Dig­i­tal cur­ren­cies won’t kill the dol­lar

The Daily Star (Lebanon) - - BUSINESS - Noah Smith NOAH SMITH

Jamie Di­mon, the CEO of JPMor­gan Chase & Co., re­cently slammed bit­coin in no un­cer­tain terms: It “won’t end well,” he said, call­ing the cryp­tocur­rency a “fraud” and “worse than tulip bulbs.”

Is Di­mon right? It de­pends. In at least two im­por­tant ways, bit­coin and other cryp­tocur­ren­cies will prob­a­bly fail to achieve the dreams of their cre­ators and en­thu­si­asts. They are un­likely to usher in a hard-money revo­lu­tion, and are also un­likely to sup­plant na­tional fiat cur­ren­cies as the stan­dard means of pay­ment. But that doesn’t mean they won’t change the world.

Many bit­coin en­thu­si­asts be­lieve that the dig­i­tal cur­rency will cre­ate what amounts to a new gold stan­dard. The ba­sic logic is that the num­ber of bit­coins in ex­is­tence is lim­ited, while the num­ber of dol­lars is not. Sim­ple in­tu­ition says that if you cre­ate more of some­thing, its value goes down – in other words, cen­tral bank money-print­ing makes the dol­lar slowly lose value over time through in­fla­tion. The great econ­o­mist Mil­ton Friedman summed it up when he said that “in­fla­tion is al­ways and ev­ery­where a mon­e­tary phe­nom­e­non.”

Faced with a choice be­tween money that slowly de­pre­ci­ates and money whose sup­ply is per­ma­nently scarce, bit­coin bulls rea­son, who would choose the for­mer? The avail­abil­ity of this sort of “dig­i­tal gold,” they be­lieve, will force cen­tral banks to hold down in­fla­tion in or­der to keep the dol­lar and other fiat cur­ren­cies com­pet­i­tive. If they fail to do so, everyone will switch to bit­coin, cen­tral banks will be­come pow­er­less, and in­fla­tion will fall any­way. This is an at­trac­tive sce­nario not just for hard-money sup­port­ers, but also for lib­er­tar­i­ans, who would rather the gov­ern­ment didn’t have con­trol over the value of their bank ac­counts.

But this think­ing is flawed in at least two im­por­tant ways. First, the num­ber of bit­coins may be lim­ited, but the num­ber of cryp­tocur­ren­cies is not. Peo­ple are con­stantly cre­at­ing new ones. Early ex­am­ples in­cluded Do­ge­coin and Lite­coin. Later came ether, a cur­rency that can be used in smart con­tracts. But the real bo­nanza came when star­tups re­al­ized that they could raise money by cre­at­ing their own cryp­tocur­ren­cies and sell­ing them to in­vestors – an in­no­va­tion known as an ini­tial coin of­fer­ing. Some cre­ate new dig­i­tal cur­ren­cies that im­me­di­ately con­vert into dol­lars, bit­coin, ether or some other form. Oth­ers stick around and can then be used just like bit­coin.

There are now al­most 900 known cryp­tocur­ren­cies in cir­cu­la­tion. That num­ber is likely to con­tinue to climb. And what hard­money folks seem not to re­al­ize is that each time a new cryp­tocur­rency is cre­ated, it ex­pands the to­tal money sup­ply. When everyone uses dol­lars, the money sup­ply is just the to­tal amount of dol­lars in cir­cu­la­tion. But if there are a bunch of cur­ren­cies that can all be used to buy things, the money sup­ply rep­re­sents the sum to­tal of all of them. There­fore, rather than re­strict­ing the money sup­ply, the ad­vent of cryp­tocur­ren­cies is caus­ing it to bal­loon.

Does this mean the econ­omy is headed for in­fla­tion? Prob­a­bly not. First of all, Mil­ton Friedman was prob­a­bly wrong – as the U.S. and Ja­pan have learned in re­cent years, more money prob­a­bly doesn’t mean more in­fla­tion after all. Also, each new cur­rency adds to the money sup­ply only to the ex­tent that it can be used to buy real goods and ser­vices. When was the last time you used Do­ge­coin to buy a loaf of bread? Cryp­tocur­rency is in­fla­tion­ary, but it isn’t very in­fla­tion­ary.

This brings us to the sec­ond way that cryp­tocur­rency will dis­ap­point: It al­most cer­tainly won’t be­come the stan­dard means of pay­ment in the econ­omy. Bit­coin might be a hot in­vest­ment prop­erty, but peo­ple would rather re­ceive their wages in some­thing less volatile – you don’t want a fifth of your pay­check evap­o­rat­ing be­tween pay­day and gro­cery day. The U.S. dol­lar de­pre­ci­ates at a nice, steady, pre­dictable rate of around 2 per­cent a year, mak­ing it per­fect for buy­ing food and pay­ing the elec­tric bill. This is the rea­son you don’t see peo­ple go­ing around buy­ing ga­so­line with gold coins – gold, like bit­coin, has too much short-term volatil­ity to be use­ful as money. To top it off, the gov­ern­ment re­quires us all to pay our taxes in the na­tional fiat cur­rency.

So bit­coin and other cryp­tocur­ren­cies won’t neuter cen­tral banks, and they won’t make fiat cur­rency go away. But they are al­ready chang­ing the fi­nan­cial world in other im­por­tant ways. Ini­tial coin of­fer­ings are al­low­ing com­pa­nies to raise money with less of a reg­u­la­tory bur­den. China bans them out­right, but the U.S. Se­cu­ri­ties and Ex­change Com­mis­sion has so far ap­plied a light touch, and other coun­tries may have few or no re­stric­tions.

It might thus be pos­si­ble for star­tups in the U.S. to raise money over­seas through an ICO, con­vert the pro­ceeds to bit­coins, and ex­change the bit­coins for dol­lars in the U.S., thus en­tirely evad­ing fi­nan­cial reg­u­la­tion.

This is not the only sit­u­a­tion where cryp­tocur­rency can help peo­ple evade reg­u­la­tion – money laun­der­ing is the other ob­vi­ous ap­pli­ca­tion. The world’s govern­ments main­tain an ex­ten­sive net­work of con­trols on fi­nan­cial flows, in or­der to stop drug deal­ers and other il­licit busi­nesses from mov­ing money around freely. The ex­is­tence of cryp­tocur­ren­cies makes those con­trols a lot harder to main­tain. Of course, since cryp­tocur­ren­cies are volatile, this is an in­her­ently risky way to raise money for your busi­ness or move your drug prof­its across bor­ders. But for many, it’s bet­ter than noth­ing.

So while cryp­tocur­rency won’t cre­ate a new gold stan­dard, it will move the world to­ward an­other lib­er­tar­ian dream – fi­nan­cial an­ar­chy. If you think reg­u­la­tions are pre­vent­ing star­tups from rais­ing the money they need to grow, or if you think laws against drugs are un­fair in­fringe­ments on per­sonal lib­erty, you should be look­ing for­ward to the new, cryp­topow­ered world.

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