Implications of Cryptocurrency Adoption to the Economy

Currency has gone through many forms and different stages of development. Throughout history, people have always been looking for a better means to store wealth in the most secure way possible. Cryptocurrency promises to be a much better alternative to fiat or gold by unlocking its true potential as a decentralized form of money.

What are the implications of adopting a singular currency on the world’s economy, and will it solve our problems with the current financial system?

 

Gold as a Standard of Value

In theory, anything can be used as money, from cowry shells, to salt (“salarium,” where we got the word “salary”). Whereas in the past, people used to barter with grain, livestock, jewelry, nowadays, we use paper, stamped coins, and electronic data. Gold and silver turned out as the most predominant form of money for thousands of years because they possess certain qualities which make them ideal as a measure of value.

Cryptocurrencies like Bitcoin makes an allusion to these precious metals because it mirrors some important qualities of its real-world counterpart (in fact, this could be the inspiration behind Bitcoin’s gold-inspired logo). We’ll learn why such reference is essential in understanding cryptocurrency’s role on the future of finance and its implications to the world economy.

 

The First Decentralized Currency

Gold has for millenniums been accepted as money, even before the adoption of state-backed fiat currencies. Anyone can turn in their gold to any bank in exchange for gold certificates or banknotes, and it will be counted as money. Under this system, gold was considered as a “decentralized” form of money.

In its early days, banks were mostly self-regulated and are bound by the fact that they cannot issue more than is redeemable without facing the risk of a bank run. However, everything changed after so many banks got into trouble issuing more money than it could pay for. They adopted a “Keynesian” approach to their monetary policy, thus ending the reign of the gold standard, and giving rise to quantitative easing, fractional reserve banking, and currencies which were nothing more than public debts and glorified IOUs.

The concept of a “decentralized currency” was put on the backburner for decades, until 2008-2009 when the world’s economy and the whole financial system came crashing down, and a mysterious author rekindled the world’s interest in a decentralized form of money – cryptocurrency. It’s no surprise that Bitcoin bears a striking similarity to gold, some even calling it as “digital gold,” for sharing the same features which make it suitable as a measure of value and store of wealth.

 

 

The Real Cost of Inflation

One of the earliest records of inflation can be traced back to 3rd century Rome when government spending went far beyond its means and began increasing its money supply with silver coins of lesser quality. This offered a false sense of security and prosperity as the government stretched its resources thin in waging wars and funding its pet projects. People soon realized that their silver coins were nothing but cheap imitations, as prices of commodities soared by 1000% across the Roman Empire.

Western and European countries committed the same error by inflating currencies through deficit spending in order to fund the war effort. Belligerents on both sides took a heavy toll on their own economy and their own people. Price levels and interest rates have gone up after the war, and millions of people have lost their jobs as many industries came to a grinding halt.

By then, the only plausible way to cure inflation is to create more of it. But after growing concerns about the value of the U.S. dollar, countries started to redeem their dollar holdings in gold. Deficit spending, balance of payments, and the run on gold eventually led to the collapse of the Bretton-Woods system, and all industrialized countries started using “floating currencies.”

The long-term effects of inflation led many people to find ways to secure their own wealth against the uncertainty of the current financial system.

 

The Need to Re-establish a Standard of Value

The gold standard made it possible for countries to maintain a more stable economy because it restrained governments from inflating the money supply and made it easier to keep track of prices of goods and services. It served as a reliable tool where one’s currency can be measured against, making it a real store of wealth as opposed to state-backed fiat which could lose all of its value overnight.

Nowadays, we have cryptocurrency which is being used as a medium of exchange, store of value, and platforms for decentralized applications. Some of the positive effects of re-establishing a standard of value on our currencies include:

Stabilize pricing. Having a standard of value on our currencies like gold or cryptocurrency makes it easier to see the relationship between money supply and the country’s real GDP. In a highly industrialized country, increased productivity meant prices will fall relative to the money supply (deflationary). Some analysts believe a deflationary currency (Bitcoin and other similar cryptocurrencies) is bad for the economy and should be avoided because it slows down borrowing and buying activity. Inflation, on the other hand, will induce consumerism since people would have more to spend. But nominal GDP (not the real GDP) arising from inflation, amongst other factors, doesn’t necessarily mean the economy is much better. It just meant everything is getting more expensive than it used to. Left unchecked, it can actually lead to situations mentioned earlier.

 Simplify trades and exchange rates. Trading goods and services with other countries can cause trading imbalances due to the fact that all currencies are “floating currencies”, except in few countries where the value of currencies is pegged to the US dollar. Since exchange rates of floating currencies are in a constant flux, it would be difficult to determine the price of certain commodity is at a certain point in time. By establishing a standard of value to all of our currencies, we might be able to make international trades and exchanges rates much easier and straightforward.

 Minimize deficit spending. One of the biggest problems in our current financial system is that it gives too much freedom for governments to spend more than they reasonably should. Quantitative easing and fractional reserve banking encourages more spending and borrowing, but only a fraction of it might actually go to productive endeavours, thereby pushing countries even deeper into debt. By adopting a system of checks and balances in the production of money, governments will be more accountable on how they chose to spend their resources.

 

 

Gold or Cryptocurrency?

 

Many people are advocating the return to the gold standard because it makes them feel safer, more secure, and gives them the ability to store wealth and manage their own resources as they see fit. But in this digital age, storing wealth can be as simple as having your own account on a global ledger, which cannot be controlled by anyone. Cryptocurrency offers a much better way, not only as a store of wealth but as a means of encouraging reforms in our current financial system.

 

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