What does a benign currency need: Why is it difficult for decentralized systems to achieve true stability?

Author: Zeus

Compiled by: Block unicorn

Preface

Money is the basis of economic activity, but we rarely explore what qualities make money effective. As digital currencies challenge traditional currency concepts, we need to reexamine what qualities enable currencies to perform their basic functions in the modern economy.

History shows that currency is defined not only in its technological characteristics, but in its ability to evolve through different stages of development. True currencies must go through a challenging evolutionary path that most emerging currencies cannot accomplish.

Complete currency life cycle

To become a fully functional currency, assets must successfully complete four stages of development:

1. Attract value

First, money must attract capital and attention. Whether through precious metals, government endorsement or potential appreciation space, all successful currencies start by attracting people to hold it. This initial attraction lays the foundation for subsequent development.

Without this stage, the currency cannot gather enough critical amounts to adopt the required scale. Many digital currencies perform well at this stage, leveraging speculation and network effects to build initial adoption and liquidity.

2. Scale development

Second, the currency must achieve sufficient scale and liquidity to support meaningful economic activities. It requires sufficient market depth to avoid excessive volatility in trading; it also requires sufficient distribution to ensure that finding counterparties is not too difficult.

Scale brings credibility, network effects and the necessary liquidity for wider applications. Major cryptocurrencies like Bitcoin have successfully passed this stage, with market caps reaching trillions of dollars.

3. Stability mechanism

Third, currency must develop a stable mechanism that makes it reliable in business and contracts. Stability does not mean fixed value, but refers to predictability and resilience under market pressure. This requires technical mechanisms and institutional support.

Many emerging currencies fail at this stage. True stability requires a system that can operate normally under various market conditions without crashing or requiring external intervention. This means that the currency must have an internal response mechanism to cope with over-demand and insufficient demand.

4. Economical utility

Finally, the currency must be truly practical in ordinary economic activities beyond speculation. It must serve as a reliable unit of accounting, medium of exchange and a means of store of value in various economic environments.

True practicality means all the financial functions required to support the modern economy: efficient payments, reliable contracts, a reasonable lending market and a stable planning cycle. This means that the currency becomes mundane and practical, not just exciting and novel.

Coordination issues

It is rarely realized that the underlying coordination problem that increases difficulty as the system scales up is needed.

Consider the basic functions of money, such as the function of providing last resort, implementing emergency stabilization measures, or intervening in a crisis. These functions are essentially public goods. They require entities to place system stability above their immediate self-interests—taking personal risks for collective benefit.

In a decentralized system that is purely personal interest-oriented, these key functions lack structural support. The system may work well under normal circumstances, but it will crash when stability is critical.

We see this vulnerability repeatedly in the cryptocurrency market:

During the March 2020 crash, exchanges such as BitMEX had to suspend trading to prevent clearing cascades from threatening the entire ecosystem and causing a complete collapse.

On Black Thursday, MakerDAO needs emergency governance response and community assistance due to insufficient mortgages.

LUNA initially survived market pressure through large-scale interventions from well-funded players, but completely collapsed when its size grew so that even these supporters could not stabilize.

These examples reveal a profound truth: Although cryptocurrencies theoretically advocate trustless systems, their survival in crises has repeatedly relied on discretionary interventions by implicit trusted participants.

As the system scales, this coordination problem becomes exponentially difficult. Problems that may be solved by informal coordination at a smaller scale become impossible once the system grows above certain thresholds.

Capital formation requirements

In addition to stability, benign currency must support capital formation - the lending process that promotes economic productivity. This is another fundamental limitation faced by existing cryptocurrencies.

Crypto assets are increasingly used as collateral, but rarely as denominated assets for debt. Few people are willing to borrow in Bitcoin (BTC) or Ethereum (ETH) because their uncertainty poses unmanageable risks to borrowers and lenders.

A fully functional currency must provide a stable unit of accounting for protocols across time. Whether borrowers are building houses, financing businesses, or developing infrastructure, they need to have reasonable certainty about the future value of their debts.

Design a complete monetary system

The limitations of existing cryptocurrencies are not temporary issues, but fundamental design constraints. Assets such as Bitcoin and Ethereum are designed primarily for the first two development stages - attracting value and scale development.

Their fixed or highly constrained supply models create strong incentives for early adoption and speculation. This design excels in starting value and achieving initial scale, but becomes a burden when stability and practicality are required for wider adoption.

Without mechanisms to adapt to changing economic conditions, provide last resort functions or stabilize in crises, these systems are fundamentally incomplete monetary systems. They work well as ownership ledgers, but they are difficult to be fully functional currency.

The complete structure of benign currency

Based on these observations, we can define what is needed for a complete currency:

Adaptive supply mechanism: Benevolent money must be able to expand when demand exceeds supply, shrink when supply exceeds demand, creating natural stable pressure.

Last-hand function: Benevolent currencies require built-in mechanisms to provide liquidity, stability and intervention under market pressure without external coordination.

• Productive reserve utilization: Benevolent currency should use its accumulated value for productive purposes rather than letting it idle or dissipate, creating sustainable value for the system.

• Lending Market Foundation: Benevolent currency must provide the stability required for the development of the functional lending market, thereby allowing capital formation without excessive risk.

• Transparent health indicators: Benevolent currencies should provide clear indicators of system health status, allowing participants to make informed decisions based on fundamental strength rather than just market sentiment.

The historical development of traditional monetary systems is not accidental—these characteristics evolve because they are necessary for currencies to operate under diversified economic conditions.

Blink the gap

This analysis does not deny the achievements of cryptocurrencies. Bitcoin and other cryptocurrencies have achieved remarkable achievements by successfully completing the first two stages of development—proving that it is possible to launch a non-sovereign monetary system through market incentives.

Their success provides a crucial strategy for the initial stages of currency evolution. The core insight is that a complete monetary system needs to be designed to consider its ultimate maturity state while still being able to cope with early stages of evolution.

Monetary technology needs to take into account mechanisms that take into account initial growth and speculation, while providing a path to achieve stability and practicality after reaching a sufficient scale. They need to combine the ability to launch cryptocurrencies successfully with the adaptive mechanisms currently lacking.

Conclusion: The road to benign currency

The evolution of currency is not only a technical issue, but a coordination problem that increases with scale. Benevolent currencies must be designed to operate throughout their life cycle—from initial adoption to mature applications—with mechanisms to adapt to changing conditions without continuous external intervention.

This does not mean returning to a fully centralized system, but rather designing a complete system with built-in mechanisms required for currency operation. This means that the money created is effective not only under optimal conditions, but also in various economic scenarios.

As we continue to develop digital currencies, these insights provide us with a framework for evaluating their potential. We should not only focus on technical characteristics or short-term price appreciation, but rather on whether a currency has the complete architectural elements required to perform the function of a high-quality currency throughout its evolution.

The future of currency is not those systems with the most advanced technology or the strongest initial growth, but those systems that have a comprehensive understanding of the actual operating mechanism of the currency when designed.