Blockchain and Cryptocurrencies might be two different things
Many people mistakenly believe that cryptocurrencies are a suitable tool for a new financial revolution based on blockchain. The reality is that blockchain is a perfect fit for the world of finance. Unfortunately, native coin projects have little use in the world of finance. If a blockchain network is to be decentralized, it needs native coins that are used as a vehicle to reach that goal. Thus, the decentralization of the Cardano network grows along with the distribution of ADA coins among new users and the emergence of new pools. ADA coins are and will be highly volatile in the future. As the importance of the network grows, the price of ADA coins is likely to grow as well. What the value will be in 10 or 20 years, no one can accurately predict today. Since growth is expected, people mostly hold the coins as a speculative asset.
It is similar for all other projects. If the coins were stable in value, there would not be so much demand for them regarding speculation. Without the ability to do something with such stable coins, there would be no demand from this side either. ADA coins will be used for project management and also generate passive income for the holders. If the network is used, the fees will go from the hands of the users to the coin holders. The speculative nature and the desire for decision rights are important parts of the decentralization of the project.
Speculation always brings price instability. In the beginning, people assumed that cryptocurrencies would be money. That assumption turned out to be wrong and made no sense economically. The world of finance needs stability and predictability. Money has two key parameters, it is a unit of account and also a unit of exchange. People must be willing to spend money or invest it for the long term. For this to work, the value of money must ideally be stable or at least maintain an approximate value in the long run. Money is not necessarily an ideal store of value. There is no asset in the world that meets all three of the basic requirements of good money. That is, it is a good store of value and a good unit of account and unit of exchange.
Some economists believe that a store of value cannot also be a unit of account. The demand for a store of value will fluctuate over economic cycles and people will always prefer to spend other money rather than what they are saving for a rainy day. The unit of account cannot be volatile, and we cannot determine the price of goods based on how scarce money is at any given time. Increasing the value of a scarce resource would reduce the price of goods and vice versa.
Cryptocurrencies derive their value from digital scarcity. Because the number of coins in a given monetary policy of a blockchain project is rigid, it will never be stable. Even though the monetary expansion curve may be known in advance, it does not mean that the price of coins will be stable. Rather, what we can observe in practice is that new cycles may emerge in which the price fluctuates by tens of percent. Predictability cannot ensure stability. This is due to the fact that a fixed monetary expansion curve cannot respond flexibly to the fluctuations and needs of the real world.
There is no stabilizing mechanism and the value of cryptocurrencies is based on current demand, which will never be stable. Demand will be influenced by many external events that cannot be predicted in advance. When something bad suddenly happens in the world, the prices of most commodities can plummet. However, the value of money and good prices cannot fluctuate according to market sentiment, as this would have an immediate and direct effect on the purchasing power of the population.
Blockchain as a technology is an excellent tool for creating a global financial infrastructure. Blockchain is essentially a global immutable database in which all transactions are instantly available to the rest of the world. All coins, assets, and tokens are owned by the users themselves and never by a third party. If a third party is in play, it will be a smart contract whose behavior is predictable in advance and whose evaluation is automatic. The parties involved have voluntarily agreed to its use. There will be no need to look for a trusted intermediary in the physical world for the custody service, as the smart contract can do the same job cheaper, more reliably, and with complete transparency.
Blockchain is natively a global network, so it will never be a problem that a service is only available somewhere in the world. No one decides on availability and there are no economic interests at stake. You could say that Cardano connects people all over the world today. Anyone can install a wallet and start interacting economically with their surroundings. Now we need to further develop this infrastructure and deliver real financial services.
Every blockchain network is for people to interact with each other financially and for ownership of wealth to remain in the hands of users who can dispose of it freely. This cannot be replaced by centralized parties holding cryptocurrencies for people, as their services are cheaper and faster. These parties are always subject to regulation and most importantly, all the benefits that blockchain offers are lost.
Blockchain as a financial infrastructure and volatile native coins of projects are two things that can’t do without each other but discourage mainstream users from using financial services. Ordinary people on the street have no desire to speculate on the cost of the projects they use. Just like they don’t hold shares in the banks they have an account with, or shares in Google, which they use every day. Financial services have to do without volatility. For Cardano, as a platform, this is an easy target.
It would be naive to think that all the people in the world will own ADA coins and just so they can be part of the decentralized financial revolution. It’s probably an unattainable goal to convince the majority of the population to use one blockchain project as the new form of money. Even more so if that asset is volatile and thus unusable for anything other than financial speculation. People would essentially have to exchange this asset for the money they use now. That means they would have to be able to use the new money immediately. It’s okay for the decentralized infrastructure of the world to be owned and decided upon by maybe only 5–10% of the population holding ADA coins. It doesn’t necessarily have to be all users, provided the infrastructure works well and everyone benefits from it. If there is a problem with this arrangement in the future, it will be possible to change the balance of power. Let us not be closed-minded in thinking that everything that is done today must be the same in 10 years’ time. We will have to take good care of decentralization and develop it as necessary.
Most people on the planet are not interested in speculation, either because they don’t have the spare funds to do so, or it is not their life goal or interest. People from poor countries would be the last ones to participate in such a revolution. The purchasing power of westerners will always be higher. The wealth disparity between people living in developing and developed countries would be perhaps even worse than today. This is certainly not what we would want from decentralized finance. The new world of finance is not about early adopters getting rich at the expense of the rest of the population. We should stop believing the false narrative that people will buy new money and stop being citizens of their countries. Blockchain, as a new financial infrastructure, and Cardano, as a global financial and operating system, is surely meant to do more than that.
The road to stability
It is hard to find something in the world that can maintain its stable value on its own. This is because many phenomena are interconnected and this constantly changes supply and demand. Stability is expected from gold, but even its value fluctuates slightly according to the mood of the markets in the short term. Movements of tens of percent within a year are possible. Fiat currencies in developed countries are relatively stable in terms of purchasing power but at the cost of some effort by monetary banks to maintain this stability. Sometimes control can get out of hand and unexpectedly high inflation can occur.
The scarcity of a resource will never be a guarantee of price stability. A scarce resource is useful as a store of value, but there is different demand for this property in different economic cycles. Our world is too complex for the demand for commodities to be stable. Let us illustrate with an example. In a crisis, there will be less production, so, for example, the price of metals will fall, but the price of gold will rise. People will try to preserve value in a crisis and the value of fiat currencies may fluctuate. Once the crisis has passed, the demand for metals will rise, but the price of gold may fall. Gold will be sold to invest in metals. New products will be made from metals.
The road to stability is likely to lead only through a controlled process that derives stability from a basket of commodities and stable currencies. It is possible to create a digital asset whose value will be stable relative to other assets. The portfolio must be suitably constructed so that the individual components are as independent of each other as possible. It is thus possible to create a stable coin whose value will be more stable than many national currencies.
If the dominance of the current financial giants is to be disrupted at the global level, the same tools are needed as now exist. The only difference will be that these new instruments will honor the ideals of decentralization. One of the most important building blocks is certainly a stable coin. Finance can only work well if it is stable.
What is Finance
Finance is definitely not about people sending volatile coins to each other. It makes no economic sense and it’s not good for payments as well. If you wanted to pay with a volatile cryptocurrency for a phone, for example, the thought process would be as follows. Find out the value of the phone, which would be expressed in the national stable fiat currency. Assess the price against other goods and your financial capabilities. You could then exchange some of your cryptocurrency for fiat currency and pay. You cannot use cryptocurrency directly as a unit of account in this process because you cannot evaluate the real price of the phone correctly and with a full context. Moreover, if the price were expressed in cryptocurrency, it would constantly fluctuate up and down according to the mood of the market. Normal buying would also eventually become just speculation and waiting for a better price. This is not how a complex economy can work. If we were to call this by its proper name, it would be the sale of an investment asset or the realization of a profit in order to purchase consumer goods. Unless you are in profit, you probably won’t want to do business this way. At least that’s how the majority of the population will perceive it.
A one-off transfer of value has nothing to do with the world of finance in the true sense of the word. Or rather, it plays only a marginal role. Finance is a broad term that describes activities related to banking, leverage or debt, credit, capital markets, money, and investments. Funding is basically money management and the process of raising the necessary funds. These are essential financial operations that are absolutely essential for economics. If we are unable to carry out these operations, we cannot talk about a financial revolution. The key parameter of these financial operations is the stability of the currency in which they are carried out. Since these are operations that last for a long period of time, even several years, any volatility would damage one of the partners in the contract. This is clearly undesirable. It makes sense to use blockchain for these operations, as these operations are a superstructure over money. Almost every adult on the planet has experience with a loan or mortgage. Or has at least thought about it. The problem with volatile cryptocurrencies is that they can’t perform these operations. This is the obvious difference between money in the true sense of the word and speculative investment.
Let’s take an example. Let’s say someone wanted a loan to buy a car, which they would pay back regularly every month for 3 years. The lender would provide the money to buy the car, which the buyer could immediately use for his business and earn the repayments. Let’s say the car costs $50,000 and the lender commits to pay $1,450 over 36 months. In total, the borrower would pay off 52,200 USD. In the normal world of finance, thousands of such contracts are made every day. The borrower can predict whether he will be able to repay the debt. In the worst case, he can sell the car and thus get rid of a significant part of the obligation. Could the same be done with a volatile cryptocurrency?
The amount of USD 1,450 will be the same, or at least approximately the same value, in 3 years. It is likely that a citizen living in the US will be able to earn that amount and have enough to pay off the debt. In the case of cryptocurrency, unfortunately, it does not work that way. If ADA was worth $1.50 at the time the loan was closed, the lender would have provided 33,333 ADA coins to the borrower. On the same terms as the dollar, the borrower would repay about 966 ADA coins per month. This is a value equivalent to USD 1,450. Now imagine if the price of ADA coins went up from $1.5 to $10 over 2 years. That would be about a six-fold appreciation of ADA coins. If the borrower still had to repay 966 ADA coins, that would be $9,660 per month. In just six such payments, the borrower would pay off $57,960, which is more than the price of the car at the time he took out the loan. The borrower would likely go bankrupt because he would not be able to pay off the car. The lender would have grown enormously and, more importantly, undeservedly rich on the loan or would not have seen the repayment. It wouldn’t work the other way around either. If the price of ADA coins fell, it would be beneficial to the borrower, who would more easily pay off the debt. The lender would be at a disadvantage because it would get less in dollar value. For example, he would not be able to buy half a car even if the borrower would have paid off the entire loan.
Volatility in the world of finance would have fatal consequences for the economy. No one would be able to borrow for business. People with money would lose the ability to easily expand their wealth by borrowing money. Some would get rich and others would go bankrupt. The whole decentralized finance sector could disappear, as it would be found that it cannot bring anything functional to the real economy.
Finance is about the long term in which one party provides money to another party. It’s about working with debit and credit, or it can be about long-term investing. Financial transactions have one thing in common. It is a certain algorithm involving multiple parties who transfer value to each other according to certain rules. In its basic essence, it is just a numbers game.
Many contracts are already automated in the traditional financial world. Identities are verified at the bank, bank account details are provided and terms are set. For a conventional loan, the scenario is as follows. One party receives a large sum of money to make the purchase. It could be a house, a car, or just money for a business. This amount has to be repaid over an agreed time, including interest on the loan. In practice, the borrower sends the money to a given bank account regularly by a certain date. If it is late, someone notices and sends a reminder. The legal system ensures that the borrower is forced to repay the amount borrowed.
Blockchain and Finance
Blockchain and smart contracts are a perfect fit for the world of finance. Entering into a contract is always a multi-party act that includes the terms of the contract and the identification of the parties. Cardano will allow participants to create a decentralized identity through Atala PRISM. Entering into a contract is just a matter of creating or finding a suitable smart contract and deploying it. All financial flows within the contract will be written in the blockchain. with all the necessary details. The mission of the blockchain is to record transactions. Smart contracts will allow multiple transactions to be combined into a single context. A smart contract can react to events and automatically fulfill the terms of the contract.
As we have shown above, it is always economically disadvantageous for one party to borrow ADA coins for a longer time horizon and try to repay the loan gradually. Once you replace ADA coins with stable coins or digital currencies issued by central banks, Cardano literally becomes a global financial operating system. The difference between Cardano and traditional financial services lies in the use of blockchain and decentralization. Most commercial banks operate on a local level with a local currency. Banks dictate their own terms for loans, including interest rates. It is difficult for banks and expensive for customers if the loan is to be international. For example, it is not common to make a loan between a European and an African. The power of a global decentralized network is that it can connect people across continents and no one can prevent this cooperation. That does not necessarily mean that people cannot be involved in the cooperation. They can and probably will. Reputation, risk assessment, and identity verification in creating the digital one will still depend on people. Cardano needs to be seen as a vehicle for financial transactions and these will always be about people first and foremost. The only difference is that smart contracts and blockchain addresses will be used instead of paper contracts and bank accounts. If there is a dispute between the parties, the legal system will be available as a judge of last resort. If, for example, real estate is to be part of the contract, it will still be necessary to cooperate with the authorities. It is only a matter of time before the authorities learn to use modern technology and are willing to provide data via Oracles. It is likely that the first cadastral offices in developing countries will be established directly on the blockchain.
In the traditional world of finance, a bank or a lender has no right to force a borrower to pay. Only an entity authorized to do so under a given country’s social contract can do so. It is important to remember that blockchain is not here to resolve all sorts of disputes. If only digital assets are in play, the smart contract will be able to take them as collateral and use them to settle the outstanding debt. This can work entirely without a legal system and disputes can be resolved exactly as it is defined in smart contracts. When it is needed to punish the debtor or deprive him of physical assets, the intervention of the authorities will be necessary. Blockchain, like a conventional database, can only record transactions. Moreover, Cardano will be able to automatically execute smart contracts and do similar work that a bank would do. That is enough to disrupt the traditional banking sector.
People sometimes mistakenly operate with the idea that everything around blockchain technology must be completely anonymous and independent from the outside world. As we suggested above, without the interconnection of the physical and digital worlds, we are unable to create the stability we need for finance. Financial services need to work with liabilities and these may not be settled by the parties involved. Failures to settle liabilities can occur for many reasons. Either the failure of individuals or external causes may be involved. The legal system needs accurate information about the contract, and blockchain can provide this instantly, accurately, and without the possibility of the data being altered.
It is good to know the possibilities and limits of the tools we use. Many people have exaggerated expectations of blockchain. Replacing people in financial processes will be a gradual process and at the moment we don’t know how successful we will be. However, we are confident that changes and improvements are possible.
The world of real finance exists, but it is mediated by traditional banking services or other intermediaries. It is therefore mainly available in developed countries, but even there it is not accessible to all people living in that country. The problem that decentralization solves is accessibility and openness. With Cardano, financial services will be available in developing countries and all the people of the world can be financially connected. Financial inclusion and meeting the “bank the unbanked” narrative is the ultimate goal for the Cardano project. It must be stressed that at the moment people are not even financially connected. If you don’t have a bank account, you can hardly send money to your relative who lives in the next village. If people have access to the internet, they can instantly set up a Cardano wallet and essentially get their first financial account.
If people do not have their identity, they can hardly apply for a fair loan. They may have an unfair loan available in the local context. Real finance is about making sure that all people have the same or similar conditions for starting or running a business. Once people have their financial account and identity, they can get loans from people in Western countries. The transfer of finance from developed countries to developing countries can really help people a lot to change their living conditions. Banks from western countries and in a way the countries themselves have failed to build something like this because they were only looking at their economic interests. Cardano is a global infrastructure that will be simply everywhere under the condition the Internet is available.
It’s also about making people from Western countries see decentralized lending as a relevant option. Borrowing funds to buy a car is possible through a bank. Peer-to-Peer lending must be an adequate option and must be risk-free in terms of the functioning and reliability of the technology. The needs of people from developing countries are diametrically opposed to those of people from Western countries. People from Western countries have relatively stable currencies and can take out loans for their businesses. They can send money to their friends relatively easily, or pay for goods online. In developing countries, the fact that there will be some financial infrastructure will be a big change. People will have access to stable coins and thus be able to preserve their wealth against inflation. It is possible that many poor countries will issue their national currency on the blockchain as this will be the easiest option. Here again, Cardano can play an important role as a platform that can issue tokens. If not, integration and tokenization will allow people to use financial services on Cardano with their national currencies.
Being able to send value between each other cheaply and quickly can help developing countries significantly. The need to build and use financial services comes second. It is important to remember that first-generation cryptocurrencies have no chance of delivering what Cardano can provide. Sending volatile value between each other makes less economic sense than sending stable value, essentially money. As we have shown in the example above, financial services cannot be built at all with volatile cryptocurrencies. Sending ADA coins to each other may be fine at first. People will be happy with an option that maybe they didn’t have before. However, once the price fluctuations come, it stops being fun. People will start speculating on the price and that will necessarily hinder development in terms of mutual financial interaction. In addition, poor people tolerate these fluctuations worse than rich westerners. Westerners are more likely to look for financial opportunities to invest. People from developing countries need a stable financial infrastructure. These are two quite diametrically opposed things. Blockchain is definitely a technology that can deliver that infrastructure.
A broader change
The world needs to make fundamental changes in the world of finance, and these will also affect the way people think. The narrative of endless growth must be replaced by a new narrative, and that is the narrative of long-term sustainability. Companies, for example, cannot just strive for profits that benefit a small group around management. Companies must prioritize the long-term sustainability of their business with regard to social welfare and the ecosystem. Societal pressures can force companies not to strive to make a huge profit and rather to align corporate interests with social and environmental concerns. This is, however, easy to say but harder to do. Anyway, it should be our common goal. Greater transparency of financial flows can facilitate this endeavor and blockchain can be helpful here too.
It is possible that in the new economy the tax structure will be completely changed. The economy should work in such a way that a business that does not work will disappear and be replaced by a business that works. Failure must be accepted as the normal state of affairs. The system must make it easier to start a new attempt at business.
It is necessary to think more about the redundancy and necessity of specific expenditures. This is better done in a local context. That is, in a decentralized way. It will probably be necessary to take most decision-making power away from central authorities and decentralize it more to smaller autonomous units. This can happen at the level of local governments and companies. If the interests of people and nature are prioritized in a local context, everything can work better as a whole.
Tokenization can completely change the way we look at project ownership and management. We are technologically ready for it, and voting will expand the possibilities even further. Now it’s just about redefining the social contract. Technology alone will not force change, but it can serve as a tool to enable change.
The COVID-19 pandemic has shown us that offices can communicate fully digitally when necessary. Offices have often operated analog, i.e. through paper documents and the need to physically visit the office. Greater digitization also goes hand in hand with decentralization.
Blockchain is a fundamental technology and will impact the way the world works. If blockchain succeeds, it can also be seen as a success for the concept of decentralization. It may have a greater impact on the structure of states than we can currently acknowledge. Technology can influence people’s thinking and it can be the cause of greater changes in society. At the moment, however, everything is open.
The first generation of cryptocurrencies is not suited to the world of real finance because of the high volatility that they will probably never get rid of. Maybe decades from now, but even then it’s not certain that they’ll be good sound money. Real finance requires much more than the ability to send value from Adam to Alice. The economy needs to work with debit and credit, and it can’t do that without long-term stability of money. Cardano will enable the necessary functionality to be built and can become a global financial operating system. For this, scalability is also essential. Blockchain is useful precisely in that transactions are irreversibly written and available to the whole world. This is where privacy can come into play, and it is just a matter of improving the technology. Once transactions are moved to second layers, the whole magic of blockchain as a financial infrastructure is lost. Blockchain is a ledger and the goal is to use it for exactly that purpose, accounting. Accounting and volatility are not compatible with each other. The cryptocurrency world is riddled with a lot of false expectations and narratives that make no economic sense. It is good to call a spade a spade and look for uses where it makes sense. Digital scarcity can be a good investment, but it is largely speculative. First-generation cryptocurrencies don’t scale well and they will never be a good ledger for the developing but also the western world. Cardano can handle the volatility and maybe it is one of the projects that is a great fit for accounting and transforming the world of finance. Both will find their uses. But let’s not mix these things together and have false expectations that one project can deliver everything we need.
Digital scarcity has made it possible to create a store of value and perhaps a new monetary system of sorts. However, the monetary system cannot function well without the fiscal system, and the latter is primarily about financial stabilization. For the economy to function well, we need to align a monetary and fiscal policy. Stability requires observation of the outside world and decision-making. Perhaps this can be automated to some extent. Fiscal policy needs to work with a unit of account that is also a unit of exchange. A global decentralized stable coin whose value would be derived by a basket of commodities and fiat currencies could be the next big thing in a world of decentralization. Cardano can deliver something like this, giving a whole new meaning to the public blockchain network, as it would enable decentralization at the fiscal policy level. A volatile asset will hardly bring stability to developing countries, or to countries whose currency has high inflation. This is a job for a stable asset. Cardano will allow people to create and use such an asset.