The 2024 U.S. election has highlighted cryptocurrency as a key factor influencing voter sentiment and reshaping the political landscape. With public figures making bold statements and regulatory attitudes shifting, it's clear that digital assets are becoming a central policy focus. This trend, however, can be challenging for the general public and business leaders to interpret accurately. The fear of missing out (FOMO) can lead to impulsive financial decisions, underscoring a broader need to better understand the nature of money itself.
Money is not just a medium of exchange—it is part of a complex institutional system. This system includes rules for issuance, circulation, and settlement, as well as broader trade, tax, and social conventions. No currency can succeed based solely on technical superiority in payment functionality. The success of third-party payment systems, for example, stems from their optimization of existing monetary infrastructures rather than attempts to replace them.
Bitcoin and other cryptocurrencies have gained recognition as tradable assets due to features like scarcity and transparency, but they have not achieved their original goal of becoming widely accepted currencies. This raises critical questions: What are the true functions of modern money? Can cryptocurrency become a supranational currency? And how can these digital assets be integrated into the existing financial system?
This article revisits these foundational questions, offering a clear-eyed perspective on the potential and limitations of cryptocurrency within the framework of modern monetary systems.
Understanding the Expanded Role of Modern Money
Modern money serves far more functions than the traditional four roles: measure of value, medium of exchange, store of value, and means of payment. In today’s economy, money is also a vital tool for macroeconomic regulation and a foundational element for investment and financing.
The modern economy operates on a system of bank accounts. Money is created not only by physical minting but through the credit generation process of commercial banks. Governments and central banks adjust the money supply and policy rates to influence economic activity—a level of control that was not possible in the era of commodity money.
Historically, when liquidity was scarce, governments had to mint more coins, a process constrained by material and logistical limits. When there was too much money, they had few tools to withdraw it from circulation. Today, central banking and credit systems allow for more responsive and flexible economic management.
Moreover, the development of sophisticated financing methods—all relying on the existence of credit money—has fueled global economic growth over the past two centuries. Without the system of credit money, the vast array of financial instruments and deep financial markets we see today would not exist.
Therefore, any innovation aiming to replace or significantly alter the monetary system must account for these expanded functions—particularly as a tool of policy and as an enabler of complex finance.
Gresham’s Law and the Reality of “Dollar Hegemony”
The principle that “bad money drives out good” is often misunderstood. It operates under three specific conditions: the currencies must be of the same type and standard; the supply of good money must be insufficient; and the monetary system must be based on physical currency.
In competitions between different modern currencies, especially under fiat systems, the rules change. A currency with stable value will outperform an unstable one. Moreover, a currency with insufficient supply cannot achieve broad acceptance, no matter how well-designed.
Historical examples abound. Ancient Chinese copper coins like the Ban Liang and Wu Zhu are considered numismatic classics, yet later dynasties did not replicate them. This was not due to lost technology, but because copper supplies couldn't meet circulation needs. Subsequent dynasties experimented with high-denomination coins and even paper money to solve currency shortages, but without sound institutional management, these often led to hyperinflation and counterfeiting.
In the modern context, compare the U.S. dollar and the Venezuelan bolívar. The dollar’s dominance isn’t due to paper quality, but to the economic, political, and military strength of the United States, coupled with a stable financial system and capable risk management. The bolívar, plagued by devaluation, is not a contender on the world stage.
Similarly, the Singapore dollar is well-managed and stable, but its limited supply and the government’s focus on domestic stability mean it is not suited for international circulation. International currency status requires both confidence and scale.
While there is global frustration with U.S. monetary dominance, the dollar’s position remains secure because it is backed by a robust system. Competing currencies like the euro, yuan, or yen must offer similar institutional stability and depth.
Can Cryptocurrency Become a Supranational Currency?
Throughout history, the failure of a currency has always been a failure of its institutional arrangements and management.
The notion of a cryptocurrency becoming a supranational currency is more an institutional challenge than a technical one. There are two hypothetical paths: one where it replaces all sovereign currencies, and another where it runs in parallel with them.
The first scenario would require a unified global market with no barriers to trade or capital—effectively, a world without borders. The second scenario would likely see economic actors still preferring sovereign currencies for domestic transactions, reducing the supranational currency to a niche role.
Another major hurdle is consensus. Historically, commodity money gained acceptance through trade, but that acceptance was cemented when governments mandated it for tax payments. Bitcoin has gained value as an asset, but no authority has granted it universal status as a currency. If the U.S. government were to hold Bitcoin as a reserve asset, it might gain status similar to gold—but that would not make it a true currency.
Furthermore, the management of a cryptocurrency as a national currency presents profound difficulties. Modern economies rely on central banks to adjust money supply and interest rates. A cryptocurrency with a fixed supply, like Bitcoin, lacks the elasticity needed to respond to economic cycles. Replacing the existing account-based system with a purely cryptocurrency-based one is currently impractical.
Integrating Cryptocurrencies into the Modern Financial System
Since Bitcoin’s emergence in 2008, the crypto space has exploded with innovation. Most of these applications are financial in nature, highlighting the technology’s potential within the sector. The rational approach is not to reject cryptocurrencies for failing to become money, nor to champion them based on price speculation. Instead, we should explore practical applications within the existing monetary framework.
There are two promising directions:
- Developing crypto as a financial asset not pegged to fiat currency.
- Creating payment and settlement tools that are linked to fiat systems.
The Asset Path: Lessons from Gold
Gold became a financial asset due to its cultural symbolism, historical role as money, and practical uses. Not every metal achieved this status. Similarly, not every cryptocurrency can become a widely held financial asset like Bitcoin.
Bitcoin’s unique status may stem from four characteristics:
- First-mover cultural significance
- A unique issuance mechanism (public mining)
- Scarcity (capped supply)
- Immutable protocol rules
These traits have made it a “digital gold” for many investors. It remains to be seen whether other cryptocurrencies can replicate this combination to become storable, tradable assets.
The Payment Path: Three Innovation Vectors
If integrated thoughtfully, crypto technology could innovate payments in three ways:
- Central Bank Digital Currencies (CBDCs): A CBDC’s success depends not just on seamless payment technology, but on a solid institutional framework for issuance and management. It also requires embedding the currency into digital lifestyles. A standalone payment app, no matter how convenient, is less useful than one integrated into broader digital ecosystems.
- Stablecoins and Tokenized Instruments: Modern fiat money evolved from instruments like receipts and bills of exchange. Similarly, stablecoins and tokens could simplify domestic and cross-border payments, potentially reducing reliance on correspondent banking and even creating new systems outside the dollar network. However, with electronic banking and third-party payment systems already highly efficient, the unique use cases for stablecoins need clearer definition. JPMorgan’s JPM Coin, for example, has struggled to find scalable applications beyond niche corporate transfers.
- Digital Securities: Traditional securities like stocks and bonds represent claims on real assets. Blockchain technology can digitize these instruments, making issuance and trading more efficient. Hong Kong, for instance, has already experimented with blockchain-based green bonds. The long-term impact of this new trading paradigm is still unfolding.
Addressing Two Common Misconceptions
For cryptocurrencies to gain widespread financial utility, they must align with the core functions of modern money. Two ideas often miss this mark.
The Myth of Pure “Peer-to-Peer” Payments
Proponents often suggest that digital currencies should enable peer-to-peer payments for all money forms (M1, M2), bypassing the banking system. This overlooks a key point: the definitions of M0, M1, and M2 are based on the existing bank account system.
From a practical standpoint, businesses and individuals prefer holding funds in banks for security and yield. Converting all bank deposits into a form of peer-to-peer digital currency would essentially mean rebuilding the entire banking ledger system on a new technological base—a monumental task with questionable benefits. In such a system, trust wouldn't be based on bilateral agreements but on cryptographic verification.
The Limited Utility of Smart Contracts
Smart contracts can program money, locking funds for specific releases—a feature that could protect consumers in prepaid scenarios like rentals or gym memberships. However, this immobilized money exits circulation, reducing the effective money supply and limiting monetary policy transmission.
A more efficient alternative would be to use escrow accounts within the traditional banking system, which still protect payers while allowing banks to use deposits for lending—generating social value and remaining within the monetary policy framework. Smart contracts may find a niche in supply chain finance, ensuring dedicated use of funds without relying on a core company’s credit, but this requires seamless integration between digital currencies and bank accounts.
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Conclusion
Cryptocurrency technology holds significant promise for the financial sector. However, to harness its potential, applications must respect the principles of modern monetary systems. Some innovations may offer incremental improvements, while others could pave the way for transformative changes based on fully digital lifestyles.
These disruptions may give rise to new monetary functions and systems, but they are unlikely to completely replace the existing framework. The future will likely involve a coexistence of traditional and digital finance, each serving distinct needs within a complex economic ecosystem.
Frequently Asked Questions
What is the fundamental role of modern money beyond being a medium of exchange?
Modern money is not only a medium of exchange but also a critical tool for macroeconomic management. Central banks use monetary policy to influence interest rates and control the money supply, which helps manage inflation, unemployment, and economic growth. Additionally, the banking system's ability to create credit money supports lending, investment, and overall economic activity.
Why hasn't Bitcoin become a widely accepted currency?
Bitcoin lacks several key attributes of effective money. Its fixed supply makes it inelastic, unable to expand or contract in response to economic needs. It also operates outside any sovereign monetary system, meaning no government or central bank manages its value or accepts it for tax payments, which are crucial for establishing trust and widespread adoption.
Can any cryptocurrency achieve the status of a global reserve currency like the U.S. dollar?
It is highly unlikely in the foreseeable future. The U.S. dollar's status is backed by the size and strength of the U.S. economy, deep and liquid financial markets, political stability, and a robust legal framework. A cryptocurrency would need similar institutional backing and global trust, which requires coordination among nations and a legal framework that does not currently exist.
What are stablecoins and how do they differ from cryptocurrencies like Bitcoin?
Stablecoins are a type of cryptocurrency designed to maintain a stable value by being pegged to a reserve asset, like a fiat currency (e.g., the U.S. dollar) or a commodity. Unlike volatile cryptocurrencies such as Bitcoin, their primary goal is to serve as a reliable medium of exchange and store of value within digital ecosystems, bridging the gap between traditional finance and crypto.
What is a Central Bank Digital Currency (CBDC) and how would it work?
A CBDC is a digital form of a country's fiat currency, issued and regulated by the central bank. It represents a direct liability of the central bank, making it a risk-free form of digital money. It could be used for everyday transactions by individuals and businesses, potentially offering the benefits of digital currency while maintaining the stability and trust of the traditional monetary system.
Are smart contracts on blockchain networks a efficient way to handle payments?
While smart contracts offer automated, trustless execution of agreements, they can be an inefficient way to lock up funds for payments. Money held in a smart contract is effectively taken out of circulation, which reduces the funds available for lending and economic activity. Traditional banking mechanisms like escrow accounts can often achieve similar consumer protection without immobilizing capital.