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What Is Gresham’s Law
Does Gresham’s Law apply to Crypto? The definition of Gresham’s Law tells us that it is an economic principle that states that bad money drives out good money. Academics use this law mainly in money markets. Initially, the law applied to coined money and the precious metals used to mint them. Since the departure of “hard” metallic coin standards, the idea has been applied worldwide to the many currencies’ relative stability.
In short, Gresham’s law articulates the concept of hard money, which cannot be quickly devalued and is more stable in value, versus soft money, which loses value by being rapidly devalued. The law states that bad money takes good money out of the market.
Bad money is a currency with less intrinsic value than its face value. In contrast, people believe good money has more intrinsic value than face value. The difference in intrinsic value is why people prefer to spend bad money and keep good money, as the former depreciates over time while the latter increases in value more and more.
How does it relate to cryptocurrencies?
Since we understand the basic structure of this idea, we can now analyze how it relates to crypto. This law states bad money drives good money out of the market. And we also understand that Bitcoin and cryptocurrencies have many characteristics that make them superior to fiat money.
In this case, we can understand that fiat money will continue circulating in the economy to spend on goods and services, while people will prefer to save Bitcoin if they want to seek refuge of value. Let’s analyze the following topics to explore how society might behave concerning Bitcoin and other currencies, such as the euro or dollar.
Save or spend Crypto
Today’s crucial use case for people using Crypto is the store of value. According to this, it has to do with the growing network effect, the rapid increase in its price, the tax treatment it has received, and the adoption by merchants as a form of payment.
It has had a compound annual growth of 200% during its history, an exciting incentive for investors to hold bitcoins. Moreover, since people pay taxes on the sale of these assets in many countries, holding these cryptocurrencies is more attractive than selling them.
If Bitcoin continues on this path, we can expect it to become the world’s reserve currency, leading to its adoption by more businesses. We can see this trend growing in countries with no financial stability, and their citizens observe the instabilities of a monetary system mismanaged for years. Venezuela, Argentina, and Turkey are great examples. Their citizens prefer to buy Bitcoin instead of staying in their local currency.
Other countries, such as El Salvador, have adopted Bitcoin as a legal tender, meaning merchants must accept BTC as their currency. This trend is growing, leading this cryptocurrency to become as widely accepted as today’s dollar.
Save or spend fiat money
By contrast, the dollar or euro has no limit to its supply, allowing those managing the total amount in circulation to manage this value as they see fit. The issuing limit is a fundamental difference from Bitcoin and has led to the dollar depreciating by more than 90% over the last 100 years.
Spending dollars or euros is more attractive than keeping them as savings since it is not intelligent to keep something that will eventually depreciate. The uncontrolled printing of money has increased even more in recent months, making more and more people begin to internalize these issues and understand the origin of inflation and its remedies.
The result is more spending of fiat money while saving by buying a more robust and less quickly devalued money such as Bitcoin. Since Bitcoin is the most solid “money” ever invented, it’s no surprise that more people think about “buy and hold.” It is the most important avenue of savings and refuge of value ever invented.
The cost of saving bad money
Over the long term, saving in a weak currency means accelerated loss of purchasing power. These small amounts accumulate when annual inflation is 1% or 2%. Today, things are even more destructive, with inflation in dollars and euros at around 6-8% per year.
Let’s assume that our money is in one of these currencies with an inflation rate of 5%. At the end of the first year, we will have 95% purchasing power. For every $1000 in our possession, we can now buy goods and services worth $950. But the matter is even more dramatic when considering a more extended period, for example, ten years. Total inflation is 60% (a compound formula), and our purchasing power is only $400 for every $1000 we had when we started.
In 20 years, virtually all of our savings will evaporate until we get only 35% of what we initially had. The examples consider only 5% as an inflation value, a lower figure than today in many countries, and have no prospect of going down.
We should also consider that inflationary indices only view a part of the goods and services that make up the expenses we may have. However, the prices of housing and other goods tend to increase even more. That is why experts consider that the real inflation in the United States is closer to 15% than the 7.9% figure.
Is Bitcoin good money?
Bitcoin, meanwhile, exhibits many characteristics of a hard currency. Whereas fiat money instead has features of bad money. People prefer to save bitcoins and spend fiat money even more so when the latter is becoming worse money every day, as the devaluation of these accelerates.
The more money governments print, the less value it has, leading to the need to issue even more to solve these economic problems. The process generates a vicious circle that does not end until we see hyperinflation. In some countries, it takes longer, and in others, less, but the result is always the same.
The United States has solved the problem because the demand for its currency has remained stable or even grown. Still, we can see a paradigm shift recently, with other governments using other currencies to make international transactions. Luckily, Bitcoin is also transforming into a better currency, and more people realize its value, mainly as a haven to protect their savings.
In Short
The concept presented by this law is interesting to know and understand. It involves all of us and helps us make better decisions. When we realize that people exchange weak money quickly while they keep strong money, it helps us navigate periods of uncertainty.
In the past, gold was a haven of value in difficult times. Now it is the turn of cryptocurrencies, which many call digital gold. As a result, societies will increasingly adopt fiat money pushed aside. Eventually, it will become a global haven of value and, consequently, a medium of exchange.
We can expect it to continue to rise if its supply is limited and demand grows. Economics tells us that the good in question tends to increase.