🍌 Could The US Dollar Be Crypto's Killer App? — Issue No. 90

As the western world enters its second month of the coronavirus crisis, it seems the absolute worst case public health scenarios have come off the table. Don't get me wrong, what's happening now is horrific enough as it is, and there's still much to be worried about as the virus spreads to the global south. It's not time to celebrate. Still, just a few weeks ago, the prospect of several million dead in the United States alone was a serious possibility. Mercifully, this is now highly unlikely.

The relative containment of the health crisis has come with costs. Unprecedented quarantines, and the shuttering of all non-essential businesses, has put the economy in a cryogenic freeze. The ten trillion dollar question is whether it comes back to life once it thaws. To avoid total financial meltdown, governments and central banks around the world have injected trillions of dollars of stimulus to keep the system sputtering forward. Will it be enough?

The popular theory among those in the crypto world is that the stimulus will lead to high inflation, possibly even hyperinflation. "Money Printer Go Brrrrr" means the value of the money goes down, right? Well, I'm not an economist, but I'm also not naive enough to think it's really this simple. In this edition of Build Blockchain, we'll unpack why the case for inflation isn't so certain, and how crypto may actually help entrench the dollar in its position as the world's reserve currency.

Banana Printer Go Brrrrr

Let's talk about bananas for a second. (I know that sounds weird, but bear with me). Imagine that two things happened at almost the same time. First, a blight wiped out a large percentage of the world's banana crops. Second, scientists discovered eating lots of bananas could help protect against covid19 infection. What do you think would happen to the price of bananas? Well, as supply contracted and demand skyrocketed, the price would certainly go through the roof.

Now imagine someone had a magic banana printer that could materialize bananas out of thin air. (Just stick with me here for one more minute, ok?). How many bananas could they print before the price cratered? Well, given the dramatic supply contraction and the huge demand expansion, they could probably afford to materialize quite a few magic bananas before the price even got back down to what it was originally. Banana Printer Go Brrrrrrr.



In case it's not obvious yet, here's the point of this potassium rich analogy. The US Dollar is not too different from magical bananas.

As the crisis hit and virtually all assets sold off, two things happened at once. First, the credit market contracted abruptly, decreasing the effective supply of dollars in the world. Second, everyone wanted to liquidate their other assets and hold dollars, because dollars are seen as the safest asset globally. This sharply increased demand. As a result, the "price" of dollars increased. This was reflected in the foreign exchange markets, where the cost to buy dollars in virtually every other currency rose.

The price of dollars is also reflected in their purchasing power through inflation or deflation, albeit this takes longer to realize. Based on the supply/demand dynamics we've discussed, the current crisis— without intervention— would probably lead to deflation. While this isn't uniform across all goods, we'd expect in general the price of most things to go down in dollar terms.

Here's the thing, unlike bananas, there really is a magical dollar printer, and it's controlled by congress and the Federal Reserve. As we know, they've been putting it to use as of late, but if you agreed that we could make many magical bananas without cratering their price in the scenario described above, it follows making magical dollars appear shouldn't lead to inflation in the current crisis.

Which Money Printer Matters

A couple of important caveats are warranted. This analysis is overly simplistic. There will be second, third, and fourth order effects of these stimulus measures. What will the long term steady state be? Nobody knows. We may very well see high inflation, deflation, or neither. The point is that the popular narrative amongst crypto folks— that monetary stimulus de-facto leads to inflation— is even more simplistic than what I've presented. Inflation is far from a given.

The same, by the way, could be said of the counter narrative some have pushed, namely that these dramatic stimulus measures somehow prove the government can always print money for whatever it wants. Just because you might be able to get away with massive stimulus in an unprecedented global crisis doesn't mean it will work forever. One way we could see inflation, in the long term, is if people might fail to understand that point, and clamour to make massive money printing a matter of political policy after this crisis resolves.

The second important caveat here is that everything discussed so far applies to US Dollars. What happens in the rest of the world? Well, as author, photographer, and former physicist-quant-hedge-fund-trader Chris Arnade put it, "Money Printer Go Brrrrrr" only translates to German and Japanese. Link.

The European Central Bank, The Bank of Japan, and The Bank of England can probably get away with massive stimulus packages for the same reasons the US Federal Reserve can. If other nations, however, attempt to print their way out of the crisis, we likely will see high inflation in countries across the developing world. The demand side of our banana equation simply doesn't hold up for other forms of fiat. Anyone in those countries who can get dollars, euros, or yen will do so.

The Rise of Crypto Stablecoins

This point, finally, brings us to crypto. Traditionally, in the developing world, most citizens didn't have access to foreign currencies. Crypto changes this with the existence of stablecoins. Anyone with an internet connection can access decentralized networks where they have a plethora of dollar-pegged stablecoins to choose from. This includes centralized IOU backed stablcoins, like Tether and USDC, and trust-minimized collateral backed stablecoins like Dai and sUSD.

Crypto stablecoins have, to varying degrees based on their implementation, many of the same benefits of cryptocurrencies themselves. They can be self-custodied, they're censorship resistant, and they can even be private with technologies like zero knowledge proofs layered on top. Unlike normal cryptocurrencies, stablecoins don't have the volatility risk that comes with holding a highly speculative asset.

Could crypto lead to a wave of global dollarization, where citizens in nations experiencing inflation simply opt-out of the local currencies in favor of dollar pegged stablecoins implemented on networks like Ethereum? This outcome would be a deeply ironic twist of fate, given many hardcore crypto proponents have long hoped that Bitcoin would supplant USD as the global reserve currency.

There are some major impediments to this playing out, of course. Local on-off ramps can be hard to come by or censored by governments, and crypto UX remains challenging for normal users. Still, this crisis is breeding an environment where many throughout the world could have a very strong motivation to overcome these hurdles.

I've been wondering since 2018 if exporting the dollar to developing nations could be crypto's first killer app. If it's ever going to happen, now will be the time. The conditions are ripe. Keep an eye on this in the months and years ahead.