Today current inflationary monetary policy constantly devalues our money. For people who don’t trade stocks or have enough money to buy real estate, there’s no other way to counter inflation than to hold money in banks and savings accounts, only to cover the loss from inflation. But many countries currently have a negative interest rate to promote spending instead of saving, which provides a supposed boost to the economy, but at the same time it means that you lose your funds even when you store them in the bank.
If a family with an average annual US salary of $52,000 starts to save money for college upon the birth of a child, they should save at least $13,500 per year to save the amount of $270,000 for, let’s say, four years at Harvard. But the inflation from the past 20 years would make it lose half of its value! Thus, in reality, they would have to save $20,600 over 20 years to keep up with inflation – nearly half of the average annual salary!
How did we come to this kind of monetary world and how can the blockchain help change it?
We would like to thank the team at Kinesis for their contributions to the design and implementation of the research and to the analysis of the result.
The abandonment of the gold standard
The current monetary system is a new invention. For centuries, every currency issued by any government was backed by gold and/or silver, mostly gold. This is called the gold standard. Any country had exactly as much money in circulation as they had precious metals in its reserve funds. But this all changed after the Great Depression. This worldwide crisis was so severe that all countries were forced to abandon the gold standard – they simply didn’t have resources to recover their economies after the great market crash of 1929, which was caused by many factors, but mostly by banks losing their funds in an overheated stock market. In this situation, printing money out of thin air to pay for all expenses seemed like a good idea. First the UK and then the US, and many other countries, switched to fiat currencies and this helped to recover the world economy. For many people, money is just money; they don’t understand the economy, and governments can print enough to cover any needs, because they don’t follow the gold standard anymore.
Since then, the monetary policy has taken the form that we’re most accustomed to: the issuance of currencies is controlled by central banks, and since they have control over the supply, it gives them the power to manage economic variables such as credit supply, liquidity, interest rates, and money velocity by injecting or removing money from the system.
However, as it’s not backed by a commodity such as gold, it only has value because everyone agrees it does.
This approach creates many problems because the value of every national currency heavily depends on the actions of its government. The recent example of the Turkish lira highlights just this. After a quarrel over tariffs with the US, the lira plunged more than 25%, entering a downward spiral when many debt holders began getting rid of their holdings. The government, instead of making any statements to calm down investors, worsened the situation by staying quiet. Only a week later had they released a statement about raising the rate, which barely managed to ease tensions. At the same time, the conditions of Turkish economy stayed the same; the downfall was caused by the change of sentiment.
The same situation happened in 2014 with the Russian rouble, when a set of sanctions coupled with falling oil prices, that Russia is heavily dependent on, halved the rouble’s value. Currently, the situation in the country’s economy is a lot better than it was four years ago, but the currency is still 50% cheaper, meaning that its purchasing power has been halved, and all imported goods, including household electronics and gadgets now cost twice as much. The rouble stays undervalued due to imposed sanctions and the political risk of new possible sanctions.
We can add a lot more countries to this list, but you get the idea. The most unpleasant moment from all this: many governments can’t stop printing money, because they spend more than they earn by collecting taxes. To raise money, they issue government bonds, and pay a fixed interest to all debt holders. To pay off the interest, they print more money, thereby increasing inflation. Our monetary system is debt-based.
The problem is that some countries, like the US, can’t stop borrowing from other countries, and they have an astronomical debt of $21.6 trillion. Other countries place their resources in US treasuries, because the payouts are stable, and the US dollar is the global reserve currency. As long as their economy grows, it’s sustainable. But what happens when this growth ends? Nobody knows it yet, but at the same time it’s obvious: they borrow all the time, and the whole world, including me and you, pays for it from our own pockets.
Alternative monetary system: blockchain-based currencies
First of all, let’s clear some things up: global changes don’t happen overnight. It took more than 80 years to get to the current state we’re in, and it will take some time (a few years) to change it. Luckily for us, however, blockchain technologies can become the key to making these radical changes.
So how is money on the blockchain different from fiat money? There are two possible vehicles that could become a new store of value: coins and tokens. The main difference is how they are stored and issued. Coins are stored on their own blockchain and are usually mined. Tokens don’t have their own blockchain, and are issued according to their predefined rules, which are coded in their smart contracts. The issuance can be periodic, it can be limited to a finite number of tokens, or it can happen when certain events occur. Anyways, both coins and tokens can serve as money. More importantly, the blockchain is an open ledger that can be run without any central authority controlling it. We can see such examples in the Bitcoin and Ethereum networks.
You would ask yourself: is it possible to maintain a healthy economy when nobody is controlling it? Many economists could disagree with that, but one of the most influential thinkers of the second half of the 20th century, Milton Friedman, deemed it necessary to return from total regulation to a free market. He even proposed the Friedman rule; a rule that would set an interest rate at zero. According to him, the central banks should seek a rate of deflation equal to the real interest rate on government bonds and other safe assets in order to achieve that. This means that those who hold money don’t suffer any loss in the value of that money due to inflation anymore.
So, an unregulated market with zero interest, where the value of money is determined by supply and demand, and the inflation of the supply is limited. That sounds like cryptocurrency, doesn’t it?
Being a trustless system, crypto can become beneficial in the long term. Let’s take Bitcoin for example. Everyone knows that its amount is limited to 21 million. There will be no additional issuance. If everyone is switching to using it, its value will be determined purely by the balance of supply and demand, but it’s unlikely that it could lose its value due to some centralized authority’s actions. No debt, no constant devaluation of ordinary people’s funds.
Regardless, it doesn’t matter how good this kind of economy would be, it’s still a distant imaginary future, but there are some things that can be done right now. It’s possible to use crypto right now to hedge savings, like people in Iran and Venezuela currently do. This happens because people in these countries don’t trust the actions of their governments. There we see an obvious example of how cryptocurrency and the blockchain are used by the people instead of official fiat money, and it works better in a self-regulated environment. But what if we go further and modify the idea for the modern world without being too futuristic?
We’ve created an infographic to better explain this idea to you:
Gold + blockchain = stability
What if we try to fuse the blockchain and gold together? Gold and silver always were the stable commodities that have backed national currencies for centuries.
Gold is a good defensive asset, it always has been. All central banks around the world buy it, and the top five countries with the largest reserves have more than 18,000 tons combined. But it’s very impractical to use: you can’t pay with gold, you can’t receive dividends if you store it in your bank, and you can’t exchange it on-the-go. But the new attempts to create digitized gold-backed tokens may soon become handy for everyday use.
There are two solid concepts for gold-backed cryptocurrencies, each one with its own approach: Digix and Kinesis.
Digix is a relatively old project that started in 2014 as a token backed by real gold. It’s an ERC20 token and each token represents 1 gram of gold. It has a registry of the so-called Proof of Asset Cards. Each card represents information about the gold assets stored in the vaults of its Custodian, The Safe House, and audited by the Bureau Veritas Inspectorate.
Each card contains the following information:
- Timestamp of card creation
- SKU of the gold bar
- Bar serial number
- Chain of custody digital signatures (Vendor, Custodian, Auditor)
- Purchase receipt
- Audit documentation
- Depository receipt
- Storage fees due
Each token is divisible to 0.001g. For storing gold, Digix take an annual 0.60% fee and another 0.13% fee is taken for transactions. Also, there is a governance token, DGD, that is used for voting on asset allocation. Every 100 tokens can be exchanged for a gold bar. Digix is a popular project, but it doesn’t allow users to use the gold that you possess via tokens, so it could be interesting only to long-term gold investors. Another project that we’ve just mentioned, Kinesis, solves this problem.
Instead of having only one token, Kinesis has two tokens, both based on a direct allocation to gold and silver. They are named KAU and KAG (“au” stands for Aurum, gold, and “ag” for Argentum, silver). These coins are also issued on their bespoke fork of the Stellar network which allows for scalability, by being able to provide over 3,000 transactions per second, perfect for a platform to host a monetary system to withstand a debit card attachment. Each coin represents one gram of bullion stored in one of seven vault locations around the world. Kinesis has strategically partnered with the Allocated Bullion Exchange a leading online exchange platform for physical bullion, with deep expertise in the gold industry and already has extensive infrastructure and fully operational exchange technology for trade and storage of physical bullion around the world.
But aside from its partners, what is the most interesting thing about this project? It has two distinctive features that allow users to use it as a defensive asset against the monetary policy of central banks from around the world.
The first one is the crypto card. There are already many crypto cards, such as the Monaco Visa Card, but this one allows users to instantly spend money, secured by gold, without the pain of converting them.
And the second feature is the payment of dividends; a certain percentage of network fees is given to the holders of KVT tokens, the third type of token,which is used for governance, and to KAU and KAG holders for owning tokens and spending them. It looks like a stable system that has a well-thought-out reward system. A banking deposit won’t give you a reward for storing your gold, but it will rather take a fee for storing it. This kind of project can become the example of the new non-regulated economy and become more and more popular in the future.
Not only this, use of Kinesis currencies is incentivised by a number of multifaceted yield structures paid out monthly to users and holders of the currency. What Kinesis has successfully achieved is the attachment of a return to an asset which previously had none whilst simultaneously allowing for instant liquidation, at point of sale, anywhere in the world that accepts a debit card.
The world is diving deeper into debt. The global debt hit $247 trillion in 2018, and it continues to increase. As long as large economies continue grow (more specifically the economy of the US, which has the biggest debt) it will be stable, but people will continue to lose money to inflation. When will this disrupt the world? Who will pay off this debt? This whole monetary policy gave birth to cryptocurrencies, because people are getting tired of someone printing money and forcing them to work endlessly only to see how the value of their hard-earned money diminishes. People don’t trust governments, they don’t want to trust anyone anymore. That’s why we’re witnessing such a surge of blockchain popularity.
Everyone who wants to secure themselves against the debt bubble seeks assets that are backed by something real, or at least not dependent on someone else’s debt. It’s very unpleasant for anyone to lose 25% of his/her savings over 10 years, even with a small 2% yearly inflation rate. So the question is: do we want to continue to lose endlessly?
Bitcoin is a universally recognized cryptocurrency, which has value because everyone agrees it has value, but it’s not debt-backed, it takes a lot of electricity to produce, and it can’t be hacked, so its inner value derives from its security. Such tokens as Kinesis have real gold backing them. The amount of gold is scarce; all mined gold in the world can fit in three Olympic swimming pools. It also doesn’t depend on anything, it’s a defensive asset, and in case of a global crisis, a demand for gold could be overwhelming. In the future, the markets might become more tidy when there will be less trust in governments, and that’s when we’ll see the true purpose of cryptocurrencies.