“When one studies the history of money one cannot help wondering why people should have put up for so long with governments exercising an exclusive power over 2,000 years that was regularly used to exploit and defraud them. This can be explained only by the myth (that the government prerogative was necessary) becoming so firmly established that it did not occur even to the professional students of these matters (for a long time including the present writer!) ever to question it. But once the validity of the established doctrine is doubted its foundation is rapidly seen to be fragile.” – Friedrich August Hayek in The Denationalization of Money [PDF].
The Keynesian response of governments around the world to last decade’s banking crises continues with further money printing announced by the Bank of England. Soon, the FED will probably follow, while ECB continues with its QE. The end result has led to negative interest rates, extreme appreciation in house prices, inflation at 40% in Argentina, an increase in nationalist sentiments, contemplation of potential barriers to free trade… to say nothing of the currency wars, depression in Greece, and a seemingly no way out.
However, the insight of Hayek, a Nobel Prize winner for his work on the theory of money and other concepts, reached while he was battling with double digit inflation in Britain more than 40 years ago, provides a solution for which he argued in the strongest words:
“If we want free enterprise and a market economy to survive (as even the supporters of a so-called ‘mixed economy’ presumably also wish), we have no choice but to replace the governmental currency monopoly and national currency systems by free competition.”
The key insight he reached upon which bitcoin was most probably designed seems obvious once expressed:
“The past instability of the market economy is the consequence of the exclusion of the most important regulator of the market mechanism, money, from itself being regulated by the market process…only competition in a free market can take account of all the circumstances which ought to be taken account of.”
Hayek argued that the solution to the constant mismanagement of national currencies by governments which, in the preface is succinctly summarized as “government has failed, must fail, and will continue to fail to supply good money,” is to allow private enterprise to issue their own currency:
“[M]oney is no exception to the rule that self-interest would be a better motive than benevolence in producing good results… Indeed, [the money issuer] would know that the penalty for failing to fulfil the expectations raised would be the prompt loss of the business. Successful entry into it would evidently be a very profitable venture, and success would depend on establishing the credibility and trust that the [enterprise] was able and determined to carry out its declared intentions. It would seem that in this situation sheer desire for gain would produce a better money than government has ever produced.”
The current vibrant ecosystem of digital currencies is an implementation of these ideas where thousands of currencies are daily priced by the market depending on changing factors, but they are currently limited in wider circulation due to excessive volatility.
MakerDAO is one of the many Ethereum projects that are trying to provide to the market what is called a “stable coin” defined by Hayek as “in a rough sense…the command over commodities in general conferred by a sum of money [remains] about the same.” He further elaborates by arguing:
“It seems… fairly certain that:
(a) a money generally expected to preserve its purchasing power approximately constant would be in continuous demand so long as the people were free to use it,
(b) with such a continuing demand depending on success in keeping the value of the currency constant one could trust the issuing [enterprises] to make every effort to achieve this better than would any monopolist who runs no risk by depreciating his money,
(c) the issuing institution could achieve this result by regulating the quantity of its issue, and
(d) such a regulation of the quantity of each currency would constitute the best of all practicable methods of regulating the quantity of medium of exchange for all possible purposes.”
MakerDAO implements a version of the above, but instead of using the price of goods as a feedback mechanism it aims to peg the token called dai to a currency basket maintained by IMF as there are, initially, no goods priced in dai. Daniel Brockman, one of the Lead Developers of MakerDAO explained to CCN that an algorithm dependent on price feeds is used to maintain price stability:
“[W]hat the stability mechanism does is to adjust the deflation rate of the dai up or down depending on whether the market price of dai is too low or too high; the deflation rate in turn slowly affects the target price of dai (which is the price used to determine collateral ratios and liquidation events); these adjustments are designed to produce negative feedback loops that induce the market to enforce the peg around the target price.”
This is very close to what Hayek envisioned, but as MakerDAO is very much at a bootstrapping stage it uses a currency basket instead of price of goods, but MakerDAO is not the only one. Different token projects are already competing to provide the best service in ensuring stability of value with potentially different stable coins used in different regions based on special strengths or qualities they may have.
A new business model has further arisen where companies issue their own tokens to fund their project with the token itself having different qualities while some are no different than a digital currency. We can therefore imagine a Microsoft coin or Barclays coin or Hedge Fund coin or a Teacher’s Association coin with their own different purpose and quality such that some may be considered as just a share, some may be a product in itself, others may be a donation, while other tokens may compete directly to be a currency.
We do not know how this explosion in experimentation and innovation in finance and technology will develop, but we can be sure there are many challenges. I want to address one because it isn’t often raised, but Hayek attacks it directly.
The concept of “legal tender” has arisen due to the state’s millennial long privilege to have a monopoly over the issuing of money. This concept has, unfortunately, led to double taxation in USA, Canada and Australia when digital currencies are used for commerce against all equitable considerations or rational justifications.
There are legal basis to challenge these taxation rules by potentially arguing that legal tender laws in USA are unconstitutional as they violate Article I s.10 of the US constitution which states:
“No State shall… make any Thing but gold and silver Coin a Tender in Payment of Debts.”
That, of course, would require a long legal battle or a relocation to UK – the only English speaking country that treats digital currencies like state issued currencies for taxation purposes.
Hayek argues that there should be no interference by the government, especially to restrict issuing or treat digital currencies differently than any other currency, as that defeats the point of free market based currency, but if there is to be any regulation I would argue that such regulation would need to take a per digital currency approach rather than apply the same regulation to all one thousand or more current digital currencies.
For example, a digital currency that is designed to be fully untraceable might require government intervention and Aml/Kyc regulation at exchanges or business level, but a currency that is at the other end of the spectrum might make any such regulation obsolete and pointless.
It is because digital currencies can be so different from each other that regulators have mistakenly acted both too quickly in imposing requirements while they most likely have little understanding and too slowly leading to the denial of some professional trading functions such as margin trading or futures.
Some governments – which tend to be the least free – have gone further and have acted to ban digital currencies probably due to a misunderstanding based on misguided rhetoric. The free market has punished them by denying them the advances of the technology with those countries now playing catch up, while rewarding other countries which had the foresight to embrace digital currencies as early as 2014 – such as UK – which had its capital, London, crowned the Fintech Capital of the World. This was foreseen. Using bankers as an example, Hayek argues:
“[T]he older generation of bankers would probably be completely unable even to imagine how the new system would operate and therefore be practically unanimous in rejecting it. But this foreseeable opposition of the established practitioners ought not to deter us. I am also convinced that if a new generation of young bankers were given the opportunity they would rapidly develop techniques to make the new forms of banking not only safe and profitable but also much more beneficial to the whole community than the existing one.”
That is not to say there should be no rules or no oversight. This Wednesday, representatives from IBM, JP Morgan, Consensys, the Linux Foundation and others are to meet to discuss – presumably – the setting up of a non-regulatory body to establish standards and perhaps closer collaboration between the many open source blockchain protocols. The body would be voluntary, but if their rules and guidelines are very sensible and they are fully transparent then market forces would come into play as they have in other industries. Moreover, they would be directly, instantly and constantly accountable as the entire body could easily be rejected by any community or by the entire ecosystem or competing bodies arise.
Although, therefore, there may be certain grey areas, the, at times, fierce, competition between different public blockchains, as well as between different tokens on the same chain or different chains, together with the competition between public and private chains, and within each the competition between established tech companies, financial institutions, new startups, combined with the competition between countries to attract talent and capital, the best result for all stakeholders, including governments, bankers, tech companies, developers, investors and the general public will be achieved by the competing free market rather than a state issued currency.
Many laws therefore, especially those concerning the concept of legal tender, require updating or a policy of general non-enforcement should be established if we are to have a solution to the mess created last decade as well as considerably increase the economic well-being of our nations and perhaps start a new golden age of innovation at the scale of the industrial revolution.
Disclaimer: The views expressed in the article are solely that of the author and do not represent those of, nor should they be attributed to CCN.
Featured image from Shutterstock.
Last modified: May 21, 2020 10:17 AM