Does Gresham's law affect cryptocurrency?

cryptoeconomics

#1

http://heavilyarmedclown.com/wp/does-greshams-law-affect-cryptocurrency/

If you’re unfamiliar with what Gresham’s law is, wikipedia defines it as…

“…a monetary principle stating that “bad money drives out good”. For example, if there are two forms of commodity money in circulation, which are accepted by law as having similar face value, the more valuable commodity will gradually disappear from circulation.”

There a few key things we need to pick up on here. In this instance, good money means a sound, hard currency that functions as a store of value, meaning that over a long period of time, the relative value of wealth will not decrease, where as bad money means a weak, typically inflationary and/or fiat currency which loses relative value over time. The second, is that Gresham’s law occurs when two monies are accepted by law as having similar face value.

The best example of this phenomenon can be observed in periods of bimetallism. Bimetallism was a frequently tested and consistently failed experiment of currency systems involving typically gold and silver. Instead of allowing the free market to determine floating exchange rates between the two, the governments enacted fixed exchange rates between gold and silver, driving out the circulation of one over the other to balance the artificial price floors and ceilings. Consumers will horde the more valuable currency and choose to spend the less valuable currency, because the exchange rates between the two are not allowed to function naturally in the free market.

Weaker monies encourage spending now to maximize capital activation while stronger monies encourage saving to maximize capital activation. This delay of gratification in the now is encourage by the promise of greater gratification later. A great example of this can be observed in what is known as the Marshmallow Test as pointed out by Saifdean Ammous in his book The Bitcoin Standard.

It seems reasonable to me that the cryptocurrency revolution will change the way we think about economics and present opportunities for new insight into markets and liquidity flow. I postulate a unique variation of Gresham’s law is taking place in the crypto space today…while admittedly, the cryptocurrencies in circulation are not “accepted by law” at similar face value, they are however, all permutations, in some way, shape or form, or a BTC trading pair.

Something I have observed in my own dealings with cryptocurrency is that the one particular coin with the strongest monetary structure behind it (BTC), is the one coin I find myself least likely to part with to engage in transaction. I am far more likely to engage in a transaction using an altcoin (any crypto other than BTC), as I feel those coins have a weaker store of value and a less likely chance of appreciation on a long enough time scale. That isn’t to say altcoins will only go down and bitcoin will only go up, but based on the monetary structure and immutable nature of bitcoin, I believe it is more likely to hold its value and appreciate than any other cryptographic digital asset.

Another example of this phenomenon comes from Peter, who often chooses to be paid in cryptocurrency when he does consulting gigs. Peter has found, that companies seem much more eager to pay in him altcoins, ethereum being the best example, than to pay him in bitcoin. Peter, by his own admission, anguishes over when and whether or not ethereum will see its next spike in value so he can liquidate it for a harder currency when he gets the chance…and so the cycle continues.

So, while we may not be experiencing the actual lawfully enforced circulation of a relatively hard and relatively soft currency at equal values, what we are seeing is the tendency to favor circulation of a softer money over harder money due to basic economics principles. Does this mean that soft money functions better as a medium of exchange than hard currency? Far from it, I would say. In such a nascent developing market as this, with loose capital pouring into every new, and not necessarily practical, idea and startup, it’s not surprising to see an inflated asset marketplace facilitating the exchange of billions of dollars in currencies that could very well end up becoming virtually worthless at some point in the future.

Do not make the mistake of believing that anything is incapable of losing its value as a money or a store of value, as it is the soundness, hardness, and scalability which give these things their value as a medium of exchange. I should like to see if in the future this phenomenon will be self eliminating as cryptocurrency projects experience attrition from lack of functional use case, or if the free market chooses to preserve the use of a weaker currency trading pair, to find an economic equilibrium between spending and saving.

Thoughts?


#2

I think it makes sense in some aspects. It’ll all even out over time.


#3

Interesting post. I have considered how the deflationary aspect of Bitcoin may affect future spending habits. Why spend it if it will be worth more tomorrow? If everyone is transacting in Bitcoin, then I suppose it really won’t matter. We will all just be happier knowing that our currency holds a stable value without manipulation. No doubt economies will have to adapt if this happens. It’s possible we may become more conscious spenders. When we have control over our own data, we will have less advertising thrown at us as well. Hopefully, it all results in a financial system that works more efficiently with the benefits distributed more evenly.


#4

That’s a good point. This is actually nothing new, currencies don’t go up in value forever, eventually they find an equilibrium with demand, based on the number of people on the earth and the amount of productivity we can create relative to the sum of all working age humans.

I highly recommend you check out the book “the bitcoin standard” Ammous actually talks about this exact concept, if you find it interesting. Hard currencies encourage saving and more prudent spending, delay of gratification so to speak, but they don’t discourage spending altogether, so much as they create a different social dynamic of consumption vs saving than we have in the world today with mostly inflationary currencies.


#5

Thanks for the recommendation. I’ll check it out. :slight_smile: