Cryptocurrency & Decentralization: The Road to Societal Transformation, Part 1
The road leading to the creation of cryptocurrency was constructed over millennia. Since the first stones were laid in the time of hunter-gatherers, it has taken twists and turns, from the use of shells, beads and gold coins to the printing of money and the creation of the Federal Reserve. Today we are on the cusp of a major societal transformation that is due in part to this evolution.
In this four-part series, Totle will discuss four crucial ways that cryptocurrency and decentralization are poised to rock the foundations of nation states and alter the world we live in.
Part 1: A New Form of Money
In order to understand the present state of currency and the rise of cryptocurrency, let’s briefly walk down the path that brought us here.
Over the past few millennia, there have been many different representations of value. In prehistoric times, people relied on barter to conduct their business. A tribe specializing in wooly mammoth fur, for example, could exchange said fur for berries gathered by a neighboring tribe. But this system ran into a problem known as the “double coincidence of wants.” That is, in order to complete a transaction, both tribes needed to have something that the other desired.
Shells, beads and other collectibles eventually filled the void, serving as representations of value through which tribes could transfer wealth. (For an excellent review of the origins of money systems, read Nick Szabo’s groundbreaking article.)
Then, around the fourth millennium BC, a shiny, lustrous metal began to captivate the imagination of the human race and quickly rose to prominence as the preferred store of value. Gold was first used in its raw form and later used to mint coins.
Eventually, gold was replaced by pieces of paper redeemable for gold in a vault. These bearer instruments were instantly convertible to gold and were initially issued by goldsmiths who would store and secure the gold on behalf of their clients. As nation-states grew in stature, they began to outlaw these goldsmiths, reserving sole rights to issue banknotes and creating a system of national currencies.
As a precious metal, it is no surprise that gold served as a peg for these national currencies, including the US Dollar. The post-war Bretton Woods system set out the terms by which every national currency would be pegged to the dollar, which would be backed by gold at a rate of $35/oz. However, inflation of the dollar supply led to the collapse of the Bretton Woods model as the other countries began to lose trust in the American-led system. In 1971, Richard Nixon decided to unpeg the dollar from gold, burying the post-war economic system once and for all. This move, known as the Nixon shock, meant that the dollar was now a pure fiat currency, backed by nothing and controlled entirely by the Federal Reserve.
But there is a problem with the Federal Reserve. The Fed has the dual responsibility of stimulating the economy while keeping inflation in check. However, the monetary policies required to achieve these goals are mutually exclusive. Economic growth requires access to cheap credit, meaning the Fed must keep interest rates low and increase the money supply. This increase in money supply reduces the purchasing power of the greenback.
Ideally, the Federal Reserve would react rationally to the fluctuations of the global economy, pulling the levers at their disposable in a way that achieves a delicate balance between economic growth and inflation control. In reality, the world’s largest central bank is governed by people who are subject to cognitive biases and political considerations that tend to impact their judgment. Witness the current pressure from the White House to stop the Fed from raising rates for a case study in political influence on Reserve Bank policy-making. In one instance, Donald Trump, whose political brand relies heavily on the success of the stock markets, began blaming the “out of control” Feds for raising interest rates too quickly after the S&P 500 tumbled 5.5% in 2 days.
Bitcoin to the Rescue
Money is essentially an abstraction of value that serves as a store of value, medium of exchange and unit of account. In order to function as a value store, money must have the capacity to transfer wealth across generations in a manner that is impervious to the ravages of inflation. However, the US Dollar has lost 95% of its purchasing power in the previous century, leading many investors to keep gold as their primary store of value.
Enter Bitcoin, which many are calling “digital gold.” The store-of-value use-case is widely considered to be the primary application of Bitcoin and other cryptocurrencies in their current form. Bitcoin core developers, in particular, are averse to implementing any protocol changes that would compromise the robustness of their blockchain as a value store. Aside from being immune to fiat inflation, cryptocurrencies share key characteristics that position them as a store of value superior to gold:
- A supply schedule that is predictable and can be audited by anyone with access to the blockchain.
- Portable, divisible and fungible — Cryptocurrencies can be divided into tiny increments that are essentially interchangeable and can be transported with ease. Users only need their private keys to move their wealth.
- Censorship resistant — No one can seize a user’s wealth or prevent them from spending it as they see fit.
- Permissionless — Using cryptocurrencies requires a wallet and a private key, which can be generated by anyone, without the need for permission.
- Self-sovereign — Users actually own their crypto wealth. They do not need to trust a third party to hold custody of their asset.
It is these set of characteristics that lead many experts to believe that cryptocurrencies may eventually capture a significant portion of the $7 trillion gold market. Cryptocurrencies also have the potential to significantly expand the market beyond traditional holders of gold. Citizens of nations whose currencies are constantly ravaged by hyperinflation (e.g., Venezuela, Iran, Argentina and Zimbabwe), few of whom have access to securitized gold trading on regulated exchanges, stand to benefit the most from a state-free wealth-store mechanism.
The Next Step: Buying Coffee with Crypto
That Bitcoin must eventually be used to buy groceries is unanimously accepted by all factions. The only debate is whether the road to adoption as a means of payment is larger blocks or layer-two technologies. This debate has resulted in several crypto-mutinies, or “forks,” in recent years, the most high-profile of which occurred in August 2017 when a sect within the Bitcoin network left to form Bitcoin Cash. But while some Bitcoin adherents squabble with the mutineers, others are stepping into the fray to offer solutions. Both altcoins and layer-two solutions such as Blockstream’s Liquid are developing the infrastructure that would see cryptocurrencies being used to buy a house or a cup of coffee, thereby fulfilling the second function of money.
Hyperbitcoinization and the Future of Crypto
The final stop on the journey to crypto-as-money is unit of account. Right now, it is difficult to imagine a world where prices are denominated in an asset whose price fluctuates dramatically from day to day. However, a future in which cryptocurrencies serve as both a store of value and a medium of exchange is a future where prices come to be quoted in crypto. Daniel Krawisz, co-founder of the Satoshi Nakamoto Institute, coined the phrase “hyperbitcoinization” to describe a world where Bitcoin supplants the fiat money system. Bitcoin’s original cypherpunk adopters are hard at work materializing this vision, one which if realized, places the worth of cryptocurrencies at multiples above their current market capitalization.
Keep an eye out for Part 2: An Answer to Privacy and Security Concerns
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