Bitcoin and other cryptocurrencies have become popular among speculative traders and investors as a capital asset, but they’re just starting to scratch the surface of what’s possible as an actual currency. While the idea of a private currency isn’t new, cryptocurrencies could play a big role in making it a reality by overcoming several key obstacles.
In this article, we will look at the history of private and public currencies and how cryptocurrencies play an important role in their evolving dynamics.Cryptocurrencies are popular among many traders and investors, but they’re just scratching the surface of what’s possible as an actual currency. Click To Tweet
A Brief History Lesson
Who is responsible for issuing currency?
Most people would correctly answer that the government prints and mints currencies. While central banks are supposed to be independent — to avoid political influence — they are still owned and heavily influenced by the government. The President nominates members of the Board of Governors and the Senate confirms them in staggered 14-year appointments designed to avoid any political influence (at least in the United States).
You might be surprised to learn that this wasn’t always the case. In fact, private banks were the main issuers of paper currencies in the United States and Canada just a century ago. And two centuries ago, private banks were the sole issuers for virtually every country around the world. Congress’s decision to issue over $400 million worth of U.S. notes (or greenbacks) to finance the Civil War ultimately led to the demise of private currencies.
In Northern Ireland, Scotland and Hong Kong, private banks are still responsible for issuing currency — there are no government-owned central banks in these countries. Circulating notes are denominated in and directly redeemable for foreign currency assets, such as Bank of England notes in the case of Northern Ireland and Scotland. Any bank issuing too many notes would see an increase in redemptions to keep them in check.
Benefits of Private Currencies
Why would you want to use private currencies?
A common criticism of central banks is that they aren’t as reliable as private banks when it comes to redemption pledges. After all, you can sue a private bank if they fail to deliver on a pledge, but central banks have sovereign immunity. There’s no way to ensure that central banks have sufficient reserve assets — and in some cases, there’s very little backing up a currency! This is especially the case when reserves are raided by governments.
In extreme cases, the lack of accountability can lead to uncontrollable inflation. The most recent example of this is Venezuela, where the inflation rate nearly reached three million percent in January 2019. Zimbabwe and many other countries fell into a similar trap in the past that led to significant challenges for citizens. While inflation can be helpful in some cases, it’s a double-edged sword with many drawbacks.
Venezuela’s Inflation Rate – Source: TradingEconomics
Private currencies would make these situations less likely to occur. At the risk of being sued and going out of business, private banks would be required to hold reserve assets, such as U.S. dollars, at a fixed exchange rate and redeem them any time. Governments would be forced to be more fiscally responsible since they couldn’t use inflation to reduce their debt load and there would be no reserves to dip into for political reasons.
How Cryptocurrencies Play a Role
Cryptocurrencies are a unique form of private currency. Rather than relying on private banks, the supply of currency is limited by a combination of cryptography and computing resources. There is no need for reserves or redemption pledges, which are at the heart of many criticisms of private and central banks.
For example, you never have to worry about the creditworthiness of a private bank or the time and cost of exchanging a private bank note for a reserve asset. You also don’t have to worry about counterfeit currencies or how to spend the currency across different countries. These are key hurdles to maintaining private currencies.
Cryptocurrencies are globally fungible commodities with low transaction costs, near-zero transportation costs, and low-to-zero storage costs. These attributes differentiate it from both traditional currencies and alternative currencies that are expensive to store and difficult to transact. For example, storing and protecting gold can be extremely costly.
Important Challenges That Lie Ahead
Cryptocurrencies face several challenges before they can become a mainstream currency.
Volatility is one of the biggest challenges. Currencies are designed to be mediums of exchange, which means that they must be relatively stable over time. The U.S. dollar varies just a few thousandths of a cent from the euro during any given day, but Bitcoin values can fluctuate by hundreds of dollars every day, making it impossible to predict its value.
The good news is that capital markets integrations could smooth volatility. For example, futures markets even out fluctuations by enabling price discovery several months out. These efforts could ultimately help make prices less volatile and cryptocurrencies more useful as currencies. Other approaches have been designed to tie values to other assets.
Another key challenge deals with government regulation. For example, the Internal Revenue Service treats cryptocurrencies as property rather than a currency. This means that anyone that accepts cryptocurrencies as income must pay tax (or claim a deduction) on any changes in value when they exchange it — a daunting task that involves a lot of paperwork.
The Bottom Line
Private currencies aren’t a new concept, but cryptocurrencies are a radical new angle on them. As a fungible, global commodity with low transaction and storage costs, cryptocurrencies could become ideal currencies for global transactions if they can overcome some important challenges. And many of these challenges are already being addressed!
In the meantime, anyone using cryptocurrencies should ensure that they remain above board with regards to the IRS. ZenLedger makes it easy to import transactions across exchanges and wallets to auto populate IRS tax forms, including Form 8949 and Form 1040 Schedule D.
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