It’s natural to be sceptical about crypto. Crypto sounds nefarious – its reputation has been coloured by its association with extreme price volatility, scams and bad actors. So tarnished is crypto that there’s an effort to rebrand it “digital asset”.
It wasn’t always like this; crypto started with noble intentions. Bitcoin, the OG cryptocurrency, was born out of the cypherpunk movement and libertarian ideology. The core ideas are:
- The control of money should be decentralised.
- Individuals should have financial sovereignty.
- Money should empower, not enslave us.
To understand crypto, we need to deep dive into what money is and how its form has evolved over time.
Money is a technology
Fundamentally, money is a technology. Our ancestors invented money to transfer value across time and space. We acquire money by exchanging our time and effort today so that we can spend it tomorrow on what we want anywhere. It’s portable power.
Humankind has had this technology for millennia. Like all technology, it evolves; what we regard and accept as money has changed over time. We’ve had money in the form of seashells, stones, livestock, grains and precious metals. The consensus (or collective hallucination) that something is money is enforced by a combination of these factors:
- Intrinsic value – it has some form of utility.
- Authority – government decree that it is legal tender.
- Rules – rules governing central banks’ operations or software code dictating the supply of cryptocurrency.
- Network effects – everyone else accepts it.
Metal-backed money
Precious metals, in particular, became dominant as money because they have characteristics that made them superior as a:
- Medium of exchange (which solves the “double coincidence of wants” problem);
- Unit of account (which provides a standard measure to compare value);
- Store of value (which allows money to be spent across time and space).
Starting in 700 BC, we had coinage minted from gold, silver, and various other metals and alloys. This evolved to paper money issued against coins deposited with trusted agents. For a good part of recent history, the world was on the Gold Standard; currencies were backed by gold reserves, and their value was pegged to a fixed amount of gold.
Fiat money
The Gold Standard imposed a constraint on money supply with good intentions but this rigidity exacerbated economic recessions. The fiat system – money with no intrinsic value but is backed by government and creditors’ promises (and the trust that they will honour them) – solves the problem as it introduces flexible money supply with which authorities can use as a lever to stimulate or contract the economy as necessary.
In a fiat system, central banks create base money in a process called “quantitative easing” where central banks buy government bonds with newly created money. Commercial banks then multiply the supply of money by lending under the fractional-reserve banking system. In effect, money is created out of thin air, constrained by prevailing monetary policies and reserve requirement on commercial banks.
The trade-off to money supply flexibility is that we need to trust a handful of decision makers to have the wisdom and discipline to operate the system in the majority’s best interest.
As has happened in some countries, currencies have been debased in a relatively short period of time via unchecked increase in money supply – more money chases a limited amount of assets, goods, and services such that the same amount of money buys less. Much less in some cases.
Money is just a number
Money does not need to be tangible in the form of coins, notes, and other physical manifestations. At its core, money is just numbers on ledgers – records of who owes what to whom. The earliest form of ledger were clay tablets used in ancient Mesopotamia to track commodities like grain or livestock.
In the digital age, even the ledger does not need to be tangible – ledgers in the modern world are databases in the ether.
As Niall Ferguson highlights in “The Ascent of Money”, “money is a matter of belief… belief in the person paying us; belief in the person issuing the money… it is trust inscribed and it does not seem to matter much where it is inscribed”.
Money is trust inscribed and it does not seem to matter much where it is inscribed.
Niall Ferguson; The Ascent of Money
Crypto as a new form of money
Viewing money as 1) technology and 2) numbers in the sky backed by trust/faith, the idea of cryptocurrency is not as radical.
Blockchain technology is an upgrade to existing ledger systems. Blockchain has unique characteristics that enable cryptocurrencies like Bitcoin – digital money secured by cryptography that can be transferred/moved without needing banks or centralised authorities.
To be clear, Bitcoin does not tick all the boxes of what money is – it’s not widespread as a medium of exchange or an unit of account. Satoshi Nakamoto, Bitcoin’s pseudonymous inventor, intended Bitcoin to be a “peer-to-peer electronic cash system“; instead, it has become a store of value, akin to digital gold that hodlers do not want to exchange for something else for as long as possible.
Bitcoin proponents like the fact that:
- It’s definitively scarce (only 21 million BTC) – no single entity can inflate its supply.
- It can be transferred/moved cheaply and it can be stored for free.
- It’s portable wealth – self-custody (i.e. not relying on third-parties to store one’s Bitcoin) enables access to wealth anywhere.
- It’s a hedge against human incompetence i.e. bad governance/management of the fiat system. However, like all hedges, a loss is incurred if the feared event does not happen i.e. if money supply does not increase rampantly.
Crypto-based financial system
Beyond Bitcoin, there’s a parallel financial system built on public permissionless blockchains. On-chain finance, as it is known, is a collection of financial products and services built using smart contracts i.e. software code deployed on Turing-complete blockchains. These promise to be better, faster, and cheaper than existing traditional finance (TradFi) equivalents.
The first killer application of on-chain finance is stablecoin. Stablecoins are crypto designed to maintain a stable value, typically pegged to fiat currencies like the US dollar. They enable instantaneous global payments with significantly lower fees.
The popularity of stablecoins has adverse implications to TradFi beyond payments – as higher yields are available on stablecoins (from various on-chain activities like lending, providing liquidity on automated decentralised exchanges etc.), there is fear that they will drain deposits from traditional banks.
Stablecoins are just the start. As more assets are tokenised, decentralised finance (DeFi) will become mainstream.
Financial sovereignty
Humans flourish when our basic needs are taken care of. That sense of security and freedom allows us to focus on self-actualisation. Money should be the last thing we need to worry about – heck, it’s a human construct and a number in the sky.
Unfortunately, the fear of not having enough money keeps us in financial servitude. We’re in a pernicious situation that forces us to chase more money as its value is debased in the fiat system. Worse, we have financial intermediaries that are net value extractors (i.e. they charge more than the value they provide). The need for financial literacy is partly due to how complex (and corrupt) the existing financial system is.
It’s time our money and financial system get an upgrade. Crypto is an attempt at this. Nothing is guaranteed but I, for one, am excited by the intellectual and capital investment in this space.
The bottom line: Money is a technology. What we accept as money has changed over time. Just as we had jettisoned precious metal as money, pockets of humanity are adopting crypto, specifically Bitcoin, as hard money. Beyond Bitcoin, there is a parallel financial system built on public permissionless blockchains. “On-chain” financial products and services promise to be better, faster, and cheaper.
Disclaimer: This is my personal view. It is NOT investment advice/recommendation. I write on this blog in my personal capacity; my opinions are NOT endorsed by my employer or the actuarial profession.
