In the previous article, Future of Cryptocurrencies – Part 1, we discussed how current monetary system and advancements in digitization of payments set an interesting stage for cryptocurrencies to be introduced to society. Cryptocurrencies allow us to create digital assets in a decentralized way that are not only provably scarce, portable and extremely divisible but also are resistant to censorship, seizure and counterfeit. Such properties of cryptocurrencies make them a strong alternative to be considered as money – especially store of value. In this article, I will touch upon the topics of seigniorage (an extension of Use Case 1 – Decentralized Money Creation) and Use Case 3 – Private Transactions.
Use Case 1 revisited: Decentralized money creation
One thing that we did not talk about in the previous article was Seigniorage. Seigniorage is the profit earned by central banks/governments in lieu of issuing new money i.e. increasing the money supply. Seigniorage profit equals the face value of the coins/interest earned on notes subtracted by the cost of producing & distributing such coins/notes. For example, in 1999 US government started 50 State Quarters series. Each quarter cost the government about 5 cents. Government made profit when someone collected that coin for 25 cents. The Treasury Department estimates that it earned about $6.3 billion in seigniorage from the quarters during the program.
Seigniorage can be interpreted as an inflation tax because increase in money supply typically makes its way into generally higher prices for consumers (although we haven’t seen massive inflation from the QE of last 10 years, just yet). It is one of the main reasons why there is support for gold standard because under gold standard a nation’s money supply cannot be increased indefinitely without devaluing the sovereign currency i.e. the concept of scarcity is difficult to get rid of. In Bitcoin ecosystem, technically, anyone can be a miner, i.e. seigniorage can be distributed to a wider population. Furthermore, Bitcoin mining is not only a very competitive business but also Bitcoin protocol has a hard cap on issuance – which will likely lead to minimal seigniorage in equilibrium condition and make Bitcoin a better Store of Value (SoV).
Use Case 3: Private Transactions
Once people start getting comfortable with ideas such as decentralized money creation and storing value in a digital asset, they will quickly start exploring other use cases of cryptocurrencies. One of the most pressing needs of our day and age is the ability to preserve our privacy in the electronic age. There have been several high-profile hacks just in the last decade such as Equifax, JPM, and Target where millions of user accounts were compromised. Also, with the advent of social media and in the world of apps, it is getting exceedingly difficult to protect our personal data. It is paramount that consumers get back their financial privacy and control of their data.
“Privacy is necessary for an open society in the electronic age. Privacy is not secrecy. A private matter is something one doesn't want the whole world to know, but a secret matter is something one doesn't want anybody to know. Privacy is the power to selectively reveal oneself to the world.”
– Eric Hughes, A Cypherpunk’s Manifesto
As stated in above quote, there is a clear difference between privacy and secrecy. One important step in getting back our privacy is to have the technology that allow us to transact privately, because a transaction history is like a digital clone of a physical person. You can get a clear insight into the shopping preferences, religious beliefs, medical conditions, political leanings, and other dimensions of a person’s life that a person may wish to keep private. Try looking at your credit card history and you’ll see clear patterns in your spending. A lot of literature has been written on negative outcomes of making your transaction history transparent to governments, corporations, etc. and the likely totalitarian eventuality of such a society. Probably the most popular example is George Orwell’s novel from 1949, called Nineteen Eighty-Four.
I speculate that private transactions are going to be a feature that will be demanded by a lot of people once cryptocurrencies become mainstream. While I am sympathetic to the idea that we may never achieve convergence in society on the privacy requirement in transactions, I am optimistic enough about the future demand for privacy. Cryptocurrencies will inevitably facilitate it. There is pretty much nothing you or I can do about it. Cat is out of the bag! In fact, we already have examples of currencies competing on that front and there are plans to add privacy features on the current leading coins as well. There is a ton of experimentation happening along the privacy spectrum: ranging from almost completely anonymous solutions to selectively anonymous. Yes, all these solutions will have to deal with KYC and AML rules, and how this will play out is yet to be seen.
Conclusion
In this article, we discussed how Bitcoin not only enables reduction in seigniorage in the monetary system but also distributes it to the wider population. Bitcoin, thereby, reduces the inflation tax in the system, which then can enable people to hold on to their purchasing power with more confidence across time. Later, we touched on the topic of how our privacy is eroding rapidly in the electronic age and how privacy is different from secrecy. We also discussed why it is necessary to regain basic privacy in financial transactions and acknowledged that there is a ton of experimentation happening in this space to deliver on the private transactions feature. These technologies will also have to handle KYC, AML requirements as they mature and how that will happen is still a big unknown.