Of Money and Crypto
The simplest definition of money is a medium of exchange that we use to eliminate the problems associated with bartering. As an economy grows, money develops into a unit of account, where all goods and services can be valued, and markets can efficiently direct resources towards their highest use. Continued economic development and proper management of the money supply, yields a stable currency that ultimately becomes a store of value for the market players.
The primary managers of money are banks. They accept deposits of money from people who have accumulated more than they need (depositors), and loan those deposits to those who would use it to create a more productive asset. This new asset pays the creator for their efforts and the bank interest for use of the money. Depositors trust banks to manage the lending process in such a way that banks do not lose their money by making bad loans. If the bank makes bad loans, they are not able to pay back their depositors, and become insolvent and fail.
Banks keep only a small fraction of their depositors’ cash on hand for direct withdraws. If depositors fear that they will lose their cash because of a bank failure, they attempt to withdraw all their cash, creating a bank runaccelerating the very bankruptcy they feared. This loss of trust can lead to a cascade of failures as the problems of one bank lead to bank runs at other institutions. If the bank runs continue like falling dominoes, they may lead to systematic risk in the financial system, and ultimately the entire economy. The US Federal Reserve has evolved over time to regulate the banking system and national money supply to protect against the systematic risk of an unregulated monetary system.
This whole economic system is rooted in the trust that money has a stable value that we can safely use for commerce, accounting and savings. When we lose this trust, we lose faith in our ability to safely conduct our lives in a modern economic system.
This is a bad thing.
I am a fan of new technology and see a lot of uses for blockchain and distributed data systems. These systems can create trust and transparency in data and record storage systems. Think food safety, medical lot tracking, fast payment transfer services and other uses where items are passed through multiple hands and quality assurance is paramount.
A cryptocurrency (crypto-currency, crypto, or coin) “is a digital currency designed to work as a medium of exchange through a computer network that is not reliant on any central authority, such as a government or bank, to uphold or maintain it.” Cryptocurrencies are based on blockchain technology. I can see some uses here as well, such as in coupon management or online universes (metaverse), where commerce and valuations are not tied to a national system of commerce.
However, if you listen to many cryptocurrency advocates, their explicit desire is to operate outside of a (US) central banking system. They don’t trust the Federal Reserve, the financial “elite” or the US dollar.
And now I feel a bit uneasy.
I get that there may be over-regulation in the banking system, and that this has created an environment of bloated banking operations, high expenses, and lack of innovation for financial products. I applaud the rise of FinTech to disrupt and correct some of these current challenges.
However, to think that a digital currency outside of federal control could rise to a stand-alone medium of exchange and unit of accounting minimizes the importance of the required standards (and regulation) for these features of money in a large economy.
I also understand the fear that cryptocurrency advocates have for the devaluation of the dollar. Figure 1 shows the ~50% rise in M2 money supply (money in circulation and <$100,000 deposits) following the stimulus response to COVID by Federal Reserve and Federal Government. The inflationary response from this easy money is now a factor in our daily life.
Yet over this same time period, the market capitalization of digital coins increased over 10X, from ~$260 B to nearly $3 T (Figure 2). Now, it is down to $1.3 T (down 57%), so it clearly has not been the store of value that people had hoped. The loss of 57% of value far exceeds any loss of value in the dollar via inflation over this time period.
But more importantly, for cryptocurrency to succeed at replacing the US dollar as a more efficient and stable currency, advocates are betting on the decline and failure of the US dollar as the national, as well as the world reserve currency.
Why would any (US) citizen wish for that outcome? The economic pain and wealth destruction that would accompany such a process would be profound.
I am confused why someone would wish for that outcome.
I am all for disruptive technologies that make processes and systems better. But this desire for a currency replacement by crypto advocates feels off, and certainly destructive for the larger population. I also wonder what (and who) really rises in its place.
Have you heard the Who song, ‘Won’t Get Fooled Again’?
I wonder if it would be better to focus on helping the Federal Reserve and Federal Government become more trustworthy rather than on our fear of losing trust in it.