I continue to look into the problem and solution for cryptocurrency. Previously, I discussed The Protocol Layer.
The Price and Market Cap of Currency
What are the two metrics people look at If they want to judge the efficacy of a cryptocurrency? The first is price. Prices of cryptocurrencies are conventionally evaluated on the same basis as any equity listed on an exchange. Discussion about a cryptocurrency will likely originate on its current price, its recent and historical price fluctuations, and its perceived upside price potential. In the cryptocurrency world, the higher the cryptocurrency price, the greater its perceived value.
If price is the obvious definition for a successful cryptocurrency, what is the other metric that defines its value? The answer is market valuation or market cap. The supply of a cryptocurrency multiplied times its price defines its market cap. A list of cryptocurrency prices ranks them in descending order by market cap size. Bitcoin remains the cryptocurrency with the highest market cap. Proponents of bitcoin address its relevance and potential to its competitors in terms of market cap.
An observation of the efficacy of cryptocurrencies based on the two discussed metrics leads to the question: What are the price and market valuation of the U.S. dollar? Does anybody care? Cryptocurrency includes “currency” in its descriptive, so presumably, we expect it to act no differently than a global currency such as the dollar.
Let’s evaluate the dollar in the same terms as cryptocurrency. What is the price of a dollar? The price of a dollar is a dollar. That’s because the dollar acts as a unit of account, despite its fiat value, due to legal tender law. Legal tender is currency that one cannot legally refuse for payment of debt. The Coinage Act of 1965, specifically Section 31 U.S.C. 5103, defines legal tender as:
United States coins and currency (including Federal reserve notes and circulating notes of Federal reserve banks and national banks) are legal tender for all debts, public charges, taxes, and dues.
Due to the enforced power of the legal tender law, at the national level, the dollar is the sole means by which we can discharge our debts, public charges, taxes, and dues. In this sense, the dollar acts as a unit of account whose value is defined by itself and enforced by edict of government. Commodities, goods, and services inexactly define the value of the dollar in real terms. Changes in these prices may or may not indicate a change in the real value of the dollar. It is only against a stable monetary reference that the real value of the dollar can be measured. There exists only one monetary reference. It is gold. Gold defines the real value of the dollar, commodities, goods, services, and all monetary units—including cryptocurrency. The abandonment of gold in 1971 left the world with a floating dollar of no defined value. A myriad of government contrived indexes, academic theories, economist Hail Marys, and confused Fed policy tools attempt without success to define the dollar’s value. The result is monetary chaos. The reality is that when measured against gold, the dollar has lost 97.5 percent of its value since 1971.
A dollar whose value is defined by itself means that its market cap is the total dollar supply—the currency in circulation. The Fed accounts for dollars in circulation in its weekly H.4.1 statistical release. For the week of Feb 6, 2019, there are 1.794 trillion dollars in circulation. Some 60 percent of dollars circulate outside the United States. We could put the dollar at the top of the cryptocurrency price list as a means of reference between the dollar and cryptocurrencies. The dollar’s market cap of $1.794 trillion vastly exceeds the $1.32 billion market cap of bitcoin and all other cryptocurrencies. Thinking in terms of cryptocurrency, if the dollar’s market cap were to double, would we celebrate that increase in the same way that proponents would celebrate a double in bitcoin’s market cap? No. A rapid increase in dollars in circulation (dollar creation out of thin air), ceteris paribus, would likely represent a potential inflationary onset. Yet, advocates of cryptocurrency celebrate increases in the market cap of cryptocurrency as a desired outcome.
There should be no difference between how one evaluates the value of the dollar or the value of a cryptocurrency. Each must be measured against a monetary standard of reference, and each is governed by what defines a currency.
- a means of exchange
- a store of value
- a unit of account.
One can chalk up this confusion to the failure of economics as a profession. The consumer-centric demand-side model that monopolizes economic thought is analogous to Ptolemy’s errant earth-centric model that attempted to explain the astrological world. If the basis of an economic model is errant, then the conclusions drawn from that model will also be errant.
Cryptocurrencies defined by expectations of increases in their price is indicative of an asset rather than a currency. Indeed, cryptocurrencies, led by Bitcoin, are celebrated for their speculative potential, the same as any other speculative asset. To hodl, meaning to hold rather than transact, has entered the crypto lexicon as a defining characteristic of cryptocurrency.
The addition of crypto in front of currency does not somehow negate the role of currency. No expanding money-based society has ever existed with a fixed currency supply.
It is not the quantity of a currency that matters; it is its quality. The same applies to a currency’s market cap. It is not the size of the market cap that matters but the stability of value of the underlying currency that defines the market cap. One can only objectively measure a cryptocurrency’s value by evaluating its supply relative to demand against a stable reference. It is the flaw of fixed supply cryptocurrency that prevents its use as a transactional currency and instead has transformed it into a speculative asset that has stymied the promise of the blockchain.
There are limits to cryptocurrency as a speculative asset. It must have an underlying utility to support its speculative valuation. The primary utility of a cryptocurrency is to transact for goods and services—the same as any currency. Technology, solutions, applications, and capital are getting thrown at the crypto space by the best and brightest. The current state of the crypto world is like the Wild West. Yet, it is increasingly apparent that there is an inherent flaw with cryptocurrencies, and the expected solutions are not happening. Enterprises are not adopting the blockchain in significant numbers, and consumer transactions remain nil. Puzzlement over the lack of cryptocurrency adoption is a trending theme. It shouldn’t be. The solution is understanding currency defined by the Classical economic model.