Cryptocurrencies: A Path to Ideal Money
Mathematician and economist John Nash, famous for his Nobel winning work on non-cooperative game theory, first conceived Ideal Money around the early 60’s. At the time he became unsettled by the fact that certain currencies, as part of the International Monetary Fund (IMF), had agreed to fix exchange rates with one another. Nash’s concern was that a fixed exchange ratio between currencies would encourage hyperinflation — and his reasoning went something like this:
- Let’s say Alice and Bob agree to a fixed exchange rate: 1 Alice Coin =1 Bob Coin.
- Let’s also say that: 1 Bob Coin = 1 Gold Nugget.
- Since Alice can always exchange her coins for Bob coins 1:1 and then redeem them for gold, she stands to benefit from inflating her currency as aggressively as possible, trading her coins for Bob coins and then for gold, before Bob catches on.
Nash, thinking this wasn’t a healthy game, immediately sought to trade his US dollars for Swiss Francs, which could be redeemed for gold but were not subject to the fixed exchange rates designated by the IMF.
He considered the Swiss Franc to be “better money” because it was more likely to hold its value against gold, but went on to imagine what an “ideal money” might look like. Eventually, he would spend the last 20 years of his career promoting the idea that an Ideal Money is one free from the conflict of interests that arise when a country’s currency is used as a global reserve currency.
1. Abstract Definition
Ideal Money is a solution to the conflict between near-term domestic interests and long-term international interests that occur, when using a country’s currency to stabilize international currencies.
Until recently, circulating new and independent currencies has been very difficult, which is probably why Nash thought extensively about how governing bodies might collectively produce stable independent money. But even Nash could not have foreseen the proliferation of distributed ledger technology, or the effect it’s had on lifting geopolitical constraints.
Today, it’s trivial to create and circulate government-independent cryptocurrencies. In fact we now we have thousands of new currencies like Bitcoin and Ethereum — many of which were created in just the last two years — and any of which could theoretically be adopted as global reserve currencies.
So if we allow ourselves to drop the previously difficult parts about geopolitical conflict from the original definition, we’re left with a simplified definition.
2. Simplified Definition
Ideal Money is a solution to the conflict between near and long term interests when creating a stable cryptocurrency.
This new definition is certainly simpler than the first, but it’s still pretty vague. In the cryptocurrency arena many economic theories, previously reserved for philosophical debate, can be empirically tested. But to actually seize this new and fertile testing ground, we need to articulate statements that can be evaluated. So the real question is: “Can we describe Ideal Money concretely?”
Well, we can at least try :)
The three functions of money are commonly known as: 1) A Unit of Account, 2) A Store of Value, and 3) A Medium of Exchange.
But for now let’s just think about Store of Value. More specifically, let’s think about Store of Value as a likelihood function over time. Imagine a simple function that assumes a fixed amount of money, takes time as its input, and outputs the likelihood of being able to purchase at least the same number of goods.
In the example of fiat money above, it’s highly likely in the near term that a person committing capital at time 0 can retrieve their committed purchasing power over short periods (looks great zoomed in).
But over long periods this likelihood decreases due to inflation. In other words, if you put $1 in at time 0 you’ll be able to retrieve $1 any time thereafter, but the number of goods you can purchase with that dollar will go down (looks bad zoomed out).
The near term supply policies that make fiat currencies excellent near term stores of value — and correspondingly great mediums of exchange — conflict with their use as long term stores of value.
By comparison, gold is volatile for short time periods, but hovers around a relatively flat purchasing power over long periods of time.
The problem with gold as a currency, apart from being hard to guard and transport, is that it has no coping mechanism for randomness. Its supply cannot easily be adjusted to target a stable purchasing power and can’t easily overtake fiat currencies as a medium of exchange.
In other words, an ideal reserve currency would appear stable zoomed in (like fiat) but also appear stable zoomed out (like gold).
Now that we have all the context, let’s take a stab at a concrete definition. In a world of easy to circulate government independent cryptocurrencies, we might simply call Ideal Money a cryptocurrency capable of storing both near and long term value.
3. Concrete Definition:
Ideal Money is a cryptocurrency that stores both near and long term value.
By looking at Ideal Money through the lens of value storage over time, our previously abstract definition has been freshened up and made concrete.
4. Looking Forward — Making the Ideal, Real
Brandon Iles and I happened upon these thoughts earlier this year when we started thinking deeply about monetary policies.
Most cryptocurrencies today are structured as floating price tokens, and are meant to become long-term stores of value. Bitcoin and Ethereum are this way, and if successful, these currencies will appear stable zoomed out (the way gold does); but without supply policies, floating price tokens will never look stable zoomed in (the way fiat does).
A much smaller cohort of projects called stablecoins focus on near term storage but have exactly the opposite problem.
With Fragments, we wanted to take things a step further by creating a cryptocurrency capable of storing both near and long-term value. At the time, we simply felt that recreating fiat on the blockchain, while entirely necessary, wasn’t a big enough step forward.
Almost immediately, we ran into the paradox of inflation: The same mechanism that keeps fiat currencies stable in the near-term is also what devalues them long-term.
Frustrated, I reached out to Joey Krug (creator of Auger) for advice. After a few weeks of back and forth brainstorming, Joey suggested that we explore the concept of stock splits more as an example of how supply can inflate but the net value of your holdings can remain unaffected. This was a tremendous connection for us. It freed us to think way beyond the prior work of central banks; and the idea that an inflation policy could provide near term stability without sacrificing long-term stability had been unlocked.
Incredibly hopeful and excited, we began developing a protocol and platform for cryptocurrencies that intelligently split upon inflation. Such currencies would be capable of storing near and long-term value, eventually converging on the characteristics of Ideal Money.
Practically none of what we’re doing (currency splits, dynamic reserve requirements, algorithmic supply rebasing, distributed market-making) would work with fiat currencies — but it would on the blockchain. And for the first time ever, there’s a ready and willing community of people across the world who can take purely theoretical concepts like Ideal Money and actually turn them into our reality.
To us, the real opportunity here is to try something different. To really learn something. Not to simply recreate gold or fiat on a digital infrastructure, but to push forward. And to push forward responsibly by encoding a positive set of values into a culture that will one day govern itself.
We hope you’re as excited as we are, and look forward to your feedback. Thanks for tuning in :)
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