Stephen Kirchner directed me to a new white paper discussing a proposal for a cryptocurrency with a stable value. Here they motivate the proposal by pointing to some drawbacks of other types of cryptocurrency:
First, consider the merchants that do accept cryptocurrency payments today. Microsoft, Quickbooks, and Spotify, for example, allow customers to pay in Bitcoin using a service called BitPay. However, none of these merchants keep their money in Bitcoin—instead, they immediately convert any Bitcoin they receive into USD. Why? Well, these merchants are not in the business of speculating on Bitcoin. They don’t want exposure to Bitcoin market risk any more than they want to hold their money in barrels of oil. What if Bitcoin dropped 90% one day? . . .
Second, imagine trying to make a purchase using Bitcoin. Because merchants want to collect a fixed amount of USD for their services, you’re faced with a constantly adjusting BTC price for your potential purchase. This is a terrible user experience.
First a disclaimer. I couldn’t explain a blockchain if my life depended on it. While I’ve read many articles on cryptocurrencies, I have not retained anything that I read. So I have no opinion on cryptocurrencies in general, or this specific proposal (termed “Basis”).
The paper discusses several options for stabilizing the value of Basis. The solution that seems most sensible to me is to fix its value to the US dollar. It seems to me that this would make it more appealing to merchants. But other options are also considered, including stabilizing Basis in terms of the basket of goods in the CPI, or even more ambitious schemes that are consistent with the Fed’s dual mandate. Whichever definition of stability is adopted, the mechanism would involve a policy rule:
The Basis protocol accomplishes this by algorithmically adjusting the supply of Basis tokens in response to changes in, for example, the Basis-USD exchange rate. This implements a monetary policy similar to that executed by central banks around the world, except it operates as a decentralized, protocol-enforced algorithm, without the need for direct human judgment. For this reason, Basis can be understood as implementing an algorithmic central bank.
The FT reports than John Taylor has been an advisor on this project:
By this stage, it should have become clearer why Mr Taylor, advocate of rules-based monetary policy and critic of unconventional policy such as quantitative easing, became an adviser to the project.
Obviously this currency could be adapted in such a way as to stabilize Basis in terms of NGDP, rather than the CPI. While I hope they decide to go this way, from a strictly business perspective it probably makes more sense to fix it to the US dollar, at least for as long as the dollar is the dominant medium of account in the US. This judgment is not based on me having any cryptocurrency expertise; rather it’s simply an observation about revealed preference in the financial markets. When private firms create new financial instruments, such as a corporate bond, the payoff is usually in terms of nominal dollars, not inflation-adjusted dollars. I’d expect the same preference applies to cryptocurrency holders.
On the other hand, NGDP stability has enormous external benefits. I hope someone creates a cryptocurrency that is linked to NGDP, and uses a rule-based system (such as NGDP prediction markets) to keep its value stable. That would be a very useful demonstration project, which would advance the cause of tying the US dollar to NGDP.
I like reading this sort of paper, because it reminds me that history is moving in the direction of market monetarism. There is no stable equilibrium where the monetary policy regime does not result in the financial markets expecting steady growth in NGDP. Any monetary rule that falls short of that criterion will be provisional, likely to eventually be overtaken by a superior regime that delivers results more consistent with stable market expectations of NGDP growth. The “end of macro history” is a regime where the market sets the monetary base and fed funds rate at a level expected to lead to on-target NGDP growth.
READER COMMENTS
Michael Byrnes
Jun 26 2018 at 6:46am
Interesting. I don’t know much about cryptocurrency either, by my impression of Bitcoin is that it was developed by “hard money” types who massively overprioritized “store of value” above other characteristics of money, leading to something tha behaves more like an asset than a medium of exchange. (Particularly in light of the relatively high trasaction costs and slow transaction times that have emerged recently.)
It would have been interesting to see what sort of cryptocurrency market monetarists, or even just those economists who understand the unique properties that define a currency (which I think includes but is not limited to market monetarists).
The “sweet spots” the developers of Bitcoin should have, but didn’t, aim for were of ease of adoption by newcomers and utility in transactions (stable value with low transaction costs).
George Selgin
Jun 26 2018 at 8:03am
Very interesting, Scott. You may recall that I raised the possibility of an NGDP-stabilizing cryptocurrency in “Synthetic Commodity Money,” originally written back in 2012. You’re quite right to distinguish between a currency’s attractiveness to its holders and its “external” or macroeconomic advantages. It’s a point too many fans of currency competition–starting with Hayek–overlook.
Scott Sumner
Jun 26 2018 at 3:56pm
Michael, I think the key distinction is whether the new money just supplements an already dominant medium of exchange (i.e. the dollar), or if it takes over as the new dominant currency. If the former, I’d go for a fixed peg to the dollar, if the latter I’d go for NGDP stabilization, such as what George Selgin proposed back in 2012.
Gordon
Jun 26 2018 at 7:21pm
Michael, the notion that bitcoin was created by hard money types is being perpetuated by cryptocurrency advocates and this notion is parroted by clueless reporters. If you read the intro to the whitepaper by Satoshi Nakamoto who created bitcoin, he was concerned about the costs and delays in electronic funds transfers. And I have to give credit to Nakamoto for understanding that the costs and delays were due to fraud protection. He wanted something which would be fast and low cost even if it meant giving up such protection (and therefor be like using cash). He assumed that traditional financial institutions would never offer up this trade off. And this is the sole reason he created bitcoin. But in recent years banks in Sweden have offered fast low cost peer-to-peer electronic payments via a service called Swish. And in the US, banks offer a service called Zelle. I’m just waiting to see what happens to the cryptocurrency mania when the general public realizes that some countries have managed to go largely cashless without needing to resort to a cryptocurrency.
Michael Byrnes
Jun 28 2018 at 11:25am
Whatever the intent, a strong deflationary bias was built into the paradigm. And the result is a product that doesn’t function as a workable currency in most scenarios.
MikeW
Jun 26 2018 at 8:43pm
Something that occurs to me is how do you automate any of these schemes? The program behind the currency has to be able to get the CPI or NGDP or whatever automatically. What if the URL for that information changes sometime in the future? If it relies on reprogramming by someone to keep it current, then it would be susceptible to hacking.
Alan Goldhammer
Jun 27 2018 at 8:24am
Gordon writes,
To me this is the correct view of things other than those who object to government issued currency. Just yesterday I used my PayPal account to purchase an item from Amsterdam. The entire transaction went through just as fast as if it were a purchase from a US based retailer. I’m not sure what technology PayPal uses to encrypt their data and transactions, only that of the 150 or so transactions I have never had any issues. I also use Zelle from my bank to transfer money and that too is seamless. Right now the same cannot be said for any of the crypto-currencies.
custom
Jul 9 2018 at 2:07am
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