Cryptocurrency has often been a divisive and controversial topic in the world of finance and economics. Some notable figures have written it off, claiming it to be nothing more than a complex Ponzi scheme, while others are insistent that cryptocurrencies are the future of the monetary system. Regardless of which party is correct, the near trillion-dollar peak market cap and multi-billion-dollar daily trading volume of cryptocurrency makes it a growing topic of research for economists and financiers alike. Current articles often portray cryptocurrency in a future oriented manner that concerns the potential for new and exciting technology. Or, cryptocurrencies are written about in a manner lacking substance that merely speaks of the previous week’s price movement. These articles concern the present and the future of cryptocurrency. I’d like to take a step back and present the topic in a different way, through the lens of economic history.
To begin, I’ll discuss the role of central banks throughout history as one of the primary purposes of Bitcoin was to eliminate the need for central banks, usurping the role of these traditionally powerful entities. The first instances of central banking arose in the late 1600s with the Swedish Riksbank and the Bank of England. Initially, the purpose of founding the Bank of England was to give the government a means to raise funds for their wartime efforts through borrowing from the bank. The Bank of England officially took on the role of a central bank later on due to the Bank Charter Act of 1844 that gave it the sole responsibility for printing currency. However, it is now difficult to discern what “officially” taking on the role of a central bank means. The role of a central bank has evolved so much throughout history that those initial banks would be nearly unrecognizable as central banks today.
Take the US Federal Reserve as an example. The responsibilities of the Fed have grown to the point where it is tasked with conducting monetary policy to meet a number of sometimes conflicting goals. These goals are maintaining maximum employment, stable prices and moderate long-term interest rates, maintaining an efficient payments system, and supervising banking operations. Bitcoin – whether intentionally or not – follows the Austrian School of Economics (pdf) that stresses the actions of the individual and derides interventionism. The criticism of central banking comes from the potential misuse of their monopoly power – be it lending power, currency creation, or interest rate manipulation – that would result in inefficient outcomes for the economy. Technology in the modern era has given consumers the ability to interact with one another without the presence of a central authority, indicating that perhaps the use of a central bank is outdated. Essentially, central banks may have grown to a point where their power is threatening to economic stability. Therefore, the decentralized nature of cryptocurrency, whereby decision-making power does not reside with one entity, makes it a sound alternative to the current system.
Another unintentional feature of cryptocurrency is that it gives fruition to the system of money envisioned by Friedrich Hayek in his 1976 book The Denationalization of Money. Hayek’s theory of a free-market monetary system involves private businesses issuing their own currencies. These currencies compete with one another for use. Hayek presumes that the most stable currencies would be favoured by the market, and that this system of competitive money would provide capitalism with the groundwork to remove depression and major fluctuations of economic activity. Essentially the cryptocurrency market works in a similar manner to this system of free-market money: private entities release their individual tokens, and these tokens compete with each other for favour. Whether or not the ideal currency has yet been created is another story, but if we follow the logic proposed by Hayek then that ideal currency would lead us to a more stable economic system than currently exists.
The rise of cryptocurrency also makes for an environment similar to the United States in the mid-1800s due to the prominence of free banking at the time. In a free/wildcat banking system, individual banks have the ability to offer their own bank notes. These notes act as a claim on the bank’s assets. Evidence from that era suggests that some regions in the US that offered free banking performed better financially than their peers, although other regions suffered financial losses. Overall the results are inconclusive due to the relatively short timeframe over which these laws were in effect. Again, this system is comparable to the cryptocurrency market as private entities were able to release their own currencies. However, this system also diverges from the cryptocurrency market due to the backing of the private money by physical assets, a characteristic not found in many cryptocurrencies. Nevertheless, the concepts of free banking and free-market money provide cryptocurrencies with a theoretical and historical framework to be considered a legitimate source of money.
Delving into the history of free banking is intended to give cryptocurrency more credibility and historical viability than one is used to seeing. Similar systems to cryptocurrency have been theorized as viable and have shown a bit of evidence that they can be in practice. Beyond this, cryptocurrencies have the potential to challenge the monopoly power of central banks which could lead to more stable economies around the globe. Of course, these theories are yet to be put into practice in a comprehensive manner, so take this optimistic outlook with some reservations. Additionally, the current volatile nature of most cryptocurrencies does not provide a solid platform from which to build an economy. Overall, the future may or may not be one involving cryptocurrency, but one shouldn’t count it out quite yet.
Dean Franklet is a recently graduated economics and finance master’s student from the University of Canterbury where he was President of the largest commerce society on campus. Spending his life in Texas and then New Zealand with a few other stops along the way, he gives a unique global viewpoint to portray in his writing.
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