Cryptocurrencies might appear to be a natural step in the evolution of money—from metal coins to paper notes to digital bits, with each step allowing for a more effective means of payment. However, as economic historian Barry Eichengreen argues in a recent NBER working paper, “there is no straight line from commodity money to fiat money and from there to crypto, nor from metallic currency to paper currency and from there to digital.” The history of money is replete with many strange episodes along the way.
So what does the history of money tell us, especially about recent developments in cryptocurrencies? According to Eichengreen, one broad trend is discernible from the historical record: “There has been a tendency over time for political jurisdictions and inhabitants of common economic spaces to converge on a single currency.” There are notable exceptions, such as the United States from 1830 to 1860, but convergence has been the norm.
The convergence has come from two different forces, one political and one economic. The political reason for convergence mirrors the convergence of modern states. Early modern states rose and fell with their ability to finance wars through their control of the mint, as Josh Hendrickson has pointed out.
Today the political reason for convergence is less important; seigniorage is no longer essential to fund national defense. Instead, “the argument for government monopoly of money issuance must rest on the economic efficiency of a currency that is both uniform (because there is only one issuer) and stable.” If all my purchases are in dollars, from my local grocery store in Minnesota to my custom “Economics Rules!”-engraved cheese board from an Etsy shop in California, I do not need to worry about exchange rates. A dollar is a dollar is a dollar. That lowers the cost of finding information needed for transacting. I also do not need to worry about the credibility of the issuer, the U.S. government.
This force of economic efficiency from the lower information costs of fewer currencies is also why we generally only interact with a few digital payment services like Visa and Mastercard. The credit card companies provide protection from default, and a dollar credit from Visa is easily and reliably converted into a dollar one-to-one. In addition, as Eichengreen notes, consolidation of currency “substitutes for information in the sense that it is not necessary to have information about the creditworthiness of each and every issuer, there being only one.”
Cryptocurrencies stand against a long-run consolidation of currencies — from the hundreds of mints in the hundreds of polities before 1648 to the single Eurozone across much of Europe today — to the point that the nation-state assumes monopoly control of the money supply. Cryptocurrencies have allowed a return to the competition between mints of centuries past. That is why Eichengreen argues that “the monetary landscape is being turned upside down by the digital revolution: by the issuance and circulation of private-label cryptocurrencies and the prospect of central bank digital currencies.”
Standing against this long-run trend is what makes cryptocurrencies so fascinating. It is also why Eichengreen seems skeptical of their long-run prospects. If the historical force toward consolidation is the lowering of information cost, then Eichengreen is correct to be skeptical, especially of cryptocurrencies with high volatility and therefore high information costs such as Bitcoin. Instead, Eichengreen sees the future of cryptocurrencies, if there is one, in “stable coins” or government-issued ones. Government cryptocurrencies share all of the aspects (good and bad) of modern non-digital currencies. We know they are feasible as a natural outgrowth of current government money.
Stable coins, unlike Bitcoin, are pegged to another asset and are a possible middle ground: more viable than Bitcoin but more revolutionary than government coins. Stable coins can potentially harness the benefits of modern currencies. Eichengreen breaks stable coins into four categories:
- Fully collateralized
- Partially collateralized
He finds problems with the scalability of all four types. For example, a fully collateralized stable coin, such as Tether, is pegged one-to-one to the dollar or another money. With a fully collateralized coin, the issuer and investors must have a lot of collateral in something liquid to meet demands. This is costly for investors in the same way that it is costly for an individual to keep all her assets in dollars; she is missing out on a higher yield somewhere else. Crypto-collateralized stable coins run into a similar problem; they must be overcapitalized to be credible since the underlying cryptocurrencies are volatile. For example, Dai, the leading coin of this type, claims a collateralization ratio of 300 percent. The other two types of stable coins face similar problems according to Eichengreen.
Because any viable currency must have low information costs and those cryptocurrencies with the lowest information costs (stable coins) have other problems, Eichengreen concludes that “the only reliable way of creating a stable-value digital currency is for the central bank to issue it.”
Eichengreen recognizes that having “the central bank issue the digital currency, much less giving it a monopoly in this space, would not appeal to libertarians who oppose all government involvement.” He concludes that “this would be less bothersome to the rest of us.” On this issue, however, Eichengreen begs the whole question since he provides no discussion of the role, pointed out by libertarians, of cryptocurrencies in places without the benefit of the dollar as the legal currency. Any history of money should not just look at the potential for progress toward a reliable monopoly on money but also to the monetary mischief along the way.