Monetary Economics of Legal Tender and Cryptocurrency
- By Lead Economist Jay Jung
Currency is a sort of social promise. A reason why mere paper with great men’s portraits can be used as a means of purchasing goods or services is a belief, the belief that the value of the currency will be maintained by the government and the central bank, building a social promise that the currency can be functioned as follow: a measure of value, a store of value, a medium of exchange, and a government’s means of paying.
Let’s dig more about the functions of the currency. First, the currency is used as a means of measuring the value of diverse goods and services. Hence, the fact that a cup of coffee is 4,000 Won and a bowl of cold noodles is 10,000 Won means that a bowl of cold noodles has a value equivalent to two and a half cups of coffee. In other words, we can measure and compare the value of various goods and services through currency. If the currency did not exist, it is likely that there would be no way of measuring and comparing the value of goods and services. The function of the measure of value makes it possible for the currency to function as a medium of exchange. That is, we can utilize the currency as the medium of exchange to purchase goods and services. If the currency did not function as measuring of value, we could have been using other products or services, such as rice or labor as a means of exchange, and it is very clear how uncomfortable this is. Moreover, the currency functions as the store of value. People store wealth or transfer through currency. However, using jewelry is enough for this kind of uses. Then, what makes a difference in using legal tender and jewelry, and why don’t people use jewelry as a means of paying or storing.
The difference is the currency’s last function, the government’s means of paying. The belief that currency’s value will remain constant and it will be constantly used in the economic system depends on the currency’s last function. That is, people use currency to pay taxes and the government uses the taxes to manage the national economy. If the value of the currency does not remain constant during the process, the government will suffer the following consequences. If the difference between last year’s and next year’s value of the currency is extremely different, it will be very difficult for the government to finance the entire national economy. We can find a real-life example in Germany’s hyperinflation right after World War 1 or Venezuela’s hyperinflation after the year 2000. When the value of the currency doesn’t remain constant, the whole national economy will be devastated.
To keep the monetary value stable and to ensure the smooth functioning of the currency, the central bank uses various policies to sustain and secure the value. For instance, if the economy overheats with the excessive liquidity in the market, the central bank raises the interest rate to reduce the liquidity, and in a case of the economic recession, the central bank lowers the interest rate to increase the liquidity in the market. Through these regulations and policies, the central bank keeps the currency value and the quantity stable. When the interest rate is too low like in the last global financial crisis, and the interest-rate control doesn’t seem to be effective, the central bank may take a quantitative easing policy, directly providing money to the market. Likewise, the currency is not merely a means of purchasing goods and services and used for the financial transaction, but a tool for economic policy that plays an important role in the national economy.
Satoshi Nakamoto presented the idea of Bitcoin, which aims financial transactions between parties without a financial institution’s interventions, in a white paper in 2008. As a result, Bitcoin was first issued on January 3, 2009. Many people formed a sympathy for Nakamoto’s white paper and Bitcoin because of characteristics of the central bank’s mechanism that stated above. In other words, the US Federal Reserve and central banks from different countries increased the volume of currency issuance in order to prevent the economic depression and to stimulate economic growth during the financial crisis. As a result, they were able to avoid economic depression. However, these policy operations could not save individuals who were in difficulties due to the financial crisis, leaving doubts on the economic system managed by the government and the central bank. Therefore, Bitcoin and other cryptocurrencies were welcomed by people.
Yet, there is a fatal problem in a cryptocurrency. That is the fact that the value of the currency cannot be assured. Surely, Nakamoto’s idea is innovative. Nonetheless, he could not predict market participant’s insane speculation tendency and behavior which cause Bitcoin’s extreme fluctuation in the price.
If cryptocurrencies, including Bitcoin, are not intended to replace legal tender but to serve as a single investment asset, the price fluctuation is not a problem, because it will be regarded as a risky investment. Despite, cryptocurrency aimed to replace the legal tender. Then, the rapid fluctuation in the price is problematic. Unpredictable price fluctuation prevents cryptocurrency to be used as a measure of value. If cryptocurrency cannot be used as the measure of value, it means it cannot serve as the medium of exchange, store of value, and the government’s means of paying.
The positive expectations of cryptocurrencies collapsed, leaving the recession in cryptocurrencies and blockchain token market. However, this is not the end. In the late ’90s and early ’20s, there was a bubble on the Internet like cryptocurrency market these days. When it collapsed, as a result, people were able to enjoy platform called FAANG (Facebook, Amazon, Apple, Netflix, Google), provided by emerging global IT corporations. As well as blockchain and cryptocurrency, though replacing legal tender ended up merely as a non-realistic daydream, blockchain’s distributed ledger technology and a smart contract is definitely an innovative technological achievement just like the Internet. Just as FAANG came out of the internet bubble and revolutionized our daily lives, there are still people around the world who are trying to renovate our life with blockchain technology.
