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This week, the Atlantic Council published a report stating that <a href="https://www.atlanticcouncil.org/cbdctracker/" rel="noopener noreferrer nofollow">around 130 countries are already exploring a Central Bank Digital Currency</a> (CBDC), a marked increase from the 35 countries that were considering it in 2020.Libertarian think tanks like the Cato Institute have criticised this trend, suggesting that CBDCs provide governments with too great an ability to monitor and surveil populations, and provide central banks with too much power.No less than Peter Goettler, president and CEO of the Cato Institute, <a href="https://dailyhodl.com/2023/07/03/130-countries-race-toward-cbdc-system-with-most-already-in-advanced-phases-research/" rel="noopener noreferrer nofollow">suggested that CBDCs are the governments’ response to the rise of cryptocurrencies.</a>“Cryptocurrencies also provide the ability to transact outside of the traditional financial sector and with more privacy. In response to the popularity of this innovation, governments are pursuing the exact opposite: more centralization, surveillance and control…CBDCs are being developed precisely because they provide governments with increased control and power. This kind of threat to individual rights will naturally drive people toward private solutions, while governments are sure to work hard to thwart such alternatives since they undermine the increased government control and power CBDCs create.”-Peter Goettler, president and CEO of the Cato InstituteIndeed, the programmability and traceability of CBDCs would provide many governments with significant powers- of money creation, of transaction surveillance, and much more.And it is no coincidence that the development of CBDCs comes as cryptocurrency’s popularity rises among those dissatisfied with the current financial system that seems to allow banks to get richer at the expense of the common folk.But we should also question why governments seem to be so attached to the financial system that we have- and if what they want to protect is worth protecting.Adam Smith, John Law, and the financial revolutionOne of the fundamental ideas of the global economy today is rooted in Adam Smith’s seminal book ‘Wealth of Nations’, which suggests that the global economy is not a zero-sum game, but one where everyone can benefit from trade through specialisation.This idea of nations, and indeed, individuals, honing their comparative advantage in production, is what gives rise to the modern economy- one where neighbours are thought of not as competitors to be dominated, but potential trading partners with whom we can cooperate for mutual benefit.This theory was posited during a time where the dominant economic ideology of the day was mercantilism- where the economy was a zero-sum game, and any one party’s gain was another party’s loss.In the context of a gold-based financial system, this made sense- wealth was considered to exist only as precious metals, and therefore, to be wealthy meant being able to obtain or at least control vast amounts of gold or some other commodity that could be exchanged for gold.And Smith was just the first in this line of thinkers that would inform and trigger the revolution in global finance and economics.John Law, several decades after Smith, argued that commodities like gold and silver had no intrinsic value of their own, and that they were only as valuable because people believed they were valuable.His most significant realisation, perhaps, was that money was not the value for which goods are traded, but the value by which goods were traded. Therefore, there is theoretically no limit to the amount of money that can exist in the world.Smith’s ideas continue to be the basis of the global economy, while Law’s ideas form the basis of much of the modern financial and banking systems.We trade because all parties benefit from it, and banks create money without backing it with anything because the system is sustained not through commodities but through faith.The side effect of such a system, of course, is that it creates inflationary pressure when we print money, because there may not necessarily be a corresponding increase in output to match the increase in money supply.It is this inflation that eats away at savings, and reduces the purchasing power of individuals who hold cash, since money becomes less scarce when banks freely print money.Enter Bitcoin and crypto- the antithesis to the debt-based monetary systemBut, this inflation is something that is not necessarily welcomed by most people.It makes saving up money, especially in the long term, especially difficult because inflation means that all the money that you have not spent will steadily lose its purchasing power, and that the effort you spent on earning that money is eroded.As such, inflation is often seen in a negative light and considered an obstacle against social advancement.The reason why Bitcoin is sometimes championed as a better store of value as compared to US Dollars is precisely because there is a limited supply of it- there will only ever be 21 million Bitcoin in existence, and therefore this currency will not inflate and become less valuable simply because more of it exists.In other words, the creation of non-inflationary cryptocurrencies like Bitcoin is essentially a rebellion against the financial and economic system with roots in the arguments of John Law and Adam Smith.Such a system would not automatically welcome the system of free trade that many of us have come to accept and expect- on the contrary, it would herald a return to the zero-sum mercantilism of the past.The return of mercantilismLet us consider the implication of widespread adoption of limited-supply cryptocurrencies like Bitcoin as money.Because there is a limited supply of such cryptocurrencies, people would be incentivised to hoard such cryptocurrencies, because these are guarantors of value- the purchasing power of these cryptocurrencies will not be eroded by inflation, and as worldwide economic output grows, these cryptocurrencies will become more and more valuable.Just as nations hoarded gold and restricted trade when it caused outflows of gold, a global bitcoin-based economy would also incentivise countries and individuals to hoard bitcoin and restrict trade when it might lead to an outflow of bitcoin.In addition, because banks and governments no longer have the ability to create debt and money, expansion of money supply for purposes like investments and government spending would be extremely difficult.Entrepreneurs seeking venture capital funding, government provision of public goods like key infrastructure projects, and any other manner of spending except on direct consumption of goods and services would slow to a crawl. Innovation would be curtailed.Of course, that is not to say that the current system of inflationary fiat currency is perfect- every system has trade offs, and under the inflationary fiat currency, it is an unfortunate truth that malinvestments and moral hazard on the role of banks exist.But we should also recognise that this system has also been responsible for much of the economic growth that the world has seen in the past century.CBDCs would provide governments with great powers- and they are rightly seen as something that would enhance current government powers. But there are also extremely legitimate reasons for why governments would seek to curtail the creation and development of cryptocurrencies, while adapting blockchain technology for their own purposes.But we should also recognise that cryptocurrencies themselves do not yet offer a viable alternative solution. Before we rush to abandon what we have for what is new, we should first question if the new trade-offs are truly beneficial, and if the risk is really worth the reward.

Tokenomics 10: the rise of cryptocurrencies and the return to mercantilism

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