Cryptocurrencies have gained huge momentum over the past few months, following Bitcoin’s explosive rally, which closed in at $64,000 in mid-April. However, amid the rise of this speculative asset class is a volatile market, which has been pushing and pulling prices to unstable grounds (Dogecoin 29,900% spike is another mania in itself). With fears over a bubble about to burst and an uncertain future for the digital economy, some have referred back to the Quantity Theory of Money, a basic economics principle that determines the factors that affect value stability.
What is The Quantity Theory of Money?
At its core, the Quantity Theory of Money presumes that any fluctuations in the currency in circulation directly impacts the prices of goods and services in the market. So, when the money circulation increases, the result would be inflation.
For instance, if country A were to increase its production of fiat notes, then more money would be in circulation, causing an imbalance between the supply of money and other economic factors. To mitigate this issue, merchants need to increase prices to meet the new value scale of a heightened currency supply. Likewise, suppose country B was to limit its production of fiat notes. In that case, it will cause a shortage of money circulating in the economy, resulting in a possible recession due to illiquidity (or the lack of transactions flowing).
Digital Currencies And The Future of The Monetary System
Cryptocurrencies aim to disrupt the current financial system by removing central authorities from the equation. These authorities include central banks and governments, both of which are organisations that control the supply of money. That means they have the power to destroy a country’s economic progression any time—a scenario that isn’t new, with Venezuela’s crisis being the most prominent in recent history.
Cryptocurrency’s complete decentralisation is its most attractive feature. Without control, there won’t be any third-party institutions determining the value of people’s money. However, as it stands, there remains an important issue that traditional coins cannot address - stability. In a market that’s dependent on emotion and mainstream interest, achieving a stable value hasn’t been possible outside of stablecoins. But for cryptocurrency to qualify as a trading currency, it needs to retain the same—or a very similar—value from Monday to Friday and two weeks later.
Cryptocurrency And The Quantitative Theory of Money
The Quantitative Theory of Money (QTM) can be applied to cryptocurrency to foster stability from the get-go, which newer altcoins were able to take advantage of by studying the downsides of their predecessors. However, unlike the original theory, which relies on central control to limit the production of currency, blockchain technology allows for decentralisation by coding a special algorithm in smart contracts.
For instance, The People’s Reserve Cryptocurrency (TPR) was able to use the basic principles of the QTM by applying a non-collateralised algorithm, which is commonly used in stablecoins. This method utilises the Seigniorage Shares system, that automates coin generation based on supply and demand. As a result, the number of new coins entering the market is dependent on market activity, resulting in no massive spikes or dips caused by an unprecedented change in supply. Following the Quantitative Theory of Money, this scenario will ensure that prices retain a stable value, despite not necessarily being pegged as a stablecoin.
As blockchain technology continues to innovate new paths for the decentralised finance sphere, more key players are expected to solve cryptocurrency’s stability issue to flourish in a new economy without depending on fiat money. The Quantitative Theory of Money offers the foundation of making this happen, but it’s up to blockchains to figure out how to integrate it into the financial system through specialised algorithms, bringing a new age of cryptocurrencies to the market.
Jack Bryan is an e-money researcher and crypto economist focused on DeFi and expanding the circulation of non-political digital currencies. He's a former pioneer in cybersecurity.