When Digital Currencies Compete, Do You Win?

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While Bitcoin dominates media and investor attention, it and dozens of other “altcoins” are competing in the market, each with unique technical and economic features. Would it be possible in the future to have widespread adoption of several digital currencies, all widely traded and accepted by merchants? Or would people converge on one or at most a few currencies? In a future where digital currencies replace dollars and euros, the latter scenario seems a good deal more likely.

Currencies, like cell phones and social media, have network effects: they become more valuable as more people adopt them. Markets characterized by network effects typically converge on a single standard. But what would be the problem if we all adopted several digital currencies at once, so long as they were freely exchangeable? Economists from the Austrian school posit that inflation distorts markets by obfuscating the true value of a dollar, making businesspeople’s calculations more difficult. Imagine if merchants and consumers also had to deal with several currencies with fluctuating exchange rates. Such an outcome seems far from efficient.

The advantages of a single dominant digital currency do not fully preclude others from competing in the market, especially if they are used by niche groups or for specific purposes. Furthermore, the same digital currency need not be dominant in every geographic area, akin to our current landscape of different currencies in different countries.

Multiple widely adopted digital currencies could potentially exist side by side in one way. If all currencies are backed by a single asset, such as gold, the problem of constantly fluctuating exchange rates no longer applies because all currencies will trade at a fixed rate. In this case, digital currencies are simply issued by institutions holding gold as claims on that gold, and the world looks like a higher-tech version of what economist Murray Rothbard famously imagined in his treatise “What Has Government Done to Our Money?As we have reported, gold-backed digital currencies are currently in development and testing phases.

Whether one views the current landscape with many competing currencies as problematic depends on how far one thinks we are from a state of widespread adoption. For those who believe that digital currencies should be widely adopted as soon as possible, the existence of so many altcoins could be seen as an impediment to quickly converging on a single standard. But for those who suspect, as I do, that widespread adoption would take decades if not generations, competing currencies for now are a good thing. One can think of Bitcoin and its smaller cousins as test cases of digital currencies, allowing the market to evolve the right combination of technology and economic incentives for wider adoption. It is likely that such a market-tested standard would be far more robust than anything anyone could design from the top down.

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Max Gulker

Max Gulker is an economist and writer who joined AIER in 2015. His research often focuses on free markets and technology, including blockchain and cryptocurrencies, the sharing economy, and internet commerce. He is a frequent speaker at industry conferences, especially on blockchain technology. Max’s research and writing also touch on other economic topics, including governance, competition, and small businesses.
 
Max holds a PhD in economics from Stanford University and a BA in economics from the University of Michigan. Prior to AIER, Max spent time in the private sector, consulting with large technology and financial firms on antitrust and other litigation. Follow @maxgAIER.