By Dr. John Lee
The rise of digitisation has led to increased speculation that cryptocurrencies are emerging as a genuine alternative to sovereign backed hard and digital currencies. This would certainly have immense and revolutionary ramifications for not just traditional monetary systems but the role of government in formulating and implementing broader national policies for their populations. However, there is little prospect that cryptocurrencies can challenge sovereign-backed money and the former will continue to serve as speculative assets held by the few rather than as real money for the economy.
The growing interest in cryptocurrencies is unsurprising given that the trend towards digitization in all areas has been a long established and unending one. There is significant polarization regarding the issue of these types of monies and whether they will replace traditional hard or physical currencies in the future. For example, Mark Carney, then the Governor of the Bank of England, recently argued that national digital currencies could pose a threat to the U.S.’s dollar’s outsized role in global financial markets. In contrast, Randall K. Quarles, the Vice Chair for Supervision at the U.S. Federal Reserve recently dismissed digital currencies as both ‘dangerous’ and a ‘fad’. More prominently, Elon Musk has generated much attention and instability in certain cryptocurrencies by affirming and also questioning the usefulness and future of cryptocurrencies such as dogecoin.
For starters, it is important to resist conflating distinct products and concepts. Digital currencies are a balance or record of monies stored digitally rather than in the form of paper money. Referring to the form of the currency (rather than source of legitimisation), digital currencies include cryptocurrencies, virtual currencies (issued and overseen by Central Banks) and e-cash (which might be issued by any entity including private firms and businesses.)
Cryptocurrencies refer to a digital currency where the record of ownership and transactions are stored in a decentralized and computerized ledger that uses cryptology to secure transaction records. That computerized ledger can generally be accessed by all users of that cryptocurrency.
Much of the confusion and hype can be put in better perspective if these broad definitions are maintained. We are seeing the constant advance of the digital world in all things, including currency and money, but the evidence for an merging cryptocurrency revolution is weak.
Digital Currencies vs. Cash
Given continued advances in digital devices, platforms, software, and security features, it is highly likely that digital currencies will increasingly be preferred to cash. But while the imminent end of physical currency has been predicted since the 1960s, it is likely cash will remain with us for quite some time. Cash allow users to remain anonymous and prevents authorities or other entities tracking our personal spending habits and movements. This is an issue of growing importance given the determination of authoritarian governments such as the one in China seeking to acquire ever more data on the behaviours of its citizens.
Cash is also insurance against financial cybercrime which is a far greater systemic and personal risk than the physical theft of cash. Moreover, the rise of state-based cyber offensive capabilities mean hostile states are increasingly able to penetrate the networks of other countries. For this reason, governments will remain reluctant to rely too heavily on a digital system of currency given the potential for hostile state-based hackers to disrupt or degrade the national digital ledger and create financial and economic catastrophe for that targeted country. In this sense, the preservation of a physical cash economy will be seen to be offering national economic systems a degree of resilience against such attacks.
Digital vs. Cryptocurrencies
In any event, whether physical currency loses dominance is the less interesting and important question. The genuine disruptive game-changer will occur if cryptocurrencies begin to genuinely challenge fiat currencies or currencies backed by a national Central Bank or financial system (whether they be in analogue or digital forms.) This brings one back to a fundamental discussion of what money ‘is’ or what ‘purpose’ it fulfils.
Here, there are three answers. First, and according to the textbook definition which still holds, money is a ‘store of value’. Second, it is a ‘medium of exchange’. These first two answers mean that money serves as an asset or commodity which can be saved, retrieved, and exchanged in the future and at the time of choosing for the holder of that asset. One cannot ‘save for the future’ or accumulate wealth without being able to hold assets which are trusted, widely recognised and accepted, and does not deteriorate dramatically in condition or value over time.
Third, and in the words of famed academic and former president of the Federal Reserve Bank of Minneapolis, Narayana Kocherlakota, ‘money is memory’. By this, he meant that “money is a substitute for a “publicly available and freely accessible device that records who owes what to whom.” This enables and allows fair and equitable transactions to take place amongst an unlimited number of people, almost all of whom are not known or even proximate to each other.
If cryptocurrencies become dominant, the reliance on central banks as the trusted authority to ensure the integrity, function and finality of payments and transfers of wealth from one entity to another will proportionately diminish. Instead, integrity, function and finality will depend on agreement between the community of cryptocurrency users. This would be a true revolutionary event disrupting, if not destroying, existing monetary regimes.
It would also fundamentally change and diminish the ability of national governments to determine monetary, economic, financial, and even social policy given that national government’s loss of relevance and agency when it comes to supervising and legitimising transactions. The rise of cryptocurrencies also diminishes the capacity for governments to use coercive or punitive measures against its citizens or those of other countries.
The case for cryptocurrencies replacing sovereign-backed currencies is that cryptocurrencies such as Bitcoin might well fulfil the second and third functions mentioned above. In other words, cryptocurrencies can do the job that fiat-backed monies have done for centuries.
However, unlike sovereign-backed currencies which are guaranteed to be legal tender in that particular jurisdiction and can be exchanged for other sovereign-backed currencies in other jurisdictions, cryptocurrencies are only of use and value within a specific crypto-community. The problem is that the use of a cryptocurrency must become universal for it to become a truly universal medium of exchange and store of memory and value.
Can crypto currencies become universally valued and exchangeable assets? There is an enormous mountain to climb for cryptocurrencies for that to occur. Because we exist in an international system or order defined by the primacy of sovereign nation-states as the primary actors, sovereign backed currencies issued by these nation-states have inbuilt legitimacy and the ability to be exchanged universally. From the beginning, the situation is rigged in favour of fiat backed currencies remaining dominant.
Moreover, it is difficult to see any major government reducing their own agency in setting and enforcing national economic and non-economic policies over its citizens by fundamentally allowing non-sovereign backed currencies to replace the dominance of sovereign-backed currencies. National governments can easily do this by banning the exchange of cryptocurrencies for their national currency and vice versa. It might be argued that the community of cryptocurrencies would still hold cryptocurrencies to transact amongst themselves. Even if that were still legal, the non-convertibility between crypto-currencies and sovereign-currencies would relegate the transacting of cryptocurrencies to the periphery, meaning that cryptocurrencies cannot meet the universality of exchange condition. It will also mean cryptocurrencies will only become a ‘store of value’ amongst the limited community of cryptocurrency users rather than the broader economy.
In short, there are compelling reasons for governments to prevent cryptocurrencies from challenging the dominance of fiat-backed currencies and governments will have decisive policy and coercive tools to prevent that from occurring. This is not just about authoritarian governments such as China seeking to extend their supervision over the actions of citizens to protect political power and punish dissent. Liberal democratic governments will want to maintain their ability to set and implement national policies and must retain control and influence over financial systems to do that. This means that the likelihood they will replace sovereign backed currencies and upend existing monetary systems is low.
Cryptocurrencies continue to exist primarily as speculative assets with wildly fluctuating valuations. That a tweet by Elon Musk can cause the value of dogecoin or bitcoin to skyrocket or else plummet speaks to the lack of suitability of cryptocurrencies to serve as genuine money. There is a question mark as to whether they can offer the relative stability in value that one has with well governed and regulated sovereign-backed currency under competent central bank supervision.
As Milton Friedman argued, “a moderately stable monetary framework seems an essential prerequisite for the effective operation of a private market economy.” With respect to sovereign-backed currencies, there is the expectation that governments of major currencies will intervene in financial and currency markets to provide some degree of security and stability as loss of these monetary virtues have broader economic impacts on the entire country, and therefore the standing and even legitimacy of that government. In contrast, the private market economy of cryptocurrencies untethered to sovereign-back monetary systems is unlikely to be able to provide that assurance or stability.
About the Author
Dr. John Lee is a non-resident senior fellow at the Hudson Institute in Washington DC and the United States Studies Centre at the University of Sydney where he is an adjunct professor. From 2016-2018, he served as senior national security adviser to the Australian Foreign Minister. He obtained his Masters and Doctorate degrees from the University of Oxford.