looking at the code somebody else has put up, grabbing it and making changes to improve it. The innovation [is] very, very fast.

Again, there are risks here. I worry about companies adding bitcoin to their treasury or their cash management. That, to me, doesn’t make a lot of sense. The idea to have a reserve for bad times I totally get, and usually you have your most liquid assets there that you can draw upon. Bitcoin is highly volatile asset, and it may not be reliable. People talk about it as being a hedge against various things. Well, it is unproven. Theoretically, yes, its money supply is not tied to anything other than an algorithm. It’s not impacted by governments. But nevertheless, it is untested. We know it’s volatile, and just the fact that it’s four times more volatile than the S&P500, that almost guarantees that it will be unreliable some of the times.

I worry about, for example, Satoshi’s vision for bitcoin is completely different than what exists today. As Neha said, bitcoin is a risky store of value, with four times the vol of the S&P500. It has done well. And maybe it’s done well because there’s some momentum. These companies adding it to their balance sheets, but at some point that’s going to stop. And I worry about that.

Again, I’m more interested, frankly, in the ethereum space. This idea of tokenizing real world assets. I agree that the big success story in RWA is the stablecoin. It’s done very well. We saw Circle IPO. This is a great innovation. But to me, it is just the tip of the iceberg. There’s so many other things that can be tokenized. I’ll give you just an example here. Stablecoin is a great business to be in. Circle IPO’d for a very rich valuation. Because if you think of what happens — people give Circle money. Circle gives them a token that is one-to-one with the dollar. Circle takes that money, invests in low-risk treasury bills and repos, and Circle keeps all the interest. So, it’s like a money market fund [in] that the money market fund keeps all the money and the consumer gets nothing.

We could do this a little differently. We could have a tokenized bond, and that bond is going to pay interest. You’ve got the ability to use this token to pay for things, but it’s also earning yield. I think that stablecoins are great. It is the most successful innovation in this space to date. But they, in my opinion, will be disrupted by yield-bearing stablecoins. Just another wave of innovation that makes it even a better experience for consumers.

Goldstein: Yes, thank you for saying that. We will also have an episode that is going to be dedicated to stablecoins. Certainly, a lot to think about there.

The one last aspect that I want to talk about is decentralization, which is clearly key to cryptocurrencies and fintech more generally. When we did the FinTech Initiative at the Review of Financial Studies, we started with that in 2017. And that was kind of the first batch of academic papers that came out on these topics. We talked about what is different in fintech revolution relative to previous technological innovations in finance. And we noted that it is certainly the aspect of decentralization and also the disruption. Both of you talked about it quite a bit.

But I think that when we are looking at it now with the perspective of almost a decade later, it seems like we haven’t really gotten to the decentralization as much as some people expected. Rather, we see that there are forces within the defi system that are, interestingly, pushing back into centralization. There is the power of intermediation. There are certainly advantages to being a large, centralized player. We see that maybe the functions are a little different, but at the end of the day, we might end up in a system that still has the big intermediaries and still is centralized to a large extent. Where do you see the tension between centralization and decentralization? And are we really going into a system where everyone is a peer, as you both mentioned before? Or will it still be an intermediated system but just look a little different?

Narula: A few things here. First, definitely want to echo your point that there are great forces towards centralization there. With centralization, you get better efficiency. Just think about if there’s two businesses that are in the same area, and then they merge. There’s an opportunity there to reduce redundancy, right? However, you’ve also made the ecosystem a little bit more fragile. And that’s what happens with centralization.

We see these cycles play out. We see these cycles where, due to this increase in efficiency and this ease, there’s more and more and more centralization. It becomes winner-take-all, winner-take-all, winner-take-all. Then things become too fragile, and we see a big break. Then, if there was any decentralization in that ecosystem, those are the players who win because there’s more fault tolerance, there was more redundancy.

We see these cycles, and I think we’re going to continue going back and forth. It’s very important to note that it’s not like centralization is evil and decentralization is good and we need everything to be 100% super decentralized. Just thinking about using an intermediary, for example. It’s often the case that it’s the right choice for someone to use an intermediary or a custodian or an exchange. It’s not the right choice for them to try to custody their own keys or to try to do something directly, peer to peer.

I think what’s most important is that we have platforms and systems where you always have the option to exit to your own self-custody. To be a part of the system, to run your own node, to do your own verification. Not that you have to do that all the time, but you always have the option to be able to do that. And that, I think, allows us to seamlessly move between the centralized and decentralized. We offer the people to seamlessly exit the centralized intermediary, start running their own nodes, start custodying their own funds. Things like that. Then we can create an overall system and ecosystem that is a bit more resilient.

Harvey: I agree with some of that. Let me add my spin on it. Centralization is not always the most efficient. Indeed, we’ve got plenty of examples that are in our face today of centralized institutions that are extracting monopoly or duopoly rents, and that leads to welfare loss in our society. Let me be clear that I am not the type of defi person that believes that in the future, everything is going to be 100% decentralized.

We have come from a time where we were 100% centralized, so I believe that the key word is efficiency. In certain applications, it might be more efficient to have some degree of centralization. In other applications, it might be more efficient to have it decentralized. These work together. I give an example of decentralized ridesharing. The matching of the drivers and the riders is purely algorithmic. You can imagine reward systems and stuff like that. You can do this in a way that greatly reduces the 45% fee that Uber or Lyft might take, or whatever it is.

But there’s certain things along the way that need to be centralized. For example, the certification of the driver, the certification that the car is safe. It’s hard to think about doing that in a fully decentralized way. I believe that there would be a combination of centralization and decentralization in the future that’s really focused on efficiency.

The last thing I will say is that this tension between centralization and decentralization plays out in real time in the decentralized space, even today. Think about the reliance of decentralized protocols, like decentralized exchanges and things like that, on centralized stablecoins. To be clear, the leading stablecoins, Tether and Circle, are centralized. Their token is used in decentralized finance. We do have decentralized stablecoins, but they’re smaller. So, the success of the decentralized finance platform is greatly reliant upon centralized technologies.

Again, I think that in the future, there will be a balance between the centralization and decentralization that depends on the particular application. And the balance will drive the cost to a point that makes it best for the consumers and the producers and the sellers and the economy in general. That’s where I hope that we end up.

Goldstein: Thank you very much. I certainly agree that this tension between centralization and decentralization is key to understanding this new wave of technologies and potentially the future of finance, and that we will probably end up in some middle ground where we have a combination of the two, or maybe partial decentralization. But hopefully it will take us to a much better place in terms of the financial system and how we transact with each other.

Thank you very much both Neha and Cam, for diving into these topics with us and providing the introduction into the rise of crypto digital assets and decentralized finance. We’re going to continue and talk about these topics, so stay tuned. Thank you.