The crypto conundrum

Synopsis: Controlling money supply and issuing money are at the root of the power and influence that the governments of this world command. Leaving the limited use case and exchange value aside, if Cryptocurrencies pose any real challenge to the existing fiat currencies it may result in a stern policy action.

Introduction

Bitcoin and other private cryptocurrencies have been on a bull run recently. Unlike previous rallies, the current rally in bitcoin has witnessed the increasing participation of retail investors in India. Yet, the future of bitcoin and other cryptocurrencies is unlikely to be as bright as many believe it to be.

What attracts retail investors towards Cryptocurrency?

The key feature which has attracted many retail investors is the limited supply of Cryptocurrencies. With increased demand, scarcity of anything will push up its price. A similar thing is happening with Cryptocurrencies.

As more and more investors are buying them, their price is going up.

And as their price goes up, more and more investors are lining up to buy them.

Now, consider the case of fiat money whose supply is unlimited and depends upon the central bank of a country. A central bank can create any amount of it as per its will. This increased supply of money in the economy devalues it further. The more money a central bank prints, the lesser its value.

Hence, scarcity of Cryptocurrencies is a key reason behind their popularity.

But, is it enough for large scale adoption?

Why scarcity is not sufficient for large scale adoption of Cryptocurrency?

Scarcity alone is not sufficient to facilitate the adoption of cryptocurrencies as money.

– Any asset must have either use value or exchange value in order for it to possess any fundamental value. This fundamental value, in turn, is reflected in the price of these assets in the long run.

For instance:

– Stocks and bonds, for instance, possess exchange value that is based on the expected future cash flow from these assets.

– Commodities such as oil and steel possess use value because these assets are used to run vehicles and build real estate.

– Gold and silver have traditionally served as hedges against inflation because they possess fundamental value derived from their use as jewellery and money.

Cryptocurrencies may be scarce but its doubtful whether they possess any use value or exchange value. Presently, Bitcoin can buy very few real goods and services.

In short, cryptocurrencies possess no significant fundamental value to sustain their current high prices.

What are the benefits of private alternatives to fiat currencies?

Private alternatives to fiat currencies offer people greater choice in what currencies they choose to use as a medium of exchange. The benefits of free market competition in money were elaborated by economist Friedrich Hayek in The Denationalization of Money.

Most notably, competition between currencies to cater to the demands of customers would ensure that fiat currencies that are printed indiscriminately simply go out of use.

Why increased acceptance of Cryptocurrencies increases likelihood of a govt crackdown on them?

The monopoly that governments (and central banks) possess over the issuance of money is at the root of their power and influence.

If cryptocurrencies like bitcoin are going to challenge fiat currencies like the U.S. dollar as a medium of exchange, they would essentially be challenging the authority of the government to print and spend. This is not an assault that governments will tolerate for long. They will allow cryptocurrencies to exist only as long as these currencies remain a speculative asset and not a medium of exchange.

Hence, the more cryptocurrencies are accepted in exchange for goods and services, the greater the chances of governments cracking down on them.