Fiat currencies or cryptocurrencies? It depends on where you put your trust

Tuesday June 12 2018

By JOHN WALUBENGO
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I have deliberately avoided talking about cryptocurrencies, because I felt it would divert attention from its more important underlying technology – blockchain.

However, due to public demand and in light of the increasing interest in some of the more popular cryptocurrencies like bitcoin, it would be important to try to demystify the topic.

First, let us dispense with the definitions. What exactly is a cryptocurrency and how does it differ from “traditional” money or what is technically known as the fiat currency?

There are three elements that make up a currency: it must be a unit of account; it should be a medium of exchange; and it should have the capacity to store value.

The Kenyan shilling is a currency because it can be used to measure the value of goods and services. It is also a medium of exchange since we use it to purchase goods and services. Finally, it is a store of value because it can be saved, retrieved and exchanged at a later date.

The shilling also has the extra property of being designated as the legal tender as per the mandate of the Central Bank.

NO CENTRALISED AUTHORITY

Cryptocurrencies, on the other hand, are virtual currencies exhibiting all the three elements of a currency – except that they are not legal tender.

Which means that they are not issued nor guaranteed by any jurisdiction, and fulfill the currency functions only by agreement within the community of users of the virtual currency.

This in itself is not necessarily a bad or a good thing. It all depends on where you stand with regard to the centralisation versus decentralisation debate.

Either way, a virtual currency is not the same as electronic money (e-money) – which is a digital representation of the traditional or fiat currency. Mobile money, such as M-Pesa or Airtel Money, are therefore NOT examples of cryptocurrencies, since they are pegged and denominated on the traditional, national currency.

Cryptocurrencies have no centralised authority nor jurisdiction. They are issued and managed by a community of autonomous global computing systems under a shared consensus protocol.

Anyone and everyone is free to join or leave that virtual community that has a shared vision of what they feel is their (crypto)currency. The value of a cryptocurrency is therefore pegged on the perceived value the community puts in the cryptocurrency.

SAME FUNDAMENTALS

Many leading economists have therefore argued that cryptocurrencies are a hoax because they are not pegged on any economic fundamentals, but on the sentimental and speculative value of the cryptocurrency.

What they conveniently forget to tell the public is that fiat currency, whether it is the dollar, euro or Kenyan shilling, suffers the same critique – they stopped being pegged on the economic value of minerals or gold reserves way back in the 1930s after the great depression in the United States.

Essentially, the Sh1,000 note in your pocket is “worth” that value not necessarily because of economic fundamentals, but because the governor of the Central Bank said so – exactly the same “sentimentals” playing out in the crypto-world.

In other words, the fundamentals behind cryptocurrencies, whether misplaced or otherwise, are exactly the same ones driving the national currencies. The only difference is that in the crypto-world, the monetary policy is hard-coded into the software and cannot be manipulated.

PREDETERMINED AND HARDWIRED

For example, with regard to bitcoin, the number of coins projected to be in circulation and the frequency of their issuance are predetermined in the software at the point of launching the bitcoin network.

Only 21 million bitcoins will ever be minted and they are currently being issued into circulation automatically, at the rate of 12.5 bitcoins every 10 minutes.

On the other hand, the traditional fiat currencies do not have a predetermined and hardwired monetary policy but instead rely on a central bank’s monetary dispositions.

And that really defines the debate between cryptos and fiat currencies.

Do you prefer to subscribe to a centralised monetary policy determined by one human-driven trust agency or one predetermined by the instructions of a transparently coded software?

That is a debate that will continue to play out for a long time.

Mr Walubengo is a lecturer at Multimedia University of Kenya, Faculty of Computing and IT. Email: [email protected], Twitter: @Jwalu