Elastic Cryptocurrency Supplies: A Step in the Right Direction

A major shortcoming of bitcoin and most other cryptocurrencies is the way in which their supplies are governed. With a perfectly inelastic supply over the relevant time horizon, a change in demand is entirely reflected by a change in the cryptocurrency’s price. Since demand shocks are relatively common, this means that cryptocurrencies are subject to high price volatility.

Volatility can be a desirable feature for a financial investment that tries to capture capital gains. But it is a major impediment to cryptocurrencies becoming more widely accepted as a medium of exchange. Hence, the observation that bitcoin and other cryptocurrencies have become financial assets does not mean they are necessarily on the path to becoming new monies.

The problem with a constant money supply is not unknown to those in the cryptocurrency world. A new cryptocurrency project, Basis (formerly known as Basecoin), is being developed with a specific focus on achieving price stability. The Basis white paper explains that it will initially be coded to stabilize a chosen price index in U.S. dollars (the CPI, for example) and eventually move on to stabilize a price index measured in Basis. Price stability, Basis proponents hope, will make it more acceptable as money.

A fixed money supply is not a good monetary rule and efforts to move toward more elastic supplies should be welcomed. But those efforts would also be well-served by careful consideration of how the supply should respond to various shocks. In particular, price-level stability should not be confused with monetary equilibrium. It is true that, under certain conditions, monetary equilibrium yields price-level stability. It does not follow, however, that achieving price-level stability necessarily yields monetary equilibrium. Maintaining price-level stability in the event of a productivity shock, for example, will tend to do more harm than good.

A better approach would attempt to achieve monetary equilibrium by stabilizing a measure of per capita nominal income or, alternatively, a price index of nominal wages. Such an approach is superior to maintaining price-level stability because it distinguishes nominal shocks, which warrant a supply adjustment, from real shocks, which do not.

Basis is a step in the right direction and might indicate that the standard view of how cryptocurrency supplies should behave is improving. But there is still much room for improvement.

Sign up here to be notified of new articles from Nicolás Cachanosky and AIER.

Nicolás Cachanosky

Nicolás Cachanosky is an Assistant Professor of Economics at Metropolitan State University of Denver. With research interests in monetary economics and macroeconomics, much of his recent work has focused on incorporating aspects of financial duration into traditional business cycle models. He has published articles in scholarly journals, including the Quarterly Review of Economics and Finance, Review of Financial Economics, and Journal of Institutional Economics. He is co-editor of the journal Libertas: Segunda Época. His popular works have appeared in La Nación (Argentina), Infobae (Argentina), and Altavoz (Peru).

Cachanosky earned his M.S. and Ph.D. in Economics at Suffolk University, his M.A. in Economics and Political Sciences at Escuela Superior de Economía y Administración de Empresas, and his Licentiate in Economics at Pontificia Universidad Católica Argentina.