China has cracked down on cryptocurrency mining. The United States is investigating various cryptocurrency providers and has also recently considered the financial regulation of the ecosystem. Meanwhile, El Salvador, a country in Central America, has embraced cryptocurrency by making bitcoin legal tender.
So, will we see merchants accepting cryptocurrencies in the future? That depends on whether a critical mass of people adopts this technology.
Trust takes time
It is not easy for merchants to trust cryptocurrencies, especially when the government does not back them.
The cryptocurrency trust-building journey so far has been undermined by high-profile hacks, frauds, and security breaches. When regulators ban cryptocurrency, its market is over for obvious reasons. But even if the cryptocurrency is compliant with regulations and offers appropriate cybersecurity, its value is still volatile. The volatility affects how merchants price their products or services.
Unfortunately, stablecoins do not solve this problem. Not only do they involve some trust in the underlying fiat currency (or currencies) to which the coin is “pegged,” merchants must also trust the coin provider to maintain their peg with sufficient backing. In other words, rather than being “trustless,” stablecoin solutions involve even more layers of trust than fiat currency.
Deflation
There are also macroeconomic reasons behind the low adoption rate of cryptocurrencies as a means for payment for goods and services.
Recent cryptocurrency markets have been increasing in value relative to other currencies, goods, and services. In economics, we call this deflation. Deflation reduces the incentive for people to transact. Rather than convert bitcoin to goods or services, people would rather hold on to it since they expect its price to rise even more in the future.
Therefore, in deflationary environments, economies also tend to have lower transactions, affecting the exchange of goods and services and economic growth. This is a problem that Japan has faced for decades, and it is also why economists typically prefer low but stable inflation to stimulate people to spend the dollars they are holding. It turns out the rising value of cryptocurrency that is hailed as a feature is actually a bug.
Markets using Cryptocurrency
But a caveat is that some merchants are willing to accept the volatility – those in the black market or countries that currently do not have their own currencies in the first place.
In a society where they do not have viable alternative options, merchants and consumers would be willing to use such alternative currencies. In fact, El Salvador – a country with a GDP per capita in 2020 of around US$ 3,800 compared to US$ 63,500 in the United States – has been accepting the US dollar as legal tender since 2001.
A lesson from economics that we should all remember is that just with any economic decision, we should evaluate the marginal benefit and marginal costs. The marginal cost for a country is the loss of control over one’s money supply, effectively eliminating monetary policy as a tool for affecting economic change.
The marginal benefit, for now, is a relatively slow, mostly single-factor authentication digital payment platform. So although the future is promising for decentralized finance and cryptocurrencies generally, its use as a currency for transactions is probably not viable.
The article is an abridged version of the one first published in SCMP.