Blockchain: Microeconomics At Work
Why the Dollar Changes in Value
Several macroeconomic factors are affecting why the dollar’s value changes over time. Surprisingly to some, geopolitical risk and market psychology affect the value of the dollar on the world market. Like any other fiat currency dependent on that country’s economic activity, the dollar’s value depends on that of the United States.
We’re going to explore the macroeconomics at work in this course. There is a perfect trifecta supporting the dollar; the Federal Reserve tightening monetary policy, safe-haven buying, and the US having a strongly performing economy.
The US dollar has been the world’s dominant currency for decades. New data from the International Monetary Fund published in June of 2022 reports the dollar’s share of total allocated reserves is 59%, down .4% from a year ago. That means nearly 60% of the world’s currency is held in the US dollar. The Euro holds steady, representing about 21%, while the Chinese renminbi and Japanese yen fall into 3rd and 4th places. *1
What Is the Time Value of Money?
Money also has time value, otherwise known as the Time Value of Money (TVM). It’s also referred to as ‘present discounted value’. A specified lump sum of money today is worth more than that amount in the future because today’s money has potential earnings through investments. If money isn’t invested, the value of the money diminishes over time. If you hide $1,000.00 in your freezer, mattress, or safety deposit box for five years, you lose the additional money it could have earned had it been invested.
There is a formula for calculating TVM; however, depending on the exact situation, this formula could change slightly. Using the following variables, the formula is:
FV = PV x [ 1 + (i / n) ] (n x t) FV = Future value of money
PV = Present value of money i = interest rate
n = number of compounding periods per year
t = number of years
Understanding the concept of TVM enables one to make informed investment decisions. Let’s say you have an opportunity to invest money and are considering two similar projects. Project X promises a 10 million payout in year one, and Project Y has a 10 million payout in year five. The payouts aren’t equal because the 10 million in year one has a higher present value (PV) of money than in year 5. *2
How the Value of Money Affects You
According to a study from Bankrate, roughly 42% of Americans say money harms their mental health. The value of money affects Americans every day at the gas station, grocery store, paying for dry cleaning, buying school supplies, and making home improvements. Inflation is pushing prices higher. The Fed is raising interest rates to rein in the economy as Americans deal with the most significant price increases the US has seen in over 40 years.
Food rose 1% for the month in April of 2022 and 8.8% over the year, as prices for goods such as rice, ground beef, citrus fruits, and fresh vegetables all posted gains of more than 2% in March of 2022 according to Jeff Cox at CNBC. Energy prices were up 11% and 32%, respectively, as gasoline prices popped 18.3% for the month, boosted by the war in Ukraine. *3
Brian Coulton, a chief economist at Fitch Ratings, has said the drop in auto prices while other industries show increases is the core cause of inflation deceleration.
What happens when the value of money declines?
Inflation is when the value of money steadily declines over time. The dollar losing value reduces purchasing power internationally. Consequently, the gas pumps are where most Americans feel this impact on their budgets. Once the dollar drops in value, the cost of importing oil increases, causing gas prices also to increase, thus constricting spending habits at the consumer level even more. *2
A weak dollar drives up the cost of all imported goods, many of which line the shelves of grocery stores, big box retailers, and mom-and-pop shops. These businesses increase the cost of goods resulting in reduced consumer spending. So, does anyone benefit when the dollar loses value? The answer is yes. The exporting industry sees an increase in market share and may help to boost economic growth by creating jobs. Companies doing business in foreign countries benefit significantly during this period. *4
When the Value of Money Increases
Deflation occurs when the general price level across the economy declines, and consumers gain purchasing power, reflecting on the US housing economy bursting between 2007 to 2011. Deflation during that time resulted in many people being unable to sell their houses due to being upside down on their mortgages. As a result, jobs were lost in the deflating housing market across construction, telecom, mortgage lending, and others. Families lost homes. It’s a FUD- driven downward spiral. *2
According to Politico, between 1916 and 1929, a war was followed by a pandemic and a financial crash. Fast forward to the period between 2008 and 2022, a pandemic and war followed an economic crash. The period following the financial crash of 1929 was The Great Depression, and the unemployment rate rose to 25%.
Deflation is terrible news for the entire economy.
How Value of Money Changes Over Time
The evolution of money includes bartering, IOUs, trade, coinage, banknotes, and digital currencies. Adam Smith, the 18th-century author of ‘The Wealth of Nations, was one of the first to identify bartering existed before money. Bartering was limited and challenging; it only worked when two parties agreed they each had a supply of something the other party wanted. Trading and IOUs were equally common. For example, if the corn were not ready to be harvested, then an IOU would be issued and later used once the crop could be harvested. *5
After writing was invented, documentation was used to track the value of goods and the details of the IOUs. Eventually, objects such as beads, shells, and lumps of gold were assigned a specific value, and thus people began using gold in exchange for goods.
Money has characteristics, and money is not money unless it has all of these:
- Store of Value – cannot be perishable
- Item of Worth – having an intrinsic value like the precious metal used to make the coin
- Means of Exchange – the money must be able to be exchanged for goods freely
- Unit of Account – money can be used to record wealth; possessed, traded, or spent
Money made it easy to assign consistent values to objects. By the early 20th century, money was separated from its direct relationship to precious metals like gold. The gold standard collapsed in the 1930s and within decades new ways of exchanging money appeared, credit cards, digital transactions, cryptocurrency, and financial derivatives. Both the amount of money that exists and the amount in circulation increased tremendously. *6
Regulating Money
Money has evolved and will continue to do so. In response to this evolution in the USA, regulatory agencies have been created to monitor entities like banks and other financial institutions. In addition to these federal regulatory agencies, states have a government agency that regulates and monitors state-chartered banks, trust companies, credit unions, insurance companies, bail bond agents, mortgage bankers, and more.
The FED and CFPB
The Fed investigates claims by citizens who claim they have been mistreated. The Consumer Financial Protection Bureau was created to protect consumers from deceptive and unfair treatment practices by financial institutions, including banks, credit unions, payday lenders, mortgage lenders, and debt collectors. *7
OCC – The Office of the Comptroller of Currency
The OCC is an independent bureau within the treasury department that charter, supervise, and regulate national banks and federal savings associations to ensure they comply with applicable laws and regulations. *8
FDIC – The Federal Deposit Insurance Corporation insures deposits up to USD 250,000.00. The FDIC is a system that boosts public confidence in the US financial system.
FASB – The Financial Accounting Standards Board (FASB) establishes the standards for financial reporting in the USA.
Money in the digital age
In the same way the internet revolutionized communication and made globalization possible, cryptocurrency will change how people pay for services and goods. Unlike any currency before it, digital money offers a single currency that is globally recognized and not under the control of any bank or central authority. *9
As of July 2022, there are more than 180 million users worldwide.
About 1 billion people globally will use cryptocurrencies in 2022.
By 2025, financial analysts say the global blockchain market will grow by 39.17 billion USD.
51% of Americans bought cryptocurrency for the first time in the past 12 months.
29% of millennial American parents own cryptocurrency.
More than 80% of people with financial advisors want to learn more about cryptocurrency.
$1 Trillion is the forecasted value of global P2P (peer-to-peer) lending by 2025.
Half of the men between the ages of 18 & 49 said they have dabbled in crypto. (Highest of the demographics group.)
42% of all people between the ages of 18 and 34 reported they have dabbled in crypto. Globally only 21% of crypto users are women.
Decentralization and what it means
A decentralized cash system means individuals may engage in ‘monetary transactions’ without involving third parties or middlemen. Also known as crowdfunding, peer-to-peer networks were developed to bypass banks and other financial institutions using specific crowdlending brokers. Higher rates of return drive this appeal for lenders, while borrowers may benefit from lower rates on their loans. P2P lending has exploded since 2008.
Kickstarter is one of the oldest and most established crowdfunding platforms. As of December 2019, $4.6 billion has been pledged since its inception in April 2009. There have been 469,286 launched projects with a 37.45% success rate.
Today there are many crowdfunding platforms. According to Investopedia in June 2022, the top six are:
Best Overall: Indiegogo
Pros
Great for entrepreneurs and investors Worldwide operations
Cons
Charges a 5% platform fee plus a third-party payment processing fee
Best for Startups: SeedInvest Technology
Pros
620,000+ investors
Helps raise awareness among venture capital firms and angel investors You don’t have to pay any fees if your fundraiser isn’t successful
Cons
All startups undergo intense vetting, but not all are selected.
Best for Nonprofits: Mightycause
Pros
Compatible with customer relationship management (CRM) systems, like Salesforce
You can request a demo for free
Social media integrations available
Option to set up year-round fundraising, special events, giving days, and crowdfunding campaigns
Cons
Features like CRM integrations are a part of the platform’s paid plan.
Best for Investing: StartEngine
Pros
$500 million raised
Kevin O’Leary, TV host on ABC’s “Shark Tank,” is the company’s strategic advisor.
Cons
Relatively new company
Best for Individuals: GoFundMe
Pros
0% platform fee
Flexibility to raise money for yourself, a friend, or a charity 24/7 expert support available
Cons
Credit and debit card transaction fees Ability to freeze and control accounts
Best for Creative Professionals: Patreon
Pros
You can create monthly subscriptions
Software integrations are available with Vimeo, MailChimp, and more.
Cons
Fees start at 5% and go up to 12%, depending on the plan level you choose (*10)
Consensus Algorithms in Blockchain
In both the 100-level course and this course, we’ve learned that blockchain is an immutable, private, secure, and transparent distributed decentralized network. If there is no central authority to validate the transactions, how is every transaction in the blockchain considered completely secured and verified? Consensus protocols which are a component of blockchain, make this possible.
A consensus algorithm is the process of all the peers in the blockchain network reaching an agreement about the present state of the distributed ledger. Consensus protocols ensure every new block added to the blockchain is the only version of the truth, and all nodes in the blockchain agree upon it. There are various types of consensus algorithms. *11
GeeksforGeeks defines them in the following manner:
Proof of Work (PoW): This consensus algorithm is used to select a miner for the generation of the next block. Bitcoin uses this PoW consensus algorithm. The idea behind this algorithm is to solve a complex mathematical equation and then be able to give out a solution quickly. This algorithm requires a lot of computational power. The node that solves the puzzle first gets to mine the next block. *12
Practical Byzantine Fault Tolerance (PBFT)
Proof of Stake (PoS): This is the most common alternative to PoW. Ethereum has shifted from PoW to PoS consensus. This type of consensus algorithm contains validators that invest in the coins of the system by locking up some of their cash as a stake. After that, all the validators will start validating the blocks. Validators will validate blocks by placing
a bet on them if they discover a block they think can be added to the chain. Based on the actual blocks added to the blockchain, all the validators get a reward proportionate to their bets, and their stake increase accordingly. In the end, a validator is chosen to generate a new block based on its economic stake in the network. Thus, PoS encourages validators through an incentive mechanism to reach an agreement.
Proof of Burn (PoB): With PoB, instead of investing in expensive hardware equipment, validators ‘burn’ coins by sending them to an address from where they are irretrievable. By committing the cash to an unreachable address, validators earn the privilege to mine on the system based on a random selection process. Thus, burning coins here means that validators have a long-term commitment in exchange for their short-term loss. Depending on how the PoB is implemented, miners burn the native currency of the Blockchain application or the currency of an alternative chain, like bitcoin. The more coins they burn, the better their chances of being selected to mine the next block. While PoB is an interesting alternative to PoW, the protocol still wastes resources needlessly. And it is also questioned that mining power goes to those willing to burn more money. *12
Proof of Capacity: In the Proof of Capacity consensus, validators are supposed to invest their hard drive space instead of investing in expensive hardware or burning coins. The more hard-drive-space validators have, the better their chances of getting selected for mining the next block and earning the block reward.
Proof of Elapsed Time: PoET is one of the fairest consensus algorithms, which chooses the next block using fair means only. It is widely used in permissioned Blockchain networks. Every validator on the web gets a fair chance to create their own block. All the nodes wait for a random amount of time, adding proof of their wait in the block. The created blocks are broadcasted to the network for others’ consideration. The winner is the validator with the least timer value in the proof part. The block from the winning validator node gets appended to the blockchain. The algorithm has additional checks to stop nodes from consistently winning the election and generating the lowest timer value.
Other consensus algorithms like Proof of Activity, Proof of Weight, Proof of Importance, Leased Proof of Stake, etc., also exist. Choosing one wisely and per the business network requirement is crucial because Blockchain networks can’t function properly without consensus algorithms to verify each transaction.
What is Byzantine Fault Tolerance (BFT)
Byzantine Fault Tolerance is the computer system or network’s ability to continue operating even if a node fails or if nodes act maliciously. BFT is a consensus algorithm introduced in the late 1990s by Barbara Liskov and Miguel Castro. BFT was derived from Byzantine General’s Problem, which was explained in a research paper written by Leslie Lamport,
Robert Shostak, and Marshall Pease at Microsoft in 1982:
“Imagine that several divisions of the Byzantine army are camped outside an enemy city, each division commanded by its general. The generals can communicate with one another only by messenger. After observing the enemy, they must decide upon a common action plan. However, some generals may be traitors, trying to prevent the loyal generals from reaching an agreement. The generals must decide when to attack the city, but they need a strong majority of their army to attack simultaneously. The generals must have an algorithm to guarantee that (a) all loyal generals decide upon the same plan of action and (b) a small number of traitors cannot cause the loyal generals to adopt a bad plan. The loyal generals will all do what the algorithm says they should, but the traitors may do anything they wish. The algorithm must guarantee condition (a) regardless of what the traitors do. The loyal generals should not only reach an agreement but should agree upon a reasonable plan.” *13 *14
The primary reason Byzantine Fault Tolerance is critical to the success of blockchain is that it protects the network from double-spending. While double spending can still happen, it doesn’t occur by copying crypto. It’s more likely crypto’s stolen from a wallet that wasn’t secured and protected. Certain types of attacks allow bad actors to reverse a crypto transaction: race attacks, 51% attacks, and Finney attacks.
Economics of Blockchain in summary
Macroeconomists look at cryptocurrency for the study of monetary theory. Microeconomists’ interests lie in the robust nature of a decentralized network. Globally decentralized cash systems enable people to engage in financial transactions without involving third parties. The Byzantine Fault Tolerance allows for disagreements and protocol to handle such agreements, thus eliminating the need for a middleman.
