After the 2008 financial crisis, some people decided to create a new currency that’s not in control of government or any other central authority. The currency is controlled by the people who use it. They named it Bitcoin.
The core idea behind bitcoin, a user controlled currency, is a great idea. No central authority to impose rules on users, but if all users decide to change, they can (through forking). It’s the democracy at its best.
Bitcoin used a genius mechanism called blockchain to create digital scarcity. A currency needs to be scarce. Otherwise, it can’t hold any value. Combining different concepts of cryptography to create digital scarcity is a genius idea.
It has many flaws though. Scalability, privacy concerns and so on. are widely discussed. So I’ll not discuss them here. Main problem I see in BTC is its inability to adjust the money supply to match the economy.
Government controlled money has its own mechanisms to deal with inflation and deflation. Print money to fight deflation, increase interest rates to fight inflation etc. But Bitcoin only has a predetermined supply.
For this article, implementation details and individual currency names don’t matter. I’m just going to say why crypto in its current state will never going to succeed as a currency. I’ll describe how greedy investors destroyed crypto. This is just my opinion.
Many people say government issued money is solely based on trust, the trust people put on the government. When government prints a 100LKR note and state it values 100LKR, people believe it.
This idea is mentioned as a way to convince people why crypto is better than government issued money. Ironically, this story is the same for crypto too. Crypto has that value because people believe it has that value. Even for a limited resource like gold, other than being attractive due to its rareness and shiny nature, it has no use except for electronics and chemical experiments.
The saying that “government issued money is based on trust” is not a completely valid statement. Yes, it’s true that when I see a 100LKR note, I believe it has a value of, well, 100LKR. But what is 100LKR?. Just like meters and kilograms, LKR is just a unit and 100 is how much of that unit I have.
So, what gives that unit a value? It’s the economy made by people using that currency.
How does currency get its value
Think of a small economy in which the only commodities dealt with are bread and pencils. The Only citizens living here are a baker and a pencil maker. The baker produces 10 breads per day, but the pencil maker only makes 1.
So naturally, 10 breads are worth 1 pencil.
Now imagine they started using money. The transaction of 10 breads for 1 pencil is now worth 100LKR. Therefore, 1 bread is worth 10LKR and 1 pencil is worth 100LKR.
Now imagine a new pencil maker comes to the town and starts making 19 pencils per day. Hence the total pencil production per day is 20. Now, the transaction of 10 breads for 20 pencils is the value of 100LKR. So now, still a bread costs 10LKR but a pencil is now only 5LKR. All of a sudden with a 100LKR note, baker can afford more pencils. Deflation!
Notice here that there was no government or money controlling body. No one said a pencil is worth this much and a bread is worth this much. (I set the initial price, but then value of LKR adjusted itself to the economy).
That’s why the statement “Government-issued currency is based on trust” is not completely true. It’s not false either; it’s just a half truth.
A single unit of government issued currency represents a tiny fraction of the entire economy that currency is used in.
Now let’s see how crypto works.
How crypto get its value
Let’s say we have a crypto currency called ABC. Originally, authors wanted to make this a replacement to government-issued currency. They managed to get a enthusiastic user base.
But one day, let’s called it the ABC Pizza day, a pizza shop accepted 10,000 ABC coins for a single pizza. This is a huge deal. From now on, ABC is not just a hobby currency. Now 1 ABC is worth 0.0001 pizza. The day a ABC user bought pizza with ABC, ABC became a real currency because it got a place in the economy.
Some greedy investors saw this. They thought, “oh wow, if every pizza shop starts accepting ABC, the value of ABC coin goes up because the supply of ABC currency is capped to 21 million”.
So they started buying ABC planning to sell when the price goes up. Because they bought a huge amount of ABC but the supply of ABC coins is limited, the price went up. Other greedy investors saw the price going up and started buying so they can sell later and make some profit.
However, still, no new pizza shop started accepting ABC coins. But somehow, the price is going up. How? If ABC is not backed by a real economy, from which the value of ABC is backed by?
Well, it’s “Hope”. Hope that one day ABC price will go to the moon.
Will that ever happen? Maybe ABC will one day worth a lot, but it’s not a constant price hike. It’s a bubble. It will burst. If an investor sells their ABC coins to someone else for a profit, the new investor is buying it for the same reason: to sell later for a profit.
These investors are living in a real economy. There’s a level this real economy can bear the bubble. When it reaches that level, the bubble will burst. When new investors stop buying into the scheme, when people don’t buy into this “hope” thing, the price will collapse.
Would ABC ever have a real economic value? It might not. Do you want to accept a currency which is just backed by hope instead of real assets and services?
It is very less likely that the ABC currency will ever have a real economic value.
Gambling vs Investing
When you invest, you buy a physical asset that can produce goods or services. When you gamble, you’re just looking for suckers. As a seasoned poker player, I can tell you that everyone thinks they’re a graet player when they’re on a winning streak.
– @ilya475 (youtube comment)
Above comments sums up the current state of crypto investing. In crypto, people are not buying to something backed by real world value such as stocks. They are buying into the hope.
If you make profit by selling your crypto, it’s just because you found a loser. May be that other guy is not the looser, but eventually someone will be. That original investor got his profit from that “someone,” but that “someone” unfortunately, could not find “another one” to sell his crypto. So he lost.
Don’t destroy crypto please
My point is, “the investors are destroying crypto”.
ABC coin started to gain value after a pizza shop accepted it. That’s how crypto should gain value. Then ABC coin got destroyed becaused some investors started stock piling ABC (They call it HODL) and falsely inflated the price. Now ABC will never ever be a real currency.
I think investors broke currencies like BTC. From my very little knowledge, I think the only currency that’s not broken is Nano and of course, monero. I hardly see people stock piling monero. Nano managed to burst the bubble and survive. Big investors holding Nano lost. Now a nano coin only worth around a dollar. After the big burst, no investor is really buying into nano. But you know who’s buying? The real users of Nano. Mostly gamers to buy in game items. Nano is acting like a currency now.
I think monero also would survive the fight against greedy crypto investors. However to succeed, it needs to have inflation/deflation controlling mechanisms.
In the bread and pencil example, price of pencils went down. If another baker comes to the town, price of bread will also go down. This is deflation. If this is a developing towm, this will happen constantly. Then people get the idea that this town’s currency will worth more tomorrow than today. So they will hold on-to their money. It’s fine for real world, because you’re forced to spend on essentials, but for crypto, this destroys the currency.
When the government of the town prints more money to fight against deflation. prices stay steady. Fighting inflation is harder than that. The only ways my stupid brain knows as of now is to increase interest rates.
In conclusion, if a crypto has proper mechanisms to fight inflation and also deflation, then investors won’t put their money into it. Only real users would use it.
In my opinion, if someone could fill the research gap of fighting deflation and inflation in crypto in a DeFi manner, that day, crypto will be a real.
Conclusion
As of now, crypto is heavily suffering from deflation. Solving deflation is easy as printing more money, but doing this in a decentralized and automated manner, matching to the currency’s economy is the real challenge.
These challenges are not yet solved.
Initial philosophy of crypto is great. But it’s not yet achieved. To save existing currencies from being destroyed, don’t invest. Use them to buy stuff. If you have a online store, accept currencies like monero instead of HODLing it.
I hope one day above challenges will be solved and crypto will be a real currency.
Thanks for stopping by 💗