What is Synthetic Commodity Money

What is Synthetic Commodity Money?

Macroeconomic stability in the current global economic regime depends upon the use of a base money that can be used as a medium of exchange, a unit of account, and a store of value. Economists have traditionally distinguished between two types of historical base monies: commodity money, and fiat money. Recent innovations within decentralized finance have paved a way for a new kind of money that cannot be classified within the traditional dichotomy. This new kind of money is called synthetic commodity money as it exhibits characteristics of both commodity and fiat money. Both commodity money and fiat money have their respective advantages and drawbacks. Synthetic commodity money has the potential to account for the drawbacks of both.

A commodity money can be defined as one which is both naturally or inevitably scarce, and has value outside of monetary use. Gold and other precious metals are classic examples of such money. Precious metals like gold, being naturally scarce, necessarily retain a positive value in equilibrium, allowing them to fulfill the three functions of money and thus making them good potential candidates for the base money of an economic regime. Nevertheless, due to its value outside of monetary use, the price of commodity money can be prone to fluctuations due to the market laws of supply and demand. Such fluctuations are inconducive to macroeconomic stability.

This is where fiat money has a significant advantage over commodity money in having no non-monetary use value, and thus being immune to market fluctuations. However, though the use value of fiat money is restricted to monetary purposes only, it is not naturally scarce. Thus, in order to retain a positive value at equilibrium, the supply of fiat money must be controlled by some monopolistic agency. This is the major downside of fiat money. Mismanagement of the supply can lead to devastating macroeconomic consequences due to the actions of a few. Furthermore, higher nominal quantities of fiat money can be supplied at virtually no extra cost to produce it, meaning that fiat money may actually have no finite equilibrium value.

Synthetic commodity money is by definition both absolutely scarce, but also has no non-monetary use value. Thus, it has the benefits of retaining a positive value at a true equilibrium without outside intervention from a monopolistic agency, while also being immune to market forces. Historically, the transition from widespread use of one classification of money to another can be at least partially attributed to a technological innovation which solved a problem which had previously made adoption impossible. It was the development of a non-counterfeitable currency which put the supply of money under monopolistic control that led to the widespread adoption of fiat. For the case of synthetic commodity money, it was the development of a digital currency with an absolutely scarce supply. BitCoin has been regarded as the paradigmatic example of a synthetic commodity money.