Digital Currencies Won't Kill the Dollar
Jamie Dimon, the CEO of JPMorgan Chase & Co., recently slammed bitcoin in no uncertain terms: It “won’t end well,” he said, calling the cryptocurrency a “fraud” and “worse than tulip bulbs.”
Is Dimon right? It depends. In at least two important ways, bitcoin and other cryptocurrencies will probably fail to achieve the dreams of their creators and enthusiasts. They are unlikely to usher in a hard-money revolution, and are also unlikely to supplant national fiat currencies as the standard means of payment. But that doesn’t mean they won’t change the world.
Many bitcoin enthusiasts believe that the digital currency will create what amounts to a new gold standard. The basic logic is that the number of bitcoins in existence is limited, while the number of dollars is not. Simple intuition says that if you create more of something, its value goes down -- in other words, central bank money-printing makes the dollar slowly lose value over time through inflation. The great economist Milton Friedman summed it up when he said that “inflation is always and everywhere a monetary phenomenon.”
Faced with a choice between money that slowly depreciates and money whose supply is permanently scarce, bitcoin bulls reason, who would choose the former? The availability of this sort of “digital gold,” they believe, will force central banks to hold down inflation in order to keep the dollar and other fiat currencies competitive. If they fail to do so, everyone will switch to bitcoin, central banks will become powerless, and inflation will fall anyway. This is an attractive scenario not just for hard-money supporters, but also for libertarians, who would rather the government didn’t have control over the value of their bank accounts.
But this thinking is flawed in at least two important ways. First, the number of bitcoins may be limited, but the number of cryptocurrencies is not. People are constantly creating new ones. Early examples included Dogecoin and Litecoin. Later came Ether, a currency that can be used in smart contracts. But the real bonanza came when startups realized that they could raise money by creating their own cryptocurrencies and selling them to investors -- an innovation known as an Initial Coin Offering. Some create new digital currencies that immediately convert into dollars, bitcoin, Ether, or some other form. Others stick around and can then be used just like bitcoin.
There are now almost 900 known cryptocurrencies in circulation. That number is likely to continue to climb. And what hard-money folks seem not to realize is that each time a new cryptocurrency is created, it expands the total money supply.
When everyone uses dollars, the money supply is just the total amount of dollars in circulation. But if there are a bunch of currencies that can all be used to buy things, the money supply represents the sum total of all of them. Therefore, rather than restricting the money supply, the advent of cryptocurrencies is causing it to balloon.
Does this mean the economy is headed for inflation? Probably not. First of all, Milton Friedman was probably wrong -- as the U.S. and Japan have learned in recent years, more money probably doesn’t mean more inflation after all. Also, each new currency adds to the money supply only to the extent that it can be used to buy real goods and services. When was the last time you used Dogecoin to buy a loaf of bread? Cryptocurrency is inflationary, but it isn’t very inflationary.
This brings us to the second way that cryptocurrency will disappoint: It almost certainly won’t become the standard means of payment in the economy. Bitcoin might be a hot investment property, but people would rather receive their wages in something less volatile -- you don’t want a fifth of your paycheck evaporating between payday and grocery day. The U.S. dollar depreciates at a nice, steady, predictable rate of around 2 percent a year, making it perfect for buying food and paying the electric bill. This is the reason you don’t see people going around buying gasoline with gold coins -- gold, like bitcoin, has too much short-term volatility to be useful as money. To top it off, the government requires us all to pay our taxes in the national fiat currency.
So bitcoin and other cryptocurrencies won’t neuter central banks, and they won’t make fiat currency go away. But they are already changing the financial world in other important ways. Initial coin offerings are allowing companies to raise money with less of a regulatory burden. China bans them outright, but the U.S. Securities and Exchange Commission has so far applied a light touch, and other countries may have few or no restrictions. It might thus be possible for startups in the U.S. to raise money overseas through an ICO, convert the proceeds to bitcoin, and exchange the bitcoin for dollars in the U.S., thus entirely evading financial regulation.
This is not the only situation where cryptocurrency can help people evade regulation -- money laundering is the other obvious application. The world’s governments maintain an extensive network of controls on financial flows, in order to stop drug dealers and other illicit businesses from moving money around freely. The existence of cryptocurrencies makes those controls a lot harder to maintain. Of course, since cryptocurrencies are volatile, this is an inherently risky way to raise money for your business or move your drug profits across borders. But for many, it’s better than nothing.
So while cryptocurrency won’t create a new gold standard, it will move the world toward another libertarian dream -- financial anarchy. If you think regulations are preventing startups from raising the money they need to grow, or if you think laws against drugs are unfair infringements on personal liberty, you should be looking forward to the new, crypto-powered world.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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