Opponents of pure crypto-currencies including those supporting stablecoins have consistently used the tokens’ perceived lack of intrinsic value as their main line of attack. Stablecoins are backed by ‘stable’ fiat currencies like US dollar and Euro or alternatively with commodities like gold. Fiat currency itself is stable because it has state backing, it’s the legal tender.
Ordinarily this lack of intrinsic value means a pure crypto-currency like Bitcoin or Ethereum is not really backed or tied to anything of value. Matters are made worse by the fact that few countries have given recognition to Bitcoin or any of the so-called alt-coins.
Without official or legal recognition as well as real assets to back them, growth and acceptance of crypto-currencies will remain stymied we are reminded. But just how far this intrinsic value argument goes is unclear. Most government issued currencies are also not backed by underlying assets, they have no intrinsic value but they remain in play.
Legal tender status
Indeed, prior to 1971, the world was accustomed to the gold standard; the US dollar was redeemable for gold. The world has since moved away from that system to one where value of the currency is determined by the forces of supply and demand. Under such a system, it is the central bank that is entrusted with the task of maintaining or stabilizing the value of a currency by either injecting or limiting the amount of money in circulation.
The abandonment of the gold standard meant a central bank issued currency was now just a token with no real value. Besides the legal tender status that is assigned to it by a government, it has no intrinsic value per se, the currency only functions because it has state backing. Logically people will have confidence in that currency’s ability to act as a medium of exchange or a store of value simply of because it has the legal tender status.
It is this confidence that matters particularly when a currency has nothing backing it. Pure crypto-currencies like Bitcoin are not backed by anything nor do they enjoy the legal tender status but have exhibited signs of a fully functioning medium of exchange. That is only possible because early users have confidence this novel currency.
In 2018, when Bitcoin’s value began heading south, critics began predicting a total crash but that has not happened just yet. After peaking to just under $20 000 in late 2017, Bitcoin value fell to below $4000 by late 2018 but only to stabilize around that price. The so-called analysts pointed to the price of $3600 being the resistance level; Bitcoin could not drop further than that, the only direction was up.
That assessment seems correct for the moment because Bitcoin has since rallied, briefly peaking at $13 000 in July 2019. Some are predicting that it will breach the $20 000 barrier later this year with reports suggest that institutional investors have joined the club.
Why the confidence in Bitcoin
Bitcoin and alt-coins have maintained their values precisely because users have confidence in the mathematics behind the creation of such tokens. The Blockchain— the technology that underpins crypto-currencies—occupies the role usually reserved for a central bank, it ensures the currency in circulation is immutable, it cannot be duplicated and more importantly, it allows users to verify if the founding rules of its issuance are being adhered to.
The same cannot be said of central bank issued currency whose security features are becoming too easy to replicate thus making it easy for criminals duplicate national banknotes.
For example, in Kenya, criminals and shady businessmen are accused of counterfeiting government issued currency and distributing this widely. The government has had to resort to extreme measures to combat this including withdrawing some banknotes from circulation. Earlier this year the CBK announced the start of a process of demonetizing the 1000 shillings banknotes which must be completed by the 1st of October.
While the plan is to ensnare those with unexplained holdings of cash, it is not clear if this alone will put a stop to illicit activities. One thing is clear though, a large volume of fake money in circulation drains confidence in the entire system.
As often is the case with currencies, it is confidence that translates to a strong and stable currency. High confidence means a strong currency and vice versa. Backing a currency or even a stablecoin with gold or oil might not be enough to sustain or support a currency when there is no confidence. That is what Venezuela has also learnt with its petro crypto token.
Oil not enough
Venezuela is in the midst of a crippling economic crisis; its currency has all but collapsed and generally the country is short of confidence. In response, the government launched its own crypto, which it claims is backed by oil or gold. However reports coming from that country show this project may have suffered a stillbirth; few people are accepting this as a means of payment. Instead, Venezuelans have placed trust in Bitcoin, a privately issued crypto-currency with no ‘intrinsic’ value. Reports suggest many are using Bitcoin to settle transactions as well as to hedge against runaway inflation.
This example proves that while precious resources or commodities are important in backing a currency, confidence in the process of issuing that currency remains paramount. Venezuela is a renowned oil producing country and backing the petro token with oil made all the sense, yet for citizens of that country that is simply not enough. Reports of abuse of national resources as well as corrupt practices by government officials are some of the factors that drain confidence in a currency as well as the economy in general, and this may have contributed to the petro failing to take off.
Legal tender not enough
Zimbabwe is another example that has proven that without satisfying certain conditions like confidence, a currency cannot stand even as it enjoys the so-called legal tender status. When the Zim dollar collapsed in 2008, the country adopted the popular and stable US dollar as the new legal tender or as the process is known, Zimbabwe dollarized. It was during this dollarization era when officials repeatedly complained that the US dollar had curtailed the central bank. The central bank could not issue effective monetary policies without a local currency was the argument. Things like inflation targeting and foreign exchange controls were not possible without a domestic currency.
Sometimes the arguments had little or no economic rationale. For instance officials averred that a country just had to have its own currency for the sake of it. A local currency was a source of nationalistic pride they argued. Local currency supporters did not want to be reminded why the currency had collapsed in the first place.
Consequently, in late 2016, the government reintroduced the Zim dollar, then initially disguised as the so-called bond notes, which were supposed to be at par with the US dollar. The Zimdollar was brought back to ostensibly enable the central bank to positively tackle monetary issues. Of course, this is not the only reason.
With capacity to mint your own currency comes the ability to print money well beyond a country’s economic means. With printing money comes power, an entire population is at the mercy of a few central bank appointees who are in fact more subservient to their appointers than to the interests of the masses.
In countries with weak governance systems, such an arrangement enables corrupt politicians to finance expensive but ultimately unviable public projects and Zimbabwe is no exception.
In early 2017,Zimbabwe launched Command Agriculture, an ambitious but costly agriculture funding initiative and this expansive exercise gobbled $3 billion between 2017 and 2019. Government had initiated this in order to bolster the country’s agricultural output and food security after years of grain deficits. Two years later, government now says Zimbabwe needs to import at least 800 000 metric tonnes of maize in order to avert a famine following a poor agricultural season! In other words, the giant agriculture project has failed even after the central bank created or printed money to fund this.
Just recently, the country’s auditor general produced a report which exposed the rampant abuses that plagued Command Agriculture leading to its now apparent failure.
It is imperative to note that this kind of unrestrained spending coincided with the return of a local currency. Command Agriculture would not have been possible without the fictitious money coming out of the central bank.
Now ordinary people are paying the price, a legal tender status or state backing will not save a currency from collapsing. The new Zimdollar has depreciated by 900% against the US dollar since its reintroduction in late 2016 and looks destined to fall even further. With official inflation figures now at 175%, ordinary Zimbabweans are dumping the currency in favor of the USD and Bitcoin.
The growing interest in Bitcoin by some Zimbabweans is particularly important as it is happening despite public warnings against the use of crypto-currencies.
Bitcoin’s popularity in countries like Kenya and Zimbabwe underlines the importance of transparency in managing a currency. Bitcoin has a known number of coins in circulation as well as the total number that will ever be issued. There is no possibility of reneging on this because this is already wired in the Blockchain and no one party can alter this. Knowledge of this creates confidence, a key attribute for anything that functions as a medium of exchange.
Intrinsic value matters yes but on its own it cannot sustain a currency. However, with just confidence, a currency will survive as Bitcoin and alt coins have shown us. Bitcoin opponents may have to look for another reason to attack the crypto, the intrinsic value is argument does not stick anymore just as the terrorism funding and money laundering argument has failed.