Cryptocurrencies In The Day And Age Of Renewed Inflation Fears

Context: Private cryptocurrencies are best treated as risky investment assets rather than actual currencies in the age of renewed inflation fears.

Rise of cryptocurrencies: Age of cryptocurrencies dawned in 2008, the aftermath of global financial meltdown and loss of trust in fiat currencies.

• Satoshi Nakamoto gave a new peer-to-peer payments system that would bypass the traditional financial system.

Drawbacks of using cryptocurrency as a currency:

• Inability to generate liquidity during payments crisis: Payment systems requires a level of liquidity backstopping that no private entity can provide as they cannot unilaterally impose financial obligations.
  • That means they cannot rescue themselves and must be bailed out by states or be permitted to fail.
• Immense volatility in prices: Makes them poorly suited to be medium of exchange or unit of account, especially for long-term contracts.
• Inflationary pressures: While Satoshi’s design was based on controlled supply, cryptocurrencies still fuel inflationary pressures. There are now 18.73 million Bitcoin in circulation (nearly 90% of all supply).
  • However, even if the supply of a single cryptocurrency is tightly controlled, the supply of all possible cryptocurrencies is not subject to any control. The reason being:
    • There is no way to prevent other private cryptocurrencies from joining the party. The web- site Coinmarketcap.com currently lists 5,145 cryptocurrencies being traded.
    • While individual prices of cryptocurrencies are controlled, far less attention has been given to how they are relatively priced to each other.
    • Moreover, some currencies are free from supply constraints: For e.g. Ethereum has no supply limit written into its design.

Potential Significance of cryptocurrencies

• Scope for innovation and new developments:
  • Linking with sovereign currencies: For e.g. ‘Stablecoins’ like Facebook’s Libra (Diem) are backed by sovereign currencies such as dollar or physical assets like gold.
• Treating private cryptocurrencies as risky investment assets: Even as the Central banks are working on using blockchain to issues sovereign currencies.