Thousands of years ago, conch shells were money. Feathers, stones, and precious metals are other examples of money that have all been used throughout history to settle debts, facilitate trade, and store wealth. If we can consider these commodities to be money, then is it such a far-fetched idea to believe that cryptocurrencies are money?
It’s a Game of Confidence
If parties come together in confidence and agree that a commodity, physical or virtual, is money; then it is money. This rule applies to gold, fiat currencies, and cryptocurrencies. Anyone can create money, as long as there is a demand for it from end users.
Governments created their competitive currency edge by charging taxes to their citizens based in local fiat. This strategy creates a demand for currency within the homeland as an attempt to circumvent payment of tax is severely punished under the rule of law.
Famed economist John Maynard Keynes stated that the ability of government or state powers to enforce payments in their fiat, that gives the currency its intrinsic value. Therefore, the demand and value of a countries currency come primarily from the need to pay taxes or be sentenced to jail time for tax evasion.
Cryptocurrencies gained their faith from users that saw potential in an open source, decentralized ledger system. These individuals formed a community and decided to use crypto as a means to transact, as well as invest, speculate and store wealth.
The difference in the two exists in the fact that fiat currency use is centralized and enforced, while cryptocurrency use is decentralized and organic. There are similarities between the two in the fact that they are both used as a medium of exchange and a unit of account.
The critical component shared by both fiat and crypto is full faith and confidence in each of the systems by their users. Both U.S. Dollars and cryptocurrencies are exchanged daily to settle debts. However, it would seem that while one system is growing in acceptance, the other is losing its grip.
Confidence in cryptocurrency has erupted as exchange volumes continue to grow, while fiat currencies devalue themselves in a global race to the bottom. Russia, China, and the Middle East are tired of U.S. Dollar hegemony, creating policies to circumvent the Dollar, leading to sanctions and a trade war between the U.S and the East.
Similarities Between Fiat and Cryptocurrencies
Cryptocurrencies and fiat both face many of the same economic issues. Central banks, such as the United States Federal Reserve, issue fiat currencies. The Fed prints Dollars at will and adds them to their balance sheet to create liquidity in global financial markets.
The Fed acts as a lender of last resort in times of financial distress. Unfortunately, the health of the financial system has declined since the liquidity crunch of 2008 and 2011. This time there may not be enough liquidity to put out the fires when the next global financial crisis strikes.
Cryptocurrencies are decentralized. Therefore they cannot be destroyed by removing any single node or group of nodes. The currency’s existence will continue through other nodes in the network.
However, the emergence of unregulated exchanges has altered the environment considerably. Hacks, fraud, and price manipulation tactics have challenged the survival of the crypto economy.
Another related feature of both U.S. Dollars and cryptocurrencies is encryption. The master register of all transactions in the virtual currency is publicly available to view on the blockchain ledger.
However, the data is fully encrypted from end to end, protecting the identity of the user from public view, with only the quantity of the transaction and wallet address recorded by the blockchain.
Exchanges have changed this environment. Traders cashing out profits into U.S. dollars are required by law to comply with KYC and AML legislation. The IRS can easily subpoena this identity information, and in a recent request, the IRS demanded the world’s largest crypto exchange; Coinbase, hand over all information of accounts held by U.S citizens.
Coinbase has complied with the request, exposing a large percentage of its user base to scrutiny from the taxman.
The vast majority of U.S. Dollars created by the Fed are just mere numbers transferred to the treasury account. The Fed prints very few Dollars, in fact, only 2% of the money supply represents physical cash.
The rest is digital money. Dollars and Euros are nothing more than code transferred between banks and used in currency markets to settle debts.
Most transactions are done electronically, with the cash needed for fewer transaction types every day. Credit cards, electronic fund transfers, tap-to-pay apps, and money transfers are all just virtual Dollars changing hands.
Dollar transactions are encrypted the same way as cryptocurrency transactions. However, they are exposed to the same risks of theft and price manipulation from criminals and fraudsters as well. The 2016 hack of the New York Federal Reserve Bank resulted in the theft of a billion U.S Dollars from the Bangladesh Central bank.
Challenges Facing Cryptocurrency as Money
Cryptocurrency markets experience high volatility, 10% to 15% swings in price are commonplace on any given trading day. The lack of price stability means cryptocurrencies do not fit the profile of an asset that is a store of value.
Crypto is more akin to a speculative asset that is yet to establish any form of price discovery. The meteoric bull run in Bitcoin during the second half of 2017 caught the attention of the world. And as the price soared to the moon, speculative investors jumped on board the bandwagon and fed fuel to the fire.
Rampant fraud in the ICO market, corrupt exchanges, and price manipulation are all critical issues for crypto to overcome to evolve into a legitimate monetary instrument.
The Money of the Future or a Passing Trend?
The history of fiat currencies always ends in disaster. The debasement of the national currency ends with hyperinflation that destroys wealth, Zimbabwe and Venezuela are modern examples of the hyperinflation phenomenon.
Cryptocurrency could be the monetary replacement for today’s current fiat system, but it will take some time to iron out the bad actors in the space. While the future may be uncertain for both crypto and fiat, it will be entertaining to watch how it all plays out.