Can Cryptocurrencies Succeed Where the Euro Failed?

Cryptocurrencies have seen a lot of hype and media attention, but can they succeed in doing what the Euro has not?

“Bitcoin – Mark of the beast, one world currency.”

This is just one example of many that you see on digital media or hear when commentators discuss on financial news channels. The concept of “ONE world currency” may feel a bit unsettling for some, who may ask: “haven’t we been that road before with the EURO? … and look what happened!” If it didn’t work on a smaller, European, scale why would it work on a larger, world-wide scale?

This is a valid concern. To address it, we need first to understand what the Euro is and how it differs from Bitcoin or any other cryptocurrency.

What is Euro and how is it administered?

The Euro is the national currency of the member states of the European Union (EU) who have adopted it (19 members out of 28).

The idea was that having one currency will remove exchange rate risk from businesses and financial institutions operating in an increasingly globalized economy. While the concept looked great on paper, problems have arisen in the way it has been administered and controlled.

The Euro is managed and administered by the Frankfurt-based European Central Bank (ECB) and the Eurosystem (composed of the central banks of the eurozone countries.) The ECB has the sole authority to set the monetary policy.

The Eurosystem participates in the minting, printing and distribution of notes and coins in all member states and the operation of the eurozone payment system. This removes the ability of the EU’s member nations to implement monetary policies specific to themselves, thus locking them into a monetary policy established for the entire Eurozone, even though local monetary conditions may differ substantially from the overall Eurozone.

This has been one of the root problems of the Euro – giving such concentrated power to set monetary policy to one centralized European bank.

So, what went wrong?

The idea of eliminating exchange rates is a good cause to pursue. But exchange rates are not the only, let alone the main, problem that we have with fiat currencies today.

The EU came up with a noble idea but failed in execution as it seems that they had not thought through the problems of one centralized currency for many different countries.

Let’s look at the problems:

Leaving the Fiscal Policy decisions in the hands of each country

Monetary policy and fiscal policy are the two widely recognized tools used to influence a nation’s economic activity. Monetary policy is primarily concerned with the management of interest rates and the total money supply in circulations and is generally carried out by central banks. In the case of the EU – that’s the ECB.

Fiscal policy is the collective term for the taxing and spending actions of government and is determined by the executive and legislative branches of the government. In the case of the EU, that would be 19 different legislative branches – one for each country, separately.

You can clearly see the illogical asymmetry here. One centralized monetary policy while having 19 different fiscal policies.

Euro a reflection of the strong economies

Economics 101 explains that the strength of the currency is a very significant indicator of the state of the economy. In many cases it reflects the strength of the economy which issued that currency.

Since Germany is the largest and the strongest economy in the EU, the Euro is closely aligned to the German economy. Other smaller nations that are in different stages of their economic cycles suffer. For example, if the German economy is booming, the Euro is likely to be high. If another nation, such as Spain or Greece, is in an economic downturn, it could use some relief with a weaker currency and under the Euro regime this is not possible.

We all witnessed the problem described above after the financial crisis of 2008, when Greece in particular, but also Spain and Italy, suffered greatly and were in need of a bailout.  In order to sustain the strength of the Euro, Germany and other economically strong EU nations came to the rescue. The bailout programs have caused a rift among the EU nations and have led to many EU member states to consider an exit from the EU a la Britain.

Different tools in the hands of different authorities lead to chaos

We mentioned above that monetary policy was left in the hands of the ECB while fiscal policy was given to each government to decide.

Going back to Economics 101, the whole idea of creating the right policy for a currency is striking the right balance between monetary policy and fiscal policy. If these policies, however, are in the hands of different authorities then that’s basically a disaster waiting to happen. 

The countries were left only with control over their fiscal policy with no flexibility to relieve their economies of dire stress through monetary policies. This led to a lot of public discontent, with Greece being but one example.

The EU, having no control on fiscal policies, was forced to bailout struggling nations in order to keep up the strength of the currency. This in turn caused public frustration in strong economies.

It seems that the EU walked itself into a “lose-lose” situation.

How is cryptocurrency different than Euro?

It needs to be kept in mind that Euro is administered by a single centralized European bank.

Conversely, if there is one word that encapsulates the entire cryptocurrency movement, it’s “decentralization”.

Decentralization is the idea that individuals or groups of individuals can interact with each other without needing third parties to validate, monitor, police or regulate these interactions. In this sense, the decentralization that blockchain technology furthers is one of the most revolutionary ideas in human history.

The strength of cryptocurrency that Euro has never had

The blockchain lets people who have no particular confidence in each other collaborate without having to go through a neutral central authority. Simply put, it is a machine for creating trust. This started with Bitcoin: “…allow online payments to be sent directly from one party to another without going through a financial institution.” (Satoshi Nakamoto, 2008)[1]

Why this is important?

“Blockchain solves the problem of manipulation. When I speak about it in the West, people say they trust Google, Facebook, or their banks. But the rest of the world doesn’t trust organizations and corporations that much — I mean Africa, India, the Eastern Europe, or Russia. It’s not about the places where people are really rich. Blockchain’s opportunities are the highest in the countries that haven’t reached that level yet.”
Vitalik Buterin, inventor of Ethereum[2]

According to a polling by Harvard University's Institute of Politics[3], Buterin’s observation about the West is not completely correct. Millennials in the West distrust institutions no less than people in the rest of the world. Three in four millennials (74 percent) sometimes or never trust the federal government to do the right thing, and two in three (63 percent) feel the same way about the president. Wall Street doesn't fare much better, with 86 percent of millennials expressing distrust, and Congress is at 82 percent[4].

Economics 101 explains that one cannot remove politics from economic policies. The two main tools used to influence a nation’s economic activity – fiscal policy and monetary policy – are directly or indirectly controlled by a nation’s government. Fiscal policy is determined by the executive and legislative branches of the government. In the U.S., the head of the Federal Reserve System (FED), central bank of the US, is appointed by the president. In the case of the ECB, the European Council, which brings together EU leaders to set the EU's political agenda, appoints the head of the ECB[5].

The relationship between politics and economic policies has been one of Euro’s main culprits. Cryptocurrency does not have this problem. Built on blockchain technology, it is not created or controlled by a single power. It replaces intermediaries with mathematics and complex algorithms to certify the integrity of all participants on a network[6]. This feature appeals to millennials, the world’s largest demographic[7].

Why would cryptocurrency not fail the way Euro has?

Now that we have explained Euro’s characteristics versus those of cryptocurrency, it is evident that cryptocurrencies do not “carry” any of the mishaps of the Euro.

More specifically,

  1. Cryptocurrency is a decentralized currency. Not managed or controlled by a central bank such as the ECB.
  2. Its value creation is spread out through nodes on the internet, in contrast to a fiat currency such as the Euro, which value is determined by central banks and political agendas.
  3. Unlike the Euro all transactions and creation (mining) of the currency are transparent. Everyone can observe, monitor and participate.
  4. Euro is a fiat currency. Like any other fiat currency, it reflects its economy (i.e., the one which issued its bills and coins). In the case of the Euro, it has struggled to reflect the economy of the entire Eurozone.
  5. Cryptocurrency, claims to be a global currency (not just Europe or any other continent) aside, is not attached to any economy and thus is not subject to the economic situation of any region locally or globally.  This is in fact the most important difference and it is the strength of cryptocurrency that would allow it to thrive where Euro has failed.

Moreover, its value is based on the transactions on the network (globally!) and not on the economic fragility of a country or a continent. It is truly a cross-border type of currency.

Why should you invest in cryptocurrency rather than Euro (or any other fiat currency)?

Blockchain technology is very powerful. Not only does it offer a decentralized currency, but it also allows people to transact and interact without needing to know or trust the other party.

In the current world, this is again where banks, brokers and agents step in. For example, if you wish to buy a property, you hire a broker to ensure that all documents are in order and the other party needs an agent to ensure they have received the payment committed to them. That is a situation of a centralized power. We are subject to middlemen who act as trusted-figures in order for the two parties to interact.

Smart contracts are the solution for this problem. Built on blockchain technology, a smart contract platform allows two parties to sign and execute a contract without needing to know and trust each other.

The blockchain economy and with that cryptocurrency offers a world where there is no centralized power or middlemen. Rather than relying on a trusted intermediary to proprietarily maintain one ledger of transactions between members of a network, blockchain technology allows all members to maintain their own copies of the same ledger and ensures that the copies are all synchronized. This obviates the need for an intermediary, who might exploit its information asymmetry advantage to act in self-interested, extractive, inefficient or corrupt ways[8].

When eliminating intermediaries, transactions are less costly and are more efficient. In 2016, a bitcoin-based remittance system could transfer $100 from Canada to Philippines nearly immediately for one dollar. In contrast, a traditional bank charged a ten dollars fee and it took three days to clear the payment[9].

Therefore, cryptocurrencies and the blockchain technology it is built on, cannot be stopped! It is where the future is heading. Whether Bitcoin or some other cryptocurrency ends up as the “one world currency” remains to be seen. It is very plausible, however, that it will be a digital currency and not a fiat or gold or any other.

Investing in Cryptocurrency is an investment in the currency of tomorrow. That is simply Investments 101!

About the author:

Dr. Merav Ozair has more than 12 years of business and consulting experience and more than 15 years of teaching experience working with both graduate students and financial professionals. She holds a PhD in Finance from the NYU Stern School of Business. For questions, comments, or clarification, contact her at [email protected]

Endnotes:

[1]Nakamoto Satoshi, 2008 “Bitcoin: A peer-to-peer Electronic Cash System,” Bitcoin.org (available at https://bitcoin.org/bitcoin.pdf).

[2] “What is Blockchain Technology? A Step-by-Step Guide For Beginners,” Blockgeeks, 2016

[3] “Millennials don’t trust anyone. That’s a big deal,” The Washington Post, April 2015

[4] The 2017 Deloitte Millennials Survey, “Apprehensive millennials: seeking stability and opportunities in an uncertain world,” explains – millennials, especially in developed countries, are anxious about their future and many of them are not sure they can trust the promises of their respective governments.

[5] Economics is a branch of social science. Adam Smith, who is widely regarded as the father of modern economics, was first and foremost, a philosopher and a politician. Furthermore, the real founder of modern economics, may be someone most people have never heard of. More than 40 years before Adam Smith wrote "The Wealth of Nations,” Richard Cantillon authored the "Essai sur la Nature du Commerce en General." Joseph Schumpeter, the great historian of economics, called Cantillon's treatise "the first systematic presentation of the field of economics." William Stanley Jevons, one of the founders of neoclassical economics, called the book the "cradle of political economy." Emphasizing the relationship of politics and economics.

[6] More on this see “Blockchain: Democratized trust. Distributed ledgers and the future of value,” Deloitte University Press, 2016

[7]Millennials, Mobiles and Money,” Telstra Global Report, 2016

[8] Examples for academic research on intermediaries exploiting information asymmetry: Lizzeri Alessandro, 1999, “Information Revelation and Certification Intermediaries,” The RAND Journal of Economics; Bessy Christian and Chanvin Pierre-Marie, 2013, “The Power of market Intermediaries: From Information to Valuation Processes,” Valuation Studies.

[9] Kim Henry, Laskowski Marck and Ning Nan, 2018, “A First Step in the Co-Evolution of Blockchain and Ontologies: Towards Engineering and Ontology of Governance at the Blockchain Protocol Level,” working paper.