THE COEXISTENCE OF MONEY WITH DIGITAL CURRENCIES, BUSINESS CYCLES, AND REGIONAL DIGITAL MONETARY AREAS.
Since I started analyzing Bitcoin, cryptocurrencies, blockchain technologies and more generally decentralized finance (DeFi), I have always discussed different economic thinking based on a new way to watch money and the contemporary monetary systems. Over time, I have always believed that the rise of these innovations would have made the world a better place.
Despite the mainstream criticism of most financial institutions continues today, I am still convinced that decentralized finance, Bitcoin, and some digital currencies have already shown huge innovations and spectacular changes in our society. Of course, we are just on the way to change the world, but the extraction of value from Blockchain technologies and the rise of decentralized finance have already started.
DeFi comes out from the basic features of Blockchain automated transactions and protocols and can transfer value to more complex uses by innovating the old financial system with no end. Essentially, it can produce a variety of financial applications with zero intermediaries but with full control of operations beyond the automated transactions. These innovations which already work are new peer-to-peer forms of lending, powerful trading platforms and decentralized exchanges, new global payment tools, alternative forms of crowdfunding to address different allocations of capital and credit such as yield, savings, and liquidity mining applications.
Furthermore, DeFi has a fundamental feature that is its ‘composability’. In other words, it is an open source that can be used to generate new apps and new financial products with full control over the transactions.
Finally, DeFi means also stablecoins that are digital currencies tied to one or a basket of assets such as Fiat currencies or exchange — traded commodities or any other asset. They are designed to stabilize the price of any digital coin with huge benefits for the stability of the entire system.
The challenge here will be to hold the original vision of decentralization and support it, despite the view of monetary and financial institutions about the future of money, Bitcoin, cryptos, and decentralized finance. To realize our idea of society definitely, we will have to fight on the battlefield of knowledge and we will have to continue to produce content and information everywhere to explain the future of money and the necessity to reform the monetary and financial institutions to fix what is wrong today.
It doesn’t matter if you live in America, Europe, Asia, Africa, or wherever you will have to continue to inform the mass population about our different views. Only in this way we will make the world a better place and pay attention to those who live in the developing economies and poor countries particularly.
That’s why the free world can’t ban our thinking, because it is already part of a new society, and we already know that our vision is everywhere.
Although some cryptocurrencies and stablecoins have already shown how they can serve as a medium of exchange, store of value, or a new investment and hedging class of assets, however, we can also predict that decentralized finance will boost the economy in a healthy and more right way.
If you accept this economic thinking, you can imagine together with us a world where the financial services are accessible to anyone and where fiat money can coexist with those cryptocurrencies that have real functionalities since the choice between cryptocurrency and Fiat money is just a ’false dilemma’ in which the financial institutions and most of the financial Elites seem to be trapped because they can’t see with our eyes.
A decentralized financial system will, of course, benefit all of humankind if you just think that today billions of people are still unbanked or underbanked and have only a few opportunities to have a safe and secure way to participate in the global economy. Despite this unfair allocation of resources, most notable financial institutions and economists can’t accept this new thinking. They always continue to express skepticism and a pessimistic view about the future of digital assets. Well, we don’t care. All of them always look at cryptos from the same angle and with the same arguments. Their best thinking is to explain first what money is and what it is not. Then, they try to convince the counterparty that there is no chance for the widespread use of cryptos and decentralized finance in the real economy.
They refuse to analyze neither the technology nor functionalities of digital currencies nor their potential interactions with the economy, business and credit cycles, and monetary systems. They simply don’t think about it with a certain arrogance.
Since the beginning, my arguments in favor of cryptocurrencies and digital assets such as Bitcoin, Ethereum, and stablecoins were not only driven by the typical thesis of Bitcoiners’ literature about the positive hedging effects against an inflationary monetary economy that can create a possible liquidity trap in an economy with zero percent or negative interest rates as the today pandemic crisis seems to generate. Of course, it is a fact that Bitcoin and other coins may be designed to encourage a deflationary attitude and used as a relatively stable store of value on a long-term basis.
What most intrigued me was to investigate the coexistence of Fiat money with cryptocurrencies and the possible interactions with the business and credit cycles. In particular, I explored how the business cycles of a regional or neighboring area can be affected by the adoption of digital currencies with deflationary characteristics, decentralized and globally accepted. This analysis is central to my arguments. For example, if you look at the effect of the real exchange rate on the economic growth of those emerging markets mostly influenced, internally, by an own inflationary economy and, externally, by a structurally weak currency, you can understand how most of these economies are essentially driven by the price of US dollars and US macroeconomic policies regarding their international trades or influenced by their weak currencies more in general. That’s why is so important to discuss these topics, because as you can understand, exchange rates of stronger currencies like the US dollar together with its monetary cycles and macroeconomic policies, ultimately may have an impact on the per capita growth of developing countries and weaker regional economic areas.
In other words, the business cycles and macroeconomic monetary policies of stronger countries can make the third world economies (or single regional areas) subdued since they represent exogenous variables that cannot be controlled by the latter. The effects of this global economic system may generate shocks in the economic growth or production structures and/or huge misdirections of capital and credit out of these regions. The result is, therefore, an ultimate impact on the business cycles of these regions that can impact on per capita growth rate and their unemployment.
According to the above assumptions at the beginning, I took a different look at the dogma declared at that time by the financial authorities between fiat and cryptocurrencies. I theorized the potential coexistence of Fiat money with some cryptocurrencies with real functions such as Bitcoin, stablecoins, and others driven by the technology factor and inflation expectations that can play an important role in some regional and economic neighboring areas particularly.
The coexistence is what I consider one of the most important achievements that cryptocurrencies and DeFi will confirm in the future if not banned of course. I looked, therefore, at the interactions with the local and foreign currencies, and at the impacts that digital monetary regional areas can have on business and credit cycles of those areas where the conditions can be more favorable for their adoption due to their monetary weakness.
Here is central to investigate how the DeFi expansion, inflation expectations, income spent can play an essential role in the demand and supply of Fiat money and cryptocurrency to form a possible equilibrium for the economies of those economic areas in which the two currencies can coexist. Then, if equilibrium may exist (and it could be multiple) at acceptable conditions, it’s possible to analyze the possible theoretical benefits that can derive in this scenario for the business and credit cycles in the local or regional economies that are in equilibrium, and finally the effects on their per capita growth rate.
Essentially, in my theoretical arguments, I paid attention to the demand for money and the variables that can be discussed to bring the economy to equilibrium. The technology factor is an essential variable of the function, and it represents together with the inflation expectations of the area, the central arguments for the adoption of a digital currency that can happen through an endogenous and competitive process. Of course, as usual, this type of process can be addressed, limited, facilitated, or banned by the central authorities, however, it is likely to happen in any case because represents an optimal possible equilibrium since some endogenous characteristics (technology expansion and inflation) can facilitate the partial transition to a digital currency.
Simply, I decided to go beyond the typical general discussions about inflation in terms of ‘safe-haven of which Bitcoin’s literature is full and although the inflation is of course a central element of my arguments, it is included in the bigger picture of a sort of new demand for liquidity and its interactions with the business cycles. According to the arguments explained earlier about the effects that real exchange rates, inflationary expectations, and macroeconomic policies of the strongest countries may have on weaker regional economic areas and their business and credit cycles, we can now understand how from a theoretical point of view my conclusions are strong arguments for the theorization of the coexistence of Fiat money and cryptocurrencies and the formation of regional digital monetary areas.
During the gestation of my theoretical arguments, I was inspired by reading the Nobel Prize Friedrich Hayek regarding his studies about capital, money, and business cycle theories (‘monetary theory of the trade cycle’).
Although I’m not an orthodox conservative, since I consider that fiscal policies may have a fundamental role together with monetary policies in a modern society, however, I’m conservative in the sense that I am firmly favorable to free markets and a deep deregulation since I think that the State should not hold relevant economic roles in the economy but it should just do its essential own homework.
In his Prices and Production (1931), Hayek argued that the business cycle resulted from the central bank’s inflationary credit expansion and its transmission over time, leading to a capital misallocation caused by the artificially low-interest rates. He claimed in a smart way that:
“the past instability of the market economy is the consequence of the exclusion of the most important regulator of the market mechanism, money, from itself being regulated by the market process.”
One of his most significant contributions was the explanations of business cycles and how monetary expansion governs the process and, at a certain time, generates a crisis and a slump (boom-busts). The severity of the recent crisis can give evidence of these intuitions and for that reason, we need to support a reform of financial institutions and monetary policies. We can find, therefore, a lot of evidence in today’s economy about Hayek’s theory if we look at his assertions about how central banks trying to lower the market interest rate below the ‘level’ which he calls the ‘natural’ level which it generates the equilibrium between the supply of available savings and the demand for investable funds.
Indeed, we always observe that every time Central Banks try to stimulate more investments financed by printing money and not by increased saving in a healthy way, the economy can’t recovery in any case, and unemployment increases. What only happen are distortions in the production, investment, consumption, and capital structures.
Hayek’s intuition was to observe how these policies may create a not ‘real’ economic boom with the consequence of future severe and painful adjustments in the production, employment structures, and in the business cycle finally. Hayek’s thinking is central to the argument that monetary expansion policies that tend to make credit cheap should not be used to stimulate too much consumers’ demand to lift an economy from depression because these monetary policies will not let the economy recover in any case and the unemployment increase until the production adjustments will be completed.
These effects depend on what he calls the ‘ interest rate effect,’ which can generate structural misalignments across production processes and the misdirection of capital. We can just add that what Hayek states about the business cycles can happen in any state or regional economic area where the monetary policy is centralized.
Therefore, the theoretical argument which I started to investigate, as said earlier, was what I called ‘the coexistence of digital currency with real functionalities with Fiat money’ (‘functioning curve of cryptocurrency’). Essentially this argument is connected to the demand for money and explores a possible alternative monetary equilibrium in any regional or economic neighboring areas where the adoption of a cryptocurrency with the functioning characteristics of being deflationary such as Bitcoin or other stablecoins are not banned. The equilibrium process is driven by the technology factor (DeFi) that is an essential variable of the curve together with the inflation expectations even as operative costs in terms of price to exchange the own currency with another foreign currency to trade (import/export) with particular attention to the case of an inflationary economic or monetary area (e.g. think about developing markets and third-world economies).
In other words, I explored the correlation between the demand for money and for a cryptocurrency with effective real functions, analysing the problem in a “different” way and explicting the demand for alternative liquidity as a mathematical function, which is dependent on variables such as decentralized technologies or DeFi, income spent, interest rate, exchange rate costs, and inflation expectations. I realized that along the curve, it is possible to demonstrate that exist possible alternative equilibria between digital currencies and Fiat money. Of course, the basic assumption is that digital currencies are allowed and are not banned. In the optimal equilibrium, households and sellers will demand Fiat currency and digital currency that will result in the same in terms of opportunity costs for both to use the digital currency according to income spent for internal consumption, international trade, investments, and fiscal payments.
The coefficient associated with the technology expansion and the benefits of accepting cryptocurrency in terms of inflation expectations represents the slope of the curve. Theoretically, this process could be endogenous with a decentralized digital currency accepted by anyone such as Bitcoin, or in some regional or economic neighbouring areas, it could be also possible to design a specific cryptocurrency. The benefit of such deflationary monetary digital areas is embedded in the technology expansion and in the capacity to be independent by monetary shocks of the strongest currencies that can have a severe influence on the balance of payments and on international trades of the weakest economies particularly. Although monetary shocks can influence the equilibrium and vary it over the above curve or move the curve on the plan to right or left, in a given region, however any equilibrium with the digital currency will preserve the economy of the region or the neighbouring area from production or monetary shocks. It may reduce the dependence on the stronger currencies such as the US dollar and mitigate the negative effect of the macroeconomic and monetary policies of the strongest countries (or neighbours).
Indeed, this theoretical argument can be used to demonstrate how it could be possible in some areas to design such a digital monetary system to mitigate the ultimate negative effects on the per capita growth that stronger currencies and countries (or neighbours). This scenario, therefore, can limit the macroeconomic inflationary policies and the economic shocks which can be caused by the local governments (in particular in some risky developing economies with weaker currencies) without loosing their monetary independence.
This intuition may represent a solution towards the misallocations caused by the monetary policies, and Hayeck’s theory of monetary cycle (Boom — Bust effects) by limiting the distortions of inflationary booms and by preserving the production structures to mitigate the severe adjustments of business cycles to allow better capital and credit allocations or transmission processes.
I’d like to conclude this story by explaining what DeFi and blockchain may represent for society since is the social basis of my thinking. Essentially, I consider these technologies a new approach of our society towards addressing the crashes of financial markets, sovereign debt crisis, geopolitical tensions, and therefore the political and ethical issues raised in the world during the last 20 years.
I believe that these innovations are also the mirror of the progress of the society towards a new concept of democracy embedded in the concept of ‘de-democratization,’ meaning the decentralization and transparency of the democracy and institutions. This change follows the crisis in the functioning of the old liberal institutions, central authorities, and political classes who failed to translate social demands into effective policies and to transform legitimate interests into rights for all citizens. Because the political class is often not transparent and not able to make decisions that are consistent with people’s needs, we are facing now a crisis of trust exacerbated by the pandemic crisis that has now severely weakened the traditional liberal democracy. This fact caused a dramatic separation between political classes and civil society with tremendous effects on the real lives of millions of citizens.
Electoral abstentionism, anti-politics, and the emergence of new populist and nationalist parties are some of the more visible indicators of this effect. The blockchain is simply an expression of this ‘de-democratization’ of society. This technology summarizes perfectly this process that coincides with the idea of decentralization or distribution of power amongst a new society to increase transparency and equal opportunities for everyone not only for the elites of a few reach countries. This process that is a rethinking of the globalization influences and requires our participation in the future of information to share all the value that will be produced in any single economy.
The future of money is part of this evolution.
I believe that we will transform the world into a new powerful society based on the accessibility and control of value and own data with the capacity to create equal opportunities and make it a better place for all persons.
This article is the property of Alessandro Raffelini and may not be used without his express written permission. This is article represents the opinions of the Author. These opinions expressed do not constitute an investment prospectus or an offer of securities or an investment solicitation in general in the financial market.