First off, let's announce a new coin. This coin sounds very exciting and has some massive advantages.

It transfers instantly.
It has no transaction costs.
It has country-level VC backing.
It is accepted for tax payments.
Its price will probably be short-term stable.

The coin also has downsides.

Its supply is not fixed, and can be changed by a single entity.
It has an interest rate, which can be positive or negative.
It's programmable by a single entity that is able to steer or restrict what you spend money on.
It will be debased with the aim of ~2% annual value loss.
It's not globally transferable.
It explicitly rules out full privacy (see below).

In many ways, these pros and cons mirror the fundamentals of fiat currency versus crypto as discussed here.

So what changes when CBDCs are issued, rather than fiat money as we know it now? By issuing a CBDC, the differences between crypto and fiat protocols become much clearer. Crypto was never just about "being digital".

If you believe that crypto is a superior paradigm to fiat, then making it easier to compare fiat to crypto is fantastic. This comparison shows the inherent trade-offs and disadvantages of both paradigms.

It then becomes crystal clear that by holding fiat you agree to be censorable, you agree to see your money debased at 2% per year, you agree to losing privacy, you agree to never having full ownership of your money. However, you gain short-term price stability.

Is that a valuable trade-off? To an extent, for many, it is.

However, there are alternatives in the market. These alternatives are uncensorable, giving you full control over your money, without inbuilt debasement, with (pseudo)anonimity, with no single party able to censor or change the rules.

No short-term price stability (yet), though.

What then becomes the logical way to hold and use your money? You hold as little fiat/CBDC as possible. You exchange into it when needed to pay for goods, services and taxes. Holding it long-term though? No way, why would I voluntarily suffer 2% annual debasement?

Side note: 2% debasement is a relatively good outcome. Most countries in the world tend to have far higher inflation than this.

The more that people look into this, the more fiat seems like a terrible long-term store of value (even in developed countries), while crypto seems very appealing for the long-term.

With crypto's current high volatility, I wouldn't expect people to hold 100% of their cash in it. But 1%? 2%? 5%? That seems to make sense. At least you're not being debased on the cash that you hold as crypto instead of fiat.

This is an interesting flywheel effect. As more people look into this, and as more people decide to allocate some of their cash to crypto, several things happen.

Crypto market cap increases
Fiat value decreases
Crypto network effect improves
Crypto volatility decreases

As more is allocated to crypto versus fiat, the total value of crypto naturally increases. This is arguably what we've seen over the past ~10 years already, but a clearer juxtaposition between crypto and fiat could speed up this process.

As fiat is effectively "sold" for crypto, the value of fiat decreases. This again has parallels - with easier access to stronger currencies like USD & EUR, weaker currencies like those in many developing countries are seeing their value decrease faster than ever. Argentina is (sadly) a good example.

This then improves crypto's network effect. When there are more people holding crypto, offering it as a payment option becomes more attractive. Your potential customer base is larger. Moreso, merchants and companies have the same thinking as individuals. They will have an incentive to hold some of their cash in crypto. Exchanging into crypto tends to have fees. Why not accept it directly? You’d get lower payment processing fees, and save on exchanging fees.

As an aside, this is one of the reasons deflationary money works just as well as a Medium of Exchange as inflationary money. If party 1 has coin A and party 2 wants coin A, why first swap into fiat rather than transacting in coin A?

Senatus’s Newsletter

Why deflationary money can be both a store of value and a currency

I’ve seen this discussion pop up more often recently, so let’s dive in. In short, the argument goes that currencies need to be inflationary so that people are incentivised to spend. A way to see it is to think of inflationary currency as a hot potato – if you don’t do anything with it and keep it in cash, it’s going to decline in value. Therefore, you m…

5 years ago · 7 likes · 1 comment · Senatus

Finally, a larger percentage of cash held in crypto, and increasing usage of crypto for transactions could lead to decreasing volatility, making crypto more viable as a true currency.

Are there also bad scenarios? Sure. If CBDC roll-out is coupled with obstruction of ability to exchange into crypto, this flywheel might never start or be far slower. The battle is not already won, and broadening access to crypto is perhaps the most important thing we can do.

But with free choice, there is very little reason to expect CBDCs to win versus crypto in the long term. Debaseable money that you never fully own and that is inherently censorable does not stand much chance against fixed supply, full ownership and open networks.

Senatus’s Newsletter

Why CBDCs might be positive for crypto.