The future currency landscape

There are thousands of currencies used for financial transactions. 180 currencies are recognized as legal tender across 195 nation-states [1]. Beginning with the introduction of Bitcoin in 2009, there are now tens of thousands of cryptocurrencies in circulation [2]. While cryptocurrency payment volumes represent a small fraction of total global cross-border payments [3], crypto payment volumes are expected to grow significantly over time [4].

With the proliferation of currencies and the increasing interconnectivity of our global economy, the notion that individuals and businesses should rely solely on a single national currency for all their financial transactions is becoming outdated. How should individual actors in the modern economy decide what currencies to use for their financial transactions? How will the future currency landscape — across national currencies and cryptocurrencies — evolve over time?

To answer these questions, we summarize how national currencies work and how national currencies can become global reserve currencies, i.e. currencies that are held in significant quantities by central banks and other monetary authorities for the purpose of international transactions, investments, and to support the stability of the global economy. We will end by positing a hypothesis for how the future global currency landscape might evolve, and how cryptocurrencies might play a role. Let’s begin.

How national currencies work

As previously mentioned, most nation-states today have their own national currencies [5]. Different countries experience different domestic economic conditions. Controlling monetary policy through a national currency is an important lever countries can use to adapt their local economies to domestic needs. Nations issue currencies so they have increased economic sovereignty and control.

The value of a national currency constantly evolves as the needs and pressures facing a nation change. The basis for currency valuation tends to follow a general pattern across national currencies. We call this pattern the national currency valuation cycle.

Most currencies start their lives as hard money, i.e. valuable resources such as gold and silver. Hard money gives currency holders confidence in the value of their currency due to the value of the hard asset. However, because precious metals are difficult to carry, most currencies eventually transition from hard money to paper claims on hard money. The value of the paper currency is tied to the underlying hard asset, and paper currency is expected to be convertible to the hard asset at any time.

As an economy grows, nations tend to engage in more borrowing, lending, and spending activities to continue fueling their growth. These activities are financed with money and credit. Because money and credit are created more easily with paper money, the ratio between the amount of paper money in circulation and the underlying hard asset eventually rises. If economic conditions arise that reduce confidence in the nation’s outlook, currency holders could attempt to convert their paper currency to the hard asset en masse, leading to a potentially destabilizing bank run that could end in central bank defaults or major currency devaluations.

To finance economic growth and limit the potential of bank runs, most nations eventually move to fiat money systems. With fiat money, the link between a currency’s value and the value of the hard asset is broken. Fiat currencies are no longer convertible to hard assets, and the value of these currencies is instead determined by global confidence in the national economy. So long as people have confidence in the currency, governments can create money and credit freely in fiat monetary systems.

This confidence never lasts forever, though. In all historical cases to date, fiat currencies have eventually collapsed under the weight of overextended national debt [7]. This usually triggers a return to hard money, and the currency valuation cycle begins anew.

How a national currency becomes a global reserve currency

We discussed the effects that markets have on the value of national currencies. A currency can reach reserve currency status if market demand for the currency becomes so significant that the currency becomes critical for global economic stability. Reserve currencies are used widely as a global medium of exchange and denominate much of the world’s debt [8]. Historical reserve currencies have included the British pound (GBP) and Dutch guilder. Today, the global reserve currency is the U.S. dollar.

One of the primary drivers for foreign currency demand is purchasing a nation’s debt. Economic growth is expensive. Countries finance this growth by creating credit — receiving financing from others, including other nations [10], in exchange for interest that accumulates while the creditors are holding national debt. For example, holders of U.S. short-term Treasuries today can expect to earn around ~5% annually [11]. The incoming funds provided by a nation’s creditors can be used to finance expenditures in areas that can entrench or advance the nation’s global standing, such as spending on military, trade, education, governance, and more.

Creditors continue to hold a nation’s debt as an asset while they believe the currency is valuable and the nation will not default on its debt burden. Recall our discussion of the national currency valuation cycle. Throughout history, nations have continued to create credit to feed their economic growth machines. While public confidence in the currency is high, nations can continue creating money and credit. Inevitably, the debt burden increases to the point where national output and growth can no longer credibly support the promises to creditors. What follows can include national default, major currency devaluation, and the start of a new world order.

In addition to the market forces that can establish a currency as the reserve currency, international agreements can also play a role. After World Wars I and II, the U.S. was by far the richest and most powerful country in the world. In the aftermath of WWII, several Allied nations gathered to ratify the Bretton Woods Agreement in 1944. The Bretton Woods Agreement established the U.S. dollar as the global reserve currency and established a system of fixed exchange rates with USD as the central currency to create stability in international currency markets.

How cryptocurrencies play a role

As we’ve seen, nations are incentivized to encourage spending and saving in their national currency. As a result, there is competition between national currencies as different world powers vie for global reserve currency status. Cryptocurrencies have the potential to introduce another vector of competition for national currencies.

Currencies such as Bitcoin have grown in popularity as a store of value to potentially rival gold over time. In certain regions of the world such as Argentina where citizens have less trust in their national governments, individuals prefer to store their wealth in Bitcoin and Ethereum because they believe these cryptocurrencies are “superior forms of money” to national currencies and even stablecoins, i.e. cryptocurrencies whose values are pegged to national currencies [17]. Today, Bitcoin’s market cap hovers around $2T. If this continues to grow, it could represent a very viable alternative to sovereign debt and even hard assets for foreign investment capital. Rather than saving in USD or another national currency, individuals, entities, and countries could choose to save in Bitcoin or other cryptocurrencies.

Payments denominated in asset-backed stablecoins are expected to reach trillions of dollars in non-bot payment volumes over the next decade [19]. Most popular asset-backed stablecoins today are pegged to USD, but several newer stablecoins are pegged to other national currencies as well [20]. While asset-backed stablecoins are cryptocurrencies, these currencies drive demand for national currencies as reserves backing the value of these currencies. Today, stablecoin issuers are the 16th-largest buyers of U.S. debt if included amongst all sovereign nations [21]. Former Speaker of the House, Paul Ryan, has indicated that stablecoins could be one potential answer to the U.S. debt crisis [22].

Historically, when nations have started to feel threats to their currencies and domestic monetary policy fails to make a sufficient impact, they have outlawed the use of other currencies. If sovereign demand for cryptocurrencies were to threaten demand for USD and U.S. national debt, the U.S. might regulate non-asset-backed cryptocurrencies more tightly. Because asset-backed stablecoins pegged to USD drive demand for the dollar, the U.S. will likely be incentivized to encourage the adoption of these stablecoins.

The future currency landscape

We’ve explored the forces driving the valuation and evolution of national currencies, how a national currency becomes a global reserve currency, and how cryptocurrencies may factor into the picture. As individuals completing financial transactions in daily life, we seldom consider the complex incentives and dynamics behind each of the currencies we use. However, currencies are a primary lever and consideration in global macroeconomics.

Looking ahead to the future, we see a world where national currencies and asset-backed stablecoins coexist happily and other cryptocurrencies challenge the global world order. Asset-backed stablecoins may be regulated subject to the same compliance, transmission, and banking requirements as money. Other cryptocurrencies, such as Bitcoin and Ethereum, may grow in global adoption to the point where they start to rival gold reserves and sovereign debt across all nations [23]. As adoption grows, these cryptocurrencies, which are not issued or controlled by any central bank, may start to challenge concepts of national sovereignty and dominance. How countries will choose to regulate these cryptocurrencies in the meantime is an open question.

For individual entities, deciding which currencies to use for financial transactions may become a more complex question over time. One’s currency choices may embed one’s beliefs about individual sovereignty versus national sovereignty and the true value of money.

While there is much uncertainty in the future currency landscape and how it affects individual behavior, we anticipate that cryptocurrencies will play an increasingly important role in the changing world order. It will be critical for industry and government leaders, economists, and technologists to work together in defining monetary systems that preserve societal order while enabling humanity to grow.

If you’re interested in exploring these topics further, reach out at hello@fernhq.com. We’d love to chat.

Footnotes and references

[1] https://en.wikipedia.org/wiki/List_of_circulating_currencies

[2] https://explodingtopics.com/blog/number-of-cryptocurrencies

[3] We compare cryptocurrency payment volumes in stablecoins to global cross-border payment volumes. While this is not an apples-to-apples comparison, as cryptocurrency payment volumes should include other assets beyond stablecoins and are not strictly used for cross-border payments, we think this is a reasonable starting point to get at the order of magnitude difference between cryptocurrency versus traditional currency payment volumes. In 2024, stablecoins were used for ~$150B in monthly transaction volume, while global cross-border is estimated to be ~$15T. This represents a ~100x difference between cryptocurrency and traditional currency payment volumes.

https://arf.one/global-cross-border-payment-flows-current-landscape/

https://www.bloomberg.com/news/articles/2024-05-05/more-than-90-of-stablecoin-transactions-aren-t-real-study-finds

[4] https://www.bloomberg.com/news/articles/2024-05-05/more-than-90-of-stablecoin-transactions-aren-t-real-study-finds

[5] There are some nuances to this statement.

Several nations have currencies that are pegged to the U.S. dollar, as the current global reserve currency, and some nations accept USD and other national currencies outright as legal tender within their borders. While these USD-pegged currencies are still national currencies, the currencies are not truly economically sovereign because their value fluctuates based on US monetary policy.

National currencies also evolve over time. In 1850s Germany, one would have used the gulden (florin) or the thaler, compared to the German mark and today’s euro.

[6] This diagram and many of the concepts discussed in this section are from Ray Dalio’s Principles for Dealing with the Changing World Order.

[7] In this essay, we use the concepts of debt and credit somewhat interchangeably. A nation being in debt is the result of issuing credit, the ability to borrow money from lenders with the promise to repay later.

[8] Furthermore, other nations may peg the value of their currency to the global reserve currency, believing it to be a stable currency that will hold its value over time. This is another way in which the reserve currency becomes critical to global economic stability.

[9] This diagram is from Dalio’s book on page 310 (Kindle version).

[10] Today, approximately 13% of the total U.S. debt, or around ~$3.7T, is held by foreign governments.

https://sgp.fas.org/crs/misc/RS22331.pdf

[11] https://www.bloomberg.com/markets/rates-bonds/government-bonds/us

[12] This diagram is from Dalio’s book on page 321 (Kindle version).

[13] https://www.usgoldbureau.com/news/post/us-dollar-fiat-currency

[14] https://pricedingold.com/us-dollar/

[15] https://www.usgoldbureau.com/news/post/us-dollar-fiat-currency

[16] This diagram is from Dalio’s book on page 332 (Kindle version).

[17] https://youtu.be/3EmAacNwiEo?si=7kufTwKtVxn8D9UH

[18] https://www.coingecko.com/en/global-charts

[19] https://www.bloomberg.com/news/articles/2024-05-05/more-than-90-of-stablecoin-transactions-aren-t-real-study-finds

[20] There are several different stablecoin experiments that attempt to preserve purchasing power and stablecoin value in different ways. Algorithmic stablecoins, inflation-adjusted tokens, and stablecoins backed by a basket of currencies are just some examples of different currency experiments.

[21] https://x.com/nic__carter/status/1790542575616639328

[22] https://youtu.be/F8vibCAFH_0?si=0ghaJWRdU9mFYdBH&t=524

[23] Total sovereign debt was $97T in 2023. There is around $12.5T worth of gold in the world. Total Bitcoin market cap around $2T is 1-2 orders of magnitude away from being at a similar scale.

https://unctad.org/publication/world-of-debt

https://goldsurvivalguide.co.nz/how-much-all-gold-in-world-worth/

https://www.cnbc.com/2024/05/29/global-debt-has-grown-to-315-trillion-in-2024.html