Ever since the first Bitcoin was mined in January of 2009, we’ve seen an ever-growing interest in cryptocurrencies and blockchain — the technology upon which Bitcoin is based. What are we to make of it all? Will Bitcoin or another private cryptocurrency displace sovereign currencies? Is this a passing speculative fad? Perhaps it’s best to begin with a brief economics refresher.
What is money? Money is the most liquid or most marketable of all commodities. It possesses three chief characteristics: 1) a medium of exchange (it can be traded for almost anything) 2) a unit of account (it’s a common language or measure for exchange), and 3) a store of value (its value remains relatively stable through time). These three characteristics enable us to avoid cumbersome barter, compare the relative scarcity of things, and engage in intertemporal trade (borrow and lend).
Money takes various forms such as cash or fiat money declared as legal tender. Money assumes digital forms, as well. The Financial Action Task Force (FATF) distinguishes these digital forms as e-money (fiat money transferred electronically) and virtual currency (a digital representation of money that does not have legal tender status). Bitcoin is one specific type of virtual currency — a cryptocurrency — and as such possesses at least some of the three characteristics of money to varying degrees. But what makes cryptocurrency distinct from other forms of digital currency is its math-based, cryptographically secured, and decentralized form undergirded by Distributed Ledger Technology (DLT). With this background in mind, let’s evaluate the Bitcoin phenomenon in light of several of Acton’s Core Principles: wealth creation, economic value, economic liberty, and the rule of law and subsidiary role of government.
The first principle, creation of wealth, describes the idea that human beings transform their environment into useful goods and services. Through their creative potential, human beings can mitigate scarcity and improve their material condition. Is cryptocurrency enabled by DLT an example of true wealth creation or is it merely the infatuation of anarchocapitalists and speculators? While some cryptocurrencies will ultimately fade into oblivion, the underlying DLT and digital currencies which use DLT are indeed transformational. The Financial Industry Regulatory Authority describes the technology in this way:
Distributed ledger technology involves a distributed database maintained over a network of computers connected on a peer-to-peer basis, such that network participants can share and retain identical, cryptographically secured records in a decentralized manner.
DLT’s key innovation is its new and rapid form of arriving at consensus in exchange. To put it simply, DLT creates wealth through its ability to ensure a new level of trust in exchange. This has enormous implications for various applications, including digital currencies. Although commerce has been conducted online for years and in electronic form for decades, those transactions follow a distinct verification process of payment, clearing, and settlement, and the volume of transactions is enormous. According to a Federal Reserve study in 2016, the payment clearing and settlement system processed around 600 million transactions daily in the United States — and the transactions are only growing. But as the Fed also points out, this process is not cost-free; verification is necessary because of the need to ensure transactions are accurate and error-free. And this is the transformational power of DLT: verification can occur in as little as a few seconds, dramatically reducing the cost of verification through cryptographic techniques. Blockchains enable trust.
A second example of the creation of wealth is the potential DLT-based digital currencies have to expand global economic access for the unbanked. As the Federal Reserve Board points out in its study:
Access to financial services can be difficult, particularly for low-income households, because of high account fees, prohibitive costs associated with traveling to a bank. Developers contend DLT may assist financial inclusion by … expanding access to customer groups not served by ordinary banks, and ultimately reducing costs for retail consumers.
A final way that DLT-based cryptocurrencies could create wealth is by establishing a new store of value. In the case of Bitcoin specifically, because the supply of Bitcoin that can be “mined” is mathematically limited, Bitcoin itself has the potential to create wealth as a store of value akin to a digital form of gold. While certainly speculation has hindered this, many Bitcoin advocates consider this both an essential feature and an inevitable outcome in the long run.
Let’s now turn our attention to a distinct but related principle as it applies to DLT: economic value. Unlike moral value, which can be objectively assessed on the basis of the natural law and Sacred Scripture, economic value is subjective and derives from the tastes and preferences of individuals in the marketplace. Digital currencies have economic value because they reduce friction in exchange and thus the cost of engaging in various transactions, something everyone desires. Additionally, DLT enables the “tokenization” of assets. Any commodity can be tokenized — that is, the ownership of any commodity can be tracked and verified by tagging it cryptographically. Through its use of cryptographic methods, DLT can verify and achieve consensus on transactions by linking assets in the real world to the blockchain or other DLT. These abilities have great potential to bring economic value to billions of people; trade becomes easier and cheaper.
Other manifestations of economic value are clearly more subjective. One form of tokenization is called a Non-Fungible Token, or NFT. An NFT can track the chain of ownership of singular digital assets, such as a unique piece of electronic art. So, for example, the original digital photograph of the so-called “Disaster Girl Meme” sold for approximately $500,000. Perhaps the most famous auction of a Non-Fungible Token in the recent past was an actual tweet! Jack Dorsey, the CEO of Twitter, tokenized his first ever tweet, and auctioned it as an NFT for nearly $3M. Economic value is being created here — though such value is clearly subjective.
Finally, there are other DLT applications that create economic value. One example is smart contracts, which, through coding logic, can create automatic transactions at specific times under specified conditions in contexts previously unexplored. So, one might develop an insurance contract designed to pay out automatically if certain conditions materialize by a certain deadline. In sum, DLT-based applications create economic value.
Let’s now consider digital currencies (and Central Bank Digital Currencies, which make use of DLT) within the framework of two more principles: economic liberty and the rule of law and the subsidiary role of government. The Acton Institute promotes the importance of economic liberty where individuals can freely operate in the marketplace while being obliged to behave lawfully and virtuously. The principle of economic liberty implies that governments also uphold the rule of law, guarantee private property rights, and provide stable rules of the game where voluntary exchange can occur in the marketplace.
DLT-based applications can promote these ends in various ways. Decentralized applications could promote pseudonymous exchange and Central Bank Digital Currencies could enable greater access to the marketplace. In both cases, individuals are less dependent upon intermediaries for economic engagement. I should note, however, that the tradeoffs between privacy and security concerns need to be carefully addressed. Without sufficient attention to the former, hostile governments or bureaucracies could threaten economic (and other) liberties. Inadequate attention to the latter could embolden criminals or terrorists to leverage cryptocurrencies in ways that harm the economic liberty of others.
To preserve economic liberty, Central Bank Digital Currencies need to operate within a clearly articulated rule of law while allowing tertiary cryptocurrencies to freely operate within a decentralized institutional framework (subsidiary role of government), which protects individual privacy while retaining economic stability. Without such a legal framework, there are real economic risks. In its 2018 report entitled “Virtual Currencies,” the Kiel Institute for the World Economy highlights the short run risk that Central Bank Digital Currencies could create for commercial banks. In essence, one could imagine a CBDC acting as electronic cash — and if everyone is holding electronic cash, there is little incentive to deposit that cash in a commercial bank. Without a clear and well-constructed means of introducing a CBDC, there are non-trivial risks to the banking system as a whole. Banks will need to compete for deposits in new ways, and since deposits are the source of bank loans—and thus income earned on the interest of these loans—banks will need to also find new ways of generating revenue.
Central banks across the globe are examining the risks and implications of creating Central Bank Digital Currencies. Commercial banks are racing to evaluate how decentralized finance and financial technology are impacting their business model. As you might expect, governments and regulatory agencies are developing frameworks to harness the benefits of these transformational technologies while minimizing the risks associated with money laundering, terrorism financing, the disintermediation of banks, and transactional security. Indeed, the evolution of digital currencies and digital finance requires a new framework— the rule of law—to enable these technologies to best promote human flourishing.
Digital currencies, Distributed Ledger Technology, and the tokenization of assets will all have transformational impacts in the marketplace. Banks, businesses, governments and regulatory bodies are all scurrying to leverage these advances and provide stable rules of the game for all involved. In spite of short run speculation, what is happening with DLT is not a temporary fad or passing financial mania. Like other forms of money, digital currencies and DLT-based applications will dramatically facilitate exchange and thereby promote human flourishing. The Acton Institute’s Core Principles of creation of wealth, economic value, economic liberty and the rule of law and subsidiary role of government, provide a helpful framework for evaluating what is transpiring and what lies ahead.