Cryptocurrenices ask you to put your trust in math and not in fallible central bankers, but they come with a lot of political baggage of their own.
In particular, cryptocurrency boosters talk a lot about how central bankers have debased currencies over the years and how the printing of money by central banks has done much to impoverish people around the world. In an imagined future world of cryptocurrencies, fallible and politically influenced central bankers are replaced with algorithms and currencies get more valuable over time, not less so.
There are a lot of problems with this narrative, starting with the fact that a little bit of inflation is actually useful and the painful era of stagflation is more than 30 years in the rear-view mirror. Independent central banks are among the most trusted institutions in our economies, and also the most transparent. And while the market capitalization of cryptocurrencies seems large by absolute standards, it’s tiny compared to the rest of the global economy. Daily trading of cryptocurrencies is between $5 billion and $6 billion right now. Daily trading on the foreign exchange markets is closer to $5 trillion.
Even if cryptocurrencies continue to grow (and they most likely will), if we want blockchains to deliver upon their promise, we must be able to transact using traditional fiat currencies. There are lots of practical reasons for this, the most important of which is the management of risk for enterprises.
Nearly all business transactions today are done in traditional fiat currencies. Traditional enterprises generate most of their revenue in those currencies and they also handle all their debts and payments in the same currencies.
In order for firms to transact on the blockchain, they will want to transact in those same currencies. If I have a deal to buy a product at a set price in euros, and I execute that contract on a public blockchain, then I also want to settle it in euros, most likely. Every time I move money between currencies or hold substantial amounts of a different currency, I’m adding foreign exchange risk to my business, which serves no purpose if it can be avoided.
One option for companies engaging in smart contracts on blockchains is to arrange payment settlement through the banking system separately and simply record that payment on the blockchain. This option works, but we believe it is a less-than-ideal solution when you start to consider the broader economic ecosystem that you are enabling on a blockchain.
All in one
The best option for companies entering into business contracts on a blockchain is to complete the full exchange of asset tokens within the same blockchain. Asset tokens (representing product) are exchanged for money tokens in the simplest format, but with all the tokens being represented in the same blockchain, more sophisticated options are possible. Companies can borrow against inventory, with loans repaid automatically upon the sale of the inventory, for example.
At EY, we’ve taken to calling this a “full cycle economic contract” as the gold standard for what enterprises will want to achieve using blockchains for commerce. Full-cycle digital contracts will not only be lower risk, since both assets and liabilities will be transparently managed on the blockchain, but almost any kind of financial service can be delivered against those flows with minimal cost for the transactions.
Ultimately, this means billions of dollars in tokenized fiat currencies must be available on the public blockchains to facilitate these transactions and payments. If this path does come to pass, however, it means that central banks will have to find a regulatory structure or approach that allows for multiple currencies and tokens to co-exist on public blockchains – networks they do not regulate or fully control. It also means that private central-banking blockchains are not necessarily likely to have a big role ahead.
We believe, however, that there are mechanisms for regulators to control their own currencies in decentralized public networks, and I will dive into that and more in my next post.