The following blog post was written by our interns, Brady Gray and Mauria Ferrell, in response to a question we received on the radio this week. You can listen to the full show here.
Money, by definition, is anything that is accepted as a form of payment in exchange for goods and services in a particular region. The official currency in the United States is the U.S. Dollar (USD) and its value is guaranteed by our federal government. Cryptocurrencies, however, are not backed by any nation’s government. This can make Cryptocurrency more volatile and riskier in general. It is important to understand that the Federal Reserve is the central bank in the U.S., and it controls how money moves, known as monetary policy.
The U.S. Dollar and the amount of money in circulation is controlled by the Federal Reserve. This along with adjusting interest rates is referred to as monetary policy. The Federal Reserve actively analyzes the state of the economy and creates or destroys money as needed. Now, when they say “destroy”, it does not mean literally shredding up paper bills. They can take money out of circulation by changing short-term interest rates and by adjusting bank’s reserve requirements. Both of those actions will decrease or “destroy” money. On the other hand, if they wanted to “create” money, or increase the supply, they would just do the opposite. For instance, we saw towards the beginning of the pandemic, record low interest rates and stimulus payments from the federal government. Note that stimulus payments were not part of monetary policy, but rather a form of fiscal policy controlled strictly by the federal government. Very low interest rates encouraged spending in the economy. Many Americans bought new homes, cars, and other things while the cost of financing was at record low levels. Today we are seeing effects of those past events. The economy started to grow at never-before-seen levels and the policies did not change in time. Inflation is currently at 8.3% as of April 2022. Inflation is the term used when the purchasing value of money decreases.
Another form of currency that has recently surfaced over the past decade is cryptocurrency. It is not specific to one country or region, nor is it backed by one. Instead, crypto uses a technology called blockchain. Blockchain is a specialized system that records all transactions made with cryptocurrencies. It utilizes several computer systems across the world to keep accurate records. As I mentioned before, cryptocurrency is generally riskier due to the fact that there are many unknowns. How do we know for certain that a coin holds the value that it claims it does? It is a great question; any many people wonder the same about the U.S. Dollar. They think that a U.S. Dollar may not have value because it is no longer backed by the gold standard of the 1960s. The difference here is that the U.S. Dollar is backed by our federal government. A one-dollar bill is recognized by everyone across the world as a ligament currency that holds its value of one dollar. With cryptocurrency, you have to believe that a specific coin is worth the amount shown. No one can prove or assure you the value of that coin.
Can we consider cryptocurrency money? Let's look at what happened with Terra. Terra is a "stablecoin," which is a cryptocurrency that is intended to have a fixed value, typically $1. Given their intended stability, they are meant to provide more reliable store of value and medium of exchange. Terra's recent downfall however lets us know that cryptocurrencies are not quite ready to be considered money.