I love cryptocurrencies, the economic revolution, the "not your keys, not your cryptocurrency" self-custody movement, its all so wonderful. Still, I pride myself on being the sort of person that asks myself the hard questions. I refuse to allow myself to join the crowd of people that allow hope and greed to control them rather than reason. So, in this healthy session of internal debate let's criticize the thing we love and hodl dear!
If someone asked you to explain what a "fiat currency" is, would you know what to say? It is a means of exchange and system of account, but one that is not backed by any sort of material resource. It holds value only because a regional government declares it to hold value and requires that taxes be paid with this currency.
Let's consider an example. If you sold products or performed a service but allowed your customers to pay you in gold, your local government would recognize that you made profit, but might require that you sell your profits in gold for the local fiat currency in order to pay them a share of your profit as taxes. Since most governments threaten citizens that don't give them a share of their income, that citizen now has a need for the fiat currency, creating the base demand for the supply of that particular currency.
The base demand for fiat currencies is a social construct and its not a lot of demand. But from that base demand (the need to pay the government a share of your income in the currency they require), additional demand is able to build upon that initial demand until you have a robust economy based in that currency. From that point governments are able to create their own "game mechanics" to how they issue and regulate the regional currency. For better or for worse, a form of economy is now off the ground.
Fiat currencies are backed by social opinion. This is true of most cryptocurrencies as well. Bitcoin is only valuable so long as enough people around the world share the view that it is valuable. Like fiat currencies, cryptocurrencies are governed by some form of game theory that serves as a economic policy. True, it is a grassroots movement and that feels more liberating than a powerful organization threatening to put you in a cage if you don't comply, but at the end of the day, they have very similar design patterns.
Similar to fiat currencies, cryptocurrencies could hyper-inflate. Does Bitcoin really have a 21,000,000 coin supply cap? Technically, this is a socially enforced rule very similar to the case with fiat currencies. The people presently involved in Bitcoin want a limited supply, but all it would take is for the majority of the Bitcoin network's users to prefer a limitless supply and social pressure could make it so.
We can already see this in the case of Ethereum versus Ethereum Classic. Interestingly, Ethereum Classic is suppose to be the original blockchain, yet most people and businesses view the blockchain called Ethereum as the true and real Ethereum. That did not happen with Bitcoin versus Bitcoin Cash, but it could just as easily have happened. How is this possible? It is possible because blockchains truly live and die by social consensus.
Cryptocurrencies are full of potential as they begin to power the future of the internet of value. However, we need to maintain a measure of wholesome skepticism. In many ways it can be argued that cryptocurrencies have quite a few soft money aspects to them when what we want to see is hard money features.
What about gold? Gold has uses, its base value could be said to be its use cases in valued products such as jewelry, decorations and in the modern world within electronics. It also maintains some appreciation due to its historic uses as the most fungible and most practical means of in-person exchange throughout the ages. In the past, gold was the best method for creating pricing customs for its durability, fungibility and economic stability.
For the most part, its multi-trillion dollar valuation is primarily based on speculative value as a hedge against the Keynesian economic system we live in today. The key to its current value is the difficulty in obtaining gold. Unlike socially-enforced currencies that can be inflated at the whim of either a small group of humans or a large population of people, gold's scarcity is enforced by physical laws that cannot be adjusted simply because humans want it to be.
Some cryptocurrencies might actually have intrinsic value, such as ether in the Ethereum blockchain, a "platform" blockchain designed to provide Security As A Service rather than just be a blockchain-based currency. In the Ethereum model there can be a fundamental use case giving it a base value. Still, as we see with gold, in today's economic climate, the greatest value comes from being a hedge against the traditional monetary policy. A community focused on a particular cryptocurrency might have ambitions toward creating a finite currency with a fixed monetary policy, however, there are just no way to guarantee it will stay that way. Blockchain features are ultimately the result of social cooperation and are adjustable. Gold on the other hand is not enforced by social agreement, but by physical limitations.
Bitcoin and Ethereum are both two of the most secure blockchains and thus are also the two most secure cryptocurrencies in the world. They are secure because people are willing to invest large sums of money securing them for rewards in the native cryptocurrency. If these "miners" ever stopped believing in the value of the cryptocurrency, they would stop securing the blockchains and they would likely lose value suddenly by everyone else. In some ways cryptocurrencies are anti-fragile, but in other ways they are extremely fragile.
Let's talk about Bitcoin's 21,000,000 coin supply again. Many holders of bitcoins are very concerned with inflation, because they want Bitcoin to be a digital gold that acts as a good store of value. In their view, inflation is counterproductive to this goal. They want a deflationary economy with Bitcoin. Is this a good idea?
I argue that all blockchains need to be inflationary in order to sustain a thriving economy. We really should hash this concept out by discussing some blockchain basics. Blockchains provide a reward system to people called miners that collect transactions and put them in the winning block. They then receive a block reward in the native coin. If you were to want a blockchain native coin to be finite one way to do this is to create a fee market. A fee market is where the miners stop receiving rewards through inflation and get it directly from the individuals seeking to perform a transaction. Using the inflation model, the reward can be very attractive to miners and seamless to users/holders as the inflation rate is so low it takes a very long time to notice any effects.
Rewards from inflation result in everyone's native coins losing some buying power over time as supply tips on the scales against the demand, but the alternative would be the users paying the cost of security directly through transaction fees. This would mean very high fees, which would very likely result in a reduction of people being willing to pay the fee and perform transactions.
Deflation has a tendency to reduce circulation of value from one person to another, because what you can buy this week is not as much as what you will be able to buy next week with the same amount of money. This creates a greater barrier to entry for young adults entering the workforce as well as overall commerce in general. Deflation trains people to be good savers, but less willing to risk or spend money, resulting in a stifled economy.
In the case of a finite cryptocurrency that depends on transaction fees for a blockchain's security, the fees per transaction could be so high that it drives the volume of total transactions down. This causes a spiral of disaster for the blockchain as miners charge high fees to cover costs + profit. Users continue to reduce transaction frequency due to high fees and miners continue losing money from reduced transactions. The miners then charge higher fees to those still transacting or shut off their machines all together. The result is a less secure blockchain, which can have an effect on the social opinion regarding the value of that cryptocurrency. That economic system could get out of hand rather quickly.
Gold is the most durable money in the world. Throughout history national currencies have come and gone and all forms of currencies have been tried and not aged well. Gold used as money, art, jewelry or some other tool thousands of years ago can still be traded and stored today. That can hardly be said of most of the other ancient currencies that were not made of precious metal.
Okay, now let's talk about the apocalypse, because, well, why not? No one thinks its going to happen. The internet keeps humming away in every home and office day after day, so, of course, we'd expect it to be that way tomorrow. But some day it just might happen. Governments are becoming well aware that their regional internet access could be harmed by an enemy state. Or, your region might do something really stupid like support China's 5G infrastructure and then live to regret it. Cryptocurrencies are a great protection in many ways, but in the case of electrical failure, which does happen on occasion, Bitcoin will not necessarily be there to save the day.
Gold is inconvenient for international trade. However, with regard to local trade during the worst of times, gold just might remain the ideal asset for storing value for rainy days. For this reason, I believe gold still deserves a pouch in my survival pack.