How Blockchain Impacts Fiat Money – Food for Thought

December 6, 2017 3:25 AM UTC

The views expressed in the article are solely that of the author and do not represent those of, nor should they be attributed to The article is penned by Constantine Kurbatoff Chief Strategy Officer BANKEX.

Constantine Kurbatoff Chief Strategy Officer BANKEX

This autumn the crypto market cap surpassed 300 bln USD, shaking the whole world and making everyone ponder the future of both cryptocurrencies and fiat money. We are to dive into the coexistence of traditional financial systems and blockchain technologies, explore how a new way of fundraising and exchange of value within a project or a company is reshaping our economies and possibly forcing central banks to review their monetary policies. In order to achieve that, we must recollect what functions money performs both in economic systems and in our society. 

In theory, money should fulfil at least three functions:

First and foremost, we all know that money is a universal metric of cost. It allows, for example, a hairdresser who earns money by cutting people’s hair to purchase food, go on vacation or buy a house. In ages, people have been exchanging (bartering) goods and services, even though it is very inconvenient when the quantities of purchases are large.

The second function of money is to preserve value. Imagine for a second that the hairdresser we mentioned earlier has earned a lot of money, he worked hard for it but has no desire to exchange it for anything else right this instance. He wants to put his money away for retirement. In the past, he would have had to purchase gold and other items of value that he could sell later. As the financial system evolved and money was introduced it took on the role of preserving one’s earning. This function of money does not necessarily represent the cost of something, because if you were to deposit it into a bank it would not be available for barter. As you know, there are types of deposits that do not permit us to use our money unless specific rules are followed. A good example of this would be a pension deposit – money that you have and own but can’t use until a certain point in time.

Now we come to the most understated function of money – informative. This role of money came about relatively recently, just one or two centuries ago. The gist of it is – prices that are set in one currency (we mostly use USD, but other currencies can be used too) are also money, but money that you cannot use, nor do you own it. Prices are simply information, information about what people are generally ready to pay for a good or a service. This information could be considered money, it is denominated in a currency and it has value, but this type of money is very different from the type that we carry in our wallet. This information is used by vendors, companies and governments in order to plan their activities.

With the arrival of cryptocurrencies, ones like Bitcoin and Ether, the economy has encountered a significant shift. We are going to have to dive into macroeconomic reasoning in order to understand why and how cryptocurrencies are changing our world. Whenever a central bank emits new money it has to analyze and predict how many new businesses and goods will emerge in the economy over the course of the next year. Why does it have to do that? The exchange rate of a currency must remain stable to an extent (high volatility will cause a lot of inconveniences to entrepreneurs, they will have to re-print menus, change price tags, reduce or increase salaries) in order to make it stable the central bank has to predict what the demand for its currency will be. The demand for money, in turn, derives from new goods and services that are bought and sold.

Apart from the obvious, amongst these products we have startups and new technologies. Usually this emerging demand arises as follows – a company that has created some new tech decides what it is going to charge its users for a product they have never used and therefore have no historical pricing knowledge about. Considering the fact that this technology is new, the former consumption traits will remain the same, adding the need for more money. The central bank must acknowledge this demand and issue more money in order to allow people to buy this new piece of tech.

Surely we can say that some things lose their value and become less expensive, but studies have shown that the demand for money grows constantly. But central banks keep inflation exists putting slightly more money into the system than needed and in moderation, it is absolutely normal, even necessary. With the emergence of cryptocurrencies however we are currently witnessing something very different. Companies emit their own currencies that do not fall under the control of central banks. They cannot be foreseen nor can they be predicted, but at the same time they carry out the function of traditional money.

Allow me to expand on that. Imagine that we have created a new network, one where people tell each other jokes and pay for those jokes in an internal currency. In this case a user of such a network, tells a joke to another user and receives a coin from him in return, in time, that same user goes back to listen to someone else’s joke and sends them that coin. Such a network would facilitate the increase of demand for its tokens, due to the fact that new users would join to listen to the funniest jokes – the demand for which would grow and drive the price up. An average user would have to either accumulate, lend or purchase tokens in order to hear the funniest jokes.

In the case of traditional fiat currencies the demand generated by this turnover would have to be satisfied by a Central Bank

However, we live in a time when a network like this can be developed with minimal use of fiat money and can later exist fueled by its internal crypto currency- which only comes into contact with fiat money, when a user decides to withdraw or add more funds to their account.

As a result we can see something extraordinary: the economy continues to grow as the number of products and services increases giving users more opportunities and the money that is used to drive the economy is not issued by the central banking system, instead it is issued by the company whose services are being used. A watchful eye will notice that this happened before the existence of blockchain and cryptocurrencies, in the form of customer loyalty cards for example. However, in the case of loyalty programs, points were awarded for purchases in fiat and, thus, would only represent a small fraction of business, a fraction so small it was unable to distort the informative function of money.

What we see today is the complete opposite – fiat money makes up the small fraction of turnover in some companies. This can lead to two scenarios from the point of view of the central banking system: scenario number one is that since the bank does not control nor sees the turnover of money in the company that is using its own cryptocurrency, the central bank may well conclude that there is no economical growth. On the other hand, it is evident that new opportunities in economies emerge and they are paid for in cryptocurrencies, which no one controls, regulates or guarantees. Part of world economic growth is still hidden from financial authorities and sometimes no one even know it exists.

The number of such companies grows and how this will impact the global economy is not yet clear. What is clear is that central banks will soon be forced to change and adapt their predictions in order to facilitate these changes.

Last modified: May 20, 2020 9:17 PM UTC