The Biggest Boon to the Dollar is Decentralized Currencies

While many observers are focused on challenges to dollar dominance from other rival national currencies, its true competitor will come from new forms of decentralized currency.

Predictions of the dollar’s demise have been so frequent that they can be compared to the proverbial boy who cried wolf.

For all of the forecasts that the dollar was on its way out of the center of the global monetary stage, it has proved naysayers wrong time and time again, coming back even stronger each time it’s been challenged.

And that’s because the facets that make up a currency’s reserve status are myriad and established reserve currencies tend to only fall over a very long period of time, well after the last vestiges of the empire that supported their reign have faded into the sunset.

A Pound of Flesh, But Not a Drop of Blood

Take the British pound for instance, the currency of the empire upon which the sun never set.

The pound’s primacy lasted well into the 1950s, long after the United Kingdom had declined to a middling power at best.

But what even got the pound to to the peak of global pecuniary processes anyway?

Well before the U.S. navy ruled the high seas, British ships were plying Her Majesty’s vast empire, and the pound was the lubricant that facilitated trading of the cargoes in these vessels — in 1860 alone, the United Kingdom was responsible for soaking up almost a third of global exports.

Between 1860 and 1914, around 60% of world trade was invoiced and settled in pounds.

In exchange for the world’s wares, the British exported capital, and plenty of it.

By 1913, the U.K.’s total net external assets were £4 trillion, or around 166% of its nominal GDP and that was because pounds were used not just for invoicing, financing and settling trade-related transactions, they were also held as a form of buffer for future uncertainties — a reserve currency.

Even as the United Kingdom waned in economic influence in the aftermath of the Second World War and the loss of its overseas colonies, other countries did not immediately abandon the pound, with the sterling remaining the reserve currency right up till the second half of the 1950s when the dollar finally overtook it.

And while the dollar’s current course looks not dissimilar to the decline of the pound, with America’s shrinking share of global trade volumes relative to the strength of the dollar, a deteriorating foreign asset position, and adverse geopolitical trends, there is one key difference between the loss of the pound’s dominance and the predicted decline of the dollar — the lack of substitutes.

The pound could decline simply because the dollar was there to pick up the gauntlet.

But what substitutes remain available for the dollar today?

Few Good Choices If Any

America’s biggest threat today isn’t from another democracy, it’s from China, yet there remains a dearth of yuan-denominated assets that investors can buy.

And even where yuan assets exist, investors are becoming increasingly leery about buying them.

Beijing’s crackdown on some of its most lucrative sectors, from real estate to afterschool education, and the risk of Chinese companies being delisted from American stock exchanges are just some of the uncertainties that foreign investors need to deal with.

China’s yuan is not fully convertible, the country lacks independent institutions and looks increasingly to be governed by fiat (not currency), and even America’s weaponization of the dollar appears relatively innocuous compared to what Beijing could do with the yuan or yuan-denominated assets if it so chose.

Global investors watching with horror as whole Chinese cities with populations the size of entire countries are locked down in draconian pandemic measures, will think twice about pouring more money into Chinese assets.

After all, what’s sauce for the goose is sauce for the gander — if Beijing is willing to imprison an entire city for its “own good,” what liberties might it take for yuan-denominated assets?

Even countries that aren’t necessarily on friendly terms with Washington may not find much comfort from the yuan, given that Beijing has show even more willingness to economically sanction countries that don’t toe the line on issues like Taiwan, just ask the Japanese and the South Koreans.

India for instance, which has sought to maintain an independent foreign policy, may not like the dollar’s hegemony, but it would be preposterous to believe that New Delhi would plough meaningful amounts of its foreign reserves into they yuan, even if Beijing would allow it to.

Money is More Than Cash

Money is as much a legal construct as it is an economic one — the dollar’s dominance works because people largely trust things like the rule of law and institutions like the U.S. Federal Reserve.

Fundamentally, there are few differences between the legal framework that the dollar exists in and that of the United Kingdom, after all, the U.S. was a British colony at one point in its history (regardless of what Americans will tell you).

And that’s why it’s been no surprise that where the dollar has lost share as foreign currency reserves of other countries, it’s not been to the Chinese yuan, but to smaller Western currencies like the Canadian and Australian dollars, which are, surprise, surprise, all former British colonies.

If nothing else, the chaos of the Trump presidency demonstrated the resilience of American institutions and the strength of the dollar.

Which is why the dollar’s main challenge isn’t likely to come from another country — it’s likely to come from a decentralized and democratic construct — a decentralized currency.

At its core, a currency represents freedom and options — the freedom to buy or consume that which an individual desires, and their option to change personal, social or geographical situations.

In these aspects, the dollar serves all of these functions, and relatively well.

Step into any major hotel anywhere in the world and dollars are almost certainly accepted.

From the covered markets of Ho Chi Minh to the highlands outside La Paz, the dollar will get you a cup of sweet Vietnamese iced coffee or a piping hot mug of Bolivia’s finest, no questions asked.

The ability of the dollar to provide that freedom of choice is also a function of what the currency represents — democracy and the rule of law.

The prospect of a rival currency like the Chinese yuan, where north, south, east, west, the Party rules them all, and all power centers on the Party, seems unlikely.

But a decentralized currency could potentially pave a path that could provide all of the faculties of the dollar without the fiat, where the software code that governs it becomes equivalent to the rule of law and the decentralization of its architecture and validity serves the role of independent institutions.

Bitcoin Not Quite Enough But a Good Start

While Bitcoin may appear to serve that role, it still falls short in other areas, more iteration or a combination of cryptocurrencies is needed to fill the myriad roles that the dollar serves.

To be sure, Bitcoin is about as decentralized as it comes — with its built-in consensus mechanism a natural extension of democratic principles.

There are no barriers to participating in the Bitcoin economy either, with the anonymity and immutability of the blockchain, providing both for the certainty of contract and execution of the rule of law without requiring enforcement.

The proof-of-work methodology of securing the Bitcoin blockchain, while arguably energy intensive, requires far less in terms of resources than a legal system, government and police force.

But Bitcoin also suffers from a major drawback in its potential to usurp the dollar as common currency — it’s deflationary.

Ever since the dollar was no longer backed by gold, the inflationary nature of fiat currencies ensured that economic citizens were committed to a perpetual cycle of production and consumption.

Because the dollars in our wallets and bank accounts were losing their value, there was an incentive to spend them and make more.

That currency cycle has perpetuated the capitalist system, warts and all, but precipitated the largest increase in economic well-being in history.

But because there will only ever be 21 million Bitcoin, there is a strong incentive to hold whatever Bitcoin one has, rather than to spend it, say for pizzas or something else.

And that’s a problem.

Bitcoin can’t be both a medium of exchange and a store of value, unless it wants to do both jobs poorly.

As such, Bitcoin in and of itself would provide an incomplete solution to rival the dollar and would need to be supplemented by other decentralized currencies that could build off the strength of its decentralized structures and cater for a more flexible monetary policy that could still facilitate the commerce and capitalism that has made nations great.

In that conception, decentralized currencies like Bitcoin, would exist alongside the dollar, enhancing democracy, rather than undermining it, building new decentralized institutions that would prevent the consolidation and abuse of power, rather than encouraging it.

Which is why it’s no surprise that Washington has been receptive to cryptocurrencies, whereas Beijing has banned them.

The United Kingdom became the world’s largest empire (at one point) because it saw value in the decentralization of power.

While rival European countries like Russia held on to the autocracy of the House of the Tsar, Buckingham devolved power to Westminster and the House of the Commons.

Even China’s own history has been one that has charted a course of centralization leading to decline, leading to decentralization, leading to ascent, and then centralization, ad infinitum.

Fortunately, America’s Founding Fathers saw fit to ensure the separation of powers, in their version of Westminster 2.0.

Decentralized currencies like Bitcoin will be an improvement and an extension to that in Washington 3.0.

If cryptocurrencies become the preferred means to settle cross border trade, using smart contracts built on blockchains like Ethereum and Solana, with finance powered off decentralized finance protocols like Uniswap and Aave, then perhaps one day the dollar could find a potential rival, but it won’t come from a nation state or the unyielding concept of currency, it will come from decentralization and the improvement to democracy that represents.