A national currency is a legal tender issued by a country’s central bank or monetary authority. National authorities guarantee the acceptance of the currency as a means of exchange. Thus, national currencies are also used as official units of accounts. Currencies are used for purchasing goods and services and it is also used for the collection of taxes. Trust to currencies is backed by the faith and credit of people in governments. Trust is not a constant and it can change over time. Trust in currencies or governments can decrease during domestic economic turbulences and global financial crises. Central monetary banks and governments try to achieve monetary stability and overcome financial crises. It is one of the most important goals of national authorities. Trust is kept when authorities succeed. If they are not then people might begin to revolt.

A nation’s economic activity is usually influenced by two major tools. It is monetary policy and fiscal policy. Monetary policy and fiscal policy are typical tools that are used to influence a nation’s economy. The focus of the monetary policy is interest rates and the total supply of money in circulation. It is usually the responsibility of the central banks to drive monetary policy. Fiscal policy is a tool that is used by governments to collect taxes and spending management.

Monetary policy is a tool that can stimulate an economy. Individuals and businesses can be either incentivized to borrow and spend money or the spending can be restricted what leads to saving money. Monetary policy can either spur the economy or limit its growth. By that, it is possible to drive the level of inflation.

The Fiscal policy addresses taxation and government spending. Governments target the taxation level, the total level of spending, and the composition of spending. It is done via a legislation process. A government needs to collect taxes to be able to effectively spend. The collection of taxes pulls money out of the economy. It can slow business activity when taxes are too high. Governments might also lower taxes or offer tax rebates in an effort to encourage economic growth. Another fiscal tool of governments for spurring economic activity is stimulus spending. Governments can decide which sectors need to be stimulated to support economic growth. If there is not enough money for spending, it is necessary to borrow money by issuing debt securities. This is referred to as deficit spending. It is expected that debts will be paid off later.

The fiscal policy usually changes relatively often. Governments decide about tax policy and spending. Specific communities, businesses, industries, investments, and commodities are targeted by governments to either favor or discourage economic activity. It is necessary to mention that not only economic considerations are taken into account when changes in fiscal policy are made. Governments have to consider long-term prosperity, peace, healths, science, security, political situation, environmental issues, and many other aspects that touch the daily lives of people.

There are always people that are accountable for monetary and fiscal policy. Hence, their decisions are hotly debated by other people.

Monetary and fiscal policies in the context of cryptocurrencies

In the context of cryptocurrencies, national currencies are often criticized for their worse abilities regarding usage as a store of value. National currencies are nearly always inflationary. It means that they lose value over time and the level of degradation differs from currency to currency. Inflation does not matter so much from the short-term perspective if it is predictable and moderate. However, it is not the case in some nations and then it can be a real problem as people are not able to save money to be well prepared for the future.

The monetary policy of cryptocurrencies is fixed and rigid. In most cases, it is set in the beginning and it is expected that it will never change. The majority of cryptocurrencies have set the maximum number of coins that are gradually released by the protocol. Alternatively, fixed never-ending inflation of coins is set. As a result, cryptocurrencies are generally very volatile. There is no authority that would be responsible for the stabilization of the price. The price is influenced only by supply and demand on the market. This property can be good for the creation of scarce resources. The high demand for a scarce resource can keep the value of coins at a high level in the long term. As a store of value, cryptocurrencies can be very good. However, they are bad as means of exchange or units of account.

The crux of decentralization is about being independent of the decisions that would be made by individuals or authorities. Nobody can centrally influence the monetary policy of cryptocurrencies. Trust in currencies, in the context of means of exchange and units of account, is related to price stability. The degree of trust in fiat currencies is high, in comparison with cryptocurrencies. Notice that people trust fiat currencies despite their centralization and authorities that make decisions. It could be even said that people might not fully trust the authorities but they still trust national currencies. Trust in currencies is related to price stability since it allows people to pay for goods, invest, save money, etc. When inflation is low and compensated in a way that people feel relatively wealthy then it can be considered a stable economic environment.

Price stability or the economy as a whole is not the only factor that matters. The happiness of people cannot be measured only economically but it is mostly the economy that can ensure happiness in a given location. In other words, people expect that they are able to find a job, buy high-quality food, are able to send kids to a good school, live in beautiful green cities with developed infrastructures. It must be true not only for you but also for your neighbors. Not only for the city you live in but also for other cities nearby. When it is not like that you can expect troubles. To ensure the happiness of people or at least to secure the best possible conditions, there must be a mechanism that takes care of all that. On the national level, we get back to fiscal policy. Tax collection and wise spending have been for long years the best solution on how to establish stable environments and relatively happy populations.

So far, we talked only about the rigid monetary policy in the context of cryptocurrencies. When we insist on full decentralization of cryptocurrencies regarding monetary policy, we are able to create only a rigid version of that. Moreover, there is nothing like fiscal policy in the world of cryptocurrencies. At the moment, cryptocurrencies are not able to respond to economic turbulences, crises, natural disasters, or even wars. In addition, there is no way on how to spur the economy. The reasons are obvious. The current generation of cryptocurrencies is not designed to solve these issues. No nation or state has adopted cryptocurrencies to use them to solve these types of issues.

Decentralization basically means that only rigid rules of the protocols are followed and the decisions of individuals are not taken into account. It is not even expected. Protocols know nothing about the economical situation of people, politics, or the environment. Protocols have no ways on how to observe our world and thus they have not any opinions. Protocols cannot make any decision that would help to resolve a potential problem. The blind following of protocol rules is only beneficial for the creation of a digital scarce resource. It is questionable whether it is a good attribute for monetary policy. It is probably a bad attribute for fiscal policy.

Currently, making monetary and fiscal decisions on the national level is mostly related to a certain level of centralization. Authorities are accountable for making observations, evaluating them, and making appropriate decisions. We have two worlds that stand against each other. The centralized world of fiat currencies and a new world of cryptocurrencies. These two worlds are going to meet. It is a question of whether it will be positive or negative.

Would it be possible to connect cryptocurrencies with the national monetary and fiscal policies? Could we technologically substitute the role of authorities or make their decisions more decentralized? Let’s go to discuss that.

Can blockchain be used for building a new financial system?

Economists debate for years about the current financial system and they do not know whether it is the best possible one. Fiscal policy often faces criticism for the need to work with debt and the inability to pay it off. It is not the goal of this article to resolve the tough questions to which economists are not able to answer. We do not want to debate much about the current situation. We will focus more on the future.

People can have different opinions on the national monetary and fiscal policies but one thing is certain. The scope of the functionalities behind it is bigger than what the rigid monetary policy of cryptocurrencies can do. The very first question would be whether we really need it. Do we need a complex fiscal policy and could it be sufficient to have only the rigid monetary policy that cryptocurrencies can offer? Could we exist without the collection of taxes or making reserves for worse times? The answer is no. It is natural that bad times occur from time to time and we need to be prepared for that.

Cryptocurrencies lack three critical functions that stable monetary regimes are expected to fulfill: protection against the risk of structural deflation, the ability to respond flexibly to temporary shocks to money demand and thus smooth the business cycle, and the ability to function as a lender of last resort.

It would be impossible to overcome troubles of any sort on the national level without the ability to either have sufficient reserve or issue new coins. Every reserve can be depleted one day so what should be done in cases that troubles sustain? When the fiscal policy fails then the monetary policy could save the situation. Debt could also be a solution but it depends on the willingness of lenders to provide loans. It seems that the ability to work with debts is also an important requirement of the real economy.

Notice that it is not only about surviving turbulent times. People, as individuals, use public services and infrastructure. It is financed collectively. Authorities are responsible for the collection of taxes to have finance for these services. It is possible to change the financial infrastructure but this type of mechanism must be preserved.

How could that all work in the blockchain world? To create a reserve, there must be some smart mechanism that will regularly collect money from people based on defined rules. We call it taxation in the fiscal policy. Alternatively, there could be some protocol mechanism that would subtract a given amount of coins from all addresses in the case of urgent need or regularly. However, it would be the same as issuing new coins. Issuing coins is actually a better solution. The only question is who would be responsible for making decisions related to changes in monetary policy or in the protocol rules. Could it be developer teams with cooperation with miners or stakeholders? It would not be the best possible solution from the point of trust. People can trust the system only if they agree with the rules and feel they can participate in decisions.