22 August 2024
By Olav Syrstad
The most ardent supporters claim that Bitcoin (or other cryptocurrencies) represents a new monetary system where a fixed supply ensures its relative value over time without the need for burdensome regulation and intermediaries. In this blog post, I will examine some of the most popular claims about cryptocurrencies in light of the current monetary system.
For all practical purposes, current money consists of call deposits issued by banks. These deposits are claims on banks' assets, primarily loans to households, companies, and governments. Such loans are again secured by real estate, production equipment, vehicles, and borrowers' future production capacity. Consequently, our deposits are also secured by these assets. When a bank provides credit, more deposits (money) are created as the debtor initially gets her deposit account credited by the bank. However, as a depositor, you can convert your deposits to other assets, including forms of bank debt or bank equity. All else being equal, when deposits are converted to other forms of bank liabilities, or loans are repaid, the money supply decreases since only call deposits can be used to settle transactions.
The supply of money is elastic, meaning it follows economic activity (demand and supply of loans) and the population's demand for money (driven, among other factors, by the efficiency of the payment system). By using bank-issued debt claims as money, we have developed an efficient and resilient monetary system. It is efficient because bank debt can easily be divided, transferred, and regulated, and resilient because the collateral adapts to structural changes in the real economy.
The value of our money is based on trust, which can be divided into two pillars. The first pillar implies that our deposits maintain their nominal value; if you have 100 in deposits, you are guaranteed to receive 100 in nominal value. Several mechanisms are built into our monetary framework to secure the nominal value of money.
First, depositors must trust that their deposits are safely stored and transferable. Deposits are held in banks, so the first layer of trust relates to these institutions. However, banks may grant loans to unqualified borrowers, and real assets can be overvalued. This may lead to excessive risk-taking, especially when the losses are socialized (as with rescue packages of banks in times of crisis). As a result, authorities have established safeguards to reduce the probability of excessive risk-taking in the banking sector, ensuring trust in banks and, by extension, the nominal value of our deposits. Regulation and scrutiny of banks' activities are the primary means to protect the value of our claims on banks' assets and ensure trust.