I know what you are thinking: Bold title.. But, read on! I promise you, that this article will be worth your time. For the last couple of years, many brilliant people have been thinking a lot about the future of money, and how digital currencies potentially have a role to play in how we exchange goods and services with each other. Personally, I don’t believe Bitcoin will ever be used as what is called a ‘fiat’ (or day-to-day) currency. But that is okay, because we can do such much better. We can have elastic money. What is an elastic currency, you ask? Well, you are in luck! This article is going to explore the economics of an elastic currency – but first, I have some explaining to do.
Up, then down
I think most people have heard of Bitcoin and cryptocurrency by now, or at least heard about it briefly, when one unit of Bitcoin was worth about 20.000 Dollars back in December of 2017. What followed was, of course, a historic crash – and ultimately a decline of interest in cryptocurrencies within mainline media. The hype died. Billions of dollars were lost in days, if not hours. ‘It was all pure speculation, based on nothing‘ became the general consensus. The show was over.
But is it really over? Surely there must be something new or useful that digital currencies can bring to the table?
Deflating the inflation
I was sitting at a bar two years ago, talking to a friend of mine who spends a lot of time thinking about numbers and outcomes (Math Ph.D.). We started talking about Bitcoin, and he brought to my attention, something that I (at the time) had not thought about very much.
He argued that, because Bitcoin is a deflationary currency, it becomes a less than ideal currency for ordinary, everyday transactions. Now, you probably already know what the essence of inflation (or, an inflationary currency) is: More money can be printed and put into circulation. Imagine the opposite of this. More money cannot be printed – there is a finite amount of it, and the total supply of money can only ever become lesser, as it is lost or destroyed. This is a deflationary currency. To really hit it home, let me exemplify:
In the inflationary model, a singular unit of money (a Dollar, for example) tends to lose its value over time, as more of it is printed. You have probably heard something along these lines before: “A Dollar in 1980 would be worth THIS much more, compared to a Dollar today“. This is because of inflation. One Dollar in 1980 had a higher relative value, because the total supply of the Dollar was lower in 1980. That has now changed, more Dollars have been printed since then.
In the deflationary model, a singular unit of money (a Bitcoin, for example) tends to gain value over time, since it can only become scarcer. There will only ever be 21 million Bitcoin in existence. We cannot make more of it, after all the coins have been mined. Wallets containing Bitcoin can only be lost – or Bitcoin can be sent to addresses where it essentially becomes unretrievable. Gone forever. Either way, the bottom line is; The circulating supply of Bitcoin can only shrink.
Alright, so.. Why does this make Bitcoin a bad base money?
Why Bitcoin won’t be money
The thing with deflationary currencies, is that they typically incentivize hoarding. This is because, as time goes on – such a currency will only become a scarcer and scarcer resource. If a society adopts such a currency as the main one that it uses – it potentially subjects its own economy to what is known as a deflationary spiral of death. In such a scenario, everyone is hoarding the money that they have – and because of this, the entire economy of the society can end up grinding to a halt.
What happens is, that everyone is trying to hang on to their money, because it will be worth more in the future. You don’t want to spend 0.01 Bitcoin on a cart of goods at the store today, when 0.01 Bitcoin potentially could buy you two of those carts tomorrow. Spending is delayed – and as a consequence, there is little economic growth anywhere.
(Side-note: I bet that guy who bought two pizzas for 10.000 Bitcoin in 2010, is kicking himself right now.)
What’s wrong with fiat currencies?
So now you might be thinking something along the lines of “Well, alright, that’s fine – but we already have money that we use. Money like the Dollar. What’s so wrong with it?”. The answer to this question will vary depending on who you ask, but a common denominator is almost always inflation.
Another thing is, that the national currencies of today, are actually backed by nothing – thanks to the Bretton Woods system, brought forward by Richard Nixon in 1971.
So let’s take a closer look at inflation. In an inflationary economy, such as the one we are all living in, more money can be printed by the people who govern the money. It’s a pretty simple concept really.
In an inflationary economy, you are incentivized to spend or invest your money as fast as you can, since it will lose its value over time – as more and more money comes into circulation. This is a type of economy that overly favors risk-takers and financially literate people who know how to make their money work for them. Now, is that really so bad? I personally don’t think so – however, there is an aspect of this money-printing that we aren’t really addressing with this.
The people who govern the money
The real issue (in my opinion) with inflationary currencies, is that the authorities who control the reserves, essentially tax everyone who is holding the currency when they print more of it. It is important to understand, that value is never created out of thin air when new money is minted. Its value is relational to all the money that already exists.
Stop. Think about that for a second.
When an entity like a Federal Reserve prints more money, everyone who is holding whichever currency is being printed, has some of their purchasing power taken away from them. Straight out of their pockets. To reiterate: This is the case – because now there are more units of the currency in circulation, and each unit now has a smaller relational value (I think you get it by now, sorry). On top of this, these governing people now get to redistribute this purchasing power, however they see fit.
I won’t get too political, but obviously, some people would also see a problem with this in many cases.
It’s a double-edged sword
I spent a lot of time thinking about this. About inflation and deflation. Both seem like natural, unavoidable consequences built in to the options that we have at our disposals, when we form our economies. We can either choose to have a currency that is finite, or one that isn’t. We will always be subject to one or the other model.. Right?
Right. Or, well, at least this was the case until recently.
The Ampleforth project
At this point in time, there are almost 8000 different cryptocurrency projects that have been launched, and are being tracked by major aggregate sites. Most of these projects involve platforms or services that try to use a proprietary cryptocurrency in the form of tokens, within whatever closed ecosystem they have established. Think of these, as poker chips that you buy at the entrance of a casino. They only work as currency inside the casino. Not many of these try to be what Satoshi Nakamoto envisioned that Bitcoin could be become; A new m0 currency, a new financial primitive – just like the Dollar, or any other national currency.
(At least, that is what we think he/she/they intended. This is also a little disputed – but with the title of the original Bitcoin whitepaper being: “Bitcoin: A Peer-to-Peer Electronic Cash System” – I think this is pretty safe to assume.)
Recently however, someone took a stab at the innovation of such a financial primitive. The project is called Ampleforth, and it is a cryptocurrency with an elastic supply, which has the long-term goal of essentially becoming Money 2.0.
I know, I know. This sounds a little fantastical and idealistic – I get it. I thought so too at first. Then I realized, that the people behind this experiment are all.. Well, very credible people. Some of them with engineering backgrounds at companies like Google. The project has also been advised by individuals at Harvard, Oxford, MIT and Stanford – which definitely also caught my eye.. I mean, how could it not.
Now – I think it’s about time. Let’s finally dive into what this is, and explore how Ampleforth (the AMPL unit), is different – and how it is a potential innovation upon money as we know it.
(Thank you for sticking with me this far, by the way. It has all been necessary set-up, to contextualize the relevance of this project.)
An adaptive base money
It was Friedrich Hayek, the Nobel-prize winning economist, who laid the conceptual foundation, which Ampleforth was eventually built upon. If you find this all very confusing or boring, I’d urge you to watch this very short teaser, which outlines the idea behind the Project; It’s mission statement in a sense.
(To succinctly summarize what the main idea behind this currency is, I’ll have to simplify and gloss over technical details. If you are interested in learning more about AMPL in-depth, you can get started here.)
Ampleforth is a currency, that cannot be inflated – but also isn’t deflationary in nature. Crazy.
The way this works, is that every day – at a set time, the Ampleforth cryptocurrency protocol adjusts the total supply of the currency automatically. This means, that during this time – everyone who is holding Ampleforth has the amount of tokens that they own, re-evaluated against the current price of a single AMPL, and then has their tokens redistributed to them. This event is called a “Rebase“.
This is what happens during one of these events:
If the demand for AMPL has pushed the price of a single AMPL unit up above a set threshold, more AMPL is printed and redistributed to everyone. If sell-pressure has pushed the price of AMPL below a lower set threshold, an amount of AMPL is taken out of circulation – and everyone is redistributed tokens again. If the price of AMPL is within a range between these two thresholds, the supply is not adjusted. Essentially, your tokens represent a fixed percentage of the entire Ampleforth network, that you own.
The point of this Rebase event, is to make the currency either more scarce or more abundant. When it is more scarce, this incentivizes the market to buy AMPL, thus creating demand – thus driving the price of AMPL up. When the supply of AMPL becomes abundant, the market is incentivized to sell AMPL, thus creating sell-pressure – thus driving the price down. The intent of this mechanism, is to keep the price of single AMPL unit somewhat stable.
What the creators of this currency have achieved, is, that they have managed to create a primitive – just like Bitcoin – but the volatility of the currency has been shifted from the price, into the supply. You are no longer incentivized to hoard single units, since the value of these will remain relatively stable at a supply/demand equilibrium. This is huge. Both for individuals who aren’t savvy investors, but also for loan-takers and loan-givers. To use my previous example, you don’t want to spend 0.01 Bitcoin on a cart of goods at the store today, because you might be able to buy two of those carts tomorrow with the same amount. With AMPL, I don’t mind spending it (or borrowing it), since the price of a single unit will remain relatively stable. I might just have more or less of it at certain times.
The currency works like an elastic band. The more pressure is applied on the band (the price) in either direction, the more incentive is created for it to equalize itself. It’s an elastic supply currency. Such a currency could not have existed before now, because it relies on recent innovations in the blockchain industry (I’ll get to those in a minute). It’s completely novel and quite brilliant, in my opinion.
Okay.. But.. Why?
I see how I might have gotten ahead of myself there, but let me send you off with the clear value propositions that a currency like this presents.
Satoshi Nakamoto, the anonymous creator(s) of Bitcoin, acknowledged in a forum post – back in 2009, that Bitcoin had taken the shape, of more something like a precious metal (like gold), since it’s deflationary nature would keep it from being used as a base money (probably). Before he/she/they vanished, Satoshi also added, that the reason why the total supply of Bitcoin couldn’t be dynamically adjusted, was because there was no way for software to know the real world value of things:
“I don’t know a way for software to know the real world value of things. If there was some clever way, or if we wanted to trust someone to actively manage the money supply to peg it to something, the rules could have been programmed for that” — Satoshi Nakamoto, P2Pfoundation (2009)
Since then, many innovations have been made in world of blockchains and cryptocurrency, and we now have what is known as reliable “oracles”, that can provide the kind of information that Satoshi was talking about. The AMPL is actually pegged to the value of a 2019 Dollar because of one of these oracles. Specifically a Consumer Price Index (CPI) oracle. This means, that as time goes on – and as the Dollar loses value – the Dollar value of a single unit of AMPL will go up (and the Rebase threshold zone with it).
The more you understand how it works, the more you realize, that AMPL sort of.. dare I say.. completes Satoshi Nakamoto’s initial vision of an electronic peer-to-peer cash?
Another thing that bears repeating, is that this currency cannot be inflated. It is impossible for you to lose any of the percentages of the network that you own. Your percentage share, will always remain fixed. Just like with a deflationary currency. It took me a while to really understand how all of this is connected and how it actually works, but I am sure that you are smarter than me – and that you are already laughing at how overly simplified this article is.
No financial advice
Before I end this article, I just want to express that I am not encouraging you to go and buy AMPL tokens. The reason why I wrote this article, is because I am very embedded in the world of cryptocurrency – and I thought this was one of the most interesting things that I have ever come across in the space. A real take on what the future of money can look like. After all, no one has managed to radically innovate on the basic economic models that we have been using since, well.. forever.
Besides, plenty of other cryptocurrency projects have already realized what immense potential lies in having a protocol with Rebase functionality. The people behind Ampleforth just incepted the idea into the community. Now, there are many different variations and takes on what a currency like this can look like. Random Rebase timings, esoteric token burn mechanics, and the list goes on.
Perhaps there is another elastic supply currency out there, that you would see more potential in. By now, it’s entirely possible at least.
You know what the say about imitation, though; It’s the sincerest form of flattery.