The “Crypto-standard”

The “Crypto-standard

A look at redefining our standards on money.

by Xiao Siming

 

What is money?

This is a question often thrown around among my friends; and they would frequently joke about the numbers and digits in their banks, or the stack of paper they have in their wallet. But does money only entail numbers and digits? Or does money have a different meaning?

 

The only reason things have any value is because we gave them one, just like the tulip mania, the king of Netherlands valued tulips so much that eventually tulips could be used to buy a car.[1] Just like the tulips, money is about the exchange and transactions we have with one another. Money isn’t anything objective. It is a collective construct that we delineate each other about value, it is a collective fiction and it is a measurement of one’s command of goods and services. Under a fiat monetary system, which we are using now, money is not backed by anything with intrinsic value but people’s faith in the nation’s paper currency [2] -essentially the stack of paper people have in their wallets can be inflated away in just a split second when the government decides to print more money. 

 

So should we tie money with something that has an intrinsic value? Or should we maintain the status quo. As we are about to enter a new phase of money, in an economy where practically everything is programmable, can we really take advantage of this emerging technology and recast our definition of money?

 

The Gold Standard

By the mid-1800s, most countries wanted to standardize international transactions in the nascent world trade market – which gave rise to the gold standard. Defined by The Encyclopedia of Economics and Liberty, a gold standard of money is “a commitment by participating countries to fix the prices of their domestic currencies in terms of specified amount of gold. National money were freely converted to gold at a fixed price.”[3] It guaranteed that government would exchange any amount of paper money for its value in gold, essentially backing the value of the currency with the supply of gold; the larger the supply of gold the country has, the higher the value of its currency. This was what countries needed back in the past, a guaranteed value tied to their currencies, allowing trust to be formed that is necessary for a successful global trade. [4]

 

Most importantly, the gold standard prevented the government from over printing money. A gold standard restricts the government to print only the exact amount of money that is equivalent to the amount of gold it has, which in turn limits the money supply of the country and eventually kept inflation rate close to 0. [5]

 

Sadly, good things never last, the gold standard eventually came to an end. USA, being the country with the largest supply of gold, needed to print more money for its expenses, funding for the World War 1 and The Great Depression. As a result, they then cut the dollar’s ties with gold, allowing the government to pump money into the economy to keep interest rates low – promoting the aggregate demand and economic growth. [6] The gold standard was thus officially abolished in 1971, replaced by the fiat monetary system.

 

The New Standard

A cryptocurrency is a form of payment which is similar to the currencies we use today, but with one key difference – cryptocurrencies are decentralized. There is no central government to print more of them when they need to, in fact, the mostly used cryptocurrency Bitcoin has its supply fixed at 21million Bitcoins. Furthermore, Bitcoins are created through mining, a process of adding records of a new transaction to the Blockchain – the public ledger of all transactions that have ever taken place in the Bitcoin network [7]. Lastly, let’s not forget about the value of Bitcoin, valued at $14,775 USD, as of 7 December 2017 [8], it sure appears valuable at least in the eyes of the general public.

 

However, do we see something similar here? Limited supplies, highly valued and requires mining? Yes – cryptocurrencies are actually closely modelled after Gold. Given that the current fiat money system has been heavily criticized by many liberal economists, especially from the Austrian School, who object to the government’s monopolistic supply and management of money. [9]And also given that a crypto-backed monetary system are able to address the shortcomings faced by a gold-backed system, such as geographical challenges – you can mine bitcoins anywhere but not gold, giving every country a level playing field. Storage concerns – bitcoins can be stored and tracked in the public blockchain, which is much efficient than storing gold. Higher value economic opportunities – demand for the computer science/engineering related jobs will increase, creating a more knowledgeable and tech-savvy workforce which is more valuable than a regular gold miner. Thus the real question we should ask is, should we then replace the current fiat system with a new “Crypto-standard”?

 

A Crypto evaluation

There are always two sides of a coin. When money is backed by something limited and with an intrinsic value, no doubt it can prevent government from printing too much money, preventing corruption and hyperinflation. But, the potential downsides of a crypto-backed monetary system is much salient than the upsides of it.

 

Firstly, as it is limited, there is only a finite amount of cryptocurrencies available, such as Bitcoins being capped at 21 million coins.[11] So if something drastic was to happen and disrupt the economy, such as a financial crisis, a major health outbreaks, or even a Nuclear Armageddon; the government has no ability to print more money to solve these pressing issues.

 

Secondly, a crypto-backed money can be deflationary. When the money supply is kept constant, interest rates will be high, consumers and investors will be reluctant to borrow to consume/invest. And since there is no inflation, a plate of $2 chicken rice will remain $2 after [10] years; consumers will have the “I can still buy it next year” mentality. Hence there is really no incentives for people to do their investments or purchase any goods & services urgently, it will depress consumptions and investments even further. Eventually leading to a stagflation and subsequently deflation.

 

Lastly, a crypto-backed money system goes toe to toe with capitalism. Under a Laissez-faire economy, transactions between private parties are free from government interventions. A monetary system with restricted money supply is a major hold back for capitalists as they are not able to generate wealth through lending or borrowing and are forced to operate under this constrain.

 

A final thought

Pragmatically, it is highly unlikely that a crypto-backed monetary system will gain acceptance. Governments and central banks are unlikely to surrender their control of national economies, particularly monetary policies, which they use to regulate the economy. For example, quantitative easing on an extremely large scale keeps the money flowing around the economy – which was the main solution to the 2008/09 financial crisis. [11]

 

In the near future, until a better monetary system is in place, the emphasis would probably be on maintain the status quo – continuing to reap the benefits of the fiat system while worrying about its potential problems. After all, the “Crypto-Standard” is nothing but a utopian fantasy, it best serves as a way to prevent social control of money, to prevent corruption within the Fed and to preserve values; but when it comes to economical values, sadly, it has none. 

 

 

 

 

Bibliography

  1. Mackay, C. (2017). The Greater Fool Theory in Action: Tulip Mania in The Netherlands. GreekShares. Available at: http://www.greekshares.com/investing-education/the-tulip-mania-bubble
  2. Radcliffe, B. (2017). Fiat Money. Investopedia. Available at: https://www.investopedia.com/terms/f/fiatmoney.asp.
  3. Bordo, M. (2017). Gold Standard: The Concise Encyclopedia of Economics | Library of Economics and Liberty. Econlib.org. Available at: http://www.econlib.org/library/Enc/GoldStandard.html.
  4. Amadeo, K. (2017). When the Dollar Was Backed By Gold. The Balance. Available at: https://www.thebalance.com/what-is-the-history-of-the-gold-standard-3306136.
  5. Moffatt, M. (2017). Benefits and Costs of a Gold Standard. ThoughtCo. Available at: https://www.thoughtco.com/overview-of-the-gold-standard-1146298.
  6. com. (2012). Why Did the U.S. Abandon the Gold Standard? Available at: http://mentalfloss.com/article/12715/why-did-us-abandon-gold-standard.
  7. Stray, K. (2017). How Are New Bitcoins Created? A Brief Guide to Bitcoin Mining. Cointelegraph. Available at: https://cointelegraph.com/news/how-are-new-bitcoins-created-a-brief-guide-to-bitcoin-mining.
  8. Price of Bitcoin available at: https://www.coindesk.com/price/
  9. Hayek, F. (1990). Denationalization of money: the argument refined: an analysis of the theory and practice of concurrent currencies. London: Institute of Economic Affairs.
  10. Reiff, N. (2017). What Happens to Bitcoin After All 21 Million are Mined? Investopedia. Available at: https://www.investopedia.com/news/what-happens-bitcoin-after-all-21-million-are-mined/.
  11. Amadeo, K. (2017). How Central Banks Create Massive Amounts of Money. The Balance. Available at: https://www.thebalance.com/what-is-quantitative-easing-definition-and-explanation-3305881.