An ideal decentralised currency is one not controlled by any central authority or government and maintains a stable value over time. The need for such a currency arises from the weaknesses of centralised currency systems, which can be vulnerable to hacking, censorship, and manipulation by governing authorities, leading to the potential loss of funds or collapse of the financial system.
Centralised currency systems may also restrict economic growth and individual freedom through strict capital controls that limit the ability to move funds across borders.
By contrast, decentralised currencies such as Bitcoin or Ethereum are based on a distributed ledger technology called blockchain, which allows for secure and transparent transactions without the need for a central authority. Decentralised currencies can also provide greater privacy and anonymity for users, as well as more flexibility in terms of cross-border transactions.
The need for such a currency became pretty clear when the issues with the centralised system came under the spotlight. Over this past week, we saw bank runs involving Silicon Valley Bank (SVB), Silvergate, and Signature Bank and the de-pegging of centralised stablecoin USDC. These events highlight the fragility and potential risks associated with centralised financial systems.
Evolution of Fiat Currency and Banking System
The fiat currency we have today is a form of currency with no intrinsic value and is not backed by a commodity such as gold or silver. It simply relies on the faith and credit of the issuing government or central bank. But it hasn’t always been so.
If we talk about the evolution of fiat currency and the banking system, it can be traced back to the early days of civilisation.
In ancient times, people used commodity money, such as gold or silver, to facilitate trade. However, as trade and commerce became more complex, there was a need for a more flexible and convenient form of currency. This led to the development of paper money, which was initially backed by gold or silver reserves.
Over time, governments began to issue paper money not backed by tangible assets. This led to the emergence of fiat currency, where the currency’s value is determined solely by the issuing government or central bank. The use of fiat currency became widespread in the 20th century, as governments abandoned the gold standard and allowed their currencies to float freely against other currencies.
Much like the fiat currency, the banking system evolved from simple moneylenders to modern commercial banks.
Banks play a crucial economic role by providing loans and other financial services. They are involved in fractional reserve banking, where they can lend out more money than they have on deposit.
However, relying on banks for currency stability has several downsides. One of the biggest concerns is the potential for bank failures, which can lead to a loss of deposits and a collapse of the financial system. This was seen during the Great Depression when many banks failed and caused widespread economic hardship.
Another downside of relying on banks for currency stability is the potential for inflation. Central banks can increase the money supply by lowering interest rates and buying government bonds. This can lead to inflation, eroding the currency’s value and reducing purchasing power.
This is exactly what has been happening over the past few years. During the COVID-19 pandemic, the US Federal Reserve engaged in a range of policies to support the economy, including lowering interest rates and increasing the money supply through quantitative easing. This sent inflation skyrocketing and drastically reduced the purchasing power of money, which is making crypto assets a popular investment class.
The Rise of Cryptocurrencies
The emergence of Bitcoin and other cryptocurrencies represents a significant shift away from traditional banking and fiat currency. Cryptocurrencies are digital assets that use cryptography to secure and verify transactions and operate independently of central banks or governments.
Bitcoin, the first and most well-known cryptocurrency, was created in 2009 by an anonymous individual or group of individuals using the pseudonym Satoshi Nakamoto. Bitcoin operates on a decentralised network, meaning that it is not controlled by any central authority. Transactions are recorded on a public ledger called the blockchain, which is maintained by a decentralised network of users worldwide.
One of the key concepts of cryptocurrencies is decentralisation. Decentralisation means no single point of control or failure and no need for intermediaries like banks or governments to facilitate transactions.
This decentralised nature of cryptocurrencies makes them more resistant to hacking and cyber-attacks. Unlike traditional banking systems, which are vulnerable to attacks on centralised servers, the blockchain is distributed across many different computers, making it much harder to attack.
Not to mention, cryptocurrencies provide greater privacy and anonymity for users, as transactions are not tied to personal information like names. This can be especially important for people who live in countries with restrictive financial systems or who want to protect their privacy.
More importantly, crypto offers transparency by recording transactions on the public ledger accessible to anyone. This means that transactions are transparent and can be audited by anyone, which can help to prevent fraud and corruption.
However, there are some downsides to cryptocurrencies as well.
One of the biggest concerns is volatility, as the value of cryptocurrencies can fluctuate rapidly due to market speculation and other factors. This can make them risky investments and difficult to use as a store of value. But that is where a stable currency like a stablecoin can help relieve the inherent high volatility of crypto.
Growing Need for Decentralised Currency
Stablecoins are vastly popular in the crypto market, designed to maintain a stable value relative to another asset, such as the US dollar or gold. These stablecoins are designed to maintain a stable value, providing a more predictable store of value than other cryptocurrencies that can be highly volatile.
The need for USD-backed stablecoins arises from the fact that many people and businesses want to use cryptocurrencies for payments and transactions but are hesitant to do so due to the volatility of cryptocurrencies like Bitcoin or Ether. Stablecoins provide a way to use cryptocurrency without the risk of significant price fluctuations, making them more attractive for everyday use.
However, there are some limitations to USD-backed stablecoins. One of the main concerns is that the backing of the stablecoin depends on the solvency and trustworthiness of the custodian holding the US dollar reserves. If the custodian were to go bankrupt or engage in fraudulent activities, the value of the stablecoin could be impacted.
This was what we witnessed this past weekend when the second-largest $40bln market cap stablecoin USDC de-pegged, falling as low as 87 cents overnight. The de-pegging of the centralised stablecoin USDC also affected other stablecoins, viz. DAI, USDD, and USDP negatively.
USDC’s decline was triggered by Circle, its issuer, disclosing that $3.3 billion of its cash reserves are held at Silicon Valley Bank (SVB), which was shut down by California financial regulators. SVB, the 16th largest bank in the US, failed after a massive deposit rush left it unable to keep afloat.
Besides SVB, crypto-friendly banks Silvergate Bank and Signature Bank also went down, demonstrating the fragility of the current banking system as they indicate how quickly a financial institution can experience a liquidity crisis and become unable to meet the demands of depositors for their funds.
In the aftermath of the bank collapse, crypto assets are enjoying an uptrend. Bitcoin is up more than 16% in the past 24 hours, trading above $24,000, while Ether is up about 13% to trade at $1,669. Greens can be seen across the broad crypto market, which has sent the total crypto market cap past the $1.1 trillion mark, up 12.8% in the past 24 hours.
Unlike centralised platforms or even centralised cryptocurrencies, decentralised digital currencies like proof-of-work (PoW)-based Bitcoin and proof-of-stake(PoS)-based Ethereum offer much better solutions. This is because they do not rely on a central authority, which is censorship resistant.
Decentralised cryptocurrencies are typically more open and inclusive, allowing anyone to participate in the network and contribute to its development. Moreover, they are more secure and transparent than centralised platforms and offer greater privacy and anonymity.
Benefits of a Stable, Decentralised Currency
When it comes to stable, decentralised currencies, they have several benefits over traditional banking and fiat currencies. For starters, decentralised currency provides a higher level of security as transactions are secured through cryptography, which makes them resistant to fraud and hacking. Also, since cryptocurrencies operate on decentralised networks, there is no single point of failure, which makes it extremely difficult for hackers to target the system.
The level of privacy available is higher, too, compared to traditional means, as transactions are pseudonymous and not tied to personal information, making it harder to track or monitor your financial activities. This can be especially important for individuals who live in countries with restrictive financial systems or who want to protect their privacy.
In the current high-inflation environment, the decentralised nature of such currencies holds much higher importance. Not being controlled by any central authority eliminates the risk of government intervention, leading to bad policy decisions and high inflation rates, which can be seen worldwide.
The decentralised currency also gives users full control over their money. No intermediaries are involved in transactions, and users can manage their funds directly without any restrictions or limitations imposed by traditional banking systems or government regulations.
This elimination of intermediaries like banks or payment processors, which often charge high fees, reduces transaction fees compared to traditional banking.
A stable, decentralised currency is accessible to anyone with an internet connection, regardless of location or socioeconomic status. This can be especially important for individuals underserved by traditional banking systems.
So, as the world becomes more digital and interconnected, these benefits can help cryptocurrencies become an increasingly important part of the global financial system.
Overall, it can be said that the need for stable, decentralised currency is becoming increasingly apparent in our digital world. Traditional banking and fiat currency systems have several limitations, including a lack of privacy, high transaction fees, and susceptibility to government intervention and economic instability.
A stable, decentralised currency here offers a promising alternative, providing increased security, privacy, and control over your own money.
As the world becomes more digital and interconnected, it’s important to stay informed about the benefits and risks of cryptocurrencies. So, whether you want to protect your privacy or gain greater control over your finances, cryptocurrencies can offer a promising solution!