When Central Bankers Make Mistakes

When central bankers make mistakes, they gradually ruin currencies, economies, and countries.

Central banks run monetary systems of countries, managing a country’s currency, money supply and interest rates; they oversee the country’s commercial banking system; and they print the money that is considered the country’s legal tender (the fiat currency).

Central Banks Are Just People

But central banks are just people, and people make mistakes. In the United States, Europe, and other developed economies, we take for granted the luxury of having central banks — such as the Federal Reserve and the European Central Bank — that have central banking skill, experience, credibility, competence, independence and ethics.

Other central banks are less competent, less independent, more political or corrupt, and most importantly cannot undo the errors of their sovereigns, such as autocratic nationalism, running economies that are overly dependent on one commodity, and more. This is often more readily evident in small sovereigns in Africa or Latin America as their currencies devalue or their economies fail, but also evident in larger sovereigns such as Russia.

Currencies of many non-developed economies are inflating at annual rates of 5–10%, sometimes more. There is more than a trillion dollars of value in hyperinflating currencies.

Non-Fiat Stores of Value

This is one reason non-fiat stores of value, such as gold, have always played a role in economies. When you buy gold, you are expressing a lack of confidence in your central bank. You may not realize that it is what you’re doing, but that is exactly what you’re doing. The industrial value of gold is only a small fraction of the trading price of gold. The rest of the value is the value of not being in a sovereign’s fiat.

Cryptocurrencies vie to play this role, in the same way that gold does. And Bitcoin is succeeding in being a better gold.

But Cryptocurrencies Are Not Currencies

Cryptocurrencies lack an important feature of currencies: price-stability. Without price-stability it is impossible to use the cryptocurrency in transactions. Non-price-stable cryptocurrencies such as Bitcoin are cryptoassets or cryptocommodities, not cryptocurrencies; just as gold is an asset or commodity, not a currency.

Price-Stability is Difficult

When we talk about price stability, by necessity we are talking about stability relative to popular fiat, such as the US dollar. Creating such stability is hard because there is an awkward bridge between the distributed, decentralized ownerless world of cryptocurrencies and the centralized world of fiat.

There have been various approaches to solving the price-stability problem, none of them quite meeting the challenge. For example, one solution is for a party to offer to take a US dollar from you, and in exchange provide you with a crypto token “worth exactly a dollar” and keep your US dollar “in a safe place” while you use the crypto token. Fine, but you take counterparty risk when you do this. Tether is an example of this approach. Often the counterparties are opaque offshore entities with unclear governance.

A number of other solutions have been attempted, none of which solve for both counterparty risk and volatility at the same time. Because it is hard to do.

Market Opportunity for Decentralized Price-Stable Cryptocurrency

Near-term, an immediate multi-billion dollar market opportunity exists for a price-stable crypto store of value usable by cryptocurrency traders. Regulatory, tax and legal issues make it onerous and costly for cryptotraders to trade with fiat, and many crypto exchanges do not even offer the ability to use fiat. A stable crypto store of value enables streamlined trading without incurring dry-powder volatility risk. The size of this market should grow with the market cap of crypto.

Long-term, a stablecoin (a cryptocurrency that’s price-stable relative to fiat, or a basket of fiats) could bring unprecedented levels of accountability to the economies of developing nations. It could be used as a global store of value and mainstream medium of exchange, initially in developing countries with unreliable central banks, and eventually globally.

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Managing Director at Bain Capital Ventures

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