How crypto currencies can help improve the fiat currency system.
(First published by Avinash Swamy – Thanks Avinash for letting us use your fantastic analysis!)
Today, all currencies issued by nation states are fiat currencies i.e. currencies that are not backed in value by any commodity like gold. Fiat currencies gain their value simply by the laws passed by governments of nation states or a group of nation sates. In general, the fiat currency system is generally accepted as the best currency system available today. Its flexibility has empowered nations with an elastic money supply to better respond to economic crisis. It has also freed the monetary policies of nations, especially in the developing world, from being shackled by the amount of commodities they have or can produce or purchase.
The key weakness of today’s fiat currency system is that there are virtually no constraints on the amount of money supply that can be created. Often, governments and politicians have not always been disciplined in managing their economies and money supply, often resulting in high national debt. Another recurring problem is an over-supply of money and high inflation which in turn affects the ability of a currency to fulfill an important function of money i.e. acting as a store of value.
To help address this problem and enforce better fiscal and monetary discipline, some advocate switching to a commodity based currency system where the currency is backed by something of value or something that takes effort and resources to produce like gold. However, it is generally accepted that a return to the gold standard is not advisable because of its own significant weaknesses. A shift would also suddenly enforce a fixed money supply resulting in deflation, smothering growth and severely hampering nations’ abilities to respond to an economic crisis.
That being said, the key reason for a call to return to a commodity based currency system is to take away the relative ease at which governments and politicians can create money to manipulate money supply, especially for short term benefits. If gold or another commodity backed currency is not the answer, are there be other options?
Enter crypto currencies, digital currencies that are produced when computers solve complex mathematical problems based on cryptography. Crypto currencies, by virtue of being digital, can be designed to incorporate a range of properties and leverage the best of both currency systems i.e. the flexibility of the fiat system and the greater accountability of the commodity system
By default crypto currencies have inbuilt scarcity so that they cannot be created out of thin air but require effort and resources to produce. This property has the potential to negate weaknesses in the fiat currency system, drive better discipline in monetary policy and money supply and improve the ability of a currency to fulfill its function of acting as a store of value. And they can help achieve this while avoiding the regressive restrictions of a commodity based currency.
They can also be designed to have an unlimited supply, unlike some existing crypto currencies like Bitcoin. While existing crypto currencies are typically decentralized in nature, a purpose designed crypto currency can have proprietary mining algorithms to enforce centralization. Another option is to have open mining algorithms which are requisitely complex and resource hungry to ensure only a government/a monetary authority would have the required computing resources to mine the currency.
Additionally, technologies like the block chain ledger associated with crypto currencies allow for faster, more secure and more efficient accounting and transfer/exchange of currency especially in an increasingly digitized world. This enables a crypto currency to better fulfill the two other functions of money namely being a unit of account and a medium of exchange.
With such interesting possibilities and potential, a customized and well-designed fiat crypto currency may be an option for governments or society in general to explore as a means to better fiat currency systems.