In a previous article, I discussed the concept of the telos or existential purpose of systems, and advocated that any attempt to analyze a system must measure its effectiveness against the purpose for which it exists rather than against some arbitrary standard unrelated to its purpose.
In a world of cash apps, Paypal, eBay and international travel, it may seem that we already understand the telos of money, as almost every social interaction involves its exchange somewhere in the equation—whether overt or covert, money is changing hands.
But what is it exactly that gives money its value? How do various currencies measure up in relation to each other and its telos? How can we continue to make rational market choices without understanding how the modern system of fiat money—and currency—came to be and where it is headed?
The backstory
Throughout history, humans have found the need to devise a way to account for an exchange of real-world value. After all, the skilled arrow-head maker would want some compensation for his day of chipping flint in the sun so his family can eat something besides his leftover flint shards. Barter was useful but limited by the need to constantly measure relative exchange power and negotiate terms. Therefore at any scale of human development beyond the immediate fire circle, objects containing mutually-agreed value (money) were best suited to lubricate such exchanges of goods or services.
Initially, tribal systems collaborated internally to designate various rare, identifiable and durable objects as money. Cowrie shells, wampum & Rai stones had their day—although today’s residents of Yap island in Micronesia can still recount who owns a particular Rai stone even when submerged by time and tide—but gold and silver were quickly adopted by various cultures independently. Both are durable, malleable, divisible and identifiable in purified form, and thus could be counted on to change hands regularly without notable deflation in value per unit of measure.
As kingdoms and empires arose, they found a need to establish ‘official’ money through which taxes must be paid, and the stamp of the emperor’s face on a silver ingot transformed it from ‘money’ into ‘currency’—a system of officially defined & centrally controlled monetary values. Their reason for doing this boiled down to an exertion of power over their conquered lands. After all, if people paid taxes in a valuable commodity such as gold dust, that could just as easily be sold to build roads and pay the army as could a stamped ingot; however, it was discovered that creating demand at the point of the lance by requiring tax paid in official currency allowed the value of the currency to rise above that of the humble nugget, and beyond that, it constantly re-asserted the supremacy of the empire in every interaction with the currency.
After the discovery of market science and the Enlightenment’s skepticism of the rights of kings and conquerors to control all commerce in their domains, new institutions called ‘banks’ arose, and with them the ‘banknote’—venues to store and exchange specie (like the ingot) and currency (officially designated money). These institutions further lubricated the wheels of progress, discovery and specialization by allowing the invention of credit, stocks, and eventually stock exchanges, terms that are standard parts of our modern landscape but are wonderful extrapolations of the ancient exchange of barter value that have resulted in the kind of world where you can board a hollow metal tube made from a substance that didn’t exist 200 years ago and outpace the birds to arrive 12 time zones away in a few hours.
The kings and conquerors, however, were not to be left out in the cold by these new developments, and various demands by governments have kept pace by and large with the advance of finance, always with an eye to control human interactions toward the needs of the state and to benefit financially from these exchanges. From the ‘wildcat’ days when independent banks could create their own banknotes—but were required to hold collaterals of State currency to do so—to the rise of fully Nationalist currency, it has become an accepted truth that Nations create currencies and a nation’s currency is to serve the state and its residents. Banks, once hubs of innovation, through regulation and inertia became yet another extension of state power.
While I am not a dedicated proponent or detractor of Nationalism or the existence of Nations—it has its advantages and drawbacks for human civilization—it is necessary to explore how Nationalist currency has modified currencies’ true telos, and the effects of such manipulations.
Monetary policy
If you give a single entity absolute power over the unit of exchange, it is desirable that the entity takes responsibility to manage the issuance of that currency. What is perhaps inevitable but not so desirable, is that the entity takes responsibility for the performance of the economy in which the currency governs exchanges of value. Today’s conventional wisdom would describe this as benign or even beneficial for the general public, but the conventional wisdom trades on immediacy bias; no matter how poorly a system is functioning, it is preferable to a system we haven’t seen working, even when it didn’t work in the past. Today’s discussions of pre-National currencies or dissolving the Fed are replete with scare quotes to indicate to us that such pre-historical times are best kept at arm’s length—this while asset bubbles are created and exploded on the regular by government promotion, regulation and outright manipulation of currency and its usage: what we call ‘monetary policy’.
Some questions, seeking to provoke thought:
Were the free-wheeling ‘wildcat’ days of ‘free banking’ so misguided in their construction, or were they ahead of their time and the requisite technology was not available to make the system work well? If so misguided, how did such a system lubricate the rapid expansion of the US from a coastal governance experiment to a continental power before Nationalist currency was imposed (more details on the validity of that argument here)?
Once ‘monetary policy’ no longer has as its primary purpose the maintenance of the value of the currency, what exactly is its proper use? In my 30 adult years I have seen policy pushed to incentivize the purchase of homes, electric cars, various financial instruments, higher education. All of these when so favored by government produced winning soundbites but also asset bubbles, financial destruction and lack of innovation. In the mean time, we have seen truly revolutionary innovations happening in areas not treated to such special favors. Is it possible there’s a causal relationship, and the efforts of powerful individuals to use their leverage to direct our economy in specific directions should be viewed with concern? Just what is our ‘monetary policy’? How susceptible is it to arbitrary changes and manipulation by the powerful? What is the end goal, and how do we even measure whether it has been a success or not?
Given monetary policies’ close ties to Nations and Nationalism, we see regular examples of currency controls, protectionism, national rivalry and other arbitrary limitations executed through the levers of monetary policy. What amount of the world’s inequality, poverty and misery is ossified by such decisions? How might the free market deliver the prosperity we rightly attribute to free exchange but for the inefficiencies introduced by such measures?
In the best of times, ‘opportunity cost’ is difficult to calculate. It defines the cost of missing out on options not taken, and usually requires an earnest imagination and personal commitment to learn from personal mistakes. When economy-wide decisions are being made by ‘monetary policy’ manipulations and reported on by elite media who have every reason to support a conventional wisdom in which they are corporately benefitting, it becomes almost impossible to gauge the cost of the roads not taken by the effectors of that policy. Then once every four years we get something of a referendum on the performance of the policies, although that decision is usually overburdened by bad reporting, extraneous fears of unrelated concerns, and sufficient manipulation of the monetary policy to coordinate enough good news to bring the establishment through the ordeal without a singed hair.
A new reality becomes possible
With the rise of cryptocurrencies has arisen something entirely new in the history of money: a social experiment in the wild, a system of accounting and exchange anchored by technological marvels, a proof-of-concept parallel economy where we can test the effectiveness of a new kind of monetary policy that governs an evolutionarily epochal transition to the use and governance of currency that is as close as possible to money’s true telos: a consistent, reliable, accessible and universally understood medium of exchange for goods and services across borders, cultures and creeds.
Cryptocurrencies’ monetary policies are first described in ‘whitepapers’—design documents proposing a new project—and later implemented in immutable code once the project launches. To abruptly change the monetary policy—even in instances where it is possible—is to destroy the currency. Some projects allow governance decisions to modify monetary policy, but the governance procedures are clearly stated in the whitepaper and the limited modifications are further weighted by the interests of the individuals invested in the currency—by design making sure that those with the most to lose by making a mistake have the most say in maintaining the operational effectiveness of the currency. This means that incentives are aligned with the telos of the project.
Not all cryptocurrencies are created equal, of course, and some projects fail. Some are outright scams, and Crypto participants have developed robust audit and research systems headlined by personal responsibility to root out bad projects. All projects are subject to market manipulations: if someone wants to spend a lot of their personal wealth to pump or depress the value of a project, they can do so—but they are also subject to the same rigid rules of economics, and must forego innumerable other options to expend their wealth in such a way.
No one in the Crypto world is advocating forcing people to use any cryptocurrencies, and given that no cryptocurrency project desires or expects public bailout in the event of failure, I regard this experiment at worst benign and at best a paradigm shift.
To date, the best argument against the adoption of cryptocurrencies is the lack of price stability. This in conjunction with the rise of hundreds of ‘altcoins’ (any cryptocurrency other than the original Bitcoin), makes the entire space seem like less of a viable system of exchange and more of a speculative money grab.
To be sure there’s plenty of that (plenty of examples in traditional finance as well), but two recent innovations are bridging the gap from experiment to reality.
Distributed Money Markets
Viewed optimistically, the hundreds of operational altcoins represents innovation. Without personal ties to Venture Capital bigwigs, without years of sunk cost development and risk, a kid in Bangkok, Seoul or Lahore can come up with a new idea, write a paper, and with some technical training and Internet access can launch a new protocol delivering some good or service to the public. The problem becomes: how does the new project attract investment, and where do you even find the token for purchase? Once it’s available for purchase, how does efficient price discovery determine the public’s value for the project’s potential and deliverables?
The answer is in the AMM: Automated Money Market.
First-wave cryptocurrencies were bought and sold for fiat on specific exchanges: centralized websites which created a medium for the exchange of cash and cryptocurrencies. These are now known as CEXs: centralized exchanges. Getting listed on a centralized exchange represents something of a coming-of-age for a particular project; listing means a project has created enough code and met enough deliverables to ensure the exchange trusts the project and is willing to risk its reputation to allow exchange. While this is cautious and protectionary, it is not infallible and still presents a high barrier to entry for our friend from Chittagong who aced his maths and wants a better option than to drive his dad’s tuk-tuk.
Automated Money Markets arose in mid 2020. AMMs (also known as DEXs for decentralized exchanges) make use of algorithmically-governed exchange methodologies that allow investors to put up their own cash to discover new projects and provide liquidity for the exchange of the new project to existing ones, with their profit found in modest exchange fees. The volume of exchange and liquidity has exploded and has allowed projects to launch earlier, receive investment sooner and experience price discovery based on their innovation, not on the basis of their VC and CEX connections.
The rise of Stablecoins
Central to the success of Automated Money Markets has been the establishment of “Stablecoins”. Stablecoins are usually pegged to the US Dollar, and issuers of Stablecoins maintain the peg to their adopted fiat value via various collateralizations, algorithms and market actions as defined in their design documents.
Stablecoins have lubricated the AMMs by allowing exchanges against fiat value without engaging the costly and slow payment rails of actual fiat, and without the holding of large amounts of fiat as the CEXs did. In this way, by allowing users to purchase and commit quantities of Stablecoins and project tokens with their own cash and reap a regular harvest of profit, AMMs have delivered a trustless but reliable platform on which low-barrier-to-entry small-caps can achieve a market presence.
I won’t go into the relative value of various Stablecoins (more detail here), but I will go into the most killer use case of Stablecoins.
While AMMs answer the valid concern of how you know the market value of a cryptocurrency, Stablecoins also answer the valid concern of price stability.
What’s in a Price?
Where the better examples of fiat currencies have succeeded is in price stability over time.
A price is best understood as a market signal defined by the crux of supply and demand for a particular object or service. An increasing price motivates more production of the good in question, a depressed price indicates an oversupply of a product, motivating more valuable production elsewhere. The value of price stability doesn’t mean that the price of something stays forever the same, it means that the price is validly determined by the supply and demand curves of the free market. When a currency doesn’t hold its own value over time, the market signals motivating production of what’s demanded get confused and the market gets more inefficient. It its terminal examples—as in Venezuela or Zimbabwe—price stability problems in the national currencies motivate a return to barter or anything more stable that can be accessed.
Except for inflationary episodes—example late ‘70s—under the current US monetary regime the price of a loaf of bread or gallon of milk or gasoline has reflected the accurate market state, at least within a calendar year. Other fiat currencies, while not always stable, offer at least the familiarity of common use. After all, if everything worldwide were suddenly priced in US dollars, the vast majority of the world would be forced to calculate the adjustment to determine if prices of goods were high or low.
Stablecoins bridge the gap between crypto and fiat by offering the same integrations with innovative cryptocurrency & blockchain technologies as well as offering the same price stability and familiarity of fiat. Terra Money in particular has built their entire project use case around the adoption and use of national crypto stablecoins pegged by arbitrage to their home currencies—20 at last count—and by algorithmically facilitating exchange between currencies based on their real-world forex values.
Are National currencies threatened by Stablecoins?
To listen to various establishment figures, Stablecoins are anything from a tax dodge to an undercollateralized loan to an existential threat to the integrity of money. Many support CBDC’s or Central Bank Digital Currencies—as if the only advantage of cryptocurrencies is that they could be programmed or as if our currency isn’t largely digital now anyway: 99% of your personal wealth exists as a collection of numbers in various databases somewhere.
Champions for CBDCs enumerate—among other things—the ability of the federal government to drain funds directly from everyone’s wallet as part of a ‘negative interest rate’ that would apply even in absence of a bank balance.
A more rational response has come from the pen of Randal Quarles, a Federal Reserve Vice Chair. In a prepared statement, he wrote that “we should be saying yes to these products, rather than straining to find ways to say no. Indeed, the combination of imminent improvements in the existing payments system such as various instant payments initiatives combined with the cross-border efficiency of properly structured stablecoins could well make superfluous any effort to develop a CBDC.”
Which makes a ton of sense. What would be the point of creating or commissioning of the creation of decentralized, blockchain-based digital money when it has already been created—and has proven highly functional and reliable—by private blockchain projects for free? There’s no reason Terra’s dollar-pegged $UST, for instance, means that the US Fed can’t inflate, manipulate and spend to their heart’s content, driving the ultimate price stability of the US dollar with their policy. With or without the $UST, the real-world value of the $USD remains in their hands, and ultimately the international availability of the $UST within a few Internet keystrokes could actually drive $USD adoption in places the local currency has failed at its telos.
There would just be a ripcord for the rest of us, as alternative stablecoins, known as Valuecoins are arising: these are pegged to baskets of real world goods and currencies, such as Terra’s SDR(Special Drawing Rights)-pegged $SDT, which can set the standard for worldwide pricing stability should the $USD ultimately fail in its telos.
The only thing we have to fear…
…is fear itself.
This is where we stand: on the brink of new technology and previously unimagined peace and prosperity brought by a world made smaller and more accessible by anyone with opportunity and willingness to learn, and to think of ideas that haven’t been tried yet.
A reaction of fear at this prospect fails to ask the question: ‘what good things will we miss out on and never know, if we don’t take the opportunities in front of us?’ What we do know is that existing tech and finance are becoming more sclerotic, centralized, cronyist and dominated by powerful elites. Nationalist economics with currencies bent to enforce the will of the state will continue to deliver diminishing returns. Internationalist elite/socialist economics even worse. Where will new and fresh ideas emerge, if a new, individualist road is not taken?
The magic of markets, properly understood, is that they work best for everyone in the marketplace the less that class, culture, location, race, language, or political connections stand in the way of ability, initiative, productivity and creativity.
Cryptocurrencies are now giving us a road-less-traveled-by demonstration of a new way of living in our world, featuring zero coercion to participate and daily options to choose or leave that path.
We should not fear—or obstruct—their development and adoption.