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Inflation and Decentralized Currencies

Updated: Dec 30, 2021

In 1981 if you were to have $1 in US dollars it would be 0.53 Naira (Nigerian currency) which means that a dollar in Naira would be worth more than a dollar in US currency. Fast forward to 2021... $1 in US dollars would be 411 Naira...that is absolutely insane. So what caused this to happen?

Inflation is when a currency has declining purchasing power. This means that the same amount of money can’t buy as much. For example, let’s say an apple costs $10, with inflation, maybe a year from now the apple costs $11. This inflation then means that if I have $10 with me, I cannot purchase an apple now. Inflation is a pretty negative thing overall, mostly it affects consumers but can hurt businesses as well. This is because now the business has to pay more to their employees since paying them the same amount now is worth less than before. Let’s say that the company selling apples has multiple apple orchards and also hires people to go pick the apples. The company will be forced to pay the workers more because the same amount of money is worth less assuming the inflation is widespread and not just within the market for apples.

So how does inflation negatively impact people? There are a few ways that are pretty straightforward, like now people's money can’t buy as much as it used to. Once people see that inflation is happening a lot of people start panicking, and for good reason. Paper money doesn’t have any intrinsic value, this means that if people didn’t believe the money had value, the actual physical piece of paper would be relatively worthless. Part of what inflation is, is people not believing in a currency's worth. One way that people try to counter inflation is investing in things that do have intrinsic value, like physical objects and things like property and goods.

This is why the value of the US Dollar and the value of gold have a historically inverse relationship that you can see displayed in this chart: (link to source)

The orange line represents gold and the blue represents the US Dollar, specifically, the trade-weighted U.S. dollar index. As you can see, when people start losing faith in the dollar, the value of gold tends to go up. This is because gold has intrinsic value since it is a physical material and can be used to create things like jewelry. But gold is just one example of physical goods that people start to invest in when there is speculated inflation.

So why does inflation usually start to happen? There can be different root causes in different scenarios, but a common reason why is the printing of money. This is because when an economy is flooded with more money to spend, then there will be more spending! More spending means that demand shoots up while the supply does not increase significantly. This means there are more people wanting to buy things than there are things to buy. Then, prices start to go up in order to counter this and thus inflation starts to happen. It is a domino effect where if some goods and services start to go up in price, then people will start to see that their purchasing power has gone down, and then companies are pressured to pay their workers more since the same amount of money is now worth less. So in order for those companies to counter that, they have to raise their prices since they are making less money with increased spending on workers' wages. As you can see, this will then start to affect the prices of even more goods and services with the added pressure of increased demand, and no significant increase in supply. If you would like to learn more about supply and demand, check out Aila’s article on what supply and demand is!

As mentioned in the beginning of this article there has been serious inflation in Nigeria. Now that you know what inflation is, the negative impacts of inflation, and some reasons why inflation happens, what has been causing inflation to happen in Nigeria, and how can the technology of decentralized currencies help Nigerians in the midst of these events?

The first question to answer is why is there so much inflation in Nigeria. One big reason is the monetary policies being put into place. More specifically putting into place an expansionary monetary policy. An expansionary monetary policy is a policy that increases the amount of money. As we just discussed, this is one of the main reasons for inflation. So why would a country struggling with inflation institute an expansionary monetary policy? There are some benefits of this type of policy, mainly it helps with economic growth since it increases spending. However, it seems to be an extremely poor choice of policy given the situation.

Nigeria has also tried a tight fiscal policy which is when the government cuts spending so it is bringing in more revenue than it is spending. This is also called deflationary fiscal policy since the main purpose is to slow inflation and stimulate deflation. The problems that arise with this policy are that it may slow down economic growth and there may be less public goods and services since the government is spending less to provide these resources. These externalities then caused Nigerians to be unhappy with this policy as well.

Currently the monetary and fiscal policies are expansionary. There is some debate on whether economic growth should be prioritized instead of reducing inflation but it looks like inflation is the most pressing issue. Also, reducing inflation will probably increase economic growth in the long run even if there may be costs in the short run.

There are also other reasons contributing to Nigeria's rising inflation as well. One of which is people expecting inflation to rise. Since inflation has been rising for so long, there is expected inflation in the future meaning that consumers are desperate to use their purchasing power while they have it. This means that demand increases even more drastically meaning more inflation and more panicked spending making the situation even worse.

Yet another reason is that Nigeria’s weather conditions are unstable meaning that there isn’t a reliable food supply. So when there are droughts and floods there is a huge amount of spending to stock up on food causing even more inflation. As I also mentioned before this causes a domino effect where employers are pressured to pay their workers more because the same amount of money will not be able to purchase the same amount of food.

There are many more reasons that contribute but the last big one I will mention that will probably take an even bigger toll on Nigeria's inflation in the future is the move to renewable energy, mainly solar. This is because Nigeria’s biggest export is oil accounting for 9.25% of Nigeria’s GDP (Gross Domestic Product) which is huge. So after all of those reasons no wonder Nigeria’s inflation is so high. But what can decentralized currencies do to help Nigerians? And what are the potential downsides to switching to blockchain currencies?

The first question we have to answer is, what is a decentralized currency? A decentralized currency is a currency that no one has control over. The way this is achieved is by having the currency on a blockchain. The basic concept of a blockchain is that there are many many nodes that all hold information on who owns how many coins. So let's say I have a spreadsheet of how many cookies I own and how many cookies all of my friends own. Let's say that we store all the cookies in one big jar all together. This makes it so that it is pretty important that the spreadsheet isn’t deleted or altered or else somebody can say they own more cookies than they actually do. So only having one spreadsheet isn’t very safe. A blockchain is where you have multiple different copies of that spreadsheet outlining how many cookies everyone owns, and everyone that owns some share of the cookies has a spreadsheet so that even if one is altered everyone can see that it isn’t consistent.

This is how a currency on a blockchain is not in control of any one person, because although you can try to unfairly give yourself a larger quantity of cookies, the data is stored in multiple different nodes spread across many different people. There is, however, a difference between a coin on a blockchain and a truly decentralized currency. This is because a coin can be on a blockchain but have a very small number of nodes. So let's say I am splitting the cookies with two other friends and so we only have three nodes on our blockchain. Someone can easily create two other nodes and make it so that they unfairly change their ownership of the cookies, so when everyone checks to see that the spreadsheets are consistent, the majority of the spreadsheets show the incorrect number of that person’s ownership of the cookies.

This is called a 51 percent attack where only 51% of the nodes have to show a certain value for all of the spreadsheets to be updated with those new values. So because of this, if your currency is on a blockchain it is only truly decentralized (meaning not in control of any one person) if there are so many nodes that the amount of money to generate enough computing power to create enough nodes that make up 51% of the blockchain would cost so much that you can pretty much be sure that your currency is safe from a 51% attack.

So how can a decentralized currency help? With a decentralized currency you have a set amount of coins which then makes it so there is no possibility of making more coins then causing the value of the currency to go down. This is extremely useful and one of the main reasons why this is so helpful. And, since the currency is decentralized there can basically be no government intervention within transactions and any other activity using the currency. But this can also be a bad thing since there are instances where government regulation is a tremendously good thing if performed intelligently. However, the flip side to this is if the government is making poor decisions then a decentralized currency would be safe from that.

There are some other downsides to decentralized currencies as well. One of which is that even though you could argue that a decentralized currency does have intrinsic value (the fact that it is decentralized) people still need to believe in the value of the currency. This is because the value of the currency is that you can purchase goods and services with it and if the people selling those things don’t believe in the value of the currency then consumers will have to use another type of currency. This can make the perceived value of decentralized currencies very volatile if there is some article that is published about a blockchain currency at risk of a 51% attack even if this isn’t true the value of that decentralized currency may plummet, however since decentralized currencies do have the intrinsic value of being decentralized these types of scenarios will most likely only last in the short term. But the actual value of these currencies will ultimately be decided by the market.

One other thing that is important to mention is that Nigeria banned Bitcoin which is a decentralized currency. This is for multiple reasons, one of which is that Nigeria has been trying to limit transactions from the US and Nigeria, including transactions with crypto. However, despite this ban, almost a third of Nigerians report to use Bitcoin and cryptocurrency. The government may continue to ban more cryptocurrencies or any crypto at all, but the question is how much can they actually enforce these laws. From how much Bitcoin transactions there are in Nigeria, it doesn’t seem as though the government is really able to enforce this law.

Decentralized currencies do seem like at least a good investment for countries that are at risk of inflation, there are some benefits of currencies controlled by the government. One of which is that the government does have some ability to enforce the value by using things like taxes, and allowing citizens to borrow money. Also when the value of a currency is solely controlled by the market, with many different decentralized currencies to choose from, which ones will be worth more? Which one do you choose to invest in?

The last thing I will talk about in this article is how the concept of inflation is relevant in people’s lives apart from thinking about the value of their countries' currency. One of the main takeaways of inflation is that not everything we perceive to have value actually has intrinsic value. With this understanding, think critically about what you invest not only your money in, but your time. Know that belief in the value of things like your money, art, even promises is fragile. Many things that we think are real are really just mental constructs, and the best thing we can do is to realize they are mental constructs, and allocate resources accordingly before the belief system behind those mental constructs comes crashing down.

So what can you take away from this article? The first thing is to know how inflation is negatively impacting people all around the world not only in Nigeria. Inflation is a very serious thing and can devastate countries if not regulated carefully. Here is a picture of children during the inflation crisis in Germany of 1923 playing with stacks of bills since they were virtually worthless:

Decentralized currencies have potential to greatly help people in these situations, but we need to be aware of the downsides. Ideally the government will just be able to regulate inflation successfully, but this can’t always happen. So we should try to understand what is going on, why it is happening, and how to make sure our hard-earned money doesn’t lose its value. Inflation, the concept, is an important and valuable thought experiment, not only to understand money, but to understand our own minds and how they work.

Anything that we perceive to have value that doesn’t have intrinsic value is at risk. Knowing that the risk exists is extremely important and makes us realize how much of what we believe to exist really only exists in our minds. This is important, but it can also be terrifying to think about.


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