Global monetary inflation. Can digital (crypto) currencies play a role?

What is Money? Money, in general, can be defined as a medium of exchange in the form of coins and banknotes. Paper money, (or also called Fiat money), has been in use for more than 1000 years, with its first recorded use in China around 1000 AD. Its adoption increased slowly but steadily around the world, and by 20th century, it was a dominating medium of exchange throughout the world.

Money has its various functions like it’s a medium of exchange, measure of value, standard of deferred payment, and store of value. To fulfill these functions, money also possess few properties like fungibility (interchangeability), durability (for repeated use), portability (for easy transport), cognizability (easily identified value), and stability of value.

The last property, stability of value, means that money has a value; i.e. how much of a certain product you can purchase with a given amount of money. In other words, it means the price of a product in a given economy. For fiat money, prices of products have a very close relation with its money supply. The theory which discusses the relationship between prices and money supply is called ‘Quantity Theory of Money’. It simply proposes the exchange value of money is determined like any other good, with supply and demand. According to this theory, increasing money supply would reduce its relative demand, driving it to lose its intrinsic value, which would result in inflation.

In simpler words, if the amount of money in an economy gets doubled, as a result, the relative price levels would also get doubled, hence causing inflation.

Fast forward to 2008, a pseudonymous entity called ‘Satoshi Nakamoto’ published a whitepaper for “A Peer-to-Peer Electronic Cash System”. It was named as “Bitcoin”. Before Bitcoin, there had been a number of attempts to create a centralized digital cash system during the 1990’s, and all of them had failed. Satoshi’s distinction was that he/she/they found a way to build a decentralized digital cash system. This meant that no central authority (banks, governments) could control its creation, transfer or distribution, and all transactions gets verified by random set of people, called ‘miners’.

This formed the basis for cryptocurrencies.

Fast forward few years and in 2013, then 19-year old Vitalik Buterin published a whitepaper to introduce a new blockchain platform called “Ethereum”. It had the capability to support smart contracts, which meant it was now possible to write software programs which would automatically execute business rules/logics, and spawned a new era for development of decentralized applications, or dApps. Its inherent cryptocurrency is called ‘Ether’.

Skip to 2017, among many other things, this year would be remembered as the year of ICO’s. ICO stands for Initial Coin Offering, also known as TGE (Token Generation Event) is similar to an IPO (Initial Public Offer), where the blockchain startups raise capital through crowdfunding. The main difference is the buyers are given the coins/tokens (instead of shares) associated with the blockchain application/product. Unlike IPO, buyers are not liable for any equity or partnership in the company, nor do they have any influence in the decision making of company’s future.

Welcome to 2018.

While there remain a large group of people still uncertain of Bitcoin uncertain value and future, it is now often referred to as ‘digital gold’. Market capitalization of bitcoin currently sits at $120+ billion USD, after reaching a maximum of $334.6 billion USD in Dec, 2017.

Ethereum’s market capitalization is currently $50+ billion USD, after reaching a maximum of $134.7 billion USD in Jan 2018.

In total, there are more than 1600 cryptocurrencies with dozens coming every week.

Total market capitalization of all cryptocurrencies currently sits at around $300 billion USD, after reaching a maximum of $823.2 billion USD earlier this year in January.

Although I am a believer in blockchain technology and the impact it can have on the global industries, I do not wish to advocate for its adoption or speculate anything for its future value. Rather, I want to raise some queries, to which I hope I can get some answers.

QTM, or Quantity Theory of Money, tells us if the money supply is increased in a given economy, it will cause inflation. The way I see it, Token Generation Event (TGE) is similar to printing new money, tokens are created out of thin air, and they are assigned a corresponding dollar (ETH, BTC) value.

When the tokens are listed on exchanges, their value/price fluctuate from high to bottom all the time, based on market dynamics, speculations, among other factors. As mentioned before, the total market capitalization of all cryptocurrencies is around $300 billion USD, which again, the way I see it, is equivalent to additional $300 billion dollars sitting in people’s crypto wallets, which can be cashed out any time they want it. 

I concur that cryptocurrencies don’t have much real world utility yet, and while they are not spent to make everyday purchases, they won’t have much impact on the global economy. However, their utility rate is increasing very aggressively, and after next 12–24 months, it might not be very uncommon to see people using crypto currencies to make everyday purchases.

When this happens, assuming overall market capitalization for all cryptocurrencies remain the same as it is today, it would mean the world would have around $300 billion USD more to spend.

This market capitalization could go beyond $1 trillion USD in couple of months’ time. How would that affect, if this can affect at all, monetary inflation on a global scale?

Next Steps:

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