Will cryptocurrencies be the basis of the digital economy of the future?

Cryptocurrencies stir quite a few conversations. Their relatively new or still little-known blockchain protocol, huge electricity consumption or speculation frequently appear in the newspapers. And yet, issuing banks of all nations and central banks around the world raise the possibility of fiat cryptocurrencies, state-backed cryptocurrencies.

How much are cryptocurrencies worth?

As of September 8, 2021, the global cryptocurrency market exceeds US$2 trillion. In European terms, €1.69 trillion. Although it sounds like a lot, it is not. By comparison, the global market of the 5,000 largest companies on the planet accounts for a total of $92.709 trillion, or €78.203 trillion.

Of course, the world market is enormously larger. Gold alone is already worth some €9.736 trillion, and silver about €1.176 trillion. All referred to the same date. In other words, cryptocurrencies have very little value relative to other assets.

As practically no cryptocurrency has been backed by other assets (with a few exceptions such as Tether, backed by dollars; Digix and PAX Gold, backed by gold; or Petro, backed by the Venezuelan National Government) their values are highly volatile. Their price changes rapidly, and they only depend on the value given to them by the people who use them.

Are cryptocurrencies stabilizing?

In practice, this means that cryptocurrencies are not, at least at present, a stable asset. Nor are they money, or at least not universally accepted money. Globally speaking, the number of online merchants that support cryptocurrencies tends to zero and those that do, support only a fraction of them.

However, they could be money at some point. According to some economic theories, with focus on the Austrian school, a value (wheat, cattle, copper, gold, dollars, …) becomes more stable as it is used and accepted by more players. Historically this has been the case, with nuances, although future values do not necessarily follow this behavior.

On the one hand, the value of a good depends on social acceptance and only fluctuates rapidly in the early stages of acceptance. After that, it tends to stabilize. When many people share the same means of payment, they expect it not to be volatile. The more volatile it is, the more it will be used for speculation, while the less volatile it is, the more it will be used as money.

Historically, when a certain good is widely accepted as a means of payment, that something tends to stabilize its price and therefore its value, because more agents acquire that something to make payments and even to do their accounting. The value consolidates and, although it is not static, its volatility is relatively limited, especially if it starts to be used as a means of accounting.

There was a time when accounting was done in grain, in heads of cattle, in valuable metals, and finally in fiat currency (backed by central banks). And in the future, some cryptocurrencies may be used as an accounting system, as well as a system for storing value and making payments. Cryptocurrencies could become money.

Energy consumption, the Achilles’ heel of the most common cryptocurrencies

The strength of cryptocurrencies as an accounting system and as money (or proto-money) is the reliability of the network. The weak point is undoubtedly the huge power consumption of its proof of work, a protocol widely used in decentralized networks such as blockchain and hash protocols on which the current cryptography of cryptocurrencies depends.

In the case of bitcoin and other cryptocurrencies, proof of work is a key element that enables authentication of transactions. In other words, it is an exceptionally reliable way for no one to cheat other users and submit false or erroneous ledgers. With today’s technology, attacking crypto-based decentralized networks with proof-of-work is nearly impossible.

However, it is this very proof-of-work that makes the power consumption of mining cryptocurrencies—a cryptographic verification process that allows reliable information to be added to blockchains—similar to the consumption of entire countries. This cryptocurrency model is not sustainable, although that does not mean that all cryptocurrencies are.

For example, IOTA is a type of cryptocurrency whose verification does not require increasing energy consumption. Without this being zero, it does resemble more closely the consumption of current banking transactions, but with a significantly higher degree of reliability. Moreover, in 2017 there were already many cryptocurrencies using less energetic protocols, and more will follow.

Cryptocurrencies as money, or fiat money with cryptographic features?

An alternative to optimizing cryptographic verification algorithms for cryptocurrencies is the cryptomonetization of fiat money, i.e., adding cryptographic protocols to fiat (backed) currency transactions. Thus, discussions have been raised about crypto currencies built on backed money, virtual currencies with many advantages.

Central banks have already considered issuing cryptodollars beyond stablecoins that use it as a backing (there are detractors); cryptographic euros (also with many critics); digital yen, currently in pilot tests, or cryptographic yuan, called DCEP or digital currency for electronic payments, for its acronym in English.

If cryptocurrency payments are still viewed with suspicion, because of the problems they have, more suspicion is caused by a radical change to the transaction verification system, for the same reason. However, this is not the first time changes have been made to improve the security of money. In fact, they constantly occur far removed from the attention of users.

Barter gave way to gold-based exchange by means of bills of exchange, and this gave way to drafts, checks or fiat money. This has evolved countless times, adding all kinds of security mechanisms both in physical bills and coins and through electronic payments. In this sense, fiat cryptocurrencies would be the next logical step.