An Antidote to Central Bank Tyranny?

Proponents of privately issued cryptocurrencies have long claimed that cryptocurrencies protect their users against the policy blunders of central banks. The biggest stated advantage of cryptocurrencies is that their value cannot be inflated away. Bitcoin, for example, has a fixed supply. In having scarcity and an incapacity to ‘print for bitcoins’, the value of Bitcoin cannot be corrupted (or so it is said).

In contrast, money printing is a tool that central banks have abused time and time again as a way to get around issues with government spending. When governments run at a fiscal deficit, central banks have typically resorted to printing more currency so the government has more money at their disposal. This is convenient for governments at the time who can continue to spend as much as they like for some time (until they hit inflation of course) and so they can repay their debts with cheaper dollars. Unfortunately, however, this comes at a cost of slowly eroding away the purchasing power of the currency so that citizens need to earn more currency to afford goods and services. Unfair? I think so. But that’s what having a monopoly does; it gives too much power to the central banks.

Given this backdrop, are cryptocurrencies the antidote to central banks abusing their position as the sole controller of their domestic monetary supply? While cryptocurrencies may theoretically be more valuable in the sense that the supply is fixed, this does not do much to prevent cryptocurrencies being in speculative investor bubbles. For instance, Bitcoin went as high as $80 000 AUD but has now crashed to $20 000 AUD. Perhaps we might start to question whether Bitcoin can function as ‘digital gold’.

Alternatively, we may also see cryptocurrencies as a more viable medium of exchange. Again, problems with volatility might undermine this purpose.

For us to have an informed debate, we need to transcend the theoretical debates surrounding cryptocurrencies and examine their track record. What we’ll find is that the future is quite unclear.

One View: Real Examples of Cryptocurrencies ‘Protecting’ Against Central Bank Corruption

Cryptocurrencies have already proven themselves to have immense value in countries where the value of the local currency has been eaten away due to inflation. The situation in Zimbabwe is a perfect example of this, where citizens have transacted with Bitcoin via the mobile money platform ‘EcoCash’ to continue conducting their daily affairs. This has provided them with a more stable payment alternative to Zimbabwe’s highly unstable domestic currency which has suffered from significant hyperinflation and is still plagued by uncertainty. It has also been in response to central banks preventing citizens from transacting in foreign currencies such as the US dollar in order to prevent too many citizens from ‘dumping’ Zimbabwe’s local currency for more stable foreign alternatives; a phenomenon that also worsens inflation. Thus, cryptocurrencies already have somewhat of a track record for empowering victims of incompetent central banks with a currency that they can use to engage in commerce.

Now, any proponent of central banking would argue that cryptocurrencies competing against domestic currencies as a medium of exchange is highly problematic because they pose a major threat to a central bank’s capacity to maintain control over the currency and credit creation process, thereby reducing its capacity to implement monetary policy to maintain a stable currency.

This was witnessed in Argentina when the Argentine peso collapsed in 2008-2009. In 2008, Argentina faced impending economic collapse and high inflation rates. To prevent citizens from ‘dumping’ the local currency, the Argentinian central bank pushed for the government to enact laws that discouraged citizens from exchanging their domestic currency for more stable US dollars. Unforeseen to them, the advent of Bitcoin in later years provided a nice loophole to this constraint because citizens could exchange their local currency for Bitcoin. Citizens dumping the Argentine peso for Bitcoin had the effect of worsening the rate of inflation and undermining the central bank’s control over the local currency.

While some would present the Argentinian situation as a reason against having cryptocurrencies, I see things differently. I see the situations in both Argentina and Zimbabwe as clear reasons why the use of cryptocurrencies should be encouraged. After all, why should citizens be forced to tolerate inept central banks? Citizens have no control over how their fiat currency is administered because they have little, if any, democratic recourse in terms of influencing domestic monetary and fiscal policies. In situations where central banks get it ‘wrong’, citizens should also have a remedial alternative they can use to keep their heads above the water.  

In sum, cryptocurrencies do have a track record for doing what they’re supposed to do: Empower the people. Yes, the examples above only relate to Bitcoin. However, the cryptocurrency space is new and perhaps we may see more cryptocurrencies being used as mainstream mediums of exchange as the space starts to mature.  

But What About Volatility?

The biggest problem that could undermine the efficacy of cryptocurrencies as an alternative medium of exchange is that cryptocurrencies can be highly volatile. While some proponents of cryptocurrencies see them as a payment alternative to domestic currencies, others see cryptocurrencies as speculative investments that they can buy, HODL and sell to make insane amounts of money. Bitcoin in particular has been heavily criticised for exhibiting substantial fluctuations in price, with some suggesting that this is a reason why Bitcoin does not have any fundamental value.

Some people might argue that corrections are simply necessary for cryptocurrencies because they function in a free-market environment while national currencies are subject to more centralised control. However, I do not think that competition alone accounts for significant fluctuations in the price of cryptocurrencies; I believe there are far bigger issues at play.

Let’s compare national currencies with cryptocurrencies. While national currencies are mandated by law in their home countries, adopting cryptocurrencies is optional and the pool of users is nowhere near as big compared to the number of people using domestic currencies. It is also fair to say that national currencies have far more use cases than cryptocurrencies. They can be spent on anything really, whether it be from groceries, books or even houses. Cryptocurrencies have not yet reached this stage as businesses have not widely accepted cryptocurrencies as methods of payment.

The combination of inferior user adoption and limited use cases means that there is not enough liquidity in crypto markets for them to function as stable currencies. Since there aren’t enough people using cryptocurrencies on a daily basis for daily tasks, it means that the price is vulnerable to collapsing when one significant player enters or leaves the market, creating a massive ripple effect on the price. In contrast, there are so many people using domestic currencies that we don’t notice people transacting with it (mostly) and the price remains stable.

The following humorous analogy (made in relation to Bitcoin) illustrates the problem:

“Imagine a fat man jumping into a small swimming pool. As he drops, he makes a huge splash and drenches everyone around him. A lot of water is displaced from the pool, as the level of water changes. Now imagine the same fat guy jumping into a vast body of water such as a lake or a sea. There is so much water that his presence in there is so insignificant, that no matter how hard he tries, it's barely impossible to change the water level.”

Whether cryptocurrencies are stable enough to function as mediums of exchange therefore depends on liquidity and mass user adoption. This isn’t necessarily guaranteed but it isn’t exactly impossible either. As central banks start confronting the problem of excessive debt, national currencies are highly vulnerable to inflation. If the issue transforms into the beast of hyperinflation, perhaps we may then see more users adopting cryptocurrencies as a more stable medium of exchange.

Issues surrounding liquidity may also undermine the argument that some cryptocurrencies will function as ‘digital gold’. I am making this comment with reference to Bitcoin. Although the mechanics of Bitcoin are such that the supply is fixed, Bitcoin’s capacity to function as digital gold also depends on the extent to which Bitcoin can function as a stable store of value. This will come down to liquidity and use cases for Bitcoin. While gold and silver no longer function as mediums of exchange per se, precious metals still have multiple use cases in industry (gold is used for circuit boards) and they are far more mature and have been around for centuries. While they can be subject to speculative investment bubbles, this is to a less extent than Bitcoin. I’d also add that there is a perceived sense of legitimacy about precious metals given that they have endured throughout history.

Now, this is not to say that Bitcoin can’t be a digital gold; it’s just to say that Bitcoin still has numerous issues that need to be resolved before it can.

Final Thoughts

Cryptocurrencies do have the potential to operate as viable alternatives to domestic currencies or as protection against inflation by acting as digital gold. This, however, is highly dependent on cryptocurrencies reaching the stage where they are widely adopted so that cryptocurrencies can reach sustainable levels of liquidity. Ultimately there is no guarantee that this will happen, but it could be hypothesised that the current inflationary economic climate might be the impetus for people to adopt cryptocurrencies. If the situations in Argentina and Zimbabwe become the norm for multiple countries (which is possible), perhaps cryptocurrencies will be seen as better alternatives.

References

[1] Cryptonews, 'Will Bitcoin Ever Be Stable?' (online, 2022) <https://cryptonews.com/guides/will-bitcoin-ever-be-stable.htm>. 
[2] Nathan Reiff, 'Why is Bitcoin Volatile?' Investopedia (online, 4th June 2022) <https://www.investopedia.com/articles/investing/052014/why-bitcoins-value-so-volatile.asp#toc-bitcoin-is-still-in-its-infancy>. 
[3] Eric Engle, ‘Is Bitcoin Rat Poison? Cryptocurrency, Crime and Counterfeiting (CCC)’ (2016) 16(2) Journal of High Technology Law 365.
[4] Reserve Bank of Australia, ‘Information Paper for the Board’ (May 2013). 
[5] R Joseph Cook, ‘Bitcoins: Technological Innovation or Emerging Threat?’ (2014) 30(3) The John Marshall Journal of Information Technology and Privacy Law 535.
[6] Claus Dierksmeier and Peter Seele, ‘Cryptocurrencies and Business Ethics’ (2018) 152(1) Journal of Business Ethics 1.
[7] Sean Button, ‘Cryptocurrency and Blockchains in Emerging Economies’ (2018) 20(3) Software Quality Professional; Milwaukee 39.
[8] Tawanda Karombo, ‘Zimbabwe banned the US dollar from being used so local bitcoin demand is soaring again’, Quartz Africa (online, 11th July 2019) <https://qz.com/africa/1662753/bitcoin-crypto-soar-in-zimbabwe-again-after-us-dollar-ban/>.