USD vs. Gold vs. Cryptocurrencies

Is the US Dollar (USD), gold, or cryptocurrencies, really money? How are the three to be compared? According to the Austrian school, "fiat money [is] money that comprises things with a special legal qualification.” Further, since the Austrian school does not recognize things as having objective economic value, all money is "fiat money", even gold:

[i]f the objective exchange-value of money must always be linked with a pre-existing market exchange ratio between money and other economic goods (since otherwise individuals would not be in a position to estimate the value of the money), it follows that an object cannot be used as money unless, at the moment when its use as money begins, it already possesses an objective exchange-value based on some other use.

There are a lot of things which have "exchange-value based on some other use." Lumber, sand, gold, and, as we shall see, cryptocurrencies, can be used for things other than exchange-value. Gold, for instance, can be used in jewelry, industrial applications, etc. One way gold differentiates itself from most other things is by being an element on the periodic table, and therefore both essentially indestructible and essentially impossible to produce. It can be found (via mining), but not produced. Its quantity is limited: demand for its uses grows with population growth or increased utility, while supply does not necessarily grow commensurate with demand. 

How does this compare to cryptocurrencies and the USD? To understand how cryptocurrencies compare, we must first,  look at how the USD works, and at how cryptocurrency is constructed. Let's start with the USD. As Forbes points out:

we already HAVE a national digital currency. It’s fast, cheap and secure! It has no issue with regulators, and it’s accepted everywhere. Who knew? It’s called … the US dollar.... almost 90% of US dollars have no physical existence – they are purely digital. But this isn’t just for the USA; world-wide, only 8% of currency exists as physical cash!

How does gold compare to national fiat money (e.g., the USD) and modern cryptocurrency? Well, primarily because all national currencies have legal recognition by their various issuing governments,  all national currencies have "a special legal qualification." As national currencies like the USD occupy space on their respective government hard drives, these same national electronic currencies are wrapped up in various cryptographic wrappers. The cryptographic wrappers are extrinsic to the currency itself. None of the currencies have built-in encryption, rather, the encryption schemes used are added "after the fact", as it were. For national currencies, encryption is necessary for safe exchange, but encryption is not technically intrinsic to the currency itself. 

Encryption is necessary because neither national currencies nor cryptocurrencies have actual, physical existence.  Both exist either primarily, or entirely, inside of computers. Gold's "encryption" is, of course, it's physical existence. If you don't have it in your hands, then you don't own it, you can't use it. Gold cannot be copied. For physical printed cash, governments try to mimic gold's characteristics by making the paper bills and metal coins hard to copy. Physical cash must be held in your hands to use it. 

For the digital versions of currency, these physical characteristics are mimicked by accounting and encryption. Accounting tracks digital cash to make sure it does not get double-spent (i.e., the same dollar is not spent on two different products at the same time). Encryption of digital assets prevents their being usefully copied. Encryption also allows only the person with the decryption key to open the encryption wrapper and make use of the encrypted money, so only people with the decryption keys "have the cash in their hands", so to speak. 

Currently, neither cryptocurrencies nor gold have "a special legal qualification". But both do have alternate exchange-value uses. Gold has industrial and cosmetic uses. Cryptocurrencies have ledger uses. What does "ledger uses" mean? Let's take a look at how crypto is constructed. 

The technology is still in its infancy, but cryptocurrency has its own market niche of usefulness above and beyond the simple ability of being able to move across national boundaries with a minimum of fuss. That movement, of course, is the one use case everyone knows. Cryptocurrency is instantly accessible anywhere in the world where the Internet is available. Even better, it is possible to move a billion dollars to another person for less than $5 in transaction fees. That cannot be done with any other form of value store.

But cryptocurrency differs from gold, USD and other national currencies in several other major ways. First, the design. The diagram above is a generic undifferentiated framework common to all cryptocurrencies. It is presented just to give you an idea of how cryptos work, generally speaking.

However, the actual design of the individual blocks in each cryptocurrency's blockchain is unique, differentiating it from all other cryptocurrencies. Design differences might lay in the size of the data block, the number of coins that can be produced, the kind of data that can be stored in the data block, the time interval during which a new block is generated, the level of modularity associated with each block, etc., but the design of each crypto is unique to itself. Thus, there is only ever one Bitcoin, no one else can invent Bitcoin again. Other cryptos very similar to Bitcoin may be produced (e.g., Litecoin), but nothing else will be Bitcoin.

Unlike USD or national currencies, where encryption is added as an after-thought, encryption is built-in, a fundamental part of the design of every cryptocurrency. This makes cryptocurrencies inherently more secure than any national currency. One may object by saying that blockchains have been hacked and large quantities of cryptocurrencies stolen, and this is true, but these hacks are much less common in cryptocurrencies than they are in national currencies. Further, these hacks occur as a result of programming errors, not encryption errors. We will see why this distinction matters in a moment.

Unlike national currencies, most cryptocurrencies have a bounded upper limit as part of their design. That means only a certain number of "coins" can exist in bounded cryptocurrencies. Although crypto is obviously not an element on the periodic table, the inherent limit to the number of coins in every bounded cryptocurrency means it acts in a way similar to gold. Crypto of this kind can only be found, not created. Once the upper limit is reached, no more coins of that type can be found. Ever. Unlike national currencies, which governments usually inflate in order to reduce their own debts, bounded crypto cannot be inflated. Indeed, given the fact that people will, over time, lose their decryption keys or die without passing their decryption keys onto others, bounded crypto is relentlessly deflationary. Once max supply is reached, the supply will only drop. This is different than gold. Lost gold can theoretically be discovered again. Lost Bitcoins are gone forever. 

Like gold, and unlike national currencies, bitcoin is decentralized. While certain geographic areas may be rich in gold, or rich in cryptocurrency miners, for most cryptocurrencies, no single entity controls a typical cryptocurrency network. No one entity can decide to change the structure of the coin or the distribution of the coin. Whereas national governments (that is, powerful individuals and groups) use the force of national law to guarantee the integrity of their own government currencies, the laws of physics guarantee the stable characteristics, accessibility and integrity of gold, while the laws of mathematics guarantee the stable characteristics, accessibility and integrity of cryptocurrencies. Given the close interconnect between the laws of physics and math, the math of cryptocurrencies is as stable as the physics of gold. Just as someone could theoretically use the power of nuclear fusion to create more gold, someone could theoretically use the power of computers to break encryption, but given the physics and the math, neither endeavor is likely to occur in our lifetimes.  

But none of these are use cases. Does cryptocurrency have a use case, as gold does? The simplest answer: Yes. Examine the diagram above. The data section in every cryptocurrency block can hold not just transactions, but anything at all. For instance, the data section can hold other cryptocurrencies inside itself, It can hold not only data, but programs. Thus, a cryptocurrency can do something that no national currency, and no bar of gold, can do.

Say, for example, you need a new refrigerator. You can program your cryptocurrency to monitor the prices of refrigerators with certain characteristics, then automatically use itself to buy the optimal refrigerator when it reaches your optimal price, and automatically have that fridge delivered to your door. You can't program a thousand-dollar bill (or any national currency) nor even a bar of gold to do the same thing. Such a program is called a "smart contract".   

Smart contracts are part of DeFi (Decentralized Finance). A smart contract is an example of a Dapp (Decentralized Application). Different cryptocurrencies have different DeFi capabilities. Bitcoin, the original cryptocurrency, is very, very hard to program with DeFi, so nobody does it. But Ethereum, BinanceCoin and Polkadot, all second-generation currencies, are much better at it. Cardano, a third-generation currency, is even better still, and much easier to program. So, in addition to being able to transfer large sums quickly and cheaply, smart contracts specifically, and DeFi + Dapps in general, are additional use cases for cryptocurrencies.

But DeFi and Dapps are not all that can be done. Cryptocurrencies can act as immutable ledgers. Once data is written into a block, the hash prevents the data from being changed. Precisely because the data section can hold... well... data that cannot be changed, cryptocurrencies may be used as a pre-eminent way of tracking information that needs to be publicly available but also needs to be tamper-proof. So, information on chain-of-custody issues, such as car ownership and maintenance, land deeds, lien information on said land deeds, food transport, high school and college transcripts, proof of employment, etc., could be put on a block chain, available for tamper-proof public inspection. 

Even medical records could be encrypted, placed in a public blockchain, and therefore be available world-wide for use. Since these records would be encrypted, they would only able to be decrypted by the record owner. The advantage? If the owner of those records is away from home but needs medical care, the medical records are still instantly available to any medical facility in the world that has an internet connection. Instead of taking days or weeks to locate and transmit the appropriate information to the emergency medical provider, the data owner simply unlocks the medical information using the decryption keys and it is instantly available. 

So, revisit the smart contract for the refrigerator. You can program the currency to spend itself for the fridge, not only if it reaches the right price point, but also if it has the right production facility, the right transport history, and a good maintenance history. If you want to buy only American, the ledger capability allows the crypto to track the provenance of the goods, allowing everyone to guarantee that you are, really, buying all and only American. The currency itself will verify that every part of the supply-chain was American, not a bit of it foreign. Or, if you only want to buy ethically-sourced products, the crypto would guarantee that you got your wish by refusing to spend itself unless the entire supply chain for the product was ethically-sourced, according to the criteria you set. Try doing that with a fifty-dollar bill.  Or a bar of gold. 

In an age where timely access to information is worth money, the blockchain is an efficient way of seamlessly making stored information quickly available while simultaneously guaranteeing the integrity of the information. Crypto is not just a store of value that is almost universally and instantly available, it is also a contract instrument and an immutable data ledger. Gold has its uses, national currencies have theirs, but DeFi  + Dapps, that is, easy access to widely available, easily transportable, tamper-proof public records, is a very valuable use case. And that is why cryptocurrencies are booming.  

Now, are cryptocurrencies in a tulip-like bubble? Yes. There is no question that many of the blockchains that currently carry significant value are not well-designed and will therefore not survive. Thousands of companies are trying to figure out how to use blockchain right now, just as thousands of companies were trying to figure out how to use the internet back in the 1990s. Most of those groups will fail. But there will be some jewels, just as there were during the dot.com bubble. Remember, Amazon, Google and Netflix all started during that late 1990's bubble. If you invested in them then, you are a multi-millionaire today. If you invested in the bubblelicious losers, you stood a good chance of losing your shirt. 

The same thing is happening right now with blockchain. Some will be jewels that survive and thrive, but most will fail. For instance, Dogecoin has no inherent value, no developers adding value, and an infinitely growing supply. It's definitely a bubble blockchain. For all its notoriety, Bitcoin is almost identical to Dogecoin. While it is is superior to Dogecoin in that it has a capped, or bounded, supply, it is hard to develop on, so it has few developers. However, it has first mover advantage, which means most people buy into it, not because it is good, but because they have heard of it. This will not last.

Ethereum has a mediocre architecture, a fairly lousy fee structure, and no upper bound to the number of coins that can be created, but it has a lot of developers. Ethereum has first mover advantage in the DeFi/Dapps space. Those developers and that first mover advantage give it much more value than Bitcoin. Cardano has a much superior architecture, a superior fee structure, an upper bound to the number of coins and lots of developers, so it also has much more value than Bitcoin. When Defi/Dapp ability is added in August, its value will increase again. Other coins vary in their characteristics as well. If you want to invest, keep in mind that blockchain is definitely in a price-discovery bubble (and has been since it was invented), but it also definitely has a few blockchain gems. You have to do your due diligence and determine which blockchains have enough value to survive the bubble. Those are the ones that will drive value.