What is the future of cryptocurrency and blockchain? | Opinion
Thanks to Lin-Manuel Miranda, it doesn’t take much for my kids to sing about “the room where it happened” and the Compromise of 1790. Don’t most kids rap about the trade-off between the national debt and the location of the capital?
This vignette in early American history, made famous in Miranda’s blockbuster musical “Hamilton,” shows the tortured and non-linear role that money played in our country’s development. On the one hand, Thomas Jefferson wanted the solitary farmer cultivating his bucolic farm to be the new model while Alexander Hamilton saw urban areas as the main driver of prosperity.
To facilitate complex transactions, Hamilton proposed a national bank that would guarantee each of the colonies’ debts incurred during the Revolution. Jefferson saw a central bank as a threat to liberty. He preferred decentralized currency to a strong monetary authority.
Debates about currency continued throughout the 19th and early 20th centuries. The Lincoln administration attempted to unify the currency during the Civil War by using green ink (hence the nickname greenbacks), and debates over the gold or silver standard spurred the candidacy of William Jennings Bryan. In 1913, the Federal Reserve Act brought formal central banking to the United States. Today’s debate about cryptocurrency and blockchain continues a central debate about what is money and who maintains its supply.
Money fulfills three purposes. First, it is a medium of exchange. In an agricultural barter system, if I grow wheat and need some potatoes, then I have to find a potato farmer who needs wheat. However, specialization is difficult, because if I write financial papers and want tacos, I need a taqueria that wants to trade their goods for financial analysis.
Money allows me to convert lawyer briefs, engineering designs or blue jeans into currency and then buy what I need. Money allows workers to specialize their talents and then act. Since I write financial newspapers and like tacos very much, I am grateful for that.
Money also preserves the value of labor over time. Tomato farmers could not withdraw from a large crop because it spoils quickly, but currency allows them to invest for the future. Finally, money serves as a yardstick for measuring the value of goods and services across a complex economy.
Paper currency and coins are not the only examples of objects that serve all three roles. Shells, stones, gold and other precious metals have all served as currency. My grandfather used to buy anything he wanted in his WWII army unit using his allotment of cigarettes as it was against his religious beliefs to smoke them. In his squad, cigarettes served all three purposes of money.
Today, cryptocurrency offers a decentralized currency that can digitally cross borders and bypass regimes. Originally, computing time or “mining” determined how many bitcoins users would have in their digital wallets. Investors can buy bitcoin on a marketplace using their country’s currency. Certification of the digital currency will come from “blockchain” – a type of electronic lock and key that will identify an individual coin with a mathematical encryption. In the wild west of cryptocurrencies, the blockchain served as a sheriff’s deputy riding along with the Wells Fargo wagon.
But does cryptocurrency fulfill the traditional roles of money? Well, in a way. It has the potential to be a medium of exchange, but only if people are willing to accept it. If my local taqueria doesn’t trust my new currency, then no taco for me.
Economists call this phenomenon a “network externality”, which means a good increase in value when more people use it (which explains why Facebook was very popular while MySpace floundered). Cryptocurrency also struggles as a unit of account. So many competing currencies make it difficult for the average consumer to know how many crypto units we need to exchange for a taco.
Finally, as investors move from one shiny digital coin to another, its value rises and falls like a classic roller coaster, causing dizzying gains and devastating losses. Interestingly, in countries suffering from extreme inflation, such as Argentina or Zimbabwe, cryptocurrency is more popular than the local currency because, despite the turbulence, crypto is more stable.
The rise of the latest digital gold rush can hearken back to the days of hopes and dreams of the California Gold Rush 49ers. Unless cryptocurrencies can better facilitate trade and hold market value, they will look more like the Dutch tulip craze than a new global currency. Crypto may teach central bankers a few new tricks as the Federal Reserve experiments with digital dollars using similar blockchain technology, but the US dollar will adjust around the edges and maintain its dominance for the foreseeable future.
Michael S. Kofoed, @mikekofoed on Twitter, is an associate professor of economics at the US Military Academy and a fellow at the Institute of Labor Economics. A native of Utah, he holds degrees in economics from Weber State University and the University of Georgia. These opinions are those of the author and do not represent the US Military Academy, the Department of the Army, or the Department of Defense.