It’s high time for sound money – What would a Bretton Woods system for the Bitcoin Era look like?

For many, the dramatic collapse of cryptocurrency exchange FTX represented the Lehmann Brothers moment for the crypto-sphere, and a watershed moment for the industry which proves it is not a viable alternative to traditional financial, also known as TradFi.

Nothing could be further from the truth. The reality is that FTX was a centralised exchange which traded decentralised financial products, so it’s demise should only serve to strengthen the case for truly decentralised finance (DeFi).

After all, DeFi is designed to enable self-custody of digital assets. If people choose to hand their DeFi assets to a centralised exchange, which subsequently loses the assets, DeFi is not to blame.

As MicroStrategy co-founder and chairman Michael Saylor recently stated, “speaking for all the bitcoiners, we feel like we are trapped in a dysfunctional relationship with crypto and we want out.”

This is the moment in the short history of decentralised finance that we need to think seriously about rules and regulations that will provide it with a sustainable future. DeFi is in need of its own version of Bretton Woods.

In July 1944, during World War II, the United Nations Monetary and Financial Conference -known more popularly as the Bretton Woods conference – reached agreements on an international financial architecture that, with some modifications and additions, has prevailed to this day.

That agreement was designed to create a rule-based international financial architecture and open trading system that would reduce protectionism, rampant nationalism and growing inequality.

(Source: Flickr)

The institutions that were established at the Bretton Woods conference and subsequently -the IMF, the World Bank Group, and the General Agreement on Tariffs and Trade (GATT) -tried to remain relevant by adapting to a changing world.

Today however our international financial infrastructure seems broken. Rampant global inflation, disrupted supply chains, increasing inequality and rising protectionism indicate that we need to radically rethink our economic architecture.

While there is no silver bullet solution to all of the world’s current economic problems, one can convincingly argue that the eventual solution for each might have one common denominator – sound money, for which truly decentralised finance is invaluable.  

To understand the need for sound money, it is first necessary to understand the deficiencies of the current fiat standard by which we operate, in which rampant money printing has become a feature rather than a bug, causing the inflation which leads to countless other problems in turn.

The consequence has been an economic system that relies heavily on monetary debasement and credit creation, both of which are achieved through quantitative easing, a euphemism for rampant money printing.

While attempting to be a source of macroeconomic stabilization, central bankers inadvertently create instability through the manipulation of the money supply. By manipulating the supply of money, all global pricing mechanisms become distorted.

As the economist Fredrik Hayek describes in “The Use of Knowledge in Society”, the price mechanism is the greatest distribution – and indeed decentralised – system of knowledge in the world. When the price mechanism becomes distorted, false signals are distributed throughout the economic system and the result is an imbalance between supply and demand which ultimately creates instability and fragility.

Here lies the problem. At no added cost to themselves, central banks can increase the supply of money at their will, causing each individual unit of currency to decrease. This represents the opposite of ‘hard’ money, because it is easy to produce.

Thankfully, the breakthrough of blockchain technology and the advent of Bitcoin provide a blueprint on which to build a new era for hard, or ‘sound’, money. According to Tim Heath, the founder and general partner of Yolo Investments, a venture capital firm, “Bitcoin represents the choice between holding a form of currency that is continually and systematically debased by central banks or a form of currency that cannot be manipulated. With its fixed supply, Bitcoin is the check, balance and ultimate opt-out of the problem of money-printing.”

So the question arises, how does one build Bretton Woods-like institutions to regulate the world towards a universal Bitcoin standard? In one sense, the answer is ‘you don’t’. You build an ecosystem that enables co-existence between decentralised finance (DeFi) and existing forms of money, and let the hand of the market reach an equilibrium between the two.

On the other hand, the FTX debacle demonstrates that it might be high time for some clearer regulatory framework which safeguards the inherent value of decentralised finance. As Michael Saylor went on to add “I think the industry needs to grow up and the regulators are coming into this space.”

The nature of DeFi means that part of the answer will simply emphasise individual responsibility, and the imperative for retail investor to take their Bitcoin off the exchanges. But more must be done to protect those who don’t. Exchanges should be obliged to issue ‘proof of reserves’ statements to ensure they are not themselves over-leveraged and have sufficient funds to back up investor deposits.

The average consumer should also have easier access to DeFi products and services, providing them with greater choice as to where to store value on the DeFi-TradFi spectrum. This would be greatly accelerated if regulators approved the creation of a spot Bitcoin ETFs (exchange traded funds), such that ordinary retail investors could buy Bitcoin on well-regulated securities exchanges.

The right balance will require a mixture of push and pull factors, but undeniably something has got to give. It’s high time that regulators recognised the value of decentralised finance and the fact that it is here to stay. The sooner we make it safe for consumers, the healthier it will be for the financial sector as a whole.

Source: Financial Content