Can central banks and crypto peacefully coexist?

11 April, 2019

There is an interesting dynamic at work in the relationship between cryptocurrency platforms and central banks. Both systems have their fan boys and die-hard detractors seemingly unable to find some middle ground. On the one hand are those who believe central banks are the be-all and end-all of economics. On the other is a group of crypto evangelists looking forward to the downfall of fiat. Can they ever get along? Can central banks and crypto peacefully coexist?

We raise these questions in response to a March 17 (2019) Crypto News post from mathematician and crypto analyst Juan Villaverde, a piece that talked about the world's four largest central banks once again criticizing cryptocurrency. To his credit, Villaverde did not take the typical view of the crypto evangelist. He asked some reasonable questions and offered some reasonable responses.

It appears as though Villaverde is not so sure that extreme views on either side are correct. He sees reality somewhere in the middle. We tend to agree. It's not likely that fiat will ever be completely replaced by pure cryptocurrency in a decentralized format. The world and its governments just have too much invested in central banking authority. But there definitely is room for crypto to work alongside fiat to give people more freedom to choose how they want to invest, use, and spend their assets.

Arguments against cryptocurrency

For the purposes of continuing this discussion, let's look at three anti-crypto arguments Villaverde says are put forth by centralized banks. The first is that crypto allegedly creates concerns over financial stability and thereby increases the risk central banks face in their attempt to prop up their respective economies.

With all due respect, nothing could be further from the truth. Even at its peak price of around $20,000 per coin, Bitcoin never introduced instability to the world's financial markets. It never threatened the dominance of the US dollar as the world reserve. Concerns over stability are completely unfounded if you look at things from a historical perspective.

The second argument is that crypto amounts to nothing more than young people trying to create their own money. That argument is true, but why is it a bad thing? If the free markets truly are the fastest and most reliable means to economic prosperity, shouldn't people be able to trade with one another using whatever currency they see fit?

It is strange that no one balks at the age-old practice of exchanging agricultural products for goods and services. Yet that ancient practice still goes on today in many parts of the world. No one is accusing farmers of creating their own money when they trade chickens for household goods. So why is crypto any different?

Finally, the third argument states that there is no need to create new money because fiat is working fine as it is. In a sense, that is also true. Fiat is more than adequate as a monetary system and a way to pay for goods and services. There is nothing inherently wrong with it.

The argument against fiat is not in a particular currency itself, but in who controls that currency. Therein is the main difference between fiat and cryptocurrency. Fiat is controlled by governments and centralized banks. Crypto is controlled by the community. And when you boil away all of the superfluity, that is really the issue. Crypto communities want to take control back while central banks do not want to give it up.

Most likely scenarios

Villaverde closed out his piece by suggesting a few possible scenarios for the future. Each one is worth exploring. Note that the likelihood of one of the scenarios coming to fruition is far greater than the likelihood of either fiat or cryptocurrency imploding and completely failing.

1. Central banks create digital currency

The first scenario has central banks ultimately creating their own digital currencies that go on to replace fiat. This scenario is likely to play out in at least some form for the simple reason that it is already happening. From Canada to the US and the UK, governments are already working on developing digital currency platforms based on blockchain.

Such digital currencies will not be crypto in a traditional sense. Why? Because they will not be decentralized or permissionless. They will not function outside of government and central bank control. They will be, more or less, digital representations of the fiat they replace.

Establishing government-backed digital currencies would benefit governments in that they would no longer have to print money. They could convert hybrid financial systems to completely electronic systems. They could introduce the same sorts of security features already found in cryptocurrency platforms to reduce fraud, counterfeiting, money laundering, etc.

2. Government-backed digital and crypto work together

The second scenario is the most likely of the three to happen. It involves an environment in which government-backed digital currencies and crypto both exist and work together. Digital currencies created by governments and controlled by central banks would replace paper bills and metal coins. Their accounting systems would be based on blockchain and distributed ledger systems just like crypto.

In the meantime, consumers would be able to freely purchase their favorite cryptocurrencies and use the digital tokens to buy and sell. Merchants would get on the crypto train once they realized it is safe and secure. Crypto would become what digital payment systems currently are: a way to pay for things instead of a separate monetary system.

Under this scenario, you would be able to trade your digital fiat for something like bitcoins. Then you would be able to use those bitcoins to play Mega Moolah online, pay for a meal at your favorite restaurant, or purchase airline tickets for your holiday. You would be able to convert your bitcoins back into digital fiat anytime you like.

3. Cryptocurrency takes on a life of its own

The third scenario is one in which cryptocurrencies continue to expand until they eventually take on life of their own. In other words, cryptocurrency could continue to grow and expand as a monetary system to the extent that it creates a shadow economy completely separate from fiat currency and the traditional banking sector.

Could this sort of shadow economy work and still remain legal? Under the current environment, yes. Cryptocurrency is a recognized payment system in many parts of the world. The only way that would change is if governments made concerted efforts to ban buying and selling with crypto. That is not likely to happen any time soon.

Under such a scenario, buying and selling with cryptocurrency would be similar to bartering. The value of any given token would be determined by the goods or services that back it up. For example, let's say you are a carpenter and a member of the Bitcoin community.

You use bitcoins to pay for the supplies and equipment you need to do your job. By the same token, those you purchase from hire you to do their carpentry work. They also pay you in bitcoins. You and your vendors are essentially bartering goods and services represented by digital coins.

Peaceful coexistence is possible

A brief look at history suggests that a peaceful coexistence between central banks and cryptocurrency platforms is possible. History shows us that there are very few watershed moments that bring drastic change to the world overnight. Rather, social and economic evolution takes time. So does technological evolution.

The most ardent crypto evangelists who expect to wake up one day and discover that Bitcoin has taken over the world often fail to realize just how old Bitcoin actually is. The platform was first introduced in January 2009; it had been in development for several years before that. It is still no closer to world economic dominance than it was a decade ago.

Likewise, the world's fiat currencies were not created overnight. Central banks did not accumulate the control and authority they now exercise in a matter of weeks. They are what they have become over generations of evolution.

This same history suggests that the relationship between central banks and cryptocurrencies will continue to evolve over time. And during that evolution, the two will coexist on the same plane to one degree or another. What we do not know is how everything will turn out.

Cryptocurrency has a rightful place

In closing this post it is important to note that cryptocurrency has a rightful place at the table. Central banks and their leaders may sometimes give the impression that they are the sole arbiters of economics, but they really are not. Human beings have an innate desire to be free. They will pursue that desire one way or another. They will pursue that desire even in their own economics.

It would be wise for central banks to accept the fact that cryptocurrency is here to stay. It is not going anywhere, ever. It would also be wise for cryptocurrency enthusiasts to understand that the centralized banking system is far too entrenched to fail. It is not going anywhere, either. If both sides could dial back the rhetoric and accept the reality of the other's existence, they could make great strides toward peaceful coexistence.