Article reprint source: Block Unicorn
Article author: Zeus
Article translation: Block Unicorn
Preface
Currency is the foundation of economic activity, yet we rarely explore the characteristics that make currency effective. As digital currencies challenge traditional concepts of money, we need to revisit which traits enable currency to fulfill its essential functions in the modern economy.
History shows that the definition of currency lies not just in its technical characteristics but in its ability to evolve through different stages of development. True currency must go through a challenging evolutionary journey that most emerging currencies cannot complete.
The complete lifecycle of currency
To become a fully functional currency, an asset must successfully complete four stages of development:
1. Attracting value
First, currency must attract capital and attention. Whether through precious metals, government backing, or potential appreciation, all successful currencies begin by attracting people to hold them. This initial appeal lays the foundation for subsequent development.
Without this stage, currency cannot gather the critical mass of adoption required. Many digital currencies perform well at this stage, leveraging speculation and network effects to establish initial adoption and liquidity.
2. Scaling development
Secondly, currency must achieve sufficient scale and liquidity to support meaningful economic activities. It needs enough market depth to avoid excessive volatility from trades; it also requires sufficient distribution to ensure finding trading counterparts is not overly difficult.
Scale brings credibility, network effects, and the necessary liquidity for broader application. Major cryptocurrencies like Bitcoin have successfully passed this stage, achieving market capitalizations in the trillions.
3. Stability mechanisms
Third, the currency must develop stability mechanisms that make it reliable in commerce and contracts. Stability does not mean fixed value, but rather predictability and resilience under market pressures. This requires technical mechanisms and institutional support.
Many emerging currencies fail at this stage. True stability requires systems that can operate normally under various market conditions without collapsing or needing external intervention. This means currency must have inherent coping mechanisms to address both excess demand and insufficient demand.
4. Economic utility
Ultimately, currency must be truly practical in ordinary economic activities that go beyond speculation. It must serve as a reliable unit of account, medium of exchange, and store of value across various economic environments.
True practicality means supporting all financial functions required by the modern economy: efficient payments, reliable contracts, reasonable lending markets, and stable planning cycles. This means currency becomes mundane and practical, rather than merely exciting and novel.
Coordination problems
Few realize that later stages require addressing fundamental coordination problems that become increasingly difficult as system scale grows.
Consider the fundamental functions of currency, such as providing a last resort function, implementing emergency stabilization measures, or intervening in crises. These functions are essentially public goods. They require entities to prioritize system stability over their own self-interest—taking personal risks for the collective good.
In purely self-interest-driven decentralized systems, these key functions lack structural support. The system may operate well under normal circumstances, but it can collapse when stability is critical.
We repeatedly see this vulnerability in the cryptocurrency market:
During the crash in March 2020, exchanges like BitMEX had to suspend trading to prevent cascading liquidations that threatened the entire ecosystem with a complete collapse.
On 'Black Thursday', MakerDAO required emergency governance responses and community bailouts due to insufficient collateral.
LUNA initially survived market pressures through massive interventions by well-funded participants, but when its scale grew beyond what these supporters could stabilize, it collapsed completely.
These examples reveal a profound truth: while cryptocurrencies theoretically advocate for trustless systems, their survival in crisis repeatedly relies on discretionary interventions by participants based on implicit trust.
As system scale increases, this coordination problem becomes exponentially more difficult. Issues that might be solved through informal coordination at smaller scales become impossible once the system grows beyond certain thresholds.
Capital formation requirements
In addition to stability, sound currency must support capital formation—the lending processes that drive economic productivity. This is another fundamental limitation faced by existing cryptocurrencies.
The use of crypto assets as collateral is increasing, but they are rarely used as debt valuation assets. Few are willing to borrow in Bitcoin (BTC) or Ethereum (ETH) due to the uncertainty they bring, which poses unmanageable risks to borrowers and lenders alike.
A fully functional currency must provide a stable unit of account for agreements over time. Whether borrowers are building homes, financing businesses, or developing infrastructure, they need reasonable certainty about the future value of their debts.
Designing a complete currency system
The limitations of existing cryptocurrencies are not temporary issues, but fundamental design constraints. Assets like Bitcoin and Ethereum are primarily designed for the first two stages of development—attracting value and scaling development.
Their fixed or highly restricted supply models create strong incentives for early adoption and speculation. This design excels in launching value and achieving initial scale, but becomes a burden when stability and practicality are needed for broader adoption.
Without mechanisms to adapt to changing economic conditions, provide last resort functions, or stabilize in crises, these systems are fundamentally incomplete currency systems. They may operate well as ownership ledgers, but struggle to become fully functional currencies.
The complete architecture of sound currency
Based on these observations, we can define what is needed for a well-structured currency:
Adaptive supply mechanisms: sound currency must be able to expand when demand exceeds supply and contract when supply exceeds demand, creating natural stabilizing pressure.
Last resort function: sound currency needs built-in mechanisms to provide liquidity, stability, and intervention under market pressures without external coordination.
Productive reserve utilization: sound currency should use its accumulated value for productive purposes rather than letting it sit idle or dissipate, creating sustainable value for the system.
Foundation for lending markets: sound currency must provide the stability required for the development of functional lending markets, allowing for capital formation without excessive risk.
Transparent health indicators: sound currency should provide clear indicators of system health, allowing participants to make informed decisions based on fundamental strengths rather than merely market sentiment.
The historical development of traditional currency systems is not coincidental—these characteristics evolved because they are essential for currency to operate under diverse economic conditions.
Bridging the gap
This analysis does not deny the achievements of cryptocurrencies. Bitcoin and other cryptocurrencies have achieved remarkable successes by successfully completing the first two stages of development—proving that it is possible to launch a non-sovereign currency system through market incentives.
Their success provides critical strategies for the initial stages of currency evolution. The core insight is that a complete currency system needs to consider its ultimate mature state at the design stage while still being able to cope with early evolutionary phases.
Currency technology needs to balance mechanisms for initial growth and speculation, while providing a pathway to stability and practicality once sufficient scale is achieved. They must combine the launch capabilities that have made cryptocurrencies successful with the adaptive mechanisms that are currently lacking.
Conclusion: The path to sound currency
The evolution of currency is not merely a technical issue, but a solution to the coordination problems that increase with scale. Sound currency must be designed to operate throughout its entire lifecycle—from initial adoption to mature application—with mechanisms to adapt to changing conditions without ongoing external intervention.
This does not mean returning to a fully centralized system, but rather designing a well-structured system with built-in mechanisms necessary for currency operation. This means that the currency created is effective not only under optimal conditions but also across various economic scenarios.
As we continue to develop digital currencies, these insights provide us with a framework to assess their potential. We should not merely focus on technical characteristics or short-term price appreciation, but rather consider whether a currency possesses the complete architectural elements necessary to perform quality currency functions throughout its evolution.
The future of currency does not belong to those systems with the most advanced technology or the strongest initial growth, but to those systems that fully understand the actual operational mechanisms of currency at the design stage.
