The Creative Destruction of Money
You’ve probably heard a lot about disruption lately. It’s a bit of a buzzword
Every day, a new company promises to disrupt some established industry and change the world. But disruption is just the modern term for an older idea: creative destruction.
In this post, we’re going to look at how industries are creatively ‘destroyed’, why this matters, and what it tells us about the possible future of cryptocurrencies.
A less friendly term for ‘disruption’
The creative destruction of industries follows a particular pattern.
You have a dominant system used by most people. It’s the best option available at a particular time. Eventually, a new system emerges that is better than the old one. It’s usually cheaper and more efficient, perhaps fairer and safer too. To replace the old system, it must first ‘destroy’ it.
The idea of creative destruction comes from Joseph Schumpeter. One of the most influential economists of all time, he based it on the earlier work of Karl Marx. To create new wealth, Marx realised, you need to first destroy old wealth. Sometimes the initial spark is a crisis that highlights the problems with the old system and makes people want a better way.
The price of innovation
First, the old system needs to go so the new one can take over.
Innovation always carries costs, even if everyone ends up better off in the long run. Creative destruction means that some jobs disappear. Entire industries can vanish. People may get angry and try to cling to the old way. Infrastructure becomes redundant. There may be legal or regulatory squabbles. Different groups with competing views collide and things get political.
It’s a bit like evolution — an ongoing move towards the efficiency necessary to thrive.
Creative destruction always begins with innovation: a new idea so powerful and different to everything that came before that it changes the world. Schumpeter believed that entrepreneurs are the driving force behind this process — people who believe they can change the world. Unlike those who have good ideas but never act on them, they take risks. Failure doesn’t faze them.
The entrepreneurs who kickstart creative destruction are often outsiders. They do things that make no sense to anyone else. They act on pure instinct, motivated by what Schumpeter saw as a mysterious force.
It takes a lot of guts to look at a system everyone else thinks is good enough and say “I could make this better.” Not “This could be better” but, “I am the person who is going to make this better.”
Horses vs Cars
Henry Ford once said if he had asked people what they wanted, they would have said “A faster horse.”
Even after the invention of personal cars, it took a long time for them to gain acceptance. Most people thought they would always be too expensive, too dangerous and too difficult. It took a long time to build the infrastructure, bring down costs, and design cars that were simple to use and weren’t total death traps.
If it’s a choice between a horse and a car, most people will go for the car- once they know it’s an option.
With creative destruction, the new way isn’t an improvement on the old way: it’s completely different.
A car isn’t a better horse. It’s a whole new category. Yet it serves the same purpose: it helps us get around. In certain situations (e.g. police crowd control), it might still make sense to ride a horse. But we can say with certainty that, in most parts of the world, the automative industry creatively destroyed the industry surrounding horses as a mode of transport.
That’s enough about horses. Let’s talk about how this relates to Bitcoin.
Catastrophe: the catalyst for change
When it comes to finance, we haven’t seen any serious creative destruction for a long time. We’re all still riding horses.
Yes, there have been minor tweaks. But fiat currency has stayed pretty much the same since its introduction.
Although some of the problems with that have been obvious for a long time, the idea of completely changing the financial system would have seemed unnecessary until a decade ago.
And then 2008 financial crisis happened. Being — arguably — preventable and the result of a lack of accountability and proper regulation in the finance industry, it led to a lot of anger.
Across the world, millions of people found themselves unemployed, in debt, with homes that had lost most of their value, and watching their tax money going towards bailouts. Stock prices plummeted and protests broke out.
This was the perfect environment for the appearance of cryptocurrencies.
The creative destruction of money
As most of the world worked on getting back to normal after the crisis, somewhere out there an individual or group known only as ‘Satoshi Nakamoto’ created the first decentralised cryptocurrency.
Bitcoin launched it in 2009, with the first mined block including a reference to the bank bailouts.
Bitcoin didn’t appear from nowhere. Activists known as cypherpunks had debated similar ideas for years. Bitcoin took inspiration from previous endeavours to make electronic currencies.
But creative destruction needs to happen at the right time. Unless people can see the flaws in the old system, they won’t be ready to adopt a new one. As they say, “if it ain’t broke, don’t fix it.” Sometimes we can’t see how broken something is until it completely collapses.
Over the last nine years, a community has grown around the belief that Bitcoin (or something similar) can and should become the dominant global currency, or at least occupy a role alongside fiat currencies.
Bitcoin meets the criteria for creative destruction. It serves the same purposes as regular currency. You can use it to pay for goods and services. You can receive it as payment or transfer it to friends and family. Unlike regular currency, you can use it as a store of value that governments can’t touch. Decentralisation, speed, lower costs, transparency — the benefits are clear.
Let’s take a look at some of the key benefits and why they matter in this case.
Cost
First, cost. This is usually the driving force of creative destruction.
Bitcoin can seem more expensive than regular currency because of the transaction costs. But that’s because those are more visible. Our current financial system involves enormous hidden costs related to regulation, law enforcement and infrastructure.
Here’s one tiny example. Law enforcement spend a lot of resources tackling counterfeiting. They even need to monitor the production of fake money as a prop for films! But there are literally hundreds of other examples.
We all also pay fees for using regular currency: account fees, transfer fees, exchange fees, withdrawal fees, and so on.
Day by day, inflation is also eroding the value of your money. This isn’t a direct cost, but it still means you can do less with your money.
Ever heard your parents or grandparents talk about buying their first house for less than the cost of a car today? That’s inflation in action. Governments can devalue local currencies. They can’t devalue cryptocurrencies.
If you run a business, you’ll know all about the huge cost of processing and chargebacks. For small businesses or those with high volume, low value transactions, these can be huge.
Financial crime is another hidden cost that we don’t think about until it affects us. Identity theft, fraud, tax evasion, money laundering and so on. Even if it hasn’t affected you yet, it almost certainly will at some point. Financial crime is devastating and costs us billions each year. It’s believed that transparency could help reduce financial crime. The UK government ranked cryptocurrencies as the least likely vehicle for money laundering. Both banks and cash ranked worse.
Any country that switched to cryptocurrency would reap enormous economic benefits. Then, it would only be logical for other countries to follow suit. Many emerging economies are willing to do anything to gain an advantage. If this happens, it could set off a chain reaction across the world.
Speed
Speed is another important advantage. Doing things faster means we can do more. So innovations are often about speed. Bank transfers can take days or even weeks. Cryptocurrency transactions can be instant, or almost instant. The same goes for processing transactions. Speed alone can be a good reason for switching to a new system.
Social benefits
Some benefits are hard to measure. We can put a number on the savings in time or money. But it’s hard to quantify the benefits of greater control, transparency or equality. That shouldn’t detract from their importance. Historically, creative destruction usually meant putting more wealth into the hands of a few.
Cryptocurrencies are different because they put control in the hands of everyone. They offer an unrivalled opportunity for financial equality. Over two billion people currently have no access to a bank, cutting them off from the wider economy.
The ability to control your own life is a vital human need. If you look at people who have lived through extreme situations, you’ll find that those who held onto some aspect of control survived. People who feel like they have some control within their jobs tend to be happier and more fulfilled.
At the moment, we have essentially no control over our money. Sure we can spend it how we like but that’s about it. Governments can still devalue it, impose controls or even seize it from us. Hyperinflation is still a real problem in some parts of the world. We see that lack of control as normal because we’re used to it. Who’s to say what would happen if that changed?
Once the infrastructure is in place to bring cryptocurrencies to everyone (that’s Luno’s mission), it’s possible that people in some parts of the world will prefer to use them because their local currencies are so unreliable. For the millions of migrants working abroad to support their families, freedom from transfer fees as high as 10% could be life changing.
We don’t need a faster horse
Transforming something as big and important as the financial system is no small task. If it does happen, it will take time.
But the opportunities the internet now offers for collaboration, and the willingness banks are showing to work with cryptocurrencies are good signs.
Luno’s perspective is that most financial technology companies, despite their tendency to call themselves ‘disruptive’, are simply building products and services within the existing systems. Doing the same things, but with slightly lower fees, or better design, or more transparency is not creative destruction. That can only go so far. Marginal improvements are not going to combat the more serious problems.
Most fintech companies are just building a faster horse. That’s what the majority of people think they want. If you ask people what they’d like to see improve in the financial system, they might say: lower exchange fees (why not no exchange fees?), faster transfers (why not instant transfers?), currency that can be used in more locations (why not money that can be used anywhere?) and so on.
Luno’s long-term goal is to build a whole new infrastructure that’s better than anything we’ve known before. Yes, that might sound crazy and audacious. But so did cars, trains, vaccines, aeroplanes, telephones, electricity, factory assembly lines, films with sound, the internet, personal music players, and…just about everything.
