How Blockchain Can Restore Normalcy in a World Gone Mad, Part 1

The global monetary system broke in 2008, and no one has bothered to fix it.

Instead, the world’s largest central banks embarked on the most extreme episode of money creation in history — $15 trillion and counting.

They flouted all conventions of monetary policy.

They created a vicious cycle of budget deficits and deficit financing that’s both unsustainable and dangerous.

They also inflated assets of all shades and varieties, leaving investors vulnerable to sudden crashes.

Now, however, the technology behind cryptocurrencies offers an opportunity to dramatically restructure the monetary system of the future.

It’s called blockchain or, more accurately, Distributed Ledger Technology (DLT).

And it supports a new kind of decision-making process that reaches consensus without most of the functions performed by central banks, finance ministries or other institutions.

That consensus is not based on a dozen Federal Open Market Committee members meeting monthly to arbitrarily decide the next change in interest rates.

Nor are critical decisions based on a hodgepodge of economic indicators and political pressures.

Instead, with DLT, consensus is reached with the exchange of digital data that is replicated, shared and synchronized across multiple sites, individuals and institutions. It all happens without centralized control or data storage.

As I’ll explain in a moment, DLT opens the door for a great leap forward in the evolution of money, and most people in the crypto world seem to understand that.

What many seem to be missing is that, in some critical aspects, a monetary system that uses DLT would also restore some of the fundamental principles of monetary systems that predate the computer age — even before unbacked paper money became widely accepted as national currency.

In fact, many students of cycle theory propose that the future is but a repetition of the past. In reality, the future is a repetition of the past PLUS the addition of innovation.

In this first part this series, I will look back to the past. In part 2, I will peer into the future.

Ancient (but Not Antiquated) Monetary Systems

Before the advent of paper money, the most common form of currency was precious metals — gold and silver.

My aim is not to praise the immutable properties of precious metals — let alone pitch a return to the gold standard as the cure for the periodic monetary crises that have plagued most of the world in recent decades.

However, there was one critical feature that metals-based monetary systems did support: Many critical aspects of the currency were mostly outside of the control of the government or any central authority.

I stress the word “mostly” because, despite the discipline imposed by limited supplies of precious metals, rulers still did find ways to debase their currency.

Sometimes, the debasement was necessary to sustain the growth of commerce. Sometimes it was simply an expedient shortcut to finance wars, corruption and outright theft.

Sovereigns couldn’t print money like they do today. But the ancient equivalent of money printing was to reduce the metal content of coins, while increasing the currency in circulation.

The ancient Romans, for example, were masters in the art of “plating” their coins. Initially, coins were pure silver. But as the Empire expanded, most of the silver content was replaced with copper with a thin façade of silver.

Despite these manipulations, the fact remains that there was something elegantly simple about metal-based money: More often than not, it did help keep governments in check.

Sure, they could debase a currency gradually over long stretches of time. But compared to what modern governments have done in the 20th and 21st centuries — doubling and tripling the monetary base with massive amounts of paper or digital fiat money — the coin debasements of ancient times were slow and ultraconservative.

No matter what new shenanigans they tried, there still was a link between the money supply and an external, incorruptible force: Nature. The natural scarcity of metals — the inability to create money out of thin air — helped keep most money issuers, including governments, mostly honest most of the time.

Metals, such as gold, boast another critical feature: Universal value. In other words, the price of the metal was universally recognized, and that price was largely beyond the control of any central authority.

Gold also provided the basis for consensus in an international monetary system, lending itself to fundamental agreements among nations and their governments. They agreed that …

•  The asset is fungible. In other words, all gold (of a pre-defined standard) is created equal and is interchangeable.Gold also provided the basis for consensus in an international monetary system, lending itself to fundamental agreements among nations and their governments. They agreed that …

•  The gold can serve as an international medium of exchange and store of value.

•  National currencies can be, in effect, proxies for different weights of gold.

•  Their exchange rate can be pretty much fixed and predictable.

•  And most important, gold is neutral and borderless. It helps create a level playing field. It IS value.

This is not to say that gold-based currency systems were flawless. Nations with an abundance of gold reserves had an obvious strategic advantage, or so they thought.

The Spanish Empire, for example, found itself in control of vast swathes of land in the Americas with apparently limitless supplies of gold, and these fed what seemed to be endless prosperity.

In the long run, however, Spain became the victim of its own success. Due to its reliance on abundant gold, it had no incentive to develop self-sustaining industry. So as soon as the flow of gold from the colonies started to dry up, the empire began its inevitable downfall.

The lesson learned: Yes, a gold- or natural-resource-based monetary system may have helped keep governments and financial actors honest most of the time.

But the success or failure of each nation in that system became too dependent on its access to the gold or other natural resources. That was not equitable. In the parlance of cryptocurrencies today, it was far from scalable.

Enter Paper Money

Another big disadvantage of gold or other physical assets was that they were not exactly easy to store or move around. They were heavy. They could attract a lot of attention from bad actors. They required a big investment in storage facilities and security.

This is largely the reason the Knights Templar first introduced paper money in Middle Ages.

The concept itself was as simple as it was brilliant:

Let’s say you were a pilgrim travelling to the Holy Land. You didn’t want to embark on a treacherous, multi-month journey carrying all your gold in a mule pack.

Instead, you deposited your gold in a temple controlled by the order of warrior monks. They gave you a bill of credit. And once you arrived in Jerusalem, you redeemed your paper for gold.

Thus, paper money had its first beginnings in the form of an I.O.U. that was redeemable for actual physical metal.

It was a breakthrough technology, and ultimately, nation-states adopted it as their own.

The sovereign issued paper bills. The bills were fungible, and easy to store and transport. And they were widely accepted so long as everyone trusted that they could be redeemed for “real money” — the metal they were supposedly backed by.

Thus, there emerged a new fundamental element in the money formula: TRUST. Now, people had to trust that the issuing institution actually had the metal to back up their paper IOUs.

That was fine as long as people continued to have faith in their governing institutions. But as soon as that faith was abused, it led to disastrous inflation and social destruction.

For example, private issuers and governments claimed they had gold to back up their paper IOUs when they actually didn’t. Or, as we’ve seen in modern times, governments simply abandoned the gold standard and openly admitted they were printing money without backing.

Here’s the key …

•  The old, metals-based money was largely a trustless system.

•  But as society shifted to an IOU-based money, it became a trusted system, with all its vulnerabilities to greed and political power grabs.

Yes, modern financial systems gained the efficiencies that paper money provided. But it did so at a tremendous cost to countless nations and peoples through the centuries:

It lost the simple elegance, fairness and long-term sustainability of trustless systems.

Now, Fast-Forward to Cryptocurrencies

The technology underlying cryptocurrencies, Distributed Ledger Technology (DLT), offers the best of both worlds:

It advances the evolution of money to a far more efficient digital form.

And at the same time, it restores the inherent fairness and sustainability of trustless monetary systems.

The economic and financial implications of this breakthrough are far-reaching; the profit potential for early investors, virtually unlimited.

I’ll explain how and why in Part Two of this series.

Best,

Juan

Editor’s note: You can read How Blockchain Can Restore Normalcy in a World Gone Mad, Part 2 here.

 

About the Editor

When econometrician and pro trader Juan M. Villaverde first applied his algorithms to Bitcoin years ago, he discovered a regular cyclical pattern. And he has since used it to build the world’s first crypto timing model based on cycles. Thanks to his analysis, the Weiss Ratings team has accurately picked the top and bottom of major crypto booms and busts.

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