Is it a currency?

Published in

Bright Matter Advisory

5 min readAug 1, 2018

Do cryptocurrencies have the potential to become a universal mechanism of exchange?

With the birth of new technologies and schools of thought, people have always looked to engineer new innovative mechanisms of exchange using alternative currencies. As a result of globalisation achieving trust and engagement is an extremely ambitious task which many have tried to tackle in the past. David Sacks (Co- Founder of PayPal) in his speech at Token Summit New York 2018 said,

All projects that tried to replace the USD during the Y2K never really went anywhere. Two key projects that attempted to create virtual currencies were Beenz.com & Flooz.com, these projects raised circa $100m and are now defunct. In the end Paypal won the race to Y2K as they bootstrapped off of the USD which meant they didn't need to create a new net work effect.

Characteristics of a currency

To date, there has been a lot of scepticism around whether cryptocurrencies will be adopted on a global scale as a mechanism of exchange. In order to answer that question, I believe it is important to determine whether or not cryptocurrencies are legitimate currencies? By definition there are 5 specifications that define a currency:

Scarcity: Through the limited supply of a given currency, value and demand are created.
Fungibility: Individual units are essentially interchangeable, providing the ability to exchange.
Durability: Ability to withstand wear, time, weather, pressure, and damage.
Divisibility: Ability to fragment and divide into smaller parcels.
Transferability: Ability to transfer value between owners.

Noting the above, cryptocurrencies can certainly be defined as currencies and arguably fit the criteria better than traditional currencies. Scarcity is the main issue for traditional currencies since leaving the gold standard. The consequence of this separation has been corruptive monetary policies and alarming levels of inflation.

During an interview with CNBC David Sacks said, “you can also feel that something revolutionary is happening. Money is being made programmable. That’s a fundamental change with implications we can still barely see.”

The Price Vs Velocity Dilemma

The purpose of the message here is not to insinuate that the payment utility tokens seen on the market to date are the answer. In a world of manic volatility, it is difficult to grasp how many of these payment-oriented utility tokens will achieve global engagement.

Going back to the basic principles of economics and taking a look at the equation of exchange shown below, there is an inverse relationship between price and velocity. As the price of a token appreciates, the velocity of transactions within the network will naturally fall due to a stronger incentive to hold the token and vice versa. This dilemma is common within the utility token economy. The reason that the price and velocity dilemma isn’t commonly seen in traditional markets is simply due to the fact that raising vehicles (shares etc.) and currency are separated. In traditional markets, the raising vehicle provides an opportunity for growth on an investment, while currency remains a mechanism of exchange.

Dual Token Model

There are four key traits that a cryptocurrency requires if it is going to have a chance at real-world adoption. These traits are price stability, scalability, privacy, and decentralisation. What is the solution? At Bright Matter it is our belief that the solution is a dual token model encompassing a stable coin and a fund-raising token (asset-backed token/security token). Unlike other cryptocurrencies which derive value from the speculation of their inherent utility, stable coins are pegged and are backed by stable assets such as gold or the US Dollar. As the name suggests, stable coins are not subject to the volatility that traditional cryptocurrencies experience where price movements can fluctuate at a minimum of 10% to 20% on a given day.

Are Stable coins the answer?

Taking a lesson the success of Paypal and boot strapping to the USD, Stable coins provide a more efficient mechanism of exchange than typical cryptocurrencies. As a by-product, stable-coins can act as a hedging strategy for investors who have liquidated positions and are looking to park funds.

The growth of a global stable currency, in addition to the USD, would be particularly valuable to people who reside in countries such as Argentina, Egypt and Turkey where inflation rates can be over 15% per annum. In these countries, people often prefer to hold USD in order to maintain their wealth. Capital controls in these countries, however, often prevents citizens from using currencies other than their domestic currency to complete international transactions. With a decentralised currency that has stable value, people in countries that are affected by hyperinflation would have access to a stable currency without being restricted by capital controls.

Stable coins, along with being a stable mechanism of exchange, can play an important role in cryptocurrency-based lending and derivatives markets. This would serve as the infrastructure for blockchain-based financial systems that don’t need the intermediaries present in traditional finance channels. In order for lending in cryptocurrency to be viable, price stability is critical. For example, if a lender were to issue an ether-based loan to a borrower, both parties would take on significant risk due to the volatile price movements of said cryptocurrency. On the other hand, the lender would have the ability to sell collateral in an instant through margin controls giving the borrower no option to salvage their position.

Conclusion

This article is not written to argue that there are no proven use cases for traditional utility tokens. Utility tokens are certainly a revolutionary technology. This article proposes a solution to the illegitimate fundraising that has been seen especially throughout 2017.

For a dive into the types & applications of stable coins, continue to our next article here.