A stable cryptocurrency?
By Scott Sumner
Stephen Kirchner directed me to a new white paper discussing a proposal for a cryptocurrency with a stable value. Here they motivate the proposal by pointing to some drawbacks of other types of cryptocurrency:
First, consider the merchants that do accept cryptocurrency payments today. Microsoft, Quickbooks, and Spotify, for example, allow customers to pay in Bitcoin using a service called BitPay. However, none of these merchants keep their money in Bitcoin—instead, they immediately convert any Bitcoin they receive into USD. Why? Well, these merchants are not in the business of speculating on Bitcoin. They don’t want exposure to Bitcoin market risk any more than they want to hold their money in barrels of oil. What if Bitcoin dropped 90% one day? . . .
Second, imagine trying to make a purchase using Bitcoin. Because merchants want to collect a fixed amount of USD for their services, you’re faced with a constantly adjusting BTC price for your potential purchase. This is a terrible user experience.
First a disclaimer. I couldn’t explain a blockchain if my life depended on it. While I’ve read many articles on cryptocurrencies, I have not retained anything that I read. So I have no opinion on cryptocurrencies in general, or this specific proposal (termed “Basis”).
The paper discusses several options for stabilizing the value of Basis. The solution that seems most sensible to me is to fix its value to the US dollar. It seems to me that this would make it more appealing to merchants. But other options are also considered, including stabilizing Basis in terms of the basket of goods in the CPI, or even more ambitious schemes that are consistent with the Fed’s dual mandate. Whichever definition of stability is adopted, the mechanism would involve a policy rule:
The Basis protocol accomplishes this by algorithmically adjusting the supply of Basis tokens in response to changes in, for example, the Basis-USD exchange rate. This implements a monetary policy similar to that executed by central banks around the world, except it operates as a decentralized, protocol-enforced algorithm, without the need for direct human judgment. For this reason, Basis can be understood as implementing an algorithmic central bank.
The FT reports than John Taylor has been an advisor on this project:
By this stage, it should have become clearer why Mr Taylor, advocate of rules-based monetary policy and critic of unconventional policy such as quantitative easing, became an adviser to the project.
Obviously this currency could be adapted in such a way as to stabilize Basis in terms of NGDP, rather than the CPI. While I hope they decide to go this way, from a strictly business perspective it probably makes more sense to fix it to the US dollar, at least for as long as the dollar is the dominant medium of account in the US. This judgment is not based on me having any cryptocurrency expertise; rather it’s simply an observation about revealed preference in the financial markets. When private firms create new financial instruments, such as a corporate bond, the payoff is usually in terms of nominal dollars, not inflation-adjusted dollars. I’d expect the same preference applies to cryptocurrency holders.
On the other hand, NGDP stability has enormous external benefits. I hope someone creates a cryptocurrency that is linked to NGDP, and uses a rule-based system (such as NGDP prediction markets) to keep its value stable. That would be a very useful demonstration project, which would advance the cause of tying the US dollar to NGDP.
I like reading this sort of paper, because it reminds me that history is moving in the direction of market monetarism. There is no stable equilibrium where the monetary policy regime does not result in the financial markets expecting steady growth in NGDP. Any monetary rule that falls short of that criterion will be provisional, likely to eventually be overtaken by a superior regime that delivers results more consistent with stable market expectations of NGDP growth. The “end of macro history” is a regime where the market sets the monetary base and fed funds rate at a level expected to lead to on-target NGDP growth.