What Exactly Is Currency?

Synopsis:

Much of what is said about cryptocurrency has little to do with economic analysis. Both hype and demonization are based in various dogmas that have nothing to do with economic valuation. The dynamics between different currencies need to be understood in order to understand what cryptocurrencies actually are. Where one currency exists in a vacuum, it is nothing but a currency; but when another is added, it immediately gains derivative value, as it can be traded for the other currency, and compete with it’s notional value. This occurs between national currencies in the global economy. What makes any currency valuable is notional value; which is influenced by supply and demand as well. All currencies are volatile; but fiat currencies have a tendency to devalue over time. This isn’t however to say that non-fiat currencies couldn’t devalue. All of these aspects are needed to properly analyze a currency.

Notional Value:

Everything that is traded has notional value. It’s one constant aspect of valuation. It’s based in what someone would trade for it. It’s generally agreed upon; because that’s the way it develops in the system. It’s how prices are set. All of the buying and selling results in numbers that are associated to the value of specific things. Currencies are a way of trading by the numbers associated with value.

Supply and Demand:

The value of all currencies is affected by supply and demand. One of the most important aspects of currency is it’s ability to have a stable value under equilibrium. When the economy has exactly as much money as it requires, the value of it is economically accurate. It is neither inflated, due to being too scarce and thus too in demand, nor is it devalued, by being too plentiful; as there are costs in creating it. Both affect prices. Currency is also intended to reflect the value of all products and services. That is essentially what a numeraire is. When there is too little currency, prices seem low; because less currency is used to buy products and services. When there is more currency than is needed, prices seem high; as more currency is traded for products and services. No matter how much currency exists, it will all be in circulation; and associated with the value of all available products and services.

Competition Between National Currencies:

Devaluation is most commonly associated with comparisons with other national currencies. There is also a global numeraire at play. In theory national currencies can be exchanged to take advantage of their volatility. When a particular national currency is temporarily devalued, an exchange could be made for a more stable one; and then exchanged back when the currency recovers. This is one way that national currencies have derivative value; which exists in any situation where more than one currency exists, and they can be exchanged. Where two or more currencies exist, they can essentially be used as derivatives.

Fiat and Non-Fiat:

Coins made from precious metals are of course non-fiat currencies; as the precious metals are a scarce resource. They are however the currency that is the most expensive to produce. The value of precious metals though more stable is still based on supply and demand. Being a scarce resource, with the demand that entails, gives it it’s value. It also has value in productivity. Precious metals are used in various products; for both aesthetic and practical uses. Considering the cost and value of precious metals; their economic value as currencies is questionable.

The gold standard has the same issues. Might as well have currency made from precious metals; as the currency backed by it has production costs as well. It would in fact be more economical to have precious metal coins; as the production costs of paper money would be averted.

The fact that non-fiat currency can’t be created out of thin air doesn’t mean that it will find equilibrium in notional value; and accurately represent the notional value of the full complement of products and services available. There is no correlation between the discrete scarcity of a currency and it’s ability to value the products and services of an economy. If it’s too scarce, prices will seem low. It could also be too plentiful. Non-fiat currency does not necessarily solve the problem of valuation.

Fiat currency does not cause domestic devaluation. That is a more general systemic issue; and non-fiat currency isn’t necessarily a solution. Though attaining it is much more restrictive, it’s not correlated to the needs of the economy. There really is no fiat currency; they all have costs to produce. The only pure fiat currency would be something like a digital credit; which would have near 0 cost. The value of a fiat currency is it’s low cost and it’s ability to find equilibrium with the needs of the economy.

We like to hold something of obvious value in our hands. We like the idea of a currency that is clearly a stable storage of value. The problem with them in an economic sense is, if they represent the value of what they can buy by their own intrinsic value; then the costs of the production of currency is equivalent to the value of products and services available. The economy essentially becomes twice as expensive to maintain. Fiat currency is the most economical currency there is; for that very fact.

What really covers the value of a currency is the economy itself. When an economy crashes the currency goes with it. For instance, the crash of Venezuelas’ economy made the currency valueless. Though a gold token would still have substantial intrinsic value; it would not buy products and services that no longer exist. When economies fall, it’s because the markets fall. The demand for products and services increase; as they become more scarce, and even a gold token would buy less. It’s not a solution. No currency is a substitute for products and services; they are only a means to access.

Closing:

This is a tool for analysis of currencies. The intent here is to provide an understanding of the dynamics between currency and economy; in hopes that it will help with valuation of currencies, both existing and emerging.