Imparting scarcity on digital entities can be quite challenging, and this is crucial as scarcity is the basis of value. The lack of scarcity in digital money is its most significant drawback and addressing this was arguably the most significant obstacle for cryptocurrency. Our objective in this blog post is to provide a comprehensive explanation, starting with the significance of preserving the value of money.
The Importance of Money Holding its Value
Money acts as a measuring tool for value, and this function is widely accepted by individuals participating in the economy through its usage as a medium of exchange. The entirety of trade and economic activity depends on it, and it serves as a universal language.
Similar to how we don’t typically stop to consider our language when speaking it, we take money for granted.
If we can imagine a world where a fixed measuring tool such as a meter constantly changes, science, engineering, and nearly all commerce would become impossible. In the same way, economic activity would be impossible in a world where the value of money fluctuates. Even buying a simple cup of coffee would require significant mathematical calculations and pose a substantial risk, not to mention more complex transactions like mortgages or insurance.
Unlike the meter, which is a fixed, objective, and universally agreed measurement that will never change, money’s value and measurement are subjective, resulting in change. This change stems from the relative scarcity of money, with an increase in its supply leading to inflation, as already known. This is precisely what occurs in countries experiencing inflation, emphasizing the significance of sound money that should not be taken for granted.
While it may be challenging to envision extreme instability of money, Germany between the wars provides a good example:
- During Germany’s hyperinflation, there were notable instances of financial instability, such as the fluctuation of meal prices between the time of ordering and paying the bill
- Individuals required suitcases or wheelbarrows to transport their salaries due to the currency’s extreme devaluation
- In October of 1923, the exchange rate between German Marks and English Pounds was so disproportionate that it was comparable to the distance between Earth and the sun
Assuming that scarcity is vital for preserving the value of money, the question arises, how does cryptocurrency attain digital scarcity?
Digital Scarcity is the Common Goal
A scarce commodity is an item that has a limited supply and is not easily produced, replicated, or accessed. While physical objects like gold can fall into this category, digital assets are a different story. The ease and low cost of copying bytes, as seen by the music and film industries during the early days of the internet, means that they are not typically considered scarce.
This lack of scarcity is why digital currencies like cryptocurrency are not stored as files on a computer’s hard drive. If they were, anyone with access to a computer could infinitely duplicate them. Instead, all forms of digital currency rely on an accounting system that uses digital ledgers. This approach ensures that each unit of currency is unique and cannot be replicated.
It might come as a surprise, but 97% of fiat money exists only in digital form. This means that the money in your bank account, for instance, is merely an entry in your bank’s accounting system. Even the remaining 3% of banknotes and coins are recorded as entries on a central bank’s digital books.
Bitcoin is also reliant on a digital ledger, but the crucial difference between it and fiat money lies in the ledger’s maintenance.
While fiat money’s ledger is maintained by centralized entities like banks and governments, Bitcoin’s ledger is decentralized. This means that the responsibility for maintaining the ledger falls on a network of independent nodes, making it less vulnerable to manipulation and corruption. Bitcoin works with a decentralized system which takes away the concept of someone overseeing the process. This adds extra trust in Bitcoin and brings new users towards Bitcoin.
It also means that the Bitcoin owners would someday want to sell their crypto coin reserves. One venue comes to mind when thinking about selling any kind of cryptocurrency these days. And it’s Dubai! People can always sell cryptocurrency in Dubai without facing any difficulties. The process is smooth and fast as it should be for any kind of exchange process.
Downsides of Trusting Digital Money
For money to be valuable and reliable, its ledgers must be trustworthy and its supply must be regulated. This ensures that unreasonable amounts of money are not suddenly created or destroyed, which would adversely affect its purchasing power.
The authority-based trust system is what keeps traditional monetary systems functioning. We can use our money online because we trust that banks will prevent people from overspending or engaging in fraudulent activity. We even trust banks to lend out more money than they hold and undertake complex investment strategies. Although the practical application of this system is complex, it depends on the trust that institutions will act in the best interest of everyone, which gives them authority and control over the monetary system.
Despite its effectiveness, the centralized system still has noticeable weaknesses. For instance, while money is legally owned by an individual, it is never truly under their custody. Whenever we use our cards to make purchases, we are essentially asking the bank to deduct money from our account and add it to the vendor’s account.
A single point of failure is more susceptible to corruption, manipulation, or external pressure, which can lead to abuse, mismanagement, and economic exclusion. Nevertheless, the most concerning side effect of fiat money is how it undermines scarcity.
Increasing Money Supply
To sustain economic activity and create more value, it is necessary to introduce new money into the system. Commercial banks are responsible for creating new fiat money, although the amount they are allowed to create is controlled by the central bank.
In simple terms, commercial banks create new money, while the central bank regulates the amount they can create.
The balance of new money creation is a critical aspect that requires delicate handling. Insufficient money introduction can cause the economy to slow down while an excessive amount may lead to inflation, ultimately resulting in a country’s bankruptcy. This has been historically observed with national currencies. Thus, human institutions control the levers of the money supply rendering fiat currencies unsuitable for sound money.
Centralized systems have their weaknesses, but before 2009, they were the only viable option for creating secure digital money.
Bitcoin broke with this approach from the very beginning and attracted so many users to become the top cryptocurrency. Nowadays, people buy and sell Bitcoin every day. If you are one of them, just don’t forget, you can always sell Bitcoin in Dubai for a winning rate. The process is safe and fast which most people look for in any kind of service.
It’s important for people to trust financial institutions to handle the fiat money supply for their accounts. This may work for the time being but there’s no guarantee that your government and the central bank may not make an error that may lead to inflation. This, in return, can affect your life. Bitcoin, on the other hand, works without a central authority managing it. This is a big difference and that has attracted many people towards Bitcoin.
The future of Bitcoin seems bright, and we can only wait and see!
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