Bitcoin as a national currency — naive thought or new frontier
To discuss the question weather Bitcoin or other cryptocurrencies could become a reasonable option for a national currency, it shall be discussed at first, what a national currency must provide and achieve, what are the common paths for adopting a currency at national level today and how would Bitcoin or another cryptocurrency play out as such.
The most common approach today is, that a nation issues a national currency through its central bank, often backed by an asset like gold to assure its value. The central bank can control the supply and therefore the value of the currency through monetary policy by printing more money (inflation) or reducing the money supply (deflation), alternatively this can be achieved by adjusting the base rate at which money can be borrowed from the central bank. This works well for countries with strong economies and stable governments, which assure trust in the currency, the monetary policy and its overall stability. Examples are the United States (Dollar), the European Union (Euro), Japan (Yen), Great Britain (British Pound) and China (Chinese Yuan).
A lot of countries do not have the same solid economic situation and a less trustworthy central bank monetary policy, which leads to weaker national currencies and various related problems. To avoid that pitfall, multiple countries have adopted foreign currencies as their national currency. Examples would be the US dollar as national currency in countries like Ecuador, El Salvador and Zimbabwe and the Euro in Montenegro and Kosovo. This adoption provides the benefit of a stable currency with low inflation. Yet it deprives these countries of the classic instruments of national banks in regards to monetary polices. Ecuador cannot print US dollars. In case the European central bank prints Euros, Montenegro is affected without consent.
This leads to a dilemma. While countries with weaker currencies adopt stronger currencies to preserve stability, it limits their options in moments of crisis and makes them even vulnerable to monetary actions of the countries they adopted their currency from.
An alternative to this would be a crypto currency like Bitcoin. Like USD or Euro, bitcoin would be in that sense a foreign currency without immediate influenceability by the adopting state but on the other hand, it provides many benefits that lie within the blockchain technology and the characteristics of cryptocurrencies. But is this sufficient for a national currency? We want to asses the two major characteristics that a (national) currency must have:
- Medium of exchange (paying for goods and services)
- Medium of value storage (savings)
Processing transactions on the Bitcoin blockchain is secure and requires relatively low fees. Transaction cannot be reversed and funds are only spendable if the account is sufficiently covered. The transaction history on a blockchain is always given One can argue that this is as much a feature as a bug. While it is certainly helpful to avoid fraud and provides the basis for fair taxation by the government, it is not always ideal when every transaction is freely available to everyone. You might not want your salary or Amazon purchase history be publicly available. This can be bypassed by including alternative cryptocurrencies like Zcash and Moneiro that hide the transaction history. It would need further investigation before implementation, to assure a certain level of privacy for transaction history. Since it is possible and just needs further detailing, it will not be covered here.
Transaction time has to be considered. Bitcoin approves a transaction covered with sufficient fees within ten to thirty minutes while six blocks assure definite clearance of the transaction. This works fine for all purchases were a transaction time bigger than one hour is sufficient. We can think of business to business transactions or ordering on Amazon. For transactions that require immediate clearance like grocery shopping or a coffee at Starbucks alternatives have to be considered. One such would be, that these transactions have to be performed in an alternative cryptocurrency with faster clearance like Litecoin. Another option would be smart contracts which keep an ‘off-chain’ count of all transactions between merchant and buyer and settles the outstanding balances ‘on-chain’ at some point when triggered. While possible, these two options both complicate the situation further, therefore an alternative would be that the merchant simple performs a more in-depth check of the transaction and the buyers available funds. The transaction is announced on the chain within seconds. While not cleared, it can be checked weather the sender address holds a sufficient balance, has no other outstanding transactions that would lead to double spending and covered the needed fees for the transaction. In that case it very certain that the transaction eventually clears.
This shows that cryptocurrencies in principal achieve the features of a currency needed for transactions. The other core feature of a currency is store of value. Value is preserved or increased as long as the value storing asset or currency maintains or increases its price. Historically Bitcoin has achieved that, when considered over long enough time periods. Nassim Taleb might correctly point out that a forward propagation based on historic data has little to no value since it can’t predict black swan events that make the whole system fold. While this is correct and a solid history of value preservation and increase does not assure Bitcoins value as an asset in the future, neither can the value of other assets and currencies be predicted or assured. Therefore this problem shall be ignored right now, since it applies to all other options the same way.
More problematic are two characteristics of Bitcoin that are well recognized and observed but not considered in the above discussion. Its volatility and its enormous increase in value. (Ironic — didn’t we just discuss that we are unsure weather it can preserve its value and we gave up on it because it is not predictable?) Yes we did, but earlier we were looking at value preservation over a long long time. In this case now we look at it for only a year or two in a time. The value of Bitcoin over a year doubles on average. This is nice for saving or speculating but it is problematic for an economy were purchases today are paid in advance (in fact lower price) or paid later on (in fact higher price). The price of any purchases that cannot be settled right away are highly affected. In addition, an increase in value for the local currency increases the international purchasing power of a country but makes its domestic products and services expensive for others. Examples are the touristic situation in Greece (on the Euro) and Turkey (on the Turkish Lira). At the adaption time of the Euro in Greece both had similar economic power and similar prices for tourists. While prices for hotels and restaurants in Greece increase with the value increase of the Euro, the Turkish Lira is valued much lower and therefore it became more and more attractive from a pure financial standpoint to visit Turkey instead of Greece over the years.
Countries that export goods or provide services like tourism, want to rather devalue their currencies. An increased value of a currency, leads to another problematic effect: If my savings double in value every year, I will try to save rather than spend. The whole system of transactions is build on moderate inflation not deflation. An incentive to either invest my money for higher interest rates than inflation rates or to spend my money today, since today it is worth more than tomorrow. Deflation flips that incentive on its head. We see that a strong increase in a currencies value is problematic.
So is volatility. Observing the daily, weekly and monthly spikes of Bitcoins value it is fairly easy to make the case that a currency is not functional with a high volatility. It is not practical when the grocery bill fluctuates more with the current currency spikes than with the actual items I purchase. The same way, it is unmanageable for businesses with complex supply chains which have to purchase raw materials to create products. Products are sold eventually but if timed wrongly the currency alone wipes out the profits. As much as we can make the case that cryptocurrencies can be a good storage of value (unless the black swan hits), it lacks some features needed to perform transactions, unless a certain price stability is given. Therefore Bitcoin in its current form is not the right vehicle for a national currency.
An alternative would be a stable coin of any given stable national currency like the US Dollar or the Euro. This brings us somewhat back to the beginning, where we discussed that foreign currencies are already used as national currencies. The benefit of course is, that a US dollar stable coin can provide all the features of a strong currency while also having all cryptocurrency related benefits. The one problem that remains is, that the adopting country is dependent on the monetary policy of this currency. If the United States decide to print more dollars, all existing dollars are devalued. While the US government can spent the newly printed money, the adopting country has no such benefit.
Therefore a better solution than adopting a stable coin matching one currency, is a stable coin based on multiple currencies. We will discuss a proposal for that in a minute. Generally, the concept of stable coins by now is well established. The most common ‘on-chain’ approach is a seignioriage-style stable coin. It consists of a stable coin, collateral as ‘on-chain’ backing and a counter-coin. Implementations exist most prominently in DAI / MKR coins where DAI represents 1 US dollar, Maker servers as the counter coin and Ether as the collateral. The details of such an approach can be found in the resources at the end of the article. What shall be proposed now, is to base this stable coin not on one currency but on a mix. In analogy you think of the stability and volatility of a single stock versus that of an index. Since two major goals of a currency are stability and limited volatility we propose a stable coin based on the SDR (special drawing rights) of the international monetary fund, so called XDR. It contains the following assets: US Dollar, Euro, Chinese Yuan, Japanese Yen and British Pound. Each asset is represented in the fund in proportion to certain economic indicators of the issuing nations. The XDR therefore has an assigned value that is calculated by the sum of the currencies values each multiplied by its fractional representation in the fund. Using XDR as the basis for a stable coin rather than a single currency reduces dependency to any one currency and limits the volatility further. Implementation can be done in the same fashion as DAI / MKR coin, only that the oracle has to determine five asset prices instead of just one and calculate the weighted sum as the current value of 1 XDR.
One trap here is of course again the incorrect assumption that all these currencies are not correlated. In good times each currency is controlled and moderately adjusted by the issuing central bank. In times of crisis the black swan strikes again. Facing a world economic crisis, it is likely that all central banks print new money and thus all currencies are devalued in similar fashion. The newly created stable coin therefore experiences that exact same devaluation. There is no way out of this dilemma. All that can be said is, that likely in such a scenario any country will experience the problem in a similar fashion independent of a traditional national currency or a newly constructed cryptocurrency as the national currency.
Finally we want to explore the option of creating some physical money. While ideally all transactions can be performed digitally, a physical exchange of goods for an old fashioned bill still holds certain benefits. Not everyone is ready for crypto payments and digital transactions. Creating physical bills for a else digital currency brings the concept of decentralization to its limits.
We will explore this as an idea but with a big question mark about its feasibility and its pitfalls: The total money supply cannot be increased, else nothing is gained from this approach. To get the right to create or print a certain amount of physical money, the equivalent amount of digital money must be either locked up in a smart contract or burned. While burning is ultimate and not reversible, a smart contract must be controlled by a trusted entity. Else the locked up amount could be released without destroying the physical money. The two hairy problems in this case are:
- Who is trusted with the collateral
- Who assures that only the approved amount is physically created
The collateral can be stored in a smart contract controlled by the holders of the counter coin which can vote weather the collateral remains, is returned (in case the print money is returned and destroyed) or redistributed in case of fraudulent behavior of the print money issuer (over printing).
How to assure that only the appropriate amount of money is printed becomes rather difficult. It is at the system boundaries, the intersection of digital and physical assets, where most problems arise. While there are certainly ideas that come to mind, it is rather speculation how this could be best achieved. The printing could be instantiated by the smart contract itself, where specification about design of the bill (securely) and amount of bills (total number and specific numbers on the bill) are included in the contract and can only be accessed by the holders of the counter coin, not the nation issuing the coin. Each printed bill would be initiated by a collateral provided by the central bank. An NFT could be created that contains the bill number on it to assure that each bill is unique. Ownership of the NFT remains with the central bank since the sole purpose of physical bills is to remove transactions on the blockchain and online interaction. Therefore constant transfer of the NFT is not practical. The purpose of the NFT is to build trust about the existence of only one physical copy of the related bill. It could work that each bill contains a QR-Code which can be scanned once ownership is transferred. The scan triggers a log entry on the NFT with time and position. This is not bullet proof but unless someone else claims to own the same bill, it assures uniqueness. In case ownership is claimed by two parties with solid proof of the physical bill with the identical number (scanning the QR-Code is only an indication since the picture of the QR-code can be replicated) the collateral could be confiscated. Such mechanisms would reduce but probably not erase the potential of fraud in regards to physical bills.
We can see that this last topic requires further investigation and more robust solutions for various scenarios. It still becomes clear that while complicated, it is possible and worthwhile to investigate.
Conclusion: Overall it can be said, that stable coins, not bitcoin can be a national currency when implemented in the right style. It assures store of value and provides all features needed for transactions. The volatilely can be reduced when pegged to the right asset or currency, in this case a mix of the worlds strongest currencies. The mix reduces dependency and influence of any one currency and the monetary policies of its issuer. While such pegging mechanism strips a country of its ability to execute monetary policies through its central bank, it assures its people that the currency is stable and not prone to hyperinflation. This separation of state and monetary policy power is not a bug but a feature. Governments still have fiscal power but cannot mix these with monetary decisions. The possibility of physical money is discussed but requires further investigation and rock solid answers and mechanisms to avoid a back door that breaks the otherwise solid approach.
Resources:
Disclaimer: // This article represents my personal opinion and is neither financial nor investment advice. I am not a financial advisor. At the time of the publication I hold a small amount of BTC, ETC and other altcoins //
