The creation of a global currency will require a balancing of the power of the market and equitable distribution of resources. Can decentralized markets make it happen?
Let's say in 20 years there is a decentralized currency worth $20 trillion or roughly 20% of the global currency market. Maybe it's bitcoin, maybe it's a new currency. Where will this $20 trillion in wealth come from? Who will be $20 trillion richer? Will some people be poorer? Who? Will global assets be more evenly distributed or will inequality increase?
These are very important questions. Below are a few thoughts.
Where the value comes from: The $20 trillion is comprised of new value creation and wealth transfers from other currencies. New value is created due to cost efficiencies, increased trade and reduced conflict. The wealth transfer happens as other currencies are used less and fall in value relative to the new currency. The value creation process is driven by network effects with currency users (buyers) and currency accepters (sellers) increasing the value through usage.
Who gets this value: Two groups of people: those who initially issue the currency (seigniorage) and those who purchase the currency and hold it as the price rises.
Wealth transfer problem: From a social perspective, many people support bitcoin and other global currency projects because of their potential to reduce inequality. If the creation of these currencies results in a massive transfer of wealth leaving one group poorer, the net benefits would be in question. Also, from a practical perspective, the creation of a decentralized currency is a voluntary, market-based exercise. If people have full knowledge of an unfair distribution, they will likely not adopt the currency. For these reasons, for a currency to reach $20 trillion in value, it must have a distribution scheme that minimizes wealth transfer.
Traditional approach: When a government is involved, the creation of a new currency is relatively easy. The government sets an exchange rate, old currency is exchanged for the new currency and the old currency destroyed. New currency holders benefit from the subsequent increase in value of the new currency in proportion to the amount of old currency held. There is no wealth transfer with the initial exchange. If the currency increases in value the government may choose to issue additional currency supply to reduce the price. What the government does with this seigniorage determines whether this value is then distributed equitably.
Volatility problem: When there is no government to orchestrate an orderly currency exchange, there may be a long period of uncertainty about the ultimate viability of the currency, which leads to price volatility. See Bitcoin is a publicly traded future currency - new territory for finance. This exacerbates the wealth transfer problem because only people who have money to lose can purchase the currency and thereby benefit from the increase value. The people who don't have this wealth will eventually need to purchase the currency at a price much higher than the others.
Seigniorage as a solution: Seigniorage can be used to solve the wealth transfer problem. The creator of the currency can distribute the currency broadly for free at inception or as the price rises.
Seigniorage as a problem: Seigniorage can also exacerbate the wealth transfer problem. For example, the currency creator could retain the seigniorage for itself or distribute the currency to a select group of people.
Bitcoin's status quo: Bitcoin's current value of $150 billion is mostly new value - the wealth transfer has not yet begun in earnest as usage of other currencies has not yet fallen significantly. Bitcoin has a potential wealth transfer problem because bitcoin does not have any form of seigniorage and the price is extremely volatile. Without a change in the distribution scheme of bitcoin, it is not clear how it will reach maturity without a massive wealth transfer.
"Stable Value" distribution: Some coin projects seek to control price increases by distributing new currency. This reduces the price by increasing the supply. The big question is who gets the new currency. If the new supply is distributed broadly to people who don't already hold the currency, this could be a good method for achieving equitable distribution. If the new supply is distributed to a small group of investors who have purchased the right to this additional supply, this could make the problem even worse than it is with bitcoin.
Bitcoin notes: New bitcoin backed notes issued by governments, finance companies and marketers can help with equitable distribution, especially where there is no seigniorage of the currency itself. See Bitcoin notes will deliver bitcoin to the world. These notes serve as synthetic bitcoin (or other currency) and can be used to effectively increase the supply of the currency. This synthetic issuance can be used to achieve distribution in a manner similar to that of seigniorage.
Government involvement: Ideally governments will be involved in the creation of a global decentralized currency. This is the easiest way to ensure an equitable distribution of the new currency. Governments can issue bitcoin backed notes and exchange these for their local currency in an orderly, equitable process. Governments that do this will protect their citizens from a loss of wealth in the event a global currency is created outside of their region and then later displaces the local currency.
Timing matters: The $20 trillion outcome presented above is a real possibility considering the potential benefits of a decentralized currency. What happens over the next several years will determine whether we are able to achieve this outcome and who benefits. New currencies like bitcoin and others risk failure if they wait too long to distribute their currency broadly. Governments risk harming their constituents if they wait too long before conducting an orderly exchange.
By Shane Hadden, CBP, CFA; firstname.lastname@example.org
About the Global Currency Group: The Global Currency Group promotes the adoption of a decentralized global currency through investments, advisory services, new currency creation and advocacy.
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