The Digital Currency Conundrum

Digital currencies (DCs) have spurred in number but the most notable of them still remains Bitcoin as it was the first proof of the crypto currency concept and has dominated the crypto sphere ever since. Bitcoin’s popularity is based on the concept of a trust-less system which does not rely on any central authority rather it is distributed over many nodes (computers) effectively diminishing, to a great extent, the vulnerability of a central point of failure. It abolishes the concept of double spending and is cryptographically secured. Its distributed ledger system based on the blockchain allows for transparency via a consensus system across the various nodes on the network eliminating the problem of fraud. Additionally, Bitcoin is largely anonymous and transactions via Bitcoin cannot be undone (yet).

Numerous tokens are available in the crypto market today and can be largely categorized within three domains; security tokens, utility tokens and crypto currencies. This article will exclusively focus on the crypto currency domain, Bitcoin in particular, as a challenger to traditional fiat currencies within the contemporary socio-economic and technological landscape.

A Brief History of Money

Bitcoin has gained widespread publicity in the past couple of years but sprung into existence after the financial meltdown of 2008 under the umbrella of Satoshi Nakamoto who still remains an enigmatic figure. Unsurprisingly, we tend to look for alternatives only when we realize the fallibility of what is present. Money in itself, be it in the form of the dollar, pound or rupee are also part of the same phenomenon — our static view of these currencies primarily hold because we have not seen anything else, let alone imagined a different possibility because of the times that we were born in.

But if we were to dive into the history of money, we would realize that money is as dynamic as technology. The reason I compare the two is because in essence, their goals remain the same while the forms keep evolving. Technology seeks to make our lives easier through efficiency and speed while currencies serve three major purposes; as a medium of exchange, a store of value and as a unit of account. These functionalities have been sufficiently present in many other items throughout history serving the needs of the time ranging from cows, shells, obsidian and beads while the extraction of metals became the pioneering enabler of the coinage system.

How the Current System works?

The bursting of the 2008 financial bubble was not only a highlight of the self-destructive mechanisms of finance-capitalism as one might argue, but it also shed light on the way money is created, by whom and how. Because above all, it was a financial collapse; no houses were burned down nor was there any political or social unrest but rather values diminished incredibly over a relatively short period of time. An event popularly and rightly referred to as a ‘meltdown’. This raises a pertinent question, how is fiat money created?

“It is well enough that the people of the nation do not understand our banking and monetary system for, if they did, I believe there would be a revolution before tomorrow morning.” Henry Ford

I believe majority of us have been brought up in the world of fiat currencies issued by each country’s central bank or in the case of Euro, the region’s central bank or rather yet by an imperial power’s issuing authority in the case of the CFA Franc (a whole other discussion in itself). Speaking strictly is US dollar terms, the Central bank or the Federal Reserve is a private entity or autonomous actor as we prefer to call them which is responsible for monetary policy. It has control over interest rates and thus directly affects the provision of credit and money supply within the economy. But more interestingly, the Federal Reserve along with private banks have the ability to create money through the creation of reserves. 

Succinctly put when banks lend, they create money.

Wait a minute, how can one eat the cake while not cutting it? This is made possible through the fractional reserve banking system, a fundamental concept in monetary economics.

So if we all were to go to the bank and try withdrawing our deposits simultaneously, most banks would shut down because they do not have an equivalent amount of cash to match its deposits; its only digits in a database which we refer to as our ‘bank balance’ (This has happened before in the 1930s).

It is important to note that this was not always the case, the dollar was backed by gold up until the 1970’s when President Nixon abolished the gold standard. Therefore, the dollar, today’s global exchange currency is essentially backed by nothing besides our collective trust. As a result currency notes have increased exponentially over time with nothing to back them up.

Source: US Debt Clock as of 15th Aug 2018

What began with excessive lending collapsed via a credit crunch highlighting the significant intermediary role played by Banks and Financial Institutions (FIs) that have historically been compliments to each other; the former creates money while the latter leverages it as an means to its own objectives. And since they are all heavily interconnected, a fault in one leads to a domino effect with ripples throughout the economy, domestically and internationally.

Why a central authority?

Money has historically been employed as a tool for social and political control; first created by kings to hamper peer-to-peer trade so subjects of the King would always be dependent on the central authority for economic transactions. Central control over money allowed for the imposition of taxes to benefit the elite while creating a mechanism to raise funds to support state interests.

As previously mentioned money has taken many forms which is seen to be correlated with temporal advancements. Paper money in particular was the enabling mechanism which sparked international trade and allowed for the creation of money markets. This reflected the tandem phenomenon of globalization which has since then encompassed the world. Globalization indeed brought the world closer but the turmoil we have gone through to reach our current state includes mass genocide, slavery and political suppression still quite prevalent today as economic interests have largely trumped socio-political interests.

Countries trade with each other in numerous goods and services but the medium of trade has largely been the US dollar after the great world wars. I would go as far as to say that the primary reason the US is still able to hold onto this hegemony is because it has been able to enforce the dollar as the sole currency for global trade. Libyan leader Muammar al-Gaddafi attempted to rejuvenate the idea of a gold backed currency which would have directly competed with the US dollar and Euro but was unable to do so. Similarly, Iraqi leader Saddam Hussein and Syrian leaders attempted to dump the dollar in exchange for the Euro. I wonder what they all share in common, rhetorically speaking of course.

But aside from politics, society is changing swiftly in the ways we transact, interact and cooperate on the global level. So is it time for a new medium of exchange, store of value and unit of account? A form of currency which is more in line with our current technological and lifestyle trends? Is it time for a phase shift? Or are we already in the process?

An S-Curve or Sigmoid function shows the growth of one variable in terms of another variable and has been used across different disciplines to map out trends. Within the realm of technological developments specifically, it is used to portray how adoption rates increase over time. The picture below illustrates this theory reflecting how adoption begins slow, grows exponentially and then stagnates once it encompasses the majority.

It has been argued that DCs are a similar phenomenon where we may be in the early adopters stage.

Setting the Stage for Bitcoin

On one hand, taking both the developed and developing portion of the world into account, we have seen a large shift towards digitization over the past few decades. Evident in the developed world, we use cards as a means of payment rather than cash and barely ever get paid in cash either. Our bank accounts are simply numbers on the screen wherever we check them from. Increasingly we have been transacting over the internet be it through online retail platforms, e-services or most discreetly through online banking. Specifically in the developing world, there has been an exponential rise in mobile banking services which fall under the domain of electronic money. All these things were not present in the last half century but have grown incredibly in recent decades while the monetary system upon which these developments are based dates back centuries. So is our current monetary system out dated?

On the other hand, besides being the state mandated currency, what else is the US dollar backed by? Is there any intrinsic value? In a global context, these questions ultimately take us back to the essential question, do we trust those who have control over the monetary system? Within this framework, Bitcoin seems to be in line with current trends and practically seems like the ultimate descendant to fiat currencies within the contemporary digital economy. Disillusionment and doubt over the government and its mechanisms reached a point of climax in the form of the Occupy Wall Street movement calling for change and transparency. Does not Bitcoin fit into that picture? A monetary structure outside the government domain.

Bitcoin has been viewed by enthusiasts as a savior from government control associated with liberation and freedom drawing on its original use cases confined to the dark web’s silk route which in itself is a point of great contention. Bottom line is, there are two factors simultaneously working towards a massive phase shift in the global market place; firstly there is diminishing trust and disillusionment with the government, banks and FIs especially in terms of misaligned incentives and secondly there is blind trust or rather dependency on our digital devices which have proliferated our lives. Many documentaries have been created and articles published about technology and its rampant effects on our social fabric coupled with the phenomenon of constant surveillance. Yet, we are hooked and are increasingly moving towards more sophisticated devices and software which have become a part of our lives given their ease, speed and efficiency. These factors combined are ideologically and systematically pushing us towards an all encompassing digitized future where digital currencies seem like a preferred alternative which we would gladly accept given the right circumstances especially under the banner of decentralization.

Threats

As much as we try to find alternative ideologies to vest our trust in, they are ultimately fallible. The underlying protocol of digital currencies, blockchain can be theoretically over taken through a 51% attack. If Bitcoin was to be widely adopted, it would allow for money with no accountability or ownership tracing mechanism. Who would this ultimately benefit? A person with $1000, $1 million or $1 billion?

Privacy, a key characteristic for DCs can also pose a huge risk by its use in money laundering; some might use it for tax evasion but malignant actors could use it for financing illicit activities and people against the common interest. This issue has been a major point of contention for states in the contemporary debate regarding DCs but it is important to remember that money laundering has been a prevalent practice since decades; the richer you are, the more access you have to launder money. The Paradise papers and Panama papers are profoundly eye-opening in terms of how the global elite hide their money and guess what, without the aid of Bitcoin. Moreover, global banks have faced money laundering charges time and time again where they have paid hefty penalties but continue operating within the public domain.

Not even Bitcoin is fully secure — I believe there are loopholes everywhere; some we have found and some we will find. In essence, it is a human made system and therefore can be cracked by humans as well but obviously by those with the relevant knowledge. There is a huge divide between those who create and program technologies and those who simply use it. There is a knowledge gap which we are blind to or rather choose to ignore; a foundational concept in Douglas Rushkoff’s book, “Program or be Programmed”.

Technology is a double-edged sword but is largely apolitical in itself; it is the users and creators that guide its application and thus give it value, meaning and direction.

Looking Ahead

“ Money does not exist in a vacuum but is part of an elaborate web of dynamic social structural conditions within which people act and interact. As such, money is a social relation in the sense that it mediates the interaction between people ” — Carl Wennerlind

In lieu of this idea, what does Bitcoin symbolize? A unified currency which transcends borders and is not bound by any national laws?

Public opinion is still divided upon the DC debate but the fact that this discourse exists may provide us with an alternative lens to look at things; in the past when prominent world leaders tried to move away from the dollar, the US government actively sought to terminate the process but with Bitcoin, it is seeking to regulate it. Some states in the US have gone so far as to accept taxes in the form of digital currencies. One may argue that the government is only branching out in terms of revenue collection but why would they support a potential competitor to their own hegemonic order? Moreover, big businesses have been known to operate discreetly in the corridors of political power yielding massive influence; could this be their plot towards greater global dominance?

Bitcoin, or DCs as a whole may seem as a medium for liberation and freedom from excessive and often reckless control over the money supply by central authorities but if we were to take into account the parallel developments taking place in the world today such as e-citizen initiatives most popularly in Estonia where a digital identity issued by the state handles all of your information from banking to health care and from insurance to voting; digital currencies may become just another piece of information stored on that card. This would ultimately lead to centralized control of all resources an individual citizen has access to and could result in the complete opposite of liberation and freedom.

In conjunction with China’s social scoring system; digitized currencies could effectively become an extension of the system and would fall under the control of a central authority. Coupled with these developments, how do DCs fit into the bigger picture?

In the short run, we may see this as profit generating opportunity but in the long run it could potentially be disastrous as adoption increases therefore we must cautiously proceed as this phenomenon unfolds. Good or bad is a matter of perspective but being informed is a matter of necessity. It is crucial for us to learn, understand and decipher the seismic transformations unfolding globally.

The DC conundrum, in my opinion, speaks to a bigger idea; it can be seen as a precursor to a fully globalized world where trade would not be hindered by national borders because the medium of trade would not be controlled by any national entity. This could effectively allow powerful private corporations to yield massive economic, political and social power.

How would these transformations materialize? How would they be implemented? What would they entail? Who would ultimately benefit from such transformations; the common man or big business? These are questions that are yet to be explored and understood but imagining various possibilities are crucial to expanding our range of thinking.

As I write this article there is a fiat crisis looming in the background which started with Turkey’s Lira but is now spreading into other developing region currencies fueling fear of contagion. If this were to supposedly grow into a full-fledged economic crisis, what would people do? Would they turn to Bitcoin as a store of value?

Additionally, the deepening of the Iran crisis has created rifts between two historic allies; namely US and Europe. In light of current events, Germany has repeatedly called for an end to its reliance on US payment systems and has allegedly started working on alternative means. Is it possible for countries to create their own DCs in order to circumvent conventional monetary institutions? How would this alter the balance of power? And what are its implications on the global scale?

These questions and opinions can only be examined with the passage of time but it is important for us all to see the bigger picture otherwise we might be deceived into our collective subjugation.

References:

Wennerlind, C. (2001). Money Talks, but What Is It Saying? Semiotics of Money and Social Control. Journal of Economic Issues, 35(3), 557.