Why Monetary Crises Justify the Existence of Cryptocurrencies
We often see national and global media reports on the monetary policies of a nation, represented by the actions of central banks and governments, but why are they important? Monetary policies are an integral part of an economy, have a direct impact on society in general, and are a vital go-to strategy for governments to manage business cycles, and deal with economic slowdowns.
However, ineffectiveness and blatant misuse has resulted in several adverse economic and social consequences. The ease in utilizing monetary policies for economic decisions has made it difficult to control its effects and effective optimization. Let’s explore the current weakness of the current monetary system and why it needs a complete overhaul.
What’s Wrong With The Current Monetary System?
There are several inherent weaknesses of the monetary system that results in inefficacy.
Total and Centralized Control by Government
The central bank controls the supply of money in an economy, which is sometimes government-independent, and sometimes managed by the government itself. Implementation and decision-making regarding money supply-related policy therefore becomes centralized; in other words, a nation’s money supply is controlled by a single body.
This body comprises individuals who are well aware of what is required and are capable of driving the economy forward, but can we really have blind faith in central banks after the recessions, depressions, and economic slowdowns suffered by nations across the globe, when there has been no recourse or accountability throughout?
The decision-making process within a central bank, or the execution of policies on a governmental basis, is opaque – with no accountability to the public on their modus operandi and/or policy ramifications. While the central bank decides the mechanics of the money supply and the reserve ratio to which member banks are required to adhere, when commercial banks lend out this money (AKA “fractional reserve”), there is no simple way to calculate the money in circulation. Across most countries, what the central bank issues as money constitutes a mere 5% to 15% of the total money supply.
When private entities (such as financial institutions) have the power to decide who is loaned the money, their motives are far from altruistic. It is not the social well being that matters but the private interest of profit maximization. This fuels the system to become a pyramid of power and wealth, with a minority at the top holding a considerable resource share; and since this minority wants to continue holding such power, it keeps fueling opacity into the system, creating a vicious circle.
Inflation is at the heart of the conventional fiat system. Banks are functionally motivated to maximize their profit; but in order to generate a higher degree of profits, more loans need to be disbursed. This oversupply of money translates to a rise in price for commodities and financial assets. The problem with the monetary system is that the supply of money is not fixed, and the central bank retains absolute autonomy over printing money. The mandate of central banks is to adjust a nation’s monetary supply according to economic conditions, which can lead to the vicious cycle of unaccountable money printing to boost a nation’s economy – and this is where inflation is born.
Inflation has a detrimental effect on society, since those at the bottom of the pyramid suffer the most. The hike in price causes the general public to lose their purchasing power, which in turn drives them to require and demand higher nominal incomes. As this redistribution takes place, it is the economically weaker sections who face the greatest financial burden.
Major Crises Across History
Crises are an unavoidable dimension of the traditional monetary landscape. Following are some examples of some of the most catastrophic crises.
The Great Depression of 1929
Perhaps the most devastating financial crisis throughout history, the Great Depression occurred as a result of the stock market crash in the 1920s. As stock prices soared in the 1920s, a general hype existed whereby the retail mass began exploring and investing into the stock markets, in the hope of profiting from seemingly perpetual capital gains. They took loans (even sometimes mortgaging their houses) to earn some quick money, hoping to repay them from perceived future profits. Financial institutions were more than happy to facilitate easy credit acquisition, since it boosted their profit margins. When the mania reversed, stock prices fell as fast as they had risen. Chaos ensued, causing an immediate rush to liquidate whatever value remains from the investments. This resulted in a bank run and the eventual collapse of financial institutions across the country.
1997 Asian Financial Crisis
This represented a systematic decline of and devaluations within several Asian countries in 1997. The crisis was triggered by the devaluation of Thailand’s national currency, following the government’s decision to abandon the Baht for the US dollar. Given the high degree of inter-linkage between Asian economies, the sudden devaluation of the Thai Baht resulted in plummeting stock prices, reduced import revenues, and government upheaval. On average, the currency of East Asian countries fell as much as 40%, with the value of international stocks free-falling by as much as 60%. The Asian Financial Crisis paved the way for protectionist monetary policies to ensure the stability of their currencies.
Global Financial Crisis of 2017
The most recent of the three, the subprime mortgage crisis began in the US. A decade of low interest rates and deregulation fostered an environment of easy credit. Banks began creating sophisticated financial instruments with minimal inherent value, and passing them off as investment grade securities for the retail public. The fuel of the derivative boom was mortgages owned by the average Joe, who were inclined to acquire more loans to support financing of more than one home, under the false assumption that real estate prices would never fall. The government, partly by maintaining near-zero interest rates, facilitated a conducive environment for cheap credit that fueled the synthetic market. These economic decisions were based on theoretical notions of economic expansion, which were later proven to hold little real-world value. All this happened despite learning from the previous crises, and the warnings of several economists.
Unfortunately, while the blame falls at the feet of those monetary bodies that failed to maintain economic balance, the brunt of the consequences fall on the shoulders of the greater masses. This has resulted in various calls to explore alternatives to our monetary systems.
What Makes Cryptocurrency Better?
The above describes the backdrop against which emerged modern day cryptocurrencies. Clearly, these digital currencies defy the laws of orthodox monetary policies and systems to allow for a radical economic transformation:
Unlike the traditional centralized structure of a company or a government, cryptocurrency was created to be decentralized. Cryptocurrency’s data architecture – represented by blockchain, a public ledge that serves as the core technology of cryptocurrencies – is a distributed one, meaning that no single entity controls the data. From an architectural perspective, there are massive benefits. Security is enhanced since there is no single point of failure. Cryptocurrency transactions are immutable and censorship-resistant, preventing any government or entity from manipulating the data on the blockchain. The blockchain itself is a transparent public ledger that stores all transactions in existence, enabling a trustless environment. Additionally, as the supply of most of these currencies are either fixed or decrease with time, they possess an inherent disposition for deflation. This also protects the monetary system from the claws of a government’s political intentions and potential fiscal mismanagement.
Transparency and Accountability
Every detail pertaining to each transaction on the blockchain is recorded and stored on this immutable, public ledger. This is perhaps the most commonly understood trait of cryptocurrency and blockchain. With transparency comes accountability. A decentralized structure does not require participants to trust one another in order to execute cryptocurrency transactions. The transparency afforded by blockchain technology allows users to interact in a trustless environment governed by mathematical and computing codes, which are far more reliable than human constructs.
Empowerment and Financial Inclusion
Despite massive monetary infrastructures that exist in the developed world, there continue to be more than 1.7 billion individuals who do not have access to the most fundamental financial services. A capitalist-functioning system would find little value in extending financial infrastructure to the developing world, which are deemed as too risky. For a true and equitable monetary system to exist, financial inclusion for everyone must be factored in. The use of cryptocurrencies facilitate borderless transactions in an instant, with little costs and relative ease.
Cryptocurrency dis-intermediates the monetary system due to their peer-to-peer network, allowing users to interact with each other rather than through a centralized intermediary, saving tremendous costs, time, and resources. Such disintermediation is critical, as apart from making the financial landscape free of selfish objectives and political interventions, it also reduces the cost at which various financial operations can take place. One needs no introduction to the moral hazards and self-serving interest of banks, which are profit-maximizing in nature.
Cryptocurrencies represent a revolutionary paradigm shift that could alleviate the inherent weaknesses of the current monetary system. Not only are they predicated on the advancement of cutting-edge technology, they also represent a political and social disruption that has been due for ages. The apparent benefits of leveraging on a public and immutable ledger of records would allow the transition into a more fair and equitable monetary system that empowers the masses.
* The information above does not constitute any form of financial or investment advice and should not be relied upon. Investing in Digital Assets carries risk. For more information please see our risk warning.