Currency Competition

Currency Competition
Lukas Dippold | TU Berlin | IM: 385829
Hayek’s intention behind his idea of competing currencies from 1976, to abolish
governmental issued currency, can get reality with cryptocurrencies which emerged
evolutionary over the past decade. The decentralization approach makes them a new form
of money. The three basic functions of money, namely unit of account, storage of value and
mean of exchange can be provided by cryptocurrencies. Due to their technological
properties these functions can also be split across various currencies.
Bitcoin & Co.: The Economics of Crypto Currencies
1 Introduction: From Hayek’s idea to Cryptocurrencies
In 1976 Nobel laureate Friedrich August von Hayek proposed the denationalization of money
in favor for competing private monies. He was very fascinated by this idea as from his point
of view the governmental monopoly for currency issuance is not providing the best money
we could have. Furthermore, he had no doubt that the recurrent periods of depression and
unemployment have their origin in the old monopoly (Hayek, 1977, preamble). His idea was
widely discussed even in mainstream economics, but it has been rejected as impractical or
politically undesirable (Thorsten Polleit, 2016). Most economists make the governmental
monopoly a standard assumption which they do not question. But recent developments in
information technology, especially cryptography, could make Hayek’s vision reality. With the
release of Bitcoin in 2009 by a pseudonym called Satoshi Nakamoto a completely new
monetary form entered the world, called cryptocurrencies (Nakamoto, 2009). The
extraordinary feature of Bitcoin is decentralization. There is not a single entity that can easily
change the monetary policy alone. Decisions are made by decentralized consensus. The
ingenious concept of Bitcoin challenges the way economists have traditionally thought about
This seminar thesis will focus on the economics of cryptocurrencies. The main research
question is if cryptocurrencies can make Hayek’s vision possible. To answer this question
Hayek’s book ‘The denationalization of money’ and the recent paper of Villaverde and
Sanches, in which they build an economic model for competing currencies, are analyzed
(Fernández-Villaverde and Sanches, 2017). The goal is to elaborate critical properties of a
denationalized currency to function as money that is providing the three basic functions of
money, namely unit of account, means of payment and storage of value.
It is crucial that governments provide a fair market conditions that the competition of the
currencies can work undisturbed. The currencies itself need to provide counterfeiting
security. Moreover, it should be impossible for any single authority to inflate the currency.
The whole competition process should also lead to price stability and provide the economy
with the socially optimal amount of money.
Cryptocurrencies are not making Hayek’s vision reality in the way he thought about it,
because they have another objective compared to the competing currencies he described.
Cryptocurrencies stand for decentralization, which is the reason for the complex consensus
mechanisms. However, Hayek’s basic intention behind his idea, to abolish the governmental
monopoly, could be realized. Cryptocurrencies like Bitcoin represent a new form of money
that is decentralized and not controlled by a single authority. This fact makes them hardly
comparable with previous forms of money.
Right now, we can observe competing currencies within the cryptocurrency market. It is a
quite unregulated environment and moreover very new. We can gain first insights how
competing cryptocurrencies behave and what possibilities there will be in the future.
Cryptocurrencies are not competing for the best monetary policy but rather attract the users
with specialized features. Market participants tend not to focus on trade with one specific
currency but use various currencies for different transactions. Additionally, transactions will
eventually consist of two currencies. The one that the seller wants and the one that is used
by purchaser. Within the transaction there is an automatic exchange. Thereby network
effects do not play a big role.
The seminar thesis is structured as follows. Section 2 studies the historical background,
especially Hayek’s proposal. Section 3 presents the model of Villaverde and Sanches. Section
4 discusses the idea of competing currencies and evaluates critical properties based on
Hayek’s thoughts and the analysis of Villaverde and Sanches. Section 5 presents
cryptocurrencies and how they can fulfil the critical properties. Section 6 concludes.
2 Historical Background
Friedrich August von Hayek published his idea in a book called ‘The denationalization of
currencies’ in 1976. While he admits that Benjamin Klein had the idea of competing
currencies already in 1974, he claims that he came up with this idea by himself as the paper
of Klein was out of his knowledge. It also relates to the idea of unregulated banking and to
the literature on the historical experience with free banking (Lawrence H. White, 1995). The
following subsection summarizes Hayek’s idea and his motivation. It shows that he has a
critical point of view towards the monetary system at the time of writing the book.
2.1 Hayek’s idea of denationalizing currencies
The proposal by Hayek is the full competition between private issuers of currency.
Governments should not interfere in the money supply process (Hayek, 1977, p. 1). This
should happen by a revolutionary process initialized by international agreements of
governments. He argues that private agents can achieve desirable outcomes through
markets even in the fields of money and banking and that this would stop the sequence of
heavy inflation and deflation.
Hayek claims, that the governmental monopoly for money supply does not work well as
governments abuse the trust of the people and supply them with bad money that they are
inflating (Hayek, 1977, pp. 6–11). In economic literature there is no indication that a
governmental monopoly on money should always be seen as something requisite. This
monopoly was not always there. Indeed, in the early days of money coins, there were
several issuers of coins that were competing against each other. The technical side of the
production of these coins was quite complex. Moreover, exchange rates between the
various coins were hardly available. In these days the government did a useful job issuing
similar and distinguishable coins (Hayek, 1977, p. 6). And after a while the governments
realized that by issuing coins they can make profit, if there is no alternative for the people to
use. Over time the myth arose that every nation needs an own money within its borders and
only governments can supply it. People always accepted it although the government abused
Hayek proposes the usage of market mechanism in money supply. An issuer must issue a
stable currency because otherwise people will switch to another one. According to Hayek
the issuer holds the value of his currency stable against a bundle of goods. For him, profit
seeking would bring a better money than governmental planning. The people would trust
more in a market player which business depends on not abusing the trust of the people
compared to a governmental monopoly that profits alone from money issuance. Even worse
central banks gave the monopoly out of their hands but are still responsible. Keeping the
control would require a 100 percent banking. But today banks profit by creating credit out of
thin air without responsibility for the monetary system (Hayek, 1977, p. 118).
He makes clear that the Gresham Law is only working when all currency issuers issue the
same currency but not when everybody issues his own currency and there is a clear
distinction between them. Then worthless money or bad money is driven out of the market
by good money and not vice versa (Hayek, 1977, p. 24).
Hayek is looking for a better monetary system. Inflation is not a volatile process but an
insidious. There are capital investments that are profitable just because of the ongoing
inflation. Therefore, production factors are wrongly allocated and this causes
unemployment. Within the current system Hayek is agreeing on the common statement,
that Inflation is necessary. But he believes that this system will ruin our civilization if we
don’t change the political frame. It is leading to heavy economic cycles which can be avoided
in that hard form by a better monetary system. (Hayek, 1977, p. 72)
Another argument for competing currencies is absurdity of interest policy in the current
system. The fixing of interest rates should be left to market forces, the offer and demand for
credit. A single planning authority like a central bank can never have all information to
determine the best interest rate. (Hayek, 1977, p. 98)
The determination of special currency areas like a country is not needed according to Hayek.
They are harmful to smooth international relations. Competition will form regions where
people tend to use a specific currency without specific national borders. (Hayek, 1977, pp.
106–10) It is important to separate fiscal policy from monetary policy as they conflict with
each other. Democracy favors abuse of monetary policy as there are elections. As there are
elections governments tend to reach positive short-term effects by the means of an
expansive monetary policy and do not worry about a resulting high long-term price. They are
selling the future. (Hayek, 1977, pp. 110–5) The free monetary market needs to be protected
from government intervention.
Hayek calls for a free money movement like the free trade movement in the nineteenth
century. For him it is crucial that society finds a better solution for its money than the system
at the time of writing his book, because this system would lead in totalitarianism.
2.2 Private Monies in history
The economic history provides several experiences with denationalized money. But they
must be distinguished from Hayek’s proposal, because in most historical cases the banks
were subject to numerous regulations. A lot of very good banking was done in lightly
regulated banking systems. Examples include Scotland, New York under the system that
prevailed in the United States before the Civil War, Canada, Sweden, Switzerland, and Chile
in the nineteenth century, and many less well studied cases. (Briones and Rockoff, 2005)
One of the most discussed examples is the free banking period in Britain (1716-1844), which
refers to a monetary system without a central bank, in which private banks would be
allowed to issue currency and bank deposits without restriction. It is considered as a success
by economic historians but it is rather called lightly regulated banking than free banking
(Briones and Rockoff, 2005). This version of free banking is based on banknotes being
redeemable in gold and silver coin. The competition between the banks was tough. A bank
collected the notes of a competitor over a long period of time and then immediately
demands its redemption with the goal of driving the competitor into insolvency and thereby
conquering market shares. Basically the banks still relied on the English government.
(Lawrence H. White, 1995) This is also a hint to the practical problem that governments do
not want big banks or money issuers to fail, because they are widely connected within the
country and the collapse of one issuer could lead to enormous instabilities.
3 The model of Villaverde and Sanches
The time when Hayek thought about this idea is very different from today. But new
technology makes old ideas interesting again. The current development of crypto currencies
is the reason why Villaverde and Sanches take a serious look at Hayek’s idea. The following
two subsections are based on the paper of Jesús Fernández-Villaverde and Daniel Sanches
(Fernández-Villaverde and Sanches, 2017).
3.1 Construction of the model
They start with a purely private monetary system where entrepreneurs issue intrinsically
worthless tokens as a medium of exchange that attain a strictly positive value. The total
amount of each currency can be verified by all agents as the trading history of the
entrepreneur is publicly observable. Into the Lagos-Wright environment they include
entrepreneurs who can issue their own fiat currencies to maximize their utility and a
predetermined algorithm that follows a protocol like Bitcoin. In this framework, competition
is perfect. All private currencies have the same ability to settle payments, and each
entrepreneur behaves parametrically with respect to prices.
3.2 Main results
The results of the paper show that in general a monetary equilibrium with private monies
will not deliver price stability. Profit-maximizing entrepreneurs will try to maximize the real
value of seigniorage. A purely private system fails to implement an efficient allocation.
Depending on the technology it is also shown that for privately-issued currencies a monetary
equilibrium with price stability can be achieved, if the cost function of minting additional
units is linear around the origin. In this case agents do not expect monetary conditions to
vary over time so that the real value of private currencies, as well as their expected return
remains constant.
But even when the cost function of minting money is such that there exists an equilibrium in
which price stability is consistent with competing private monies there exists a continuum of
equilibrium trajectories with the property that the value of private currencies monotonically
converges to zero. Villaverde and Sanches argue that private monies are also subject to selffulfilling inflationary episodes like government issued currency. Self-fulfilling inflationary
episodes are a consequence of using money with no intrinsic value.
There are two ways to overcome self-fulfilling inflationary episodes. The first way is the
usage of asset or service tokens. Thereby every unit of the currency gets an intrinsic value,
namely the service that can only be paid in that token or the asset, that represents a real
economic value. For such a currency the convergence to zero is impossible. If there is a
demand for is real economic value, there will also be a demand for the tokens. It is possible
to obtain an allocation that is arbitrary close to the efficient unique one which vindicates
Hayek’s proposal. The second way is a decentralized token issuance handled by an
immutable protocol. Then there is no single entrepreneur or a small group of them that can
maximize profit by minting additional units of the currency. It is also shown in the paper that
the existence of an upper bound on the available supply of each brand, make privatelyissued money consistent with price stability in a competitive environment, given that the
government does not intervene. In that case it is also difficult for a government to
implement a monetary policy through a money-growth rule.
Villaverde and Sanches also take network effects into account. From their analysis they
conclude that they can be relevant for the welfare properties of equilibrium allocations a
competitive environment. The better the exchange systems are, the less relevant get
network effects.
In the end the results cast serious doubts on Hayek’s proposal of currency competition. But
they also make clear that the threat of private monies imposes market discipline on any
government which issues money. The worse a government behave as money issuer the
harder it will be to allocate the currency. That can be seen in Venezuela nowadays where the
inflation rates are so high that people completely lost the trust in their government
(Venezuela inflation rates). If people can switch quickly to alternative currencies, central
banks are forced to provide a tolerable monetary policy.
4 Discussion of competing currencies
In this section the idea of competing currencies is discussed against the background of the
introduced literature. The goal is to evaluate critical properties of competing currencies and
compare them to the functionalities and characteristics of cryptocurrencies afterwards.
4.1 Review of Hayek and Villaverde and Sanches
Hayek’s idea of denationalized currencies is very interesting and makes sense following his
arguments on the first view. The competition as a discovery process would leads to a stable
non-inflationary outcome. In contrast, most economists would argue that free competition
with respect to money could guarantee neither a stable nor an efficient outcome. Issing
argues that a competitive monetary system has problems in providing the unit of account
function, which is considered as the most basic monetary function. Money used as a unit of
account has characteristics of a public good. (Otmar Issing, 27.05.1999)
Polleit argues that Hayek underestimated the costs and inefficiencies of competing
currencies. The simplest and most efficient way to do accounting, taxation and processing of
transactions is when there is only one single currency. (Thorsten Polleit, 2016)
Hayek also left a lot of open questions regarding the discovery process and how it would
work in practice. If an issuer abuses his position and inflates his currency, he is driven out of
the market. But during that process the inflating has already happened. Another problem is
how to handle a monopoly or oligopoly situation that evolves out of the discovery process.
However, Hayek states clearly in his monography that his idea is quite far away from praxis
but economists need to think beyond (Hayek, 1977, pp. 126–30). His idea needs to be
transferred in today’s world and economy. A lot of general conditions under which Hayek
was arguing have changed during the last forty years.
In the European Union a big change happened with the Monetary Union. In favor for the
Euro, a supranational currency, the countries gave up their own monopoly. On the one hand,
this shows that it is possible that governments give up their monopoly and sign international
agreements on monetary policy. On the other hand, this process is leading to even less
competition of currencies in the Eurozone. Hayek expected that the Euro would never
become reality, but, nevertheless, his own scheme seemed to him more preferable and
more practical. (Otmar Issing, 27.05.1999)
Villaverde and Sanches implemented Hayek’s idea in a modern model. This is quite a difficult
process, as Hayek was not a big fan of mathematical methods in economics and never tried
to build mathematical models in his work. Villaverde and Sanches need to from the model
with their own assumptions and adjustments. Critical properties need to be evaluated for a
system of competing currencies by taking both views into account.
4.2 Evaluating critical properties of a denationalized monetary system
There are basic functionalities a currency must provide to grant value (Dwyer, 2015). It must
not be possible to spend the currency more than once. This is also called double spending
problem. Additionally, the currency must be counterfeiting secure.
The three basic functions of money are still valid for every monetary system, whether it is
competition or monopoly. Money fulfils three functions, namely that of unit of account, a
means of payment and a store of value.
As we see nowadays, the governmental system is not able to provide a store of value in the
long term. Hayek makes this point very clear in his monography. High inflation rates show
that this function is not fulfilled. Villaverde and Sanches claim with their model that this is
also happening in a competing environment and it leads to convergence to zero of the
currencies. Productive capital holds the chance to avoid this by including it as equivalent to
the money. As already elaborated, the other way to overcome this problem is an immutable
protocol that handles the issuance. This makes the inflating of the currency by a single entity
impossible from beginning. The money should be like a tool for all market participants and
not the business itself.
The free banking period teaches that the different issuers of money fight against each other
for market shares. If an institution promises redemption in anything specific, like gold, it is
hard to keep that promise when its attacked by a competitor and there is no 100 percent
reserve. A promise for redemption bears instabilities and should not be inherent of
competing currencies.
In the model of Villaverde and Sanches the governmental money drives out private money
by deflation financed by taxes. As this is ruining fair market, another critical property is to
avoid this as well. For not a single player it should be possible to make use of unfair
techniques. In a competition model, it is always possible for one player to become the sole
issuer of money and we end up in a monopoly. Therefore, it is very important that it is
always possible for competitive players to re-enter the market and provide good solutions if
the monopolist makes unfair use of his position. All that means that we need fair market
conditions. Good exchange markets are needed to provide this functionality. Villaverde and
Sanches state that good exchange systems also make network effects less relevant.
We end up in a setting, where free market conditions must be given. The government should
not interfere unnecessary, but provide a fair framework that the market can produce the
best outcome for everybody, the socially optimum. This relates to the optimum quantity of
money (Sanches, 2012). It is meant to fit the demand in the economy to be socially optimal.
That is the justification of governments today to do monetary policy, but a central bank can
just regulate the amount of outside money with a time delay. A monetary system with
competing currencies holds the chance to provide this better because the issuers can focus
on the specific money demand in various sectors and regions. In Hayek’s argumentation it is
given if the institutions issuing money keep the value constant by regulating the circulating
amount (Hayek, 1977, pp. 126–30). However, Villaverde and Sanches found that the
competition does not provide the socially optimal amount of money in their specific setting
because they assume profit maximizing entrepreneurs. This is a problem of opposite
assumptions and it could be avoided if the amount of money is fixed in advance.
5 Cryptocurrencies as money
Electronic money can be divided into two types– currency and deposits (Dwyer, 2015). While
electronic currency is an asset which can change hands from one person to another, deposits
can be defined as money that is a liability of the accounting institution like a bank. Electronic
deposits are very established in the current monetary system. They are the inside money in
the definition of Issing which consist mostly of bank deposits supplied competitively by
banks (Otmar Issing, 27.05.1999). The outside money, in contrast, is the supply of currency
and bank reserves exclusively supplied by governments. As governments have always
permitted and indeed increasingly encouraged competition in the production of inside
money, the fraction of outside money is quite small in relation to inside money. But there is
a symbiotic relation between the two, because issuers of inside money are legally bound to
redeem it in outside money. Furthermore, outside money provides the unit of account for
the whole system. Inside money is not necessarily brought to markets by banks. It can also
be issued by payment providers like Paypal. For such an important system like money, a
decentralized system is offering a lot of chances. Cryptocurrencies aim exactly this and it is
showed that the critical properties can be fulfilled by them.
5.1 Forms of crypto currencies
Advances in cryptography and computer science made cryptocurrencies robust to overissuing, the double-spending problem and counterfeiting (Narayanan et al., 2016). The
critical elements of a cryptocurrency can be formalized as follows: the blockchain to keep a
history of transactions, the distributed updating of information and consensus through
competition for such updating (Chiu and Koeppl, 2017). Thereby cryptocurrencies get
decentral with millions of nodes spread all over the world. As far as the last node is running,
the network is still existing. That makes it practically impossible to switch it off.
From the historical free banking periods and from the current monetary system we can
clearly differentiate cryptocurrencies by their goal of decentralization and not being
controllable by a single entity. That is the core idea, but it is also often misguided because
there is right now a hype and many entrepreneurs want to make money with buzzwords like
blockchain and cryptocurrency. In the ecosystem there are also approaches like Ripple that
are quite centralized (Ripple Website). Their goal is not to become a currency itself but to
provide a way to transfer funds in the current banking system more efficiently. That type of
projects is not part of the considerations in this work.
Furthermore, the notes issued by the institutions during the free banking periods usually
represented claims against deposits in gold or other assets. Cryptocurrencies can also
represent an asset but the biggest cryptocurrency today, Bitcoin, is fully fiduciary.
Additionally, Crypto coins are issued by computer networks and are not related to credit.
(Fernández-Villaverde, 2017)
Important features are the programmability, velocity and scalability. They are constantly
improving. Exchange – rates between the various cryptocurrencies are instantly available
from various exchanges. (Narayanan et al., 2016)
Talking about cryptocurrencies makes it necessary to differentiate between the various
forms in terms of their basic functionalities, because it is crucial for the economic evaluation.
As cryptocurrencies are at the core computer code, almost any design one can think of is
possible. In general, the supply of the units of a cryptocurrency is fixed by a protocol and
every participant in the network behaves according to that protocol. If not, he is
automatically no longer part of the network. The more people take part in the network, the
more decentralized it gets. The authority taking care that everybody behaves honestly are
the rules held in the protocol. The distribution process is much wider and dispersed
compared to all currencies before (Narayanan et al., 2016).
The first type being discussed here are fully fiduciary cryptocurrencies like Bitcoin. They are
comparable to gold as they have a small economic usability besides being medium of
exchange, but its scarcity combined with demand gives them a value.
The second form are cryptocurrencies as tokens in an ecosystem. In this case there is
productive capital behind the currency, the service or the products that can be bought
within the ecosystem only by that currency. They are the only possible way of payment
because they provide special functionalities that other currencies do not have. The number
of tokens is mostly also restricted by a protocol. The second largest cryptocurrency at the
moment, Ethereum, is an example for this from. (Buterin, 2013)
Cryptocurrencies as assets can be considered as the third form. In this case, one unit of the
currency represents an asset for example like gold (Digix Global Website). The discussable
point here is that there is the need for a single authority that brings the real-world values in
the digital ecosystem and everyone must trust this authority. It basically the same as the
well-known gold-standard. Then there is the legitimate question if there is really the need of
making a cryptocurrency, but this discussion is not the topic here right now. As the
technology is quite new and rapidly evolving, there will be maybe found a solution to
implement this in a way which justifies a blockchain. But for the economic considerations it
is useful to include cryptocurrencies with an underlying asset.
5.2 Application of the critical properties on cryptocurrencies
Hayek’s vision of denationalized currencies can get reality with cryptocurrencies but
probably not in the way he thought about it. Even if banks or single entrepreneurs issue a
cryptocurrency, the problems shown by Villaverde and Sanches or Polleit are not solved. The
self-fulfilling inflationary process remains with cryptocurrencies issued by a single authority,
because there is a chance for this authority to change monetary policy by a self-sufficient
The important aspect, that must be considered here, is decentralization which is also
completely new in economic history. It was never possible to have a medium of exchange
that is issued by a distributed protocol in the past. Cryptocurrencies make it possible to
realize a wide distribution to anyone who is wanting to participate in the network. The
process is also not an outcome of planned policy change but a result of many individual
decisions (Fernández-Villaverde, 2017).
There are different options how cryptocurrencies can regulate the amount of money. The
inelasticity of supply of a single currency like bitcoin is viewed as an advantage by some
economists and a disadvantage by others (Dwyer, 2015). An inelastic supply is roughly in line
with Friedman’s solution for the optimal quantity of money if the income elasticity of the
demand for the money is one and the loss of coins is unimportant. Thereby,
cryptocurrencies avoid the inflationary trajectories that drive the value of the competing
currencies to zero.
Cryptocurrencies can also regulate the quantity of money with their value because their
tokens are divisible in very small units and the amount is fixed. If the value of a currency is
increasing and the total supply of the currency is inelastic, there is no monetary lack when
the amount is dividable in infinitesimal small fractions.
It is also plausible that the regulation of the amount of money could be automatically
fulfilled as there will always be various issuers of money when there is demand. If there is
more offer than demand, players will be driven out of the market. As cryptocurrencies can
be quickly issued there is the legitimate assumption that they can provide this property.
Even if for example Bitcoin with its fixed supply will eventually remain as only single currency
there is still the possibility of fractional reserve banking like it is happening today. Thereby,
the amount of money can also be adjusted. Banks would then extend loans denominated in
Bitcoins, thereby offering Bitcoin substitutes (Thorsten Polleit, 2016).
In counterfeiting security cryptocurrencies are previous monetary forms very superior.
Strong cryptography makes it impossible to counterfeit digital coins. Of course, there are
security threats to cryptocurrencies like Bitcoin, for example a 51-percent-attack. But in the
case of bitcoin, it is very unlikely and since its inception there was not a single successful
attack like this. (Antonopoulos, 2015)
Cryptocurrencies are also highly exchangeable. Services like Shapeshift already show how
easy it is to change currency today (Shapeshift Website). With APIs the exchange rates can
easily be implemented in every service developers want to build.
Of course, the three basic functions of money need to be discussed. The mean of exchange is
the feature where cryptocurrencies have obvious strengths. They provide a safe and secure
method for exchanging value around the whole world at low cost. With the current
capabilities, cryptocurrencies cannot handle all transactions within an economy like Europe.
But they are quickly evolving and new second layer solutions like Lightning Network are very
promising (Poon and Dryja, 2016). The unit of account is the most basic monetary function
according to Issing (Otmar Issing, 27.05.1999). To have a common money language, a unique
leading currency seems to be without alternatives. But cryptocurrencies are highly
connected and can be exchanged in real-time. Highly available exchange rates between
various cryptocurrencies make it possible to get the price instantly in the currency or value,
in which the market participant is accounting. Nevertheless, with a second layer like
Lightning Network, that in theory can handle an unlimited amount of transactions, it is also
possible for a currency like Bitcoin to become the single and stable unit of account,
comparable to gold.
As cryptocurrencies fluctuate strongly in value (Coinmarketcap Website) they do also not
work as a storage of value at the moment. But as they are quickly exchangeable at low cost,
it is possible to store the value within a cryptocurrency with an underlying asset. If a
cryptocurrency becomes a widespread used currency, the value tends to increase as the
money supply is fixed by the protocol. This would make it quite a good storage of value.
This shows, that cryptocurrencies can divide the three basic functions of money among each
other, where every brand serves the functionality that it does best. A currency with an
underlying asset or productive capital is providing a storage of value. Fast exchange systems
and APIs are providing the unit of account function and the mean of exchange is provided by
any currency that the participant wants to use for the transaction, probably the one with the
lowest transactions fees and a fast execution. This is a new approach made possible by
5.3 Cryptocurrency competition in today’s crypto market
As this thesis is about competing currencies, it is worth to look at today’s cryptocurrency
market which is a highly unregulated market. Coinmarketcap provides a good overview over
the whole crypto economy (Coinmarketcap Website). At the time of writing there are around
1600 different cryptocurrencies. Bitcoin, the first cryptocurrency, is dominating the market
with 40 Percent of the total market capitalization in US Dollar. The market is highly
speculative and fluctuating. It shows parallelism to stock-markets where people speculate on
small startups that might have a bright future. Moreover, not all cryptocurrency projects
listed on Coinmarketcap meet the critical properties worked out in this thesis, mostly
because are not created with the goal of becoming a currency used as a medium of
However, it provides valuable insights about the market mechanisms. It can clearly be
observed that there are not many cryptocurrencies that want to dominate the market just
by monetary policy. Cryptocurrency creators try to differentiate the currency by special
features and functionalities. A use-case that is only medium of exchange is quite rare, but
the inventory spirit for additionally features nearly has no boundaries.
Another interesting observation is that market participants tend to accept more than one
currency. It is very easy for them to change the currency afterwards in the wished currency
at low costs. Projects like COMIT will eventually make it possible for two counterparts of a
transaction that everybody can use his preferred currency (COMIT network Website). The
exchange is done automatically in the background during the transaction. This shows that
network effects are passed. Thus, for different use-cases market participants tend to use the
specific currency that fits best in the situation.
Moreover, the process of introducing cryptocurrencies is more like an evolution than like a
revolution. In 2009, when Bitcoin was initially proposed by a person or a group of people
using the pseudonym Nakamoto, there was not paid much attention. But it evolved over
time and the network started to grow steadily. It gained quite a lot of prominence for
example by becoming the currency usable on the Silk Road, a website where drugs and some
legal good were traded anonymously (Dwyer, 2015). The underlying software of Bitcoin is
still continuously improved. Taking this way, cryptocurrencies chose the exact opposite
proposed by Hayek who thought about the introduction of competing currencies as a
revolution initialized by governments.
6 Conclusion
In this seminar thesis it is shown that cryptocurrencies do not make Hayek’s idea of
denationalized currencies reality in the way he thought about it. The process of inception is
evolutionary and does not have the revolutionary inception envisioned by Hayek. The
concept of private entrepreneurs or banks that issue the currency while competing against
each other is not exactly what cryptocurrencies implement. The distribution of coins is
realized by a decentralized protocol what represents a new attempt in monetary history. The
three basic functions of money, namely unit of account, storage of value and mean of
exchange can be provided by cryptocurrencies. They have the technological requirements to
split these functions across various currencies. Especially as mean of exchange
cryptocurrencies are superior to every form of money ever used in history. Counterfeiting
security is also a strength of cryptocurrencies. As they are programmable money, the
number of additional features seem endless. The technology is also quite new and quickly
developing. Moreover, single cryptocurrencies like Bitcoin are constantly evolving.
Therefore, it is hard to make economic statements as the system might already have
changed during preparation. There will be needed more research on how the optimal
amount of money can be provided by cryptocurrencies. This new form of digital money is a
very promising approach that has already changed the way how we think about money.
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