At Davos, the world’s most powerful Central Bankers have found a new enemy: “crypto.” But as they attempt to describe what is wrong with crypto, they slip between different definitions and understandings of the word, suggesting they don’t have a clear picture of the phenomenon they claim to oppose — or its benefits.
Very simply, cryptocurrencies are a form of money for the internet age. They don't make sense in a world without the internet, but in a world with the internet, they are inevitable.
The "crypto" in cryptocurrency refers to the technology — cryptography — that enables these natively digital currencies to circulate without counterfeiting or duplication. Saying "cryptocurrency" is therefore like saying "paper currency": While paper currencies are printed on special papers made of specific fibers, watermarks, and other security features, cryptocurrencies are defined and circulated using the tools of advanced cryptography and distributed ledgers, sometimes called blockchains.
Paper currency can represent a hard asset, like gold; an intangible “asset”, like sovereign fiat; or nothing at all, in the case of fraudulent schemes or collateral that has lost its value. This means that paper currency is not inherently valuable or worthless — it’s a question of what the currency is "backed" by. Cryptocurrencies are no different. As Christine Lagarde, president of the European Central Bank, and Kristalina Georgieva, managing director of the International Monetary Fund, pointed out in Davos, stablecoins — which are a type of cryptocurrency — can have value if they are backed 1:1 with sovereign fiat currencies.
But Georgieva made an even stronger claim about money than simply that it must be issued by sovereign governments: She said it must also be a "stable store of value." So what does "stability" mean? The US dollar — the world’s most widely-used sovereign currency since the end of the Second World War — has lost over 96% of its value since it was first introduced in 1913. Is it "stable" because the decline in value occurred over a century, rather than a week? If so, what timeframe for devaluation does the IMF propose as the benchmark for a currency’s stability?
Most Central Banks answer this question by setting implicit or explicit inflation targets — in other words, by using monetary policy to control the rate by which prices increase each year. Inflation of around 2% is a sort of informal global consensus target, though some countries target more and some less. When economies are strong, these inflation targets can often be reliably achieved, giving their currencies a sense of stability. During times of economic crisis, however, Central Banks use monetary policy to try to prevent recessions and depressions by stimulating spending and lending. This often means lowering interest rates and “printing” money: injecting billions or even trillions of dollars into the economy, generally through commercial banks. Such policies often have the direct result of increasing inflation, for the simple reason that more money is now chasing fewer assets.
This highlights the paradox at the heart of Central Banking: the more Central Banks intervene to “save” the economy by “printing” money, the less that money is worth–and the more debt the government accumulates. The more indebted a government becomes, the more banks and investors lose confidence in the government’s ability to pay its debts. This makes banks more reluctant to lend (counteracting the ostensible purpose of the injected liquidity) and causes the interest on government bonds to increase. When governments can no longer pay even the interest on their debts, sovereign default occurs. The process above has been called “the doom loop” by economists, and that is squarely where many of the world’s countries find themselves today.
Central Banks around the world adopted the above countercyclical policies during the COVID-19 pandemic. IMF Director Georgieva acknowledged recently that this response has had a strong accelerating effect on inflation, which is now at historic highs in countries around the world. But skyrocketing inflation is not simply the result of Central Bank stimulus in response to COVID-19; it has roots in Central Bank interventions going back many years, which have resulted in an unprecedented accumulation of sovereign debt worldwide. Most recently, between 2016 and the end of 2021, global debt-to-GDP ratio increased by 30% to an extraordinary 356%. For reference, 130% has been the historical threshold for sovereign defaults. In other words, COVID-19 spending only made a bad government debt situation worse.
One might well ask, then, whether fiat currencies are indeed “stable stores of value.” Indeed, for those looking to preserve and grow their wealth for a generation or more, storing that wealth in a commodity like gold — which has about quadrupled in value since 1915 — may justifiably appear much safer than storing it in a government-issued currency. This long-term preservation and growth of wealth is precisely the value provided by bitcoin, the original cryptocurrency, and the one that Davos elites are most hostile to. Because bitcoin is stateless, generated through a leaderless proof-of-work computational process, it more closely resembles a commodity like gold than scrip issued by a centralized authority. Yet, many government officials see a currency that reliably loses value over time–but which they can influence–as more “stable” than a currency that, despite near-term volatility, reliably grows in value over the long term.
In other words, Central Bankers at Davos have made clear that they don’t like “crypto” because it forces them to challenge their assumptions in two major ways: First, bitcoin has offered the world an off-ramp from devaluing fiat currencies and a safe haven for long-term wealth building that Central Banks cannot directly influence. The second counterintuitive proposition is that stablecoins, when properly backed by fiat currencies as Central Bankers recommend, may offer precisely the kind of support for sovereign debt that dries up during doom loops by introducing new, global demand for fiat currencies issued by fiscally weak states.
Yet perhaps the most challenging aspect of cryptocurrencies for the Davos elite is that they seem to be preaching to a shrinking choir. Only a week earlier, representatives from 32 Central Banks and 12 financial authorities met in El Salvador, the first country in the world to declare bitcoin legal tender. These government leaders from countries across Latin America, Asia, and Africa represent countries that have been historically beholden to economic policies dictated by multilateral institutions like the IMF and the World Bank — to their great detriment. Today, they are envisioning a new economic order backed by bitcoin — a currency that no country or group of countries controls.
A New Bretton Woods is happening, but not at Davos. All thanks to the power of cryptography and the internet.
Natalie Smolenski, Fellow with the Bitcoin Policy Institute and Executive Director of the Texas Bitcoin Foundation.