Cryptocurrency is gaining ground, but could it one day replace national, fiat currencies?

Written by Maria Voloshchyuk, Guest Blogger

Cryptocurrency’s deflation issue

One criticism generally levelled against cryptocurrencies, and in particular, bitcoin, is that the currency is ‘deflationary’, meaning there is a limited supply to be ‘mined’ and after this point, there will be a constant number of bitcoins in circulation. It’s this attribute of bitcoin that prompts holders to hoard it, in the hopes that its value will increase. This is why it’s known as ‘digital gold’ and commentators compare it to the gold standard currency model that prevailed in most of the world before the 1930s.

Bitcoin’s deflation issue is one often targeted by economists arguing against its feasibility as a national currency. The main argument is that people would be encouraged to hoard their cash rather than spend it, which of course has a detrimental effect on the economy, because cash remains unused instead of being channelled back into production.

Aside from the fact that once all of the bitcoins have been mined and there is a fixed amount in circulation, many of the parallels between crytpo and the gold pegged currency model would disappear, what also must be noted is that the gold pegged currency didn’t fail to work simply because it was deflationary. There were also fundamental issues that arose through underpinning the system with a commodity, mainly stemming from the government’s promise that anyone could use a certain number of dollars to redeem gold from the bank, and the simultaneous imperative for banks to keep their gold reserves stocked in order to be able to issue cash.

These are issues that would not afflict bitcoin or other cryptocurrencies. In fact, cryptocurrencies may have more in common with fiat currencies given that their value relies solely on faith, rather than being tied to any intrinsically valuable commodity.

Another argument against deflationary currencies is that in times of crisis, this form of currency makes it harder for the government to reverse recessions. However, if we look at the causes of at least two major financial crises – the financial crash of 2008 and the great depression – it was mainly the behaviour of over-zealous bankers and lending policies that precipitated them.

In this day and age, it’s not changes in material fortunes that cause crises – for example, a country’s crops being destroyed by drought or flooding. This is not what triggered the global recession in 2008. The abundance of goods didn’t change; the availability of materials, jobs and workers stayed the same. It was the black box ‘magic’ of banking which pushed the world’s economy into a slump.

Cryptocurrencies are decentralised by nature, and this means that the supply of currency is out of the control of a centralised body – namely, bankers. Considering that the behaviour of bankers pushed us into the last major economic crisis, which in turn led to the worsening of the lives of millions, some would advocate we might just do better without them. Therefore it may be true that deflationary money makes it harder to reverse a financial crisis, but without a centralised model of banking, these crises may not even arise in the first place.

But even if a deflationary or ‘constant’ model of currency proved untenable, contrary to the belief of some spectators, cryptocurrencies are not completely outside of any form of control. It would be possible to change the model of a cryptocurrency, with enough consensus that this is the right thing to do. For example, Ethereum stakeholders recently agreed to adapt the currency from a ‘proof-of-work’ model to a ‘proof-of-stake’ model.

Therefore, it’s possible that with enough agreement, bitcoin, for example, could be adapted into a slightly inflationary currency. To engineer this, what is known as a ‘major fork’ would have to take place (that is, a major change in the protocol). Therefore, it’s not that these currencies are beyond control, it’s that any adaptation would have to be made with the consensus of the most invested users, rather than governments or banks. Also, given that cryptocurrencies are used globally, this would be unlikely to occur in response to the particular economic conditions of any one country.

It’s also important to note that as cryptocurrencies can adopt any model, and there are an increasing number launched every day, the ‘deflation problem’ doesn’t apply to all of them. In fact, some, such as Steem are intentionally slightly inflationary – with a set amount of new tokens released each year – to prevent people from hoarding. There is also an increasing number of stablecoins launching that are pegged to commodities such as the US dollar or crypto assets.

In addition, there’s the point that more than one cryptocurrency could be used for different purposes – bitcoin or a cryptocurrency with similar attributes could act as a store of value – the commodity selected for a rainy day fund – and another, slightly inflationary currency could be adopted for everyday transactions.

Currency Substitution

The gold standard currency model provides a weak parallel to cryptocurrencies. For a closer cultural reference point of what crypto replacing national currencies could look like, it’s perhaps better to look at the phenomenon of ‘currency substitution’. This is where a country accepts a different national currency as legal tender. Another country’s currency could be the only legal tender, or it could be accepted alongside a domestic currency.

The European Union embraces a form of currency substitution, through common use of the euro, meaning that fiscal policy concerning the currency is defined not in accordance with the economy of any one of the membership countries.

Substituting a different currency does not mean that prices do not reflect the economic climate in that country. For example, Cambodia and the US both use the dollar but the amount commanded for a motorbike or a property is vastly different in each.

What it does mean however, is that the country cannot manipulate the amount of money in supply in response to economic factors, which can have the effect of forcing the government to be more prudent in terms of what it borrows, because it cannot simply print money on a whim. Instead, these countries must rely more heavily on taxation and issuing government debt to raise funds.

It also means that the country cannot act as a lender of last resort to commercial banks in this scenario, again possibly forcing banks in this situation to act with a level of prudence that is severely lacking in countries where this is the case. This can in turn promote greater financial stability, but at the cost of losing control over monetary and exchange rate policies.

Therefore, countries that employ currency substitution could provide a blueprint for what the ‘substitution’ of national currencies for cryptocurrencies could look like. However, there are some differences, in that the volume of currency in supply would not be adjusted by an ‘anchor’ country.

Interestingly, Venezuela has examined the possibility of adopting a cryptocurrency instead of the national currency following a period of intense upheaval and rapid inflation.

However, the lack of the ability to create debt in cryptocurrencies – an essential means of creating capital for future projects – would be problematic. Right now, cryptocurrencies do not offer an obvious way to create debt, as this is typically controlled by banks. While there are blockchain systems that allow peer-to-peer lending, it’s less clear how this could be facilitated on a grander scale.

There is a need for governments to issue debt to be able to pump money into public infrastructure and services. Obviously this creates a problem for governments and implies that at the moment, it seems likely that even if the majority of online transactions shift into cryptocurrencies, national fiat currencies would remain necessary to facilitate certain activities such as raising taxes and issuing debt.

Problems with fiat currency

Cryptocurrencies are not poised to challenge national currencies just yet. “I think it’s actually going to pose more threat not to government money, but to companies like Visa, MasterCard, major banks, maybe other industries – the finance industry,” says Aaron Greenfields, the founder of The Eliquid Boutique and a major investor in the Vape Coin. “That’s where the destruction is going to be.”

But many see cryptocurrencies as a possible antidote to problems afflicting the global economy. At the moment, the economic system is rigged: fiat currencies have been overtly linked to the increasingly distorted distribution of wealth because pumping more currency into the economy causes cash to accrue in the upper echelons of society; fiscal policy aimed at easing financial crises such as quantitative easing have been clearly linked to increasing wealth at the top without causing a downward circulation of wealth; and while the wealthiest in the world have continued to grow their stocks of cash since the 2008 crash, wages for normal people have stagnated and even fallen in real terms. This is not an accident, it’s the natural outcome of the global economic system we have in place today, which is underpinned by governments, central banks and their inexorable links with the super rich global elite.

This in turn causes increasing instability in the economic system, because a millionaire will buy fewer consumer products than 10 households each with £100,000. This means less and less money is returned back into the economy. There’s also the insurmountable fact that smaller households would likely be paying their fair share of tax, whereas the super rich are experts at siphoning off their cash and rerouting it through legal grey areas and offshore accounts to avoid paying what they owe.

Increasing use of cryptocurrencies would in a sense decouple currency from the workings of the economy and dethrone bankers as the lever pullers. It would rob bankers of their black magic, through which wealth is steadily leached from the lower layers of society and floats to the top as naturally as an inhalation of air. It’s widely agreed by economists that there were not sufficient adjustments to the banking system or great enough retribution for bankers following the 2008 crash, meaning that we are inevitably heading for another global economy crushing implosion sooner or later. This will be of little consequence to the engineers of such crises – fat cat bankers and the super rich