Cryptocurrency, inflation, and the elephant in the room

7 December, 2019

There is an English idiom that speaks about the 'elephant in the room'. When an English speaker says there is an elephant in the room, he is insinuating that there is something that is very important and rather obvious that no one wants to discuss. A good example is government spending. Leaders love to talk about tax cuts and fiscal restraint while at the same time spending more money than they have to spend. Their overspending is the elephant in the room.

There is an elephant in cryptocurrency's room as well. While analysts speak of prices moving one way or the other, this elephant is standing tall just waiting to be noticed. While governments try to figure out how to regulate cryptocurrency, Facebook is foundering in its attempt to get Libra off the ground, and China sends signals that are more mixed than a bag of nuts, this lumbering elephant wanders around grazing.

So what is the elephant in the room? The reality that cryptocurrency is worthless, at least monetarily, without fiat. Such thinking probably goes against all that cryptocurrency purists hold to be true, but stop and ask yourself one question: how is the monetary value of a cryptocurrency determined? Every cryptocurrency is measured against the U.S. dollar to determine its price.

Selling cryptocurrency tokens

Bitcoin was the first commercially viable cryptocurrency when it was launched more than a decade ago. Its price was not all that remarkable in the first couple of years given the fact that very few people knew what Bitcoin was or what it could do. But once people caught on, BTC suddenly had value. There was only one problem: getting your hands on the tokens without actually being a coin miner required a financial investment.

In other words, you had to spend fiat in order to acquire BTC. Many people did, which caused Bitcoin's price to start climbing. That inspired other cryptocurrency developers to launch their own projects as well. Thus, the initial coin offering (ICO) was born. The result was a marketplace in which all sorts of crypto tokens were being bought and sold.

Let's say you are in the market to obtain Bitcoin for the very first time. There are a few ways for you to get your hands on your first coins. First, you can sell some sort of asset for Bitcoin. Second, you can invest in purchasing some computer hardware and start mining. Third, you can go on to any exchange and simply buy BTC. It is this third option that most people utilize.

Buying BTC is a lot like buying stocks. You deposit fiat with an exchange, browse exchange listings for a favorable deal, and make your offer. Boom! Now you own BTC. But remember that you traded fiat to get that BTC. Should you decide to sell it later, what will you get in return? Either fiat or some other cryptocurrency.

Inflation invites cryptocurrency

For something to qualify as an elephant in the room, it has to be big and obvious enough as to not be avoidable. People have to purposely overlook it because they do not want to deal with its reality. Cryptocurrency being tied to fiat qualifies based on how people view cryptocurrency as an asset. To understand this point, we look to a couple of recently released reports from Coinshares and the World Gold Council.

Data from both reports show an interesting trend among millennials and their younger Gen Z counterparts. The data shows that consumers are losing confidence in fiat due to double and triple-digit inflation in many places around the world. We already know of Venezuela's hyperinflation and the bottom falling out on the bolivar, but Venezuela is not alone.

From Argentina to Zimbabwe and Turkey, inflation is killing national economies. Governments do not seem to know any solution other than printing more money and placing artificial price controls on goods and services. Increasingly, consumers are looking to cryptocurrency as their own hedge against inflation.

Cryptocurrencies like Bitcoin and Litecoin offer a modest amount of inflationary protection as long as consumers and merchants agree to use them to cover their transactions. In a perfect world, a community would not even need fiat if every merchant and consumer agreed to honor one or two cryptocurrencies. But this is not a perfect world. Therein lies the difficulty.

Before cryptocurrency existed, global consumers protected themselves against inflation by purchasing a stronger currency. More often than not, that stronger currency was the U.S. dollar. As the world's favored reserve, the U.S. dollar maintains a stable value across the globe - even when the U.S. is facing inflation. People bought dollars because they knew there would always be value in them AND they could spend those dollars just about anywhere.

Cryptocurrency does not enjoy that same luxury. It is fine to put all your money into Bitcoin in order to protect yourself from inflation, but what if you can't spend your coin with most of your favorite merchants? You still need fiat to pay for goods and services. Thus, you haven't really gained anything.

Good but no panacea

None of this is to say that cryptocurrency is bad and fiat is good. Nothing could be further from the truth. Cryptocurrency is a very good thing with very legitimate uses. But it is no panacea. Cryptocurrency cannot solve the world's economic woes all by itself. It cannot prevent inflation either. All it does is give consumers an alternative monetary system through which to conduct day-to-day business.

What must be understood is that inflation is neither normal nor organic. Inflation does not just occur by itself. It is the result of intentional manipulation by both government and its central bank partner. Furthermore, inflation is used as a tool to control economics. There is nothing about cryptocurrency capable of changing that fact.

As long as consumers continue buying cryptocurrencies with fiat, there will not be any way to decouple the two. As long as crypto project developers continue offering ICOs, their projects will be defined by their value in fiat. Again, there is no decoupling. This is neither good nor bad. It simply is.

If there's anything alarming about all of this it is the fact that younger people are looking to cryptocurrency as protection against inflation without fully understanding what inflation is, how it works, and why it affects the value of their cryptocurrency holdings. Ignorance about inflation and government monetary policy are two of the contributing factors that gave rise to cryptocurrency to begin with. Remaining ignorant about them doesn't help.

Stablecoins could be the solution

If cryptocurrencies inexorable linked to fiat is the elephant in the room, is there any way to get rid of said elephant? Absolutely. Dealing with the issue means finding a way to separate cryptocurrency from fiat with a clean break that cannot be restored. Enter stablecoins.

Have you wondered why so many world governments seem to be so panicked by Facebook's Libra? For all its imperfections - including more intrusion by Facebook - Libra could theoretically displace fiat if it were pervasive enough and Facebook decided to back it with a basket of securities rather than fiat.

Governments and central banks understand the threat to their own economic control posed by a stablecoin from a company that already has global reach. Allowing Libra to prosper in a completely unregulated and unfettered environment would be a big problem for central banks and fiat currencies. And if fiat ever takes second place to any stablecoin, government control over economics ceases.

It is not likely that Libra will ever get off the ground. There are just too many problems attached to it. However, that does not mean another stablecoin couldn't come in and do what Libra could not. A strong stablecoin could truly displace fiat if backed by a strong asset and supported by solid infrastructure.

The right idea

Venezuela had the right idea in launching Petro as a way to get around economic sanctions and restore confidence in its economy. Unfortunately, Petro is backed by the country's petroleum assets which are, themselves, worthless. Exacerbating the issue is the reality that Venezuela's government leaders will not relinquish control of the economy.

Imagine a scenario in which a stablecoin rose to a prominent place in a powerful, first-world nation. Imagine the government and central bank of that nation backing off and allowing the stablecoin to survive or fail on its own merits. Provided the stablecoin was backed with some asset other than fiat or government securities, it would have a very real chance of succeeding. It would not be dependent on the U.S. dollar for its intrinsic monetary value. It would also not be dependent on America's economy.

There is an elephant in the cryptocurrency room. That elephant is the fact that cryptocurrency's monetary value is intrinsically tied to fiat. Maybe someday there will be a stablecoin capable of changing that fundamental truth. Until then, crypto users will continue sidestepping the elephant in hopes of not getting trampled on.