Cash’s Demise, Cryptocurrency’s Rise
Who says only governments and central banks can make money? This year the value of cryptocurrencies has climbed to unprecedented levels, while at the same time becoming far less volatile than in previous periods of rapidly increasing demand. Leading the pack is Bitcoin. The first mover among cryptocurrencies has reached new benchmarks despite news that might have depressed its value, such as the Securities and Exchange Commission’s rejection of a fund permitting small traders to invest in Bitcoin on the stock market.
The “official” action prompted obituaries, yet Bitcoin is thriving. A prime reason is the distrust many citizens have in their governments’ currencies. They want to use Bitcoin or any other cryptocurrency as a hedge or an alternative mechanism of payment and transfer when government currencies don’t efficiently perform such basic functions. It’s no surprise that millennials, many of whom understand the digital currency much better than their baby-boom forbears, are investing in cryptocurrencies at far greater rates.
All modern fiat currencies depend on trust in a government for their value and stability. Some governments have institutions, like the U.S. Federal Reserve, that inspire substantial trust, but others have monetarily oppressive regimes many citizens want to bypass. Argentina continually debased its currency until last year. China puts burdensome restrictions on transferring its currency out of the country. Both countries have seen substantial trading in cryptocurrencies.
Unlike national currencies, cryptocurrencies do not depend on a regime that can be corrupted by politics. With Bitcoin for instance, trust is required not in government but in the decentralized order of those who verify bitcoin transactions — the so-called miners. They maintain what is popularly known as the “blockchain” — a public ledger on the Internet of all Bitcoin transactions, which accounts for the ownership of every Bitcoin in existence.
The innovation of Bitcoin and similar crypto coins is creating a decentralized process to update the blockchain as new transactions in Bitcoin occur. Anyone with Internet access can attempt to update the blockchain by employing substantial computer power to solve a mathematical problem.
As with any currency, sometimes the rules governing Bitcoin’s operation need to be tweaked. With fiat, governments pass laws or issue administrative decrees. With Bitcoin, new code is adopted when the community of miners reaches a consensus on the change.
Bitcoin miners sometimes disagree about how best to meet the demands of the market, as shown by a current dispute about the optimal size of each block — and by the more fundamental challenge about a fork or not. But the genius of Bitcoin is that because miners are paid in their own currency, their incentives are strongly aligned with Bitcoin’s value and future.
Government officials, by contrast, might not face such strong incentives to maintain the value of their national currency. In developing nations, sometimes those interests include taking valuable property in exchange for an abuse of their power. In developed ones, job retention, promotion and ideological perspectives can all distort official behavior.
Money has been described as a social contract, but politicians charged with enforcing that contract often have incentives to advance their own interests or those of particular political factions at the expense of their legal duties.
Bitcoin’s creation of order without centralized law is not unknown to society. Social norms often regulate behavior without the benefit of formal law. Rules of etiquette tell people how to behave at the table without causing offense. But while order without law is possible without software, software can improve its enforcement. One might ignore a social convention, but it is impossible to ignore the operation of an algorithm that tells the world whether you own a cryptocurrency coin.
To continue to flourish, cryptocurrencies do not have to become a more stable store of value than the U.S. dollar. They can climb the rungs of respectability by prevailing over less trustworthy currencies. They are already gaining strength and stability by competing successfully against monetarily oppressive regimes and helping poor immigrants in the developed world remit money to their relatives back home.
As cryptocurrencies gain stability, they can become even more competitive because even the best fiat money is subject to political risks.
National and international crises will continue to fuel cryptocurrencies’ rise. The instability caused by problems with the euro, Brexit and the many Western democracies’ growing ratio of debt to gross domestic product threatens the value of even established currencies. Cryptocurrencies are likely to succeed so long as the value of other moneys rests on politics.
And yes, in the day and age of full transparency with big brother society it’s more than welcome to have an alternative to government-issued and -controlled money.