Can Digital Currencies Only Succeed With Government Backing?
Stability and reliability of value are necessary for a currency to serve a dependable purpose. This basic economic principle—also valid for fiat currency—highlights how decentralized digital currency can only succeed with government backing.
Currency purpose relies on four main factors. It must hold common acceptance, retain accurate valuation, and possess the ability to both incur debt and to be saved. Economics refers to these factors, respectively, as the exchange medium, value measure, deferred payment standard, and value storage.
Price Fluctuations
Cryptocurrency, by nature, is volatile due to price fluctuations. The instability of the medium means that its worth is difficult to measure with any level of preciseness. When currency values repeatedly change overnight, these fluctuations can cause inflation or deflation.
Dramatic rises in currency purchasing power over a short time can cause hyperdeflation. If this happened, it would result in more pronounced debts, goods and services price increases, and eventually a halt to spending and investment. Conversely, hyperinflation can occur when the currency value nosedives quickly. A volatile currency sweeping back and forth in extremes can lead to a spiral of unrecoverable highs and lows in the economy.
Bitcoin Variances
Bitcoin’s 2009 pseudonymous creation did not reach $1 in value until early 2011. In December 2017, the value rose to nearly $19k but then dropped to less than $8k by the following February. By December 2018, the value had halved to less than $4k.
The cryptocurrency saw a meteoric rise in 2020 to nearly $27k by the end of the year. And it more than doubled that by April 2021 to almost $65k.
Value can continue to fluctuate by 20% in just a matter of days. These inconsistencies cause chaotic changes in price, debt reconciliation, and savings. A service or good that costs 6 BTC in May 2020 would cost less than 2 BTC today but could cost 4 BTC in another week.
Likewise, a contract with a future payment date can lead to unpredictable results with dramatic changes in value. With such a high risk, businesses may be less inclined to offer credit. They cannot predict how much the cryptocurrency will be worth when the debt is due.
Balances in savings accounts would not have security for the same reasons. A catastrophic decline in cryptocurrency value is as unpredictable as a dramatic rise. And without stored value, it is similar to fiat money. Supply and demand determine its worth, rather than a physical commodity like gold or silver backing it. The difference is that governments back fiat money.
Why Cryptocurrency Can’t Be Stabilized
Economically supported traditional currencies maintain value with world trade, central banks, foreign reserves, and the ability to create more as needed. Money becomes worthless when authorities fail to sustain stability.
Decentralization makes cryptocurrency attractive to many people. But that decentralization is the reason for the inability to respond to fluctuations with a stabilizing system. It also means a lack of value protection because there’s no backing country.
Not Real Currency
Cryptocurrencies are unnecessary for obtaining legal goods and services accessible by the national currencies. Further, cryptocurrency lacks tracking of funds. Governments have expressed concerns over possible illegal and illicit use, including ties to terrorism, for these reasons.
Even for those who are just trying to play the market, the high volatility comes with high risk with digital token owners who sell too early or buy too late. Most people don’t want to spend their days speculating and tracking daily exchange rates.
This modern age is perfect for currency digitalization. But it needs to be implemented, regulated, and managed by authorities to keep the values realistic and control volatility. Blockchain opens up a variety of exciting possibilities. Still, it’s unrealistic to assume digital currencies without government backing will ever be stable enough to offer low-risk investing or use.