The rates of Bitcoin and many other cryptocurrencies, even relatively stable coins, such as Ripple, have fallen by seven percent or more after the overall recovery and uptrend of last week. In the meantime, no less interesting events are taking place in the classical economy and fiat exchanges as the financial systems of many countries are reacting to external political actions. Because of American sanctions in connection with the Skripal case and the growing Turkish crisis, the Russian ruble began to fall as of August 8, the dollar rate exceeded 68 rubles for the first time in two years, and the Central Bank of Turkey, in turn, introduced extreme measures to save the national currency, the lira, and will spend $11 billion on the endeavor. At first glance, a similar downward trend may manifest a direct link between the digital and the classical economy. But are the two systems that are developing according to their own scenarios at different rates so similar and subject to the same moods?
Analysis of Terminology
The economy, according to one of the dictionaries, is the economic activity of society, as well as the totality of relations that are formed in the system of production, distribution, exchange, and consumption. The main function of the economy is to constantly create the necessary benefits for life, without which society cannot develop. That is, the classical economy has been satisfying human needs in the world of limited resources for several thousands of years and has gone beyond the boundaries of the relationship between sales and purchases. Some experts and observers often argue that the crypto economy performs all the same functions and differs only in behavioral instincts as the reaction to some events is much more emotional and cardinal because of the large amounts that are not inherent in the classical economy.
For example, a year ago, when the crypto industry was approaching the peak of its hype, the well-known venture capitalist of the Silicon Valley Parker Thompson wrote in his tweet that "the concept of crypto-economics is stupid. It’s economics. Inventing your own word is just an excuse to ignore a well-understood concept."
A few weeks later, Joshua Stark, co-founder of L4, which deals with projects on Web3.js, published an article analyzing the concept of the crypto economy. The following definitions were made:
The crypto economy is primarily based on a technology, and not the application of macroeconomic and microeconomic theory for cryptocurrency markets or ICOs. It is also not a kind of economy, but rather an area of applied cryptography that takes into account economic incentives and economic theory;
The products of the crypto economy are cryptocurrencies based on public blockchains, which also refers to one of the products of the new practical science;
The crypto economy is based and exists in decentralized peer to peer (P2P) systems, which exclude the control of any third party, such as the state, central banks, and governments;
The crypto-economic approaches combine cryptography and economics to create reliable decentralized peer to peer networks that evolve despite constant attempts by opponents and intruders to destroy the network;
The crypto economy, in fact, deals with the construction of things and has much in common with the design of mechanisms in the field of mathematics and economic theory.
Market Economy vs. Digital Economy
Indeed, some basic concepts of cryptography are borrowed from an economic dictionary. Formulas for calculations, conversion of exchange indicators, explanations of manipulations, and various types of movement in the cryptocurrency market are all taken from the classical system that, for many centuries, developed certain indicators that allow us to quickly and accurately calculate the financial benefit and predict the future of the market. Therefore, it is not worthwhile to deny fundamental knowledge in a new and emerging system. For example, to determine the value of a crypto asset, you need to use the equation of exchange, the discount model of dividends, Metcalfe’s Law, and you can discover a cryptocurrency bubble using the NVT indicator. All economic theorems are adapted and changed to the inconsistent character of the blockchain industry because the use of formulas in its pure form can lead to inaccurate indicators and financial losses. Ph.D. Amber Cazzell speaks of these similarities and adds that at the moment there is a trend emerging from the nature of goods and ways of tracking wealth, that is, from the capitalist economy.
"So what am I saying? I am saying that there is a departure between the nature of goods today, and the means by which wealth is tracked. When we purchase information, we give a scarce resource (a physical dollar bill, or Bitcoin as we currently know it) up in order to obtain a non-scarce resource. And guess what? We, humans, know it and hate it," says Cazzell and she suggests that the digital economy, unlike the classical system, will be able to obtain free and unlimited resources that will be available to everyone.
"The secret power of digital currency is that it can be made infinite. There’s no physical bill floating around in the world that needs to replicate itself out of thin air. When I stream a movie through YouTube online, a digital currency ledger could add five points to YouTube (they’ve given me access to Hollywood information after all), and not subtract any points from little ol’ me. The secret power of digital currency is that it can be additive-only, just like Clue (a board game in which a murder mystery is taking place). And this is where things get really crazy. This is a more accurate reflection of today’s goods than the scarcity-centric financial systems we’ve been clinging to anyway," as Cazzell compares the blockchain industry with usual items.
In addition, digital currencies minimize corruption, which traditional structures fail to do, and third parties have a personal interest, although incentives for all representatives of the network are not yet fully agreed upon. While the capitalist system seeks to be a win-win ("I give you a dollar, you give me goods"), the blockchain continues to write zero-sum transactions, subtracting Bitcoins (or dollars) from a private key and adding it to another secret key. But digital currencies in the future are unlikely to preserve this economic paradigm.
"The crypto economy will differ from the usual economy in approximately the same way that the socialist model of society differs from the capitalist one. And this will not be a smooth transition, but a quantum leap for society from the point of view of restructuring all social and economic ties and structures within the society and between economic entities," said Dmitry Marinichev, executive director of Russian Mining Coin, while speaking at the Vestifinance forum.
Is There a Connection or Not?
All economic sectors in different degrees of influence and depend on each other. But each of them develops according to its plan, and therefore the reaction to certain events will occur only if the novelties come into contact with the tendencies of the other system. As a rule, interweaving and dependence occur in moments when the situation concerns earnings or loss of investment. That is, all models rely on the behavioral psychology of a person who is afraid of losing their assets.
To describe the example of this interaction, we can return to the Turkish lira (TRY), which in the past seven days has collapsed by 25 percent, and in eight months by 45 percent. Shares have lost twice their previous value, inflation in Turkey has reached almost 20 percent, and the current account deficit amounted to $57 billion. This situation arose after the introduction of U.S. sanctions against the backdrop of the fact that the Turkish economy depends on imported goods from the United States. The economic situation of the country caused panic among local investors, who, amid frustration and fear of subsidence of the fiat market, invested in Bitcoin. Therefore, on August 13, the rate of the first cryptocurrency reached a seven-month high and amounted to more than 47,000 TRY.
"The sharp slide in the lira has already pushed up inflation, which, along with a slump in spending power for TRY holders, has certainly boosted bitcoin's appeal as a store of value. Looking forward, BTC could well rise further against the lira, as Turkey's President Erdogan continues to oppose interest rate hikes to stabilize the currency and, rather than backing down, has referred to U.S. President Trump's decision to impose sanctions on Turkish steel and aluminum as an ‘attack’ on its economy," says Coindesk observer Omkar Godbole, despite the fact that the general tendency of the Bitcoin exchange rate against the dollar has a bearish trend.
After this news, users began joking about the emergency sales of all Bitcoins and buying up the Turkish lira: "It seems that now is the time to sell all BTCs and buy TRY. Buy cheap, sell high, really high.” But reverse cases have taken place in the history of the crypto market when inexperienced players of the market withdrew their assets against a background of a general negativity against the digital system. Hacks of crypto exchanges, attacks on ICOs, bans on the public collection of funds for crypto projects, and manipulation by the state have all prompted users to sell coins and return to the fiat industry. On August 12, the State Committee of Saudi Arabia and the Middle East countries reminded of the ban on trade in cryptocurrencies and issued a statement, which spoke about the negative consequences and high risks for traders.
"The Committee asserts that no citizen or organization of the country has a license for trade. Therefore, all cryptocurrencies, including Bitcoins, are illegal in the kingdom," the document says. Such state prohibitions hamper the development of the crypto economy, which, with a positive reaction from the authorities, could develop better than it is doing now.
All man-made systems have a common tendency and some relationship since common measures and innovations are designed to improve life. The crypto economy, however, despite its name, differs from the classical economy with the building of financial relations within society, since blockchain is a technology with a complex architecture that will help eliminate many of the shortcomings of the existing model.