January 27, 2024

Sound money is any form of globally recognized currency that can function as a stable and reliable store of value. Even under this simplistic definition, it becomes difficult to continue recognizing mainstream currencies as sound, due to manipulations by central banks and similar bureaucracies.

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Cryptocurrency is sometimes proposed as a sound alternative, but can we really consider cryptocurrency to be sound money?

The Dynamics of Cryptocurrency

First, we must understand what cryptocurrency is — and what it isn’t. Cryptocurrency is any form of digital currency that relies on the blockchain, or similar technology, to facilitate transactions. The blockchain is a technology that relies on an interconnected network of nodes to preserve and update a shared ledger through consensus.

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Each user in the network functions as a node, processing a kind of vote to legitimize transactions and update records. Because this process involves the processing of cryptographic hashes, it’s anonymous and secure — or at least more anonymous and more secure than something like a credit-card transaction.

Unfortunately, we can’t say much else about what cryptocurrency is because there are so many different kinds of cryptocurrency. Each cryptocurrency has its own model for how transactions are processed, how new currency is created, and other variables.

Still, we can take what we know about cryptocurrency, in general, to evaluate whether it’s possible for a coin to be considered sound money.

Reasons for Skepticism

There are some reasons for skepticism, and we’ll address those first.

  • Volatility. Most people are familiar with Bitcoin price fluctuations — and Bitcoin is arguably the most stable and mainstream coin available. One of the most important factors for a currency to be considered sound is its reliability, but if a currency fluctuates too wildly, no one can reasonably call it reliable. As a counterpoint, it’s important to remember that Bitcoin and other cryptocurrencies are still in their infancy, and temporary volatility in the early days of a currency is no measure of whether the currency has the potential to be sound in the future.
  • Digital nature. Some people argue that cryptocurrency can’t be sound because it’s digital, but this point is somewhat weak. Some economists claim that the U.S. dollar is sound, or at least the most sound currency currently available, but no one would argue that paper itself is a sound currency. The fact that cryptocurrency is digital doesn’t change its capacity to meaningfully represent and store value in the same way that fiat currency values don’t fluctuate based on the medium of which they’re composed.
  • Vulnerability to manipulation. Blockchain-based systems, like cryptocurrency, are based on consensus. The majority of nodes on the network must agree to something before it’s considered legitimate. But this creates a vulnerability; in a 51 percent attack, a malicious user or group of users can hijack the consensus model and manipulate the currency as they see fit. There are ways to guard against these types of vulnerabilities, but it’s important to acknowledge that they do exist.

Reasons for Validation