Fiat money versus Cryptos - A brief update

The debate over crypto assets is bound to intensify, as wider adoption challenges fiat money.

Fiat money versus Cryptos - A brief update

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• The story: Since October 2021, there was a rally in bitcoin, which attracted increasing participation of retail investors in India. The regulatory system is not ready to let it go mainstream. Crypto assets are commonly known as cryptocurrencies, with examples like Litecoin, Ripple, Bitcoin, and Ethereum.
• Crypto assets: A crypto asset is a digital asset; but not all digital assets are crypto assets. The distinguishing features of crypto assets are - (a)   uses cryptography, (b) depends on distributed ledger technology (a blockchain), (c) no need for a third party such as a bank to issue crypto assets, and (d) have three primary uses: as an investment, a medium of exchange, and to access goods and services.
• Speculation: The idea revolves around 'scarcity' and 'value'.

1. Scarcity - Money creation by central banks causes the price of all goods to rise. It also tends to accelerate the adoption of alternative assets as currencies, gold and silver. In case of  cryptocurrencies , their limited supply has been the major feature for increased participation of investors. Satoshi Nakamoto, in 2008, was so upset with the money printing by Central Banks (that would drive the value of his money lower) that he invented the Bitcoin, that would not depend on fiat money at all.
2. Value - Any asset must have either use value or exchange value in order for it to possess any fundamental value. Stocks, bonds, gold, silver, and commodities like oil possess fundamental value. But critics allege that cryptocurrencies possess no significant fundamental value to sustain their current high prices. The investors are bidding up the price of bitcoin because they foresee a future in which private currency is widely accepted as money. Crypto enthusiasts say that a globally distributed system that needs no central control "is" the value inherent in Bitcoin (and others).

• Crypto versus the State: The monopoly of governments and central banks over the issuance of money allows governments to fund their budget deficits. It also allows central banks to alter the money supply under the mandate of managing aggregate demand in the economy. Monopoly control over money allows governments to indirectly tax citizens by increasing the supply of currencies, thus devaluing them. If cryptocurrencies challenge fiat currencies like U.S. dollar as a medium of exchange, they would essentially challenge the authority of the government to print and spend. This assault on the authority of the government will lead to the existence of  cryptocurrencies only as a speculative asset and not a medium of exchange.

1. The competition between currencies to fulfill the demands of customers would ensure that fiat currencies that are printed indiscriminately simply go out of use.
2. So countries such as China are imposing  a ban on cryptocurrencies and are planning to issue their own central bank-issued digital currency. (CBDC)
3. Many countries are contemplating doing that, including India's RBI. That will significantly change the entire monetary system, leading to monetary disintermediation of the formal banking system.

• Banning cryptos: It is practically not possible to ban cryptocurrencies, as they are digital assets residing on the internet-based systems. Over time, their use is bound to rise, and the governments will come in with their own CBDCs. A competition will ensue. Another interesting aspect is which currency will be used (or which monetary system) when man begins colonising the moon, and Mars, in near future.
• EXAM QUESTIONS: (1) Explain the friction between cryptocurrencies and fiat money. (2) Fifty years from now, how will the global financial system look like? Explain.

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