What Does Modern Monetary Policy Have to Say About Cryptocurrencies?

Conventional wisdom states that, for a currency to be useful, it must have certain properties. It must be accepted as payment for goods and services (medium of exchange), provide a common measure of value (unit of account), maintain its value over time (store of value), easily divisible, interchangeable (fungible), durable, portable, and be of limited supply. When evaluating the viability of cryptocurrency it is natural to check it against this list, and many have. It excels along the dimensions of store of value, divisibility, fungibility, portability, and limited supply. It is weaker on medium of exchange and unit of account, but this is improving over time. So cryptocurrency dominance is inevitable then? Hold on.

You get a kind of “This is Water” effect when you look over the above list of properties because the fundamental property is assumed but never mentioned: does the currency have value? The closest we get is “store of value” which is more about maintaining value than having it in the first place (by analogy, a fridge maintains the nutritional value of food but cannot transform non-food into food). If the currency does not have value to begin with, cryptocurrency is cosplaying a real financial instrument, despite (or because of) all the other properties it does have.

From where does the value of currency derive? Modern monetary theory (MMT) highlights the role of taxation by governments as the true source of value of a currency. To make a long story short, the threat of imprisonment hangs over every taxpayer that does not supply the government with the right amount of the currency denomination of their choosing. And it turns out, that threat is a pretty good way to animate any type of object with value.

So far I have argued that the conventional list of currency properties is not sufficient for value, let’s go a step further and consider why they are not even necessary. Imagine what would happen if the government announced tomorrow they will exclusively demand tax in an unusual denomination: cupcakes. Cupcakes do not stay fresh (not a good store of value), they stop exactly being cupcakes if cut in half (not divisible), they differ wildly from each other (non-fungible), they are not durable or particularly portable, as anyone who has tried to enjoy a squashed cupcake will attest. None of that matters; it is up to the payee, i.e. the government, to decide the boundaries of what valid cupcake is. And formulating a sprawling set of arbitrary rules is one of government’s core competencies (look at the real tax code).

One thing is for certain in this thought experiment: you can bet your life that people would figure out a way to regularly deliver a batch of cupcakes to the government that meets their specifications. And in the process, cupcakes would have value, even if people didn’t enjoy eating them. Now, it would certainly be more convenient if cupcakes did always stay fresh and were divisible, fungible, durable, and portable. You might even argue that such a policy would deform the economy enough to grind it to a halt. But still, as the general economic landscape became barren, no one could deny that a cupcake had value in that scenario.

So if the conventional currency properties are neither necessary nor sufficient for a currency to have value, where does that leave a cryptocurrency like bitcoin? Like Pinocchio, it was designed to have all the right properties, without being a real boy yet. I write “yet” because things can always change. A country could announce, like in the cupcake thought experiment, that they will exclusively tax in bitcoin. If that happened anywhere in the world, bitcoin would have legitimate value globally because the economy (with a few exceptions) is one big network. But this is unlikely, because deflation discourages consumption which in general is bad for an economy. For this reason, governments target low single digits inflation as a policy goal. Famously, El Salvador announced bitcoin as legal tender at a cryptocurrency conference in 2021. But USD also remains legal tender there, as it has been since 2001 — and this makes all the difference. The deflationary pressure of bitcoin is avoided because taxes are calculated in USD but this also means that El Salvador is not creating a demand pressure on bitcoin.

Nonetheless, history shows that prophesies can be self-fulfilling, even if I think it’s unlikely in this case. Cryptocurrency advocates, with their surge in wealth, have provided political support on both sides. (They recently fueled Donald Trump back to office, and before that, Sam Bankman-Fried was a prominent political donor to Democrats.) What happens when lobbying pressure finds a government, somewhere in the world, willing to exclusively adopt a cryptocurrency? MMT predicts that’s when the puppet will turn into a real boy.

Disclaimer: I am not an economist and these ideas are my own and do not reflect the opinions of my employer.