Is this why cryptocurrencies are better than gold?

In October, I wrote a post about the fiasco that was Amazon’s New World game. They accidentally created a world where the supply of currency was limited and could not be increased. The result was a massive deflation and a collapse of the economy in that virtual world. I compared this scenario to what would happen if we return to a fixed gold standard or adopted a cryptocurrency like Bitcoin with its limited supply as standard.

As with every post I write about cryptocurrencies I got lots of responses from crypto advocates (and in this case also from gold advocates). The basic argument of gold advocates is that gold supply increases by a few percentage points each year from gold that is freshly mined. My counterargument is that this is true, but if you want to fight the collapse of an economy, you have to be able to temporarily increase the supply of money dramatically in order to prevent a run on banks or hoarding of good money (see my remarks on Gresham’s Law in the previous article). And economic crises don’t care if gold mines can produce enough output or not. So, a gold standard will inevitably lead to a deflationary economic collapse. This is why central banks had to abandon the gold standard in the Great Depression and why the financial crisis of 2008 would have been as bad as the Great Depression had we still been on the gold standard then.

But the crypto advocates had a different argument and one that is seemingly better. They argued that cryptocurrencies can adjust their supply with relative ease to react to changing demand. This is not true for Bitcoin with its stable demand, but it is true and actually happened for Ether. On 5 August 2021, the Ethereum Improvement Proposal 1559 (EIP-1559) was put into action. Since then, every new transaction that is included in the Ethereum blocks levies a base fee that is eventually destroyed. This means that the supply of new Ethereum tokens is curtailed by the base fee, thus creating a reduction in supply growth. This was done to prevent oversupply of Ethereum since this digital currency has no upper limit to how many Ether can be mined. But the same mechanism can be used in reverse to create additional supply should there be a need for it. Essentially, with a small coding change, the supply of Ethereum can be adjusted upwards or downwards at a moment’s notice.

This is great and should prevent a New World style deflationary collapse.

But assume we are using Ethereum as the standard currency. Who is going to decide when and by how much to increase or reduce the supply growth of Ethereum? The current methodology of democratic decision making about EIP is far too slow and too cumbersome to work in an emergency. Besides, assume that the UK adopts Ethereum as its currency. If the people in the UK decide that they need a higher supply of Ethereum but a majority of Ethereum holders in the world (most of whom will not be British or even live in the UK) decide that this is not a good idea, these foreigners can dictate monetary policy that applies to the UK. A democratic process run by owners of Ethereum worldwide clearly doesn’t work on a national level.

Thus, what one needs is a cryptocurrency that is controlled by the British and able to make fast decisions if there is an economic emergency. In order to make a quick decision one needs a group of experts that is competent enough to make the right decisions in the best interest of the people and that can act fast enough to implement changes in the supply of the cryptocurrency. And because they need to be able to act in the best long-term interest of people instead of every whim and populist call for more money, they should not be elected representatives of the people. We see in so many countries what happens if you elect populists.

But wait, don’t we have such a group of experts that are able to make quick decisions about the supply of currencies without being exposed to populist tendencies? Yes, we do. They are called central bankers. It is the reason why we have central banks in the first place because for centuries we have tried other ways of managing the money supply and they all failed. And this is why I am supportive of central bank digital currencies but not the dreams of cryptocurrency optimists who think that a decentralised currency will somehow be able to better for our economic wellbeing. I have not seen any solution to the problem of dealing with economic emergencies like the financial crisis, the Great Depression or the New World deflation crash coming out of the cryptocurrency world that is even remotely realistic. And I doubt there is one.