Why a deflationary currency isn’t suitable for everyday payments
by Maryna Trifonova, Head of Content at Jax.Network
Most cryptocurrencies are created to be speculative assets, hence, they are deflationary by nature and can’t serve as a day-to-day payment method. Read the article to learn why using a deflationary currency for everyday payments isn’t a good idea.
Purpose of a transactional currency
To be considered transactional, a cryptocurrency should have a number of properties specific for its purpose, which is to finance transactions along with a system able to prevent bubbles on money. Indeed, money as we know it is intrinsically worthless and its value should not grow above the price of interest (Tirole, 1985). However, we agree that most existing cryptocurrencies aren’t suitable for everyday payments.
First of all, Bitcoin, Ether, etc. are deflationary coins. It means that their purchasing power will only grow along with the constant decrease in prices. For example, over a decade ago a man bought two pizzas for 10,000 BTC. Today, it’s nearly $500 mln, with Bitcoin trading around $50,000. But how much do two pizzas cost now? Well, if the average price for a pizza is $15, then two pizzas will cost $30 or less than 0,0006 BTC. It’s a tremendous difference in price over a decade, isn’t it?
Money debt versus commodity money
As deflationary currencies increase in purchasing power, people will tend to hold them instead of spending. If Bitcoin is a store of value with market returns higher than that of stocks, then it makes no sense to invest time and money in other productive projects. Just store your savings in your Bitcoin wallet and voilà.
Charlie Munger, a vice chairman of Berkshire Hathaway, recently criticized Bitcoin for exactly the same reason. He said he didn’t want to go “shoveling out a few extra billions and billions of dollars to somebody who just invented a new financial product out of thin air.” He went on to say it’s “contrary to the interests of civilization.” So, basically, he argues that Bitcoin doesn’t bring anything to the world, unlike other investments.
In other words, money based on debt helps the economy grow through leverage and investments, while commodity monies would prevent such investments from occurring. Would a Bitcoin standard lead to under-consumption and under-investment, or some sort of debt deflation? Let’s have a look at both history and theory. According to the 20th-century economist Irving Fisher: “Thus over-investment and over-speculation are often important; but they would have far less serious results were they not conducted with borrowed money. That is, over-indebtedness may lend importance to over-investment or to over-speculation.”
This conclusion was shared, albeit in a different context, by another economist, a contemporary of Fisher, Friedriech Hayek. In “Prices and production”, Hayek went on to argue that price level disturbances can lead to bad economic decisions, including bad investment. A central bank over-issuing paper money would trigger such price disturbances. Commodity monies work as a backstop to such economic cycles. A bank would/could only issue as many banknotes as its reserves, preventing it from over-producing money and therefore misleading economic actors when making long-term decisions.
Going back to the debt-deflation part. Any fall in nominal prices would entail a deflationary spiral, where debtors can not repay their loans anymore. However, according to Fisher, it is often triggered by an overextension of credit, as his quote above suggests. The 1929 Great depression is one recent example. But Bitcoin is peculiar, in the sense that, you cannot create debt out of thin air like in the current system, suggesting that debt deflation is less risky with Bitcoin than in a fractional reserve currency system.
Commodity money has been the norm in the 19th century. Did it slow down investments? But wait, is Bitcoin even commodity money? Well, not exactly. Of course, to produce one Bitcoin you are required to spend quite a lot of resources. The common denomination here is the hashrate, or the computing power (i.e. electricity) used to produce one Bitcoin. A bit like gold that was backing money in the 19th century, Bitcoin is backed by your electricity cost for its production. But here’s the catch, unlike gold, you cannot go to the Bitcoin miners and claim back the electricity that was spent to produce that particular BTC. In that sense, Bitcoin is non-redeemable.
A big difference with other commodity monies where you could at any time go to your bank and claim back the gold that was backing your banknote. Thus, Bitcoin and other PoW cryptocurrencies were coined “synthetic commodity monies” by Selgin (2015). Their production is still backed by an economy — mining — and their rate of issuance, as well as their monetary mass, are fixed and absolute, contrary to fiat currencies.
Overall, “under the gold standard, the money supply in a country depends on the quantity of gold in that country. Thus, following the quantity theory of money, the price level in a country increases when it receives gold and declines when it loses gold.” A Bitcoin standard would probably act similarly. However, wild volatility makes economic decisions more difficult, preventing cryptocurrencies from being mass-adopted.
Stablecoins as a solution
When deflationary currencies are clearly not suitable to serve as a day-to-day payment method, stablecoins may be perfect for this role. Let’s take JAX as an example. Unlike other stablecoins, it’s pegged to the hashrate and therefore remains stable in value without compromising decentralization. The block reward is based on PoW difficulty and, hence, the expected value of each JAX coin is mathematically equal across all parallel independent chains that can be created. That allows us to claim that JAX can become a new global standard for the quantification of economic value. JAX coins are synthetic stablecoins with issuance rate flexibility, preventing wild volatility and helping economic actors to assess their economic decisions.
Thanks to our unique JaxNet protocol based on merge-mining and sharding, all transactions within our network are processed almost instantly, rivaling existing payment processors such as Visa and Mastercard. Besides all that, transactions carried out with JAX are inexpensive and completely decentralized, as they don’t require a third-party intermediary such as a banking institution. Indeed, JAX is a perfect stablecoin for ordinary day-to-day payments like a book purchase and cross-border transactions like payments to merchants for goods or services provided.
Conclusion
Progress has gained unbelievable speed over the past centuries. We need to adjust to the pace and think of the future, as it’s coming with all sails set. Now humanity needs a global transactional currency for day-to-day payments more than ever and JAX seems like a perfect option. It’s scalable, decentralized, secure, and inexpensive.
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