This series of essays explores how cryptocurrencies, despite the frauds and scams in the system, can possibly go beyond the speculative asset category. Rather than investigating the underlying utility value for a cryptocurrency system, this series will focus on power interplays between people, and how that can draw a narrow scenario in which cryptocurrencies become mainstream.
When reading materials on monetary policies and financial history, inflation-enabling property of currency is universally praised by academics. It gives the government the ability to act properly as the lender of last resort. It promotes consumption by suppressing hoarding behavior. It is generally considered pro-innovation because money needs to seek higher-return / riskier investments than itself. This is easier if the baseline is low.
Thus, academics project their likes to inflation-enabling currency back to the cryptocurrency market then predict they won’t be a worthy money replacement because of their limited supply. Even for Proof-of-work cryptocurrencies that don’t have a 21-million cap, it is pretty obvious these are front-loaded. Many of their mining rates are not matched to the economic growth. If you factor in how many wallets lost their private keys, these are strictly supply-limited.
What many academics didn’t factor in, is how higher-level consensus was achieved. In the cryptocurrency world, per-transaction consensus can be achieved through algorithms implemented in C++ / Rust or Go programming languages. Higher-level consensus, decisions such as which version of the software to use, what new features need to be included in a certain release, what are the new features would be interesting to experiment, was achieved, in this day, through human negotiations such as EIP. There could be added motivations to move miners over to newer software through difficulty bomb but nothing prevents larger pools to collude and fork the software.
The supposed supply-limited nature of cryptocurrencies are not immoveable ancient laws set on stone. It is, at its core, a brilliant if not deliberate marketing ploy to attract the unsophisticated. Market participants knew well that it cannot be the Gold standard of our time if there is no circulation. If most participants are HODLers, the circulation will be limited. But no matter, this is only the first stage.
For how ridiculous the marketing goes, look no further than
As far as the first stage goes, cryptocurrency market needs to solve the paradoxical challenge that while remain low in circulation, it also needs to get as many people as possible to be HODLers. This helps to gain wide political support in democracies. More importantly, if cryptocurrencies truly want to be the second-coming of commodity money, they need to have the needed breath once the circulation knob is turned on.
Inflation
Before we discuss the “circulation knob”, current conventional consensus still treats cryptocurrencies as speculative assets. For the plot to be “the better commodity money”, cryptocurrencies need yet to prove itself in a high-inflation world. It is actually not obvious that as speculative assets, how cryptocurrencies can compete with harder things such as commodities. It is even more unclear how it would fare with safe heavens once the inflation triggered monetary tightening.
With brilliant market ploy, low circulation and capital controls, it seems possible to maintain the herd psychology long enough that the hardness of cryptocurrencies can be self-reinforcing (at a certain point, you can point CPI / cryptocurrency price graph and claim that it is “inflation-proof”).
“Circulation Knob”
To be “the money” for everyday use, cryptocurrencies need to turn on their circulation knob at a certain point. The circulation knob would be an implementation that allows cryptocurrencies to have better adjusted supply mechanisms. In a healthy economy, this meant no longer to be forced into deflation. It is hard to imagine, as it stands, that Central Banks would allow broader circulation of unregulated currencies in their respective economies.
However, this is not impossible. In modern democracies, no matter how many ivory-towered academics in the Central Banks and how much they disliked cryptocurrencies collectively, they need to appease the political establishment. At the end of the day, Central Banks only care about impacts to their monetary policy tools. This can be managed by nationalizing mining operations, issuing additional cryptocurrencies to Central Banks or adding new money-supply mechanisms that Central Banks can use to play as the lenders of last resort if needed. These new tools in the cryptocurrencies world would be acted on as higher-level consensus aforementioned. It can be possible because this is another validation to the viabilities of cryptocurrencies at large.
The pursuit of hardness for cryptocurrencies, in addition to the competitions between different cryptocurrencies would be the more challenging part when turning on the circulation knob. They will hold out the circulation knob as long as possible to prove its hardness to the others. This will be a complex play between Central Banks, different cryptocurrencies and their respective philosophies.
Notes
Path Dependence
Monetary history is full of accidental path dependent coincidence. One one hand, the prevalence of cryptocurrencies in its current form would be a deterrent to any Central Banks to issue their own alternatives. It is hard to balance the convertibility of their alternative programmable money in relation to others. Getting it wrong, especially on conversion rate and programmability, could be disastrous to their existing monetary system.
On the other hand, the cryptocurrency world gets its first notice on the back of Austrian doctrine. To depart from the nature of limited supply could be death on arrival for the community. Higher-level consensus that is to the satisfaction of the Central Banks may never be reached. It is very difficult to imagine how eliminating all existing monetary policy tools, effectively abolishing or fully privatizing Central Banks (cryptocurrency players with large sums will be the new unregulated “Central Banks”) would be a good idea. It is not impossible, given that the United States has done that several times, with a semi-private Federal Reserve already. The implied transfer of power if that happened would be worth another essay in itself to explore.
What can go wrong?
A lot. This essay simply plotted a narrow path acting in stages that is imaginable how cryptocurrencies can possibly be a form of money. It requires changes in higher-level consensus carefully several times. One early test would be to see how current slew of cryptocurrencies fare with post-Covid inflation to prove their hardness. So far, the result is mixed.
One thing in the past decade the academics failed to appreciate is the power of believing. In democracies like the United States, if the power of believing can be maintained long enough, a supporting structure from both the political and economic side will emerge. In every aspect, cryptocurrencies are moving along the right direction to establish themselves with such supporting structure despite scams and frauds associated around them.
The news of frauds (Polynetwork, IRON) and crackdowns at this point only strengthens the belief in the resilience of the system. People will point to these events and claim the robustness of the cryptocurrency systems. The centralized exchanges, centralized protocol maintainers / miners and the intentional light regulations (or no regulations at all) seems to be a stable triangle to maintain the cryptocurrency systems.
All these, makes it very interesting to contemplate what’s the exact endgame for cryptocurrency.
Many critics claim that the most risks for the cryptocurrencies come down to the slew of stablecoins that effectively set the price for other cryptocurrency assets. They suggest that the stablecoins such as USDT or USDC are backed by fractal reserves at the most. These fractal reserves are so small (less than 4% for USDT), the critics suspect that they will face liquidation crisis if a run of bank scenario happens.
Unfortunately, these critics failed to read the fine footprints of these said stablecoins. While you can exchange either USDT or USDC and with hundreds of alternative coins in decentralized exchanges, you cannot do so between USDT / USD pair or USDC / USD pair. It is these centralized exchanges that control how you can redeem these stablecoins into USD. Like countries with capital controls, the fixed exchange rate can be maintained indefinitely.
The endgame for cryptocurrency won’t be the crash of the stablecoins.
While the stablecoins cannot crash with absence of regulations, for the current slew of stablecoins, their power has been associated with the power of USD. It is possible to have a stablecoin to be associated with a basket of currencies, but that also means the said stablecoins will face not only the U.S. regulations, but regulations from the EU, China or Japan, depending on what is in the basket.
Paradoxically, stablecoins won’t crash, but can land to safety with the slide of the USD from its global reserve currency position. However, that won’t be good news to cryptocurrencies at large.
The academics largely got it wrong in the past decade regarding the cryptocurrencies because they failed to factor in the waning power of the United States. The U.S. has lost both willingness and political power to maintain absolute control globally. Its regulators moved too slowly to defend the USD’s global interests. Meanwhile, the internet moved from fear of creating any digital USD alternatives (e-gold) to that any individual can do ICO. Now, there is no willingness to regulate cryptocurrencies as long as the market is high and people make money.
The waning power of the United States is both a blessing and a curse to the cryptocurrencies.
At the moment, the cryptocurrencies need a powerful democracy that can maintain global hegemony. Without global hegemony, cryptocurrencies will face real issues with intermittent internet connectivities, difficulties of consensus convergence, widely-fluctuating exchange rates against commodities. With any form of government other than democracy, powerful authoritarian or dictatorial governments simply cannot tolerate the loss of capital control.
There could be alternative scenarios that cryptocurrencies succeed without the United States. Central operators need to grow to be powerful transnational entities that have controlling shares in commodities and other life essentials globally, potentially have their own enforcement militias to maintain such hegemony. This scenario has been explored in other anarchist’s readings extensively since the 1980s (or earlier). The problem, of course, is that such a transition of power takes time.
To believe in cryptocurrencies, you have to simultaneously believe that the U.S. power is waning and it can maintain global hegemony for an extended time. However paradoxical this proposition is, it increasingly seems to be a likely scenario for the next 15 years. Will this be the Goldilocks situation for cryptocurrencies? I don’t really know, and the readers, you have to make up your own mind.
Notes
What about KYC (“Know Your Customer”) rules?
If anything, this limits the number of centralized exchanges that can do stablecoin / USD pair. Limited number of centralized exchanges also means that it is easier to collude and fix pricing.
What about increasing regulations / self-regulations on USD?
The heavy regulations on USD (such as KYC rules mentioned prior) and recent news about self-regulations on USD (MasterCard / OnlyFans speculations) suggest the political willingness to regulate. However, USD is an easier target for politicians because no one else profits from USD other than the United States itself. Piling regulations on USD to “save our children” is an easy win in democracies. Piling regulations on cryptocurrencies because regular people make money on it (while the market is high) is a political suicide.
The imbalance of regulations against USD and the no regulations against stablecoins only reinforces the ability to do capital control from centralized exchanges. As long as these regulations exist in one form or another, it is much easier to accept the capital controls imposed by exchanges because you cannot do X with USD but can with stablecoins.
What about utility values of cryptocurrencies?
While there are utility values from cryptocurrencies, I am trying to explore alternative frameworks to assess based on power structures rather than the underlying utility values provided by a technology. This essay treats transition to cryptocurrencies as any other transitions: yes, there are utility values to motivate the transition in the first place. But ultimately, it is about people, especially people in power to make decisions on actions and inactions.
What can go wrong?
A lot. People can do stupid things. No amount of rosy scenario planning can prevent that.