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Inflation-proof Currencies

by Ronan McGovern
First published: January 6th 2021

Summary:

  • Inflation makes planning hard for businesses and individuals, and devalues the net worth of those holding the currency.
  • In recent decades, inflation has disproportionately been in poorer countries.
  • Across all time, strong inflation has been a systemic risk in all countries, rich or poor.
  • Inflation-proof currencies are of therefore immediate benefit to poorer countries, and of systemic benefit to all countries.
  • As a first step, via for-profit orgs, non-profit orgs and governments, the digitisation of fiat currencies will improve worldwide access to (at least temporarily) more stable currencies - at the cost of increased centralisation of risk.
  • As a second step, organisations could create currencies that are indexed to baskets of goods and services.
  • These new currencies may be regional, but they may also be community-specific, as people are less defined by their geographic location and more defined by their online presence.
  • These new currencies may first be enabled by overcollateralisation with digital tokens - as done by MakerDAO and Celo.org.
  • Later, it may be possible to collateralise these currencies on a 1-for-1 basis with on-chain futures contracts or contracts for difference (see FTX.com).

The problem of inflation:

Strong inflation is a big problem because a) it creates uncertainty for businesses and consumers, forcing them to constantly re-plan and reprice what they sell and purchase, and b) it devalues the net worth of those holding that currency (typically the middle class because the poorest have little money, and the richest do not hold their wealth in currency).
In recent decades, inflation has been low in many richer countries, for example Ireland (where I live). Over the same time period, other countries such as Zimbabwe and Argentina have seen periods of strong inflation. Over longer time periods, strong inflation has occurred in all countries at some time.
Therefore, inflation-proof currencies are of therefore immediate benefit to poorer countries, and of longer term systemic benefit to all countries.

Increased globalisation of the US dollar and Yuan

For those in countries with high inflation, a first improvement would simply be for them to have better access to more stable currencies such as the US dollar/Euro (via private initiatives such as for-profits, non-profits or DAOs) or Chinese Yuan (via Chinese government initiatives).
There are limits here because:
a) Allowing local residents to access foreign currencies typically devalues the local currency (as residents move their funds out of the local currency). Bans or limits are often imposed by local governments.
b) Owing to bans/restrictions, it requires sophistication/expense to move funds into foreign currencies, which particularly disfavours poorer residents of the country.
And so - at the margin - the digitisation of currencies such as the US dollar and Yuan can lead to:
i) Improved worldwide access to more stable currencies,
ii) Potential resistance from countries currently issuing less stable currencies, and
iii) Increased power for currencies like the US dollar and Yuan.
A specific example of how this is happening is the creation of the cUSD and cEUR stable currencies on the Celo.org platform. We are in this period now.

Inflation resistant currencies based on cost indices

While globalisation of the dollar (or Euro or others) brings improved short term currency stability to the world, it comes with the downsides that:
a) it centralises monetary power further in the world, increasing the impact of a collapse in one of these currencies
b) movement in dollar/yuan prices may not be a good match for the local cost of goods or services in many countries, e.g. Brazil or Sri Lanka.
c) while inflation in the dollar and euro has been low in recent times, one would have to expect - based on historical precedent - that strong (10%+) inflation will hit at some point.
One way to address strong monetary inflation is to develop new currencies that track cost indices in a certain country or a certain community or sector. I say "sector" because the world is now less defined by geographical boundaries. I think currencies may also move to reflect that.
As an over-simplified example, one may decide to create a price index composed of
a) 33% housing rental costs in Europe,
b) 33% wheat in Europe,
c) 33% steel in Europe,
and then base a digital currency on that index.
In terms of implementation, I see two options, likely appearing over time in this order:
  1. 1.
    An overcollateralisation approach whereby the currency takes the form of a price-tracking peg that is overcollateralised by digital assets, perhaps including Bitcoin and Ethereum. This is the approach taken by Celo.org (see https://celoreserve.org/ for how this works) and by MakerDAO.
  2. 2.
    A 1-to-1 collateralisation approach. For this to be possible in the example above, there would need to be on-chain futures contracts for each of the three index components. The currency would be directly collateralised by these contracts. Potentially, a contracts for difference type of approach might be possible, as is used by FTX.com .
To summarise:
  • By tracking a price index, digital currencies can be inflation-proofed by reducing the level of governance involved in defining the price level. There would still be some form of governance required in defining the basket of goods/services (although maybe there are ways to generalise that), but there would no longer be any governance around how to control the supply of money.
  • Potentially, we may also see community or sector based currency indices. For example, a tech currency might track some combination of software engineer salaries plus semiconductor prices.

Decisions for Trelis

I see Trelis is as a framework, or tooling, to allow for cheaper payments systems with inflation-proof currencies.
Trelis is a layer down from the definition of currencies and the payment network themselves, both of which I am optimistic can take an open source form that wins out over currencies (fiat US dollar) and networks (Visa/Mastercard) today - although I may be wrong.
So, there is the question for Trelis of what payment networks and what currencies to support?
For now, and I expect this to change over time, the choice is to support Celo, because:
  1. 1.
    Celo supports cStables (cUSD and soon cEUR, cREAL)
  2. 2.
    Celo has cheap and quick transactions
  3. 3.
    Celo is Ethereum Virtual Machine compatible, so there is optionality to move to Ethereum over time depending on how Optics bridging technology works, and how quickly layer twos evolve on Ethereum.
Trelis will soon also support payment with Bitcoin Lightning (with direct cash-out to Bitcoin, so we are non-custodial) because:
  1. 1.
    Payments are quick.
  2. 2.
    The most held crypto right now is Bitcoin, and Lightning is adjacent.
Even though Bitcoin is not a convenient currency in which to make or receive payment because of price volatility, it does have a big user base and maybe will prove to be an ok store of value.