Cryptocurrencies as they are now, are not money and never will be. Crypto is a store of wealth but doesn’t work as a currency. That doesn’t mean there is no place for crypto and that it is incompatible with standard currencies. China is currently testing an electronic currency and Canada and other nations are also investigating one although nothing is known about their approaches, so what will a blockchain world look like?
Money and crypto currencies are created and processed in different ways and each have distinct advantages. Currencies are stable and have an efficient means of creating new money and are easily scalable on a national level. Blockchains have potential to reduce transaction friction. What I foresee is that national currencies will keep their essential elements and adopt some of the best elements of crypto.
How Money is Created
Money is usually created by banks when they loan money. When a bank receives deposits, it then takes the money and issues mortgages and this is how money is created – the original money is still on deposit, but the new money is used to buy a house. The amount of money banks are allowed to create is regulated by minimum capital requirements. That means they need to keep between 1% and 8% of loans as cash that is not owed to anyone. If money is created faster than future economic production, the result is inflation and central banks raise interest rates to decrease the affordability of loans.
Disadvantages of Existing money
Paper money exchange is anonymous and doesn’t have transaction fees but can’t be completed electronically. The vast majority of money exists electronically and not as physical currency and there are transaction fees for the transfer of electronic money, even though the fees may be hidden. Intermediaries such as Mastercard charge merchants between 1.55% – 2.6% and Paypal charges 2.9% plus 30 cents domestically and much more for international transactions.
These companies do provide an insurance function for the buyer but this can be used to scam the seller if the buyer fraudulently claims their account was hacked, or use any number of other scams. Chargeback fraud can and does take place in Interac transfers as well. This is particularly dangerous for international transfers where the seller would find it difficult to request a fraud investigation. When a transaction is between two trusted parties, such as with overseas remittances, this insurance is an unnecessary expense.
Transaction fees work like a sales tax adding friction to commerce but the government receives no revenue.
Anonymity is important to everyone. When people make financial transactions using electronic money, the person receiving it may see credit card or bank account numbers. People need to protect their information from being stolen from an unscrupulous or compromised seller – that’s also one of the reasons why people use services like Paypal, or pay for Interac transfers to hide their financial information from the seller. Loonies will provide this anonymity at almost no charge.
Disadvantages of Crypto
Crypto currencies are created and transacted through proof of work. Computers must perform time consuming, electricity wasting calculations to maintain the integrity of the transactions and mine new coins. Miners also face increasing difficulty as more miners mine and this also increases the amount of electricity used. These create unneeded expense and lead to increased production of greenhouse gas.
Cost of Crypto
Transaction fees for crypto are very high so it is impractical to use for the purchase small items, such as a cup of coffee. Currently, the average price for an immediate bitcoin transaction is $25. If you are willing to wait a bit, the median price is around $11. If you can wait a half hour, you can get it processed for as low as $9. Most of the cost comes from the difficulty of mining crypto. There are also fees for converting crypto into money. Currently, small fees of between .1% and 1% are being charged by online cryptocurrency exchanges and high fees of between 7% and 12% by bitcoin ATM.
Crypto is Like the gold standard
Mining crypto coins is costly and is comparable to the cost of mining gold. Crypto currencies, if they are currencies, are more like the gold standard prior to the Great Depression, where they needed more gold to issue more currency. Great Britain was able to keep up the gold standard when they had large amounts of gold payments arriving from the colonies, but had to drop it when they didn’t. Since the gold standard money supply generally does not keep up with production, you get deflation. Deflation is toxic for the economy as seen in the Great Depression. Bitcoin would not be a good choice as a national currency but there could be a better solution.
Government Minted Blockchain
A government minted blockchain currency could eliminate many of the disadvantages of existing cryptocurrencies. I call these hypothetical blockchain currencies loonies. They will have many elements of a standard scalable currency and have a supply that can be cheaply and efficiently managed using mechanisms that are mostly already in existence.
What are Loonies?
Loonies will be a blockchain cryptocurrency authorized by the central bank then created and distributed by the banks. They will be legal tender and freely exchangeable with existing currency so will maintain the same value and be just as stable.
How Will Banks Use Loonies?
A bank’s customers will deposit loonies into their accounts. The bank will keep a ledger and pay interest and loan most of them out to other customers and create new loonies just like how new money is created. Once in the system, they will be used just like money, although instead of using credit cards, we could use a loonie wallet app to pay for our double-doubles or frappuccinos.
No Difficulty Increase
The creation of new loonies will be regulated by the central bank through existing monetary policy and financial regulation so there will be no need for expensive increases in difficulty used by crypto currencies to prevent over production. With no increase in difficulty, loonies are easily scalable and could be quickly ramped up to replace or augment an existing currency and the cost of the creation and the transaction of loonies will be lower.
Processing
The processing of loonies will be much more efficient than it is with other cryptocurrencies. Crypto uses nodes to verify transactions and some of those nodes may be dishonest. Proof of work is used to prevent a shady node from submitting a fraudulent translation. In contrast, the blockchain nodes for loonies, will be trusted networks made up of any reputable banks. There will be small fees for transactions but many banks will be involved so there will be competition to prevent gouging. Verification will be done by several banks at once so if one goes rogue, it will be outvoted by the others and will no longer be trusted. Eliminating proof of work will reduce transaction cost and decrease processing time.
The Bottom Line
As mentioned, loonies can be created and transferred efficiently and cheaply. They give customers the option of direct and anonymous transfers. By reducing friction on transactions, government issued blockchain currencies have the potential to disrupt existing systems and improve the economy. Since nodes are all part of a trusted network, the expensive proof of work and increases in difficulty will not be required and transactions will be secure, fast, cheap, and green.
William Marshall 