I no longer endorse the contents of this article. This was my attempt at applying MMT to the analysis of cryptocurrency when I was just entering the fray (I first learned about bitcoin in, I believe, 2011 — but didn’t get heavily involved until after the publish date of this article). I think there are still a few insights about why smart contracts provide value and stability to blockchains, and that is why I am leaving this up.
In a previous post, I laid out the problem with bitcoin and other crypto-currencies. In summary, even if a crypto-currency is “decentralized”, there are pinpoints of centralization in the software development process and when it interplays with financial markets (i.e. when trading dollars for BTC). My thesis is that, over time, these pinpoints can cause major problems. Due to the constantly deprecating nature of technology, even if we solve the issues pertaining to exchanges and financial markets, there will still be relative centralization in the development process due to the need for constant updates.
I am not an avid follower of Bitcoin, but I am aware that this has become somewhat of an issue. There have been many schisms in the development process and it has been extremely hard for developers to make important changes. Also, a grossly large amount of people keep their BTC in coinbase and other exchanges, which defeats the purpose of Bitcoin altogether.
That being said, all hope is not lost. Ethereum, I believe, has a much better model. To understand why, let’s first look at the US Dollar (USD).
The USD somehow has value, although it is literally a currency made out of thin air by the US government. If I made “Liam Dollars”, which were just arbitrary green pieces of paper that I cut out, I wouldn’t be able to get anybody to use them. But despite massive money printing on the part of the federal reserve, somehow, the value of the dollar is relatively stable.
How can this be?
Well, it’s actually quite simple. The US dollar is backed by violence. If you create wealth in the United States, you are obligated to pay US taxes. If you don’t pay taxes, the US government will arrest you. Since taxes must be paid in dollars, there is automatically a huge demand for dollars to pay said taxes.
Similarly, many currencies around the world are pegged to the dollar, thereby creating demand for dollars by taxation and commerce in other countries.
But it doesn’t stop there. Another huge driver for USD is oil. Most oil contracts are negotiated in dollars. In fact, it has been speculated that the US has toppled regimes in the Middle East simply because they attempted to switch oil contracts out of USD. Since oil is a multi-billion (or maybe trillion?) dollar per year commodity, this also creates massive amounts of demand for USD.
Now think back to Econ 101. The higher the demand, the higher the price.
This makes sense. A currency, just like any other commodity, has a value that corresponds to its supply and demand.
So let’s apply this to Ethereum. With the advent of smart contracts, Ethereum is enabling applications and other crypto-currencies to be built on top of its blockchain.
Just look at the Ethereum Alliance‘s member list: big banks, big oil, and big tech. Massive amounts of very important applications and other crypto-currencies are being built on top of the Ethereum blockchain– and this creates demand for Ether.
Smart contracts create demand for Ether in the same way that oil contracts, pegged currencies, and taxes create demand for USD. And since I perceive that the amount of people building on the Ethereum platform is growing, I am, therefore, bullish on Ether.
That being said, I still think that Ethereum is subject to the criticism in my original article; however, it is much safer because its demand is more entrenched. Bitcoin also has some cool projects, such as Rootstock, that aim to bring smart contract functionality to its blockchain.
Although I like to talk about the shortcomings of crypto-currencies (and there are many problems with even Ethereum), I, on net, like the concept and am even in the process of developing my own currency token on the Ethereum (and maybe eventually, Bitcoin) blockchain. More on this at a later date.
Note: when talking about demand for USD, I did not mention the most obvious one: that US vendors are forced to accept USD and therefore it must be used for commerce in the US.