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Building a new economy on Cardano

Cryptocurrency fans believe that blockchain has the potential to disrupt banks and create a new form of sound money. There is a close relationship between national currencies and governments. The reality is that it is not possible to replace national currencies without having technologies that will substitute the functionalities of governments or help to build a new form of government.

Cardanians.io 09-04-2021, 08:47 · 22 mins read
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National currencies and tools for keeping their stability

A national currency is a legal tender issued by a country’s central bank or monetary authority. National authorities guarantee the acceptance of the currency as a means of exchange. Thus, national currencies are also used as official units of accounts. Currencies are used for purchasing goods and services and it is also used for the collection of taxes. Trust to currencies is backed by the faith and credit of people in governments. Trust is not a constant and it can change over time. Trust in currencies or governments can decrease during domestic economic turbulences and global financial crises. Central monetary banks and governments try to achieve monetary stability and overcome financial crises. It is one of the most important goals of national authorities. Trust is kept when authorities succeed. If they are not then people might begin to revolt.

A nation’s economic activity is usually influenced by two major tools. It is monetary policy and fiscal policy. Monetary policy and fiscal policy are typical tools that are used to influence a nation’s economy. The focus of the monetary policy is interest rates and the total supply of money in circulation. It is usually the responsibility of the central banks to drive monetary policy. Fiscal policy is a tool that is used by governments to collect taxes and spending management.

Monetary policy is a tool that can stimulate an economy. Individuals and businesses can be either incentivized to borrow and spend money or the spending can be restricted what leads to saving money. Monetary policy can either spur the economy or limit its growth. By that, it is possible to drive the level of inflation.

The Fiscal policy addresses taxation and government spending. Governments target the taxation level, the total level of spending, and the composition of spending. It is done via a legislation process. A government needs to collect taxes to be able to effectively spend. The collection of taxes pulls money out of the economy. It can slow business activity when taxes are too high. Governments might also lower taxes or offer tax rebates in an effort to encourage economic growth. Another fiscal tool of governments for spurring economic activity is stimulus spending. Governments can decide which sectors need to be stimulated to support economic growth. If there is not enough money for spending, it is necessary to borrow money by issuing debt securities. This is referred to as deficit spending. It is expected that debts will be paid off later.

The fiscal policy usually changes relatively often. Governments decide about tax policy and spending. Specific communities, businesses, industries, investments, and commodities are targeted by governments to either favor or discourage economic activity. It is necessary to mention that not only economic considerations are taken into account when changes in fiscal policy are made. Governments have to consider long-term prosperity, peace, healths, science, security, political situation, environmental issues, and many other aspects that touch the daily lives of people.

There are always people that are accountable for monetary and fiscal policy. Hence, their decisions are hotly debated by other people.

Monetary and fiscal policies in the context of cryptocurrencies

In the context of cryptocurrencies, national currencies are often criticized for their worse abilities regarding usage as a store of value. National currencies are nearly always inflationary. It means that they lose value over time and the level of degradation differs from currency to currency. Inflation does not matter so much from the short-term perspective if it is predictable and moderate. However, it is not the case in some nations and then it can be a real problem as people are not able to save money to be well prepared for the future.

The monetary policy of cryptocurrencies is fixed and rigid. In most cases, it is set in the beginning and it is expected that it will never change. The majority of cryptocurrencies have set the maximum number of coins that are gradually released by the protocol. Alternatively, fixed never-ending inflation of coins is set. As a result, cryptocurrencies are generally very volatile. There is no authority that would be responsible for the stabilization of the price. The price is influenced only by supply and demand on the market. This property can be good for the creation of scarce resources. The high demand for a scarce resource can keep the value of coins at a high level in the long term. As a store of value, cryptocurrencies can be very good. However, they are bad as means of exchange or units of account.

The crux of decentralization is about being independent of the decisions that would be made by individuals or authorities. Nobody can centrally influence the monetary policy of cryptocurrencies. Trust in currencies, in the context of means of exchange and units of account, is related to price stability. The degree of trust in fiat currencies is high, in comparison with cryptocurrencies. Notice that people trust fiat currencies despite their centralization and authorities that make decisions. It could be even said that people might not fully trust the authorities but they still trust national currencies. Trust in currencies is related to price stability since it allows people to pay for goods, invest, save money, etc. When inflation is low and compensated in a way that people feel relatively wealthy then it can be considered a stable economic environment.

Price stability or the economy as a whole is not the only factor that matters. The happiness of people cannot be measured only economically but it is mostly the economy that can ensure happiness in a given location. In other words, people expect that they are able to find a job, buy high-quality food, are able to send kids to a good school, live in beautiful green cities with developed infrastructures. It must be true not only for you but also for your neighbors. Not only for the city you live in but also for other cities nearby. When it is not like that you can expect troubles. To ensure the happiness of people or at least to secure the best possible conditions, there must be a mechanism that takes care of all that. On the national level, we get back to fiscal policy. Tax collection and wise spending have been for long years the best solution on how to establish stable environments and relatively happy populations.

So far, we talked only about the rigid monetary policy in the context of cryptocurrencies. When we insist on full decentralization of cryptocurrencies regarding monetary policy, we are able to create only a rigid version of that. Moreover, there is nothing like fiscal policy in the world of cryptocurrencies. At the moment, cryptocurrencies are not able to respond to economic turbulences, crises, natural disasters, or even wars. In addition, there is no way on how to spur the economy. The reasons are obvious. The current generation of cryptocurrencies is not designed to solve these issues. No nation or state has adopted cryptocurrencies to use them to solve these types of issues.

Decentralization basically means that only rigid rules of the protocols are followed and the decisions of individuals are not taken into account. It is not even expected. Protocols know nothing about the economical situation of people, politics, or the environment. Protocols have no ways on how to observe our world and thus they have not any opinions. Protocols cannot make any decision that would help to resolve a potential problem. The blind following of protocol rules is only beneficial for the creation of a digital scarce resource. It is questionable whether it is a good attribute for monetary policy. It is probably a bad attribute for fiscal policy.

Currently, making monetary and fiscal decisions on the national level is mostly related to a certain level of centralization. Authorities are accountable for making observations, evaluating them, and making appropriate decisions. We have two worlds that stand against each other. The centralized world of fiat currencies and a new world of cryptocurrencies. These two worlds are going to meet. It is a question of whether it will be positive or negative.

Would it be possible to connect cryptocurrencies with the national monetary and fiscal policies? Could we technologically substitute the role of authorities or make their decisions more decentralized? Let’s go to discuss that.

Can blockchain be used for building a new financial system?

Economists debate for years about the current financial system and they do not know whether it is the best possible one. Fiscal policy often faces criticism for the need to work with debt and the inability to pay it off. It is not the goal of this article to resolve the tough questions to which economists are not able to answer. We do not want to debate much about the current situation. We will focus more on the future.

People can have different opinions on the national monetary and fiscal policies but one thing is certain. The scope of the functionalities behind it is bigger than what the rigid monetary policy of cryptocurrencies can do. The very first question would be whether we really need it. Do we need a complex fiscal policy and could it be sufficient to have only the rigid monetary policy that cryptocurrencies can offer? Could we exist without the collection of taxes or making reserves for worse times? The answer is no. It is natural that bad times occur from time to time and we need to be prepared for that.

Cryptocurrencies lack three critical functions that stable monetary regimes are expected to fulfill: protection against the risk of structural deflation, the ability to respond flexibly to temporary shocks to money demand and thus smooth the business cycle, and the ability to function as a lender of last resort.

It would be impossible to overcome troubles of any sort on the national level without the ability to either have sufficient reserve or issue new coins. Every reserve can be depleted one day so what should be done in cases that troubles sustain? When the fiscal policy fails then the monetary policy could save the situation. Debt could also be a solution but it depends on the willingness of lenders to provide loans. It seems that the ability to work with debts is also an important requirement of the real economy.

Notice that it is not only about surviving turbulent times. People, as individuals, use public services and infrastructure. It is financed collectively. Authorities are responsible for the collection of taxes to have finance for these services. It is possible to change the financial infrastructure but this type of mechanism must be preserved.

How could that all work in the blockchain world? To create a reserve, there must be some smart mechanism that will regularly collect money from people based on defined rules. We call it taxation in the fiscal policy. Alternatively, there could be some protocol mechanism that would subtract a given amount of coins from all addresses in the case of urgent need or regularly. However, it would be the same as issuing new coins. Issuing coins is actually a better solution. The only question is who would be responsible for making decisions related to changes in monetary policy or in the protocol rules. Could it be developer teams with cooperation with miners or stakeholders? It would not be the best possible solution from the point of trust. People can trust the system only if they agree with the rules and feel they can participate in decisions.

To whom should we actually trust when we start using blockchain technologies? Does it mean that there will be no central authority? Then how could we survive turbulent times or ensure the prosperity of a given region? Using blockchain technologies definitely does not mean that we can get rid of the ability to make critical decisions. A serious social or natural problem can occur and only a sufficient amount of money can be a remedy. Nowadays, our world rotates around money in all aspects of our lives. It is smarter to accept moderate inflation than have riots on the streets. The question remains. Who should make decisions and how in the world where blockchain will become the financial backbone?

Another tough question appeared. It is a free decision of individuals to join or leave a global decentralized network. You might be a fan of cryptocurrencies but what about your neighbors? Your neighbors might either like different blockchain projects than you or do not like them at all. They can prefer fiat currency. When there is a need to have a flexible monetary and fiscal policy in a given location, people are expected to use one currency. It does not matter much whether it is fiat currency or cryptocurrency. However, it is rather more about a set of rules than only about the currency. People must agree with rules and they must be followed by everybody in a given location. It can never work in a way that people using fiat currency will be obliged to pay taxes and cryptocurrency users not. People living in a given area are members of the community and they have the responsibility not only for their lives but also for the prosperity of the community and location.

In our view, people can be allowed to use different currencies but they need to follow the same rules on the national level. It can be said that rules are more important than currency. In the current setup, governments dictate rules and are responsible for fiscal policy. The issue is that cryptocurrencies and their monetary policies are decentralized and global while we have many domestic fiscal policies that are centralized. Is it possible to merge these two worlds together?

We presented a few tough questions regarding the usage of blockchain on the national level. A nation is a large group of people who inhabit a specific territory and are connected by history, culture, or another commonality. We provided a few reasons why we think that nations need some sort of set of rules for monetary and fiscal policies. There are close relations between a nation, economy, and government. The nation definitely needs to have a working economy. It is hard to achieve that without government. It is a question how a modern government should or could look like.

The adoption of cryptocurrencies on the national level is inevitably related to governments. Governments use fiat currencies mainly for taxation reasons since it is a part of fiscal policy. Moreover, central banks use the same currency as the government to manage the monetary policy. In both cases, it is about the control that central banks and governments have upon fiat currencies. Government must ensure that taxes are collected and it is hard to achieve that with cryptocurrencies that are out of its control.

Having control is about making decisions. We are getting back to the problem we faced in the whole section. Which rules should be decentralized and out of control and which one should be controlled? Who or what should have the control and how to make collective decisions?

How to build a more decentralized economy

It seems that the rigid monetary policy of cryptocurrencies is not capable of substituting the current national monetary and fiscal policies. Luckily, Cardano is designed to become a global social and financial operating system. Thus, appropriate capabilities will be available to substitute or complement necessary functionalities of national policies. The key features of Cardano will be the ability to issue tokens, use smart contracts, work with real identities of people, and have an embedded voting system. In the future, abilities to use artificial intelligence could also be handy. Let’s explore what we could do with that.

Cardano has limited inflation risk because the supply of ADA coins is limited. As we said, a limited number of coins is great for the creation of a scarce resource but it does not mean that it is a good attribute for the national monetary policy. ADA coins could be used as collateral to a currency which price or issuance would be algorithmically adjusted. It would be possible to create something like algorithmically driven central banking. In the distant future, the issuance rules of coins could be driven by artificial intelligence.

Some people often argue that the volatility of cryptocurrencies will stabilize in the future. Even if that could happen the problem is that we need to create a currency that would work fine in a domestic context. The monetary policy of ADA will probably never change. If it changes then it will be a decision that will be made in the global context. All stakeholders would be affected by the change. A domestic community could propose a change in the monetary policy of Cardano to resolve domestic difficulties but the issue is that stakeholders are spread around the world and they would not probably agree with the change. Domestic needs at a given time can be different from the global context. It seems that it is smart to issue tokens on Cardano that will be used locally as currency. Thus, domestic changes in monetary policy do not influence the global monetary policy of Cardano. It will be possible to resolve domestic difficulties and ADA will remain a scarce resource.

The domestic economy needs to have its own currency to be ensured that monetary and fiscal policy is effective and able to solve domestic problems. Moreover, a nation is considered autonomous when it has the currency under its own control. Having one currency for the whole world seems to be an impossible goal at least at the moment in the context of nations. Imagine that the wealth of a nation would be determined by the amount of possession of a global currency. If it was Bitcoin then a few whales would be richer than many nations. Nations need to keep their sovereignty and the right to issue their own currency is one of the symbols of sovereignty.

The current dollarization in some developing economies provides an analogy. When a large part of the domestic financial system operates with a foreign currency, monetary policy for the domestic currency becomes disconnected from the domestic economy. Imagine that there is a hyper-inflation and people start using dollars instead of the domestic currency. People benefit from the more stable currency in the short term but in the long term, the nation can collapse. The reason is that fiscal policy cannot work well when monetary policy does not work. Government cannot fund public services and the maintenance of infrastructure. It is a matter of time when the absence of critical services and infrastructure lead to collapse.

Would it be useful to have global supranational cryptocurrencies? We think that it still makes sense and Bitcoin could be a good candidate. For example, these currencies could be used as partial collateral to domestic currencies. Rich people could use it as a store of value. It is definitely useful to have global monetary policies that never change. By separating global and national currencies, we can achieve monetary flexibility in domestic contexts but have a stable global monetary policy.

Global decentralized networks will be important for the future. For example, cross-border payments are still a big problem for the traditional banking system. Cardano is a better settlement layer in that respect. Cardano settlement layer can treat all issued tokens in the same way as ADA coins. Tokens issued on Cardano can be sent to the other end of the world in a few seconds. Thus, stocks, bonds, debt, assets, and everything that can be tokenized can be transferred easily, fast, and cheaply. Moreover, it will be an easy and fast process to change one token for another. Smart contracts allow us to create decentralized exchanges.

Thanks to Cardano, domestic economies can easily be globally available. It can be expected that through tokenization the majority of economic activities will move to blockchain networks. Currently, there are many information silos in the economy and financial systems are not well interconnected. Global networks will nicely solve this inefficiency. The usage is, however, a matter of regulations. It is not solely a matter of people’s choice.

In the previous section, we faced many questions about making decisions. Cardano will also have the answer for that. Cardano will have an embedded voting system. Together with Atala Prysm, the decentralized identity management, it will be easy to establish a voting system in both global and domestic contexts. The Catalyst project is a nice working example. ADA stakeholders can vote about projects that will be funded from the Cardano project treasury. The idea can be easily replicated and it can be used in the domestic context. It can be even better in the domestic context since the voting rights might not be connected with the holding of coins but with the real identity. Any kind of hierarchy could be possibly created.

Cardano is not built with the intention to necessarily replace the current structures. It can help to improve current structures and make them more effective, transparent, secure, reliable, cheaper, decentralized, etc. The adoption of blockchain technologies will be a gradual process. It does not happen in one moment. It is even possible that developing countries will adopt it sooner than the developed countries. The team behind Cardano has an adoption strategy for Africa. There is a high probability that it will succeed. This approach is very important since the Cardano technology will be used in the whole state by the majority of people.

Governments and regulators can have an open approach to cryptocurrencies but it does not mean that the majority of the population will adopt them and use them. Moreover, the adoption of cryptocurrencies does not mean that governments will not be needed. It seems that governments must actively participate in the adoption of blockchain technologies in order to ensure people will use them as the predominant and preferred infrastructure. It is probable that central banks and governments will want to keep control of the monetary and fiscal policies despite the fact that Cardano will be used to issue domestic currencies. Cardano is a platform and the issuer can keep control of issued currencies. The advantage is that it will be easy to change it or adjust it in the future. Control is something that can be more decentralized in the future. It can be needed to adjust interest rates and people might have many opinions about it. What is more important, though, who will decide about the rates and possibly about other conditions related to the adjustment. Making the decisions can have many forms in the future and they can significantly differ from the current form. We can imagine the situation that the control of monetary and fiscal policies will be distributed to trusted entities and transparent voting will be the main driver of changes.

Conclusion

Many people do not realize that in many countries a payment for goods might be a subject of taxation. Thus, payments are part of the fiscal policy. The same tax must be paid regardless of currency and the mechanism must work in the same way for all payers. Payers usually do not care about it and just pay the price of the goods but merchants have to care about it. Luckily, it is not a difficult technological problem and it is possible to pay by cryptocurrencies. Taxation is a more complex topic in the context of cryptocurrencies. It cannot be said that we can avoid taxation just because we start using cryptocurrencies. It would basically mean that we are going to get rid of fiscal policy or even the government.

It would be a pity if cryptocurrency remains just a speculative asset and payments would be attractive only for those who have multiplied the wealth. Let’s do not mix the financial freedom of lucky individuals with the role of national economies and the needs of the population. These are two different things. The adoption of volatile cryptocurrencies would probably be on the level of gold and it would have no transformative impact on governments. Even if the adoption would be higher, the question would still be here: what governments should do with cryptocurrencies or what people should do with governments. Blockchain technology together with smart contracts and other decentralized infrastructure can become the backbone of the financial world. We believe that with further innovations it will be technologically possible and the usage will be advantageous for governments. Nations need some form of monetary and fiscal policy. We can debate about the level of decentralization, decision making, etc.

We expect that with the further development of blockchain technologies the governments can start thinking about the usage for monetary and fiscal policy. It could have an influence on the quality of governments if it would be implemented in the right way. We expect that it can take tens of years to get to the point when it becomes reality and it is hard to predict what it will look like. On the other hand, the adoption can be faster in the developing countries and we hope that Africa could be a nice example. Cardano will probably be the leader of innovations and the teams discuss with representatives of businesses, industries, and governments about deployment. It does not mean that Cardano is less decentralized just because people debate about usage. At the moment, there are people that are members of governments and are accountable for changes in the financial infrastructure on national levels. It is not going to magically change overnight. It will always be about discussions.

Source: Building a new economy on Cardano

Author Cardanians.io
We are cryptocurrency enthusiasts, especially believing in Cardano. We are official ambassadors operating staking pool. We write articles, translate them and develop tools for the community.
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