Mining Fiat is Unsustainable

In an earlier article, I outlined the opportunities that blockchains offer investors from a fairly wide angle. This prompted a number of requests for more in-depth analysis of the disruptive qualities of this technology (or better: paradigm). The following is a first principle examination of the market opportunities blockchain-, and graph-based solutions offer within the realm of government-controlled currencies, commonly referred to as "fiat money", so, quite literally addressing all the money in the world.

The problem that is "government money"

While there is generally now legal requirement for private market participants to chose government-created money - such as the US Dollar - as unit of account, most transactions default to the national currency. (Mostly) due to the burdens associated with the exchange from the money of one country to that of another, consumers will turn to foreign fiat, only during times of significant debasements of their national currency (i.e. "hyper-inflation").

Thus far competition between fiat currencies is largely limited to large international transactions and/or to the dealings of professional FX-traders. Setting aside the ability of commercial banks to create money via the creation of collateralized notes (i.e. mortgages), governments have enjoyed a monopoly on the creation of money.

Currencies address a fundamental challenge in commercial activity: the barter problem, more formally referred to as the "coincidence of wants" problem. Today, currencies are mostly under the purview of central banks in collaboration with and/or supervised by national governments. Physical manifestations of fiat money take the form of printed or minted legal tender (such as Federal Reserve notes and coins) used mostly for in-person transactions with instant settlement. However, according to data published by Trading Economics, less than 6% of the world's money manifests in this physical form. More than 94% of fiat exists only as demand deposits, savings accounts, money market accounts, etc. This is to say they are records in databases controlled by commercial banks.

The general removal of commodity backing requirements, such as the gold exchange standard, greatly increased the inflationary nature of fiat money. According to data published by the International Monetary Fund, fiat inflation rates currently range from under 1%, such as in Switzerland and Thailand, to more than 500,000% in Venezuela (the average annual percent change is 4.6% across all recorded countries). The latter is just one example of the collapse of a government-controlled currency, a situation that has occurred more than 150 times in the recorded history of fiat, with devastating effects for the population.

Total Addressable Market

The world's total supply of fiat money amounted to $157 trillion in the fourth quarter of 2019. Consequently, the reported inflation rates of cash and fiat accounts results in total depreciation of almost $7.4 trillion. In other words, the total addressable market opportunity could exceed the combined market cap of Saudi Aramco, Apple, Microsoft, Alphabet (Google), Amazon and Facebook. That assumes, of course, that blockchain-based solutions and other decentralized systems can address this apparent downside of current fiat systems.

Potential Solutions

A fast growing vertical within the blockchain space is peer-to-peer banking, without the need of fiat money. These decentralized financial services, or "DeFi" for short, for the most part make use of smart-contract platforms, such as Ethereum, to allow anybody with a digital wallet to lend or borrow blockchain-based assets. Some custodial exchanges also started to offer interest payments on widely traded "cryptocurrencies," such as ether, bitcoin and USDC. The latter is especially remarkable, as USDC is a digital token pegged one-to-one to the U.S. dollar. Several other examples of these so-called "stable coins" are present on most crypto exchanges where they are used as a refuge from more volatile cryptocurrencies, without the need to revert to fiat money. While the settlement of digital tokens can take place within minutes or even instantly, the latter conversion of cryptocurrencies to fiat is often plagued with friction in the form of fees and time delays.

Product Market Fit

The Federal Reserve reports on the velocity of money as a significant value of the health of the U.S. dollar. The measure records the number of times that the average unit of the currency is used to purchase goods and services within a given time period. While the velocity of the U.S. dollar has steeply fallen since 2008, U.S. dollar pegs (confusingly referred to as "stable coins"), such as tether, regularly exceed several multiple of their market capitalization within a 24-hour window.

While the use case of these particular instruments is still mostly limited to crypto-exchanges, stable-coins have extended their reach to most decentralized finance solutions, including digital wallets. From here, it might be a small step for other applications to accept these tokens as an alternative to fiat currencies.

Conclusions

The inflationary nature of fiat systems provides a potential large market opportunity for blockchain-based solutions that mitigate or even solve for the erosion in purchasing power. These systems may take on the form of simple fiat pegs immediately available for credit markets, or more sophisticated products that avoid inflationary products entirely, swapping one asset presentation for another — similar to commodity-backed currencies of the past. While current applications still require users to initiate the transfer and/or conversion of fiat to suitable alternatives, it is easy to see how extending the benefits of these solutions to employers can lead to network effects that greatly increase their accessibility. The latter provides additional (saving) opportunities for merchants adopting these new paradigms.

Further reading: Understanding Cryptocurrency