The Bitcoin Debate Is Flawed. Look past the noise, and you will find the real questions to ask about the technology. At its core, the debate surrounding cryptocurrency is about control: Who do you want to control the supply of your currency?
Modern Monetary Theory (MMT) is an economic theory that states that a government should issue its own fiat currency: This control lets the government create money without regard to anything but inflation. So how does this theory relate to sentiments surrounding cryptocurrency?
The global reserve currency is the U.S Dollar, controlled by the Federal Reserve (Central Bank): The U.S Dollar itself is backed by nothing but belief after being removed from the gold standard in 1971 to curb inflation. So while the Fed doesn’t follow MMT directly, its policy of control over money does.
The significance of the Federal Reserve’s control over the global reserve currency is that most people are familiar with fiat currency controlled by a central bank. In contrast, cryptocurrencies such as Bitcoin are controlled by algorithms, which do not allow direct manipulation of the money supply. People are averse to change, so it’s no surprise that mainstream criticism against cryptocurrency advocates for tenants of the current system.
In times of inflation and major bank failures, one must wonder whether the current system — which uses fiat cash — is more effective than alternatives. Cryptocurrency is an alternative currency backed by a resource (depending on the currency’s protocol). For example, Bitcoin operates using a proof of work mechanism which backs the currency with computing power.
So does currency need to be backed by a resource to be useful?
Scarcity in Economics
Humans must create a system to distribute resources in a world with limited resources. This scarcity is a key concept in modern economic theories such as the Law of Supply and Demand: When a resource is unlimited in supply, it ceases to be economically valuable.
There are many historical examples of what happens when a currency is oversupplied: Mansa Musa’s supply of gold in Egypt led to a noticeable effect on the value of gold. Hyperinflation is common when a country issues money without regard to supply or inflation. So you could claim that a resource that becomes arbitrarily abundant ceases to be a valuable currency.
With this logic, a currency should be backed by a resource so it doesn’t become arbitrarily abundant. When currency is used to exchange resources, worthless currency is… worthless. So you could argue that cryptocurrency is a better form of currency than fiat cash because it cannot become arbitrarily abundant.
In contrast, Monetarism holds that the value of fiat cash stems from a lack of limitation in growth to the monetary supply. In other words, monetarists believe that fiat cash is useful because it can become arbitrarily abundant; as a limited resource doesn’t back it. So you could argue that fiat cash is a better form of currency than cryptocurrency due to its unlimited supply.
Backed By Government
Chartalism is a theory that argues that the purpose of money is to help the government direct economic activity. In other words, the government should use money to control the economy. Under chartalism, fiat cash is not backed by its intrinsic value but rather by the government’s taxes and the consequences when you don’t pay them.
You could argue that chartalism is indirectly backed by the resources required to tax people. However, the amount of money needed to tax people — with force — is not correlated with the amount of cash in circulation: Once in power, a chartalist government can control how much of a currency exists regardless of available resources.
Modern cryptocurrencies are not valuable under chartalism because the government can’t directly control their supply: This lack of control means that the government would exert more effort to direct economic activity. So you could argue that fiat cash is a better form of currency than cryptocurrency due to the control that fiat cash provides.
Backed By Usage
Gresham’s law predicts that fiat cash — which maintains no intrinsic value — would drive out cryptocurrencies such as Bitcoin — backed by computing power — when both are in circulation. So this principle predicts that the U.S Dollar would drive out cryptocurrencies backed by resources. That’s because cryptocurrency backed by a resource can be considered an asset, which would — under this principle — make it less useful as a currency compared to fiat cash.
However, you must not confuse “less useful” with “less valuable”.
Abundance in Cryptocurrency
Not all cryptocurrencies are backed by a resource: The Proof of Stake (PoS) protocol uses the quantity of holdings to validate transactions and governance. So it’s theoretically possible that entities in a PoS system adjust the supply of currency through their governance: This behavior functions similarly to institutions where the majority owners of currency control its monetary policy.
Proof of Work cryptocurrencies are backed by computing power that costs energy (electricity). So if the cost of energy achieves Zero Marginal Cost, then these cryptocurrencies would no longer be backed by a scarce resource. This change is significant because it means cryptocurrencies backed by resources can still be arbitrarily abundant, barring a supply limit.
So does currency need to be backed by a resource to be useful? You tell me.