Fintech Holds Promise, Challenges for Regulators

Simon Johnson says rapid technological change in finance, in part based on blockchain technology used in cryptocurrencies like Bitcoin, could reshape the monetary system in fundamental ways.

Simon Johnson (PIIE)

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Unedited Transcript

Pedro da Costa: Hi, I'm Pedro da Costa, I'm joined by Simon Johnson, Senior Fellow here at the Peterson Institute for International Economics and Professor at MIT. Thank you for joining me.

Simon Johnson: Thanks for having me.

Pedro da Costa: So, I wanted to talk to you a little bit about Fintech, which is a short term for financial technology. You've been very optimistic about the potential for these new developments to kind of improve perhaps the efficiency of the banking system and even perhaps financial stability. Can you talk a little bit about what promise you see in the developments and what the technology specifically you see as potentially promising?

Simon Johnson: Well, obviously, Fintech is a huge area and a very active fascinating area right now. What I've been drilling down into more--this is with colleagues at MIT in particular is blockchain technology. So, the certain technologies that have sort out of the space around Bitcoin that more decentralized, you can get away from using so-called trusted intermediaries. There's very big applications in clearing and settlement for financial markets for example, but we think there's a lot of nonfinancial implications.

And interesting enough, just sort of to complete the circle, the central banks are also getting interested in what does this mean for the kind of monetary system and the mechanics that you want in any well-function order system going forward.

Pedro da Costa: Interesting. So, how would blockchain improve the financial system in practice. And, is the idea that you would be basically doing more peer to peer lending or business to business lending directly because the technology would replace the financial intermediary, is that where you think we're headed?

Simon Johnson: Well, let's take it step by step. So, first step would be the thing about clearing and settlement for securities transactions for example in the United States. This is extremely complicated. There's many intermediaries. People need to handle pieces of paper or what are essentially pieces of paper at this stage. And it also has many points of failure where each one of them, if it fails, create ripple effects and damaging consequences and we saw some of that in the financial crisis in 2008 for example. And there were also many worries about, "Oh, if this goes down, this other piece go down, the consequence will be terrible." And that of course brought in all kinds of government assistance.

So, if you're building a more robust architecture and one that is more decentralized, think of it as having more backups. And think of it like the internet actually in this sense that if one computer or even one fairly large part of this that goes down, the traffic gets rerouted and you probably don't notice at all actually these days.

So building that kind of market infrastructure and when you're doing that, you also have a better and more efficient way to handle these transactions. It's just data. After all, it's digital. There are some very specific security and other requirements around high value data like financial transactions. But that can all be handled as we redesign and roll out this new kind of system.

So, I'd say the big picture, Pedro, is you get more robust, stronger -- if we do it right -- more secure financial architecture for United States rather developed countries but this should also be available for emerging markets, this should also be available for any country at any level of income.

So, I think that's extremely constructive.

Pedro da Costa: Interesting. And so, how did the central bankers see themselves as fitting into this picture; because they're clearly--I feel like in the beginning when I talk to authorities or officials and the economists about Bitcoin, they would kind of laughed it off when it first appeared. And they suddenly had to become familiar with that as it became, as they noticed that the technology had larger applications than simply Bitcoin as a store value.

And the same with Wall Street. It seems like banks are now investing in this technology. So, where do the existing players fit into this picture?

Simon Johnson: Well, banks are investing very heavily by themselves, with other banks and in various kinds of consortia that are forming. And the reason is exactly what you put your finger on just now, which is--that originally what people thought was sort of a peripheral private money crypto currency Bitcoin, not going to go anywhere which is on the sidelines. People realized that the underlying technology there, the protocol that runs Bitcoin is either itself going to become incredibly important or another protocol, a rival protocol ethereum for example, which you could think of as being separate or you could maybe build it on and link it to a Bitcoin protocol. Or another protocol on the same sort of lines that something like this will become really important in financial market architecture and also in the way we pay for things.

So, there's the buying and selling of securities, there's also how I give you cash or how I buy services from you or how I pay for a cup of coffee. All of that is in play right now and it's obviously--the good news is, the central banks are on this. They're running hard to catch up like the rest of us. Anything that changes this kind of fundamental architecture has got heavy implications for the monetary system and for monetary policy and for the broader macroeconomy including is it stable, do we grow and so on.

So, I think the central banks see this very clearly right now. There are a lot of open issues about what should be the regulatory approach, what should be the approach of central banks. But these are all the issues that we can and are working on it as a community.

Pedro da Costa: And of course, cyber security is a major concern for everyone at this point. And so, how much is introducing new technology mitigate risks versus introducing risks? Of course, with new technologies come new challenges and that I guess the narrower the body of people that have this specialized knowledge, the more potential risk for, I don't know, for kind of hacking or other types of kind of attacks. So where does this cyber security issue fit into the --?

Simon Johnson: Well, it's clearly a massive issue. Now, I'm not a cyber security expert. I talk to many people who are and then one of the points they make is that the internet after 20 plus years still has some substantial cyber security issues, but we can't live without it

And saying that we're not going to go to certain direction because we're worried about our data being compromised. Well, frankly, our data are being compromised on a daily basis by our existing architecture. We are living with that not very comfortably. We need to do better and that raises the whole set of issues about example privacy. Who has your data? How was it protected? Why do various intermediaries like the people you shop with and the people you do your social media with, why do they own so much of your data and lose it sometimes or lose control over it? Why shouldn't that data be controlled more effectively by you as an individual? And what would that mean? How would you ensure that? These are super important and very hot topics right now.

Pedro da Costa: And lastly, folks at the Federal Reserve thinking about economic growth and kind of the underlying weakness of the economy often talk about the need for job retraining for folks whose skills have become obsolete. It seems like this new technology is going to require some retraining for regulators themselves. I mean, they're going to have to become suddenly tech savvy. Is there a whole new host of expertise that folks employed at places like the Federal Reserve and other regulators are going to need?

Simon Johnson: Yes, of course. And the good news is that they're working on that. The world is changing. The world is changing very fast in this tech space and we all need to follow that and understand it, and catch up as appropriate. I do not hear any regulators, simply not across the industrial world saying no to this. I think that would be like saying no to the internet in 1993. Perhaps you could slow down, you could have slowed down in 1993. But looking back, would that have been a good decision? Would your economy had done better if you said no to those jobs or no to that kind of technology?

On the contrary, I think people would like to be hubs for the development of sensible ideas that are implemented in a way that respects consumers, in a way that doesn't damage, maybe helps financial stability and in a way that can be shed or if you like exported to other parts of the world.

So, I think that really is an opportunity and in 10 years, we're looking back in this and say, "Okay, this country or that country made a smart early move both in terms of private sector investments and public sector initiatives or approvals or not getting in the way." And that combination has led to the following really good jobs and prosperity in the following places.

And that when we -- retrospectively how we see this. Obviously, we're in the moment right now and so there are a lot of hard decisions to make, but one way or another, you have to make it.

Pedro da Costa: Great. Well, thank you so much. I'm glad regulators are catching up and I'm glad we have you here so that I and our reviewers can catch up because it's fascinating, but daunting stuff. Thank you so much, Simon.

Simon Johnson: Thank you. I appreciate it.