You are here

Wealth
sponsored by
DRIVING DISRUPTION

Bridging the trust gap in cryptocurrencies

Understanding and consciously addressing the key policy concerns will help to nudge a cryptocurrency towards wider acceptance

wealthjune2018_24.jpg

“Money makes the world go round”, but will new forms of money such as cryptocurrencies ever gain widespread adoption? What role will the government play in this process?

Money is an evolving concept which has taken various forms, from Cowry shells to gold and silver coins to the paper money believed to have originated from China during the Tang Dynasty (AD 618-907). More recently, we’ve seen the emergence of cryptocurrencies such as bitcoin as a new form of money. But what gives money value and what leads to its widespread adoption? The answer is the trust that underpins our collective belief in its value. Trust that your local coffee shop accepts it as payment. Trust that the numbers you see in your online bank statement or pension pot today will still be there tomorrow. It is a lack of trust that is hindering the widespread adoption of cryptocurrencies today.

Trust and the historic role of government

Private money supposedly came about as a solution to the inefficiencies of barter. While precious metals were adopted over time by the private sector as a more practical medium of exchange, trust was still a problem as people could not be sure whether the metallic content of coins were equal to their stated amounts. Only when governments standardised and verified such coins were they widely used as a medium of exchange. British economist Charles Goodhart observed that much of the Roman Empire regressed from a relatively sophisticated monetary economy back to barter after the Empire’s decline.

sentifi.com

Market voices on:

From currencies with intrinsic value, like gold, we transitioned to the fiat currencies we all use today. Fiat comes from the Latin saying “let it be done”, meaning that the currencies we use today are valuable only because they have the “full faith and credit” of the economy in which they exist.

We collectively trust paper currency because a government entity tells us it is credible, saying “it shall be” currency, prints it and accepts it as the only valid form of tax payment.

Barriers to trust for cryptocurrencies

More recently, we have seen the emergence of a number of cryptocurrencies, such as bitcoin.

Fans argue that it is a more effective facilitator of transactions than paper money. It’s digital and can be used for international transactions; there are no currency conversion fees and transaction fees are substantially lower. The central technology of all cryptocurrencies, the blockchain, deals more effectively with issues of trust and reciprocity than a central bank.

Moreover, the distributed nature of the blockchain increases the security of the currency and makes it less susceptible to manipulation or attack than a central bank. This all sounds good, but then why aren’t we all using them?

To gain widespread adoption, any form of money must be trusted to serve three primary functions. It must act as:

  • An accepted medium of exchange
  • A reliable store of value
  • A unit of account

Currently, no cryptocurrency in the market is trusted sufficiently to satisfy these requirements for the following reasons:

  • Network effects of money. Money can only  be a medium of exchange when there is a critical number of buyers and sellers accepting it. Until the day when you are willing to accept compensation in the form of bitcoins and are able to pay for your morning coffee in bitcoins, it cannot be considered a widely accepted medium of exchange.
    Furthermore, there are practical barriers to widespread adoption. Few of us understand how to obtain them, set up accounts in them, remit them or convert them.
  • Volatility of cryptocurrencies. One bitcoin hit a high of nearly US$20,000 in December last year, but then lost two-thirds of its value in just over a month. With this level of speculator-driven volatility, no crypto- currency will be widely trusted as a store of value or as a unit of account. Added to this, there is the possibility that governments intervene to render cryptocurrencies worthless (where for example they are seen to facilitate illegal activities or endanger wider economic stability).
  • Effective tool of government policy. The widespread acceptance and adoption of any form of money in society is hard to consider outside the context of government policy priorities (eg social, economic and political). As the most recent financial crisis has shown, control of the money supply and use of the levers of monetary policy remain powerful tools in governments’ and central bankers’ tool kits. A form of money which takes away this control potentially risks not just financial, but social cohesion, which no government will countenance.

So can governments bridge this trust gap and is it their role to do so?

For many cryptocurrencies fans the answer is “No!” Circumventing traditional financial markets and regulation is one of the chief appeals of cryptocurrencies. The last thing they want is any form of government involvement, and given the woeful records of many governments’ monetary policies, they may well be right. In certain countries, legal tender has effectively been replaced by the US dollar, reflecting a widespread lack of trust in government.

Nevertheless, the reality is they might not have much choice. So far, government responses to cryptocurrencies have varied dramatically, ranging from outright bans, through proactive exploration of frameworks to permit private crypto- finance, and even development of their own forms of cryptocurrency. Governments are understandably resistant to any challenges to fiat currencies given the risks they see to financial, and ultimately, social stability. However, a clear message to crypto-innovators from their varying responses to date is that understanding and then consciously addressing governments’ key policy concerns will help enormously in developing cryptocurrencies towards wider acceptance. Equally, governments actively embracing the underlying technologies may be the only way to fully understand and effectively counteract threats to their sovereignty and enable them to supervise their economy and develop tools to prevent systemic risks from developing. Whether that leads to the loss of some of the attractive features of cryptocurrencies remains to be seen. W

Powered by GET.comGetCom