Currency
Competition
Lukas Dippold | TU Berlin
25.06.2018
Abstract:
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.
Seminar:
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 money.
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
them.
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
self-fulfilling inflationary episodes like government issued currency. Selffulfilling 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 privately-issued 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 over-issuing, 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 decision.
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 technology.
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 exchange.
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.
7 References
Antonopoulos, A.M. (2015). Mastering Bitcoin, Sebastopol, CA: O'Reilly
Media.
Briones, I. and H. Rockoff (2005). ‘Do Economists Reach a Conclusion on
Free-Banking Episodes’, Econ Journal Watch vol. 2(2), pp. 279–324.
Buterin, V. (2013). ‘A Next-Generation Smart Contract and Decentralized
Application Platform: An introductory paper to Ethereum, introduced
before launch, which is maintained.’.
Chiu, J. and T. Koeppl (2017). ‘The Economics of Cryptocurrencies - Bitcoin
and Beyond’, https://www.chapman.edu/research/institutes-andcenters/economic-science-institute/_files/ifree-papers-and-photos/
koeppel-april2017.pdf (last accessed: 18 June 2018).
‘Coinmarketcap Website: Cryptocurrencies by market capitalization’,
https://coinmarketcap.com/ (last accessed: 16 June 2018).
‘COMIT network Website’, http://www.comit.network/ (last accessed: 16
June 2018).
‘Digix Global Website’, https://digix.global/ (last accessed: 17 June 2018).
Dwyer, G.P. (2015). ‘The economics of Bitcoin and similar private digital
currencies’, Journal of Financial Stability vol. 17, pp. 81–91.
Fernández-Villaverde, J. (2017). ‘On the economics of currency
competition’, https://voxeu.org/article/competition-betweengovernment-money-and-cryptocurrencies (last accessed: 16 June 2018).
Fernández-Villaverde, J. and D. Sanches (2017). ‘Can Currency
Competition Work?’.
Hayek, F.A.v. (1977). Entnationalisierung des Geldes: Eine Analyse der
Theorie und Praxis konkurrierender Umlaufmittel, Tübingen: Mohr.
Lawrence H. White (1995). Free Banking in Britain: Theory, Experience,
and Debate, 1800 - 1845, London.
Nakamoto, S.(p.) (2009). ‘Bitcoin: A Peer-to-Peer Electronic Cash System’.
Narayanan, A., J. Bonneau, E. Felten, A. Miller and S. Goldfeder (2016).
Bitcoin and Cryptocurrency Technologies: A Comprehensive
Introduction, Princeton: Princeton University Press.
Otmar Issing (27.05.1999). Hayek - currency competition and European
Monetary Union, London.
Poon, J. and T. Dryja (2016). ‘The Bitcoin Lightning Network:: Scalable OffChain Instant Payments’, http://lightning.network/docs/ (last accessed:
17 June 2018).
‘Ripple Website’, https://ripple.com/ (last accessed: 17 June 2018).
Sanches, D. (2012). ‘The Optimum Quantity of Money’, Business Review
Q4, pp. 8–15.
‘Shapeshift Website’, https://shapeshift.io/ (last accessed: 22 June 2018).
Thorsten Polleit (2016). ‘Hayek’s ‘Denationalization of Money’: a
Praxeological Reassessment’, Journal of Prices & Markets, pp. 69–84.
‘Venezuela inflation rates’,
https://tradingeconomics.com/venezuela/inflation-cpi (last accessed: 20
June 2018).