Time For A Digital Monetary Theory As Crypto Gains Global Ground

Cryptocurrencies have transitioned from being a fringe fascination to a mainstream financial force. Bitcoin, Ethereum, and an array of other digital assets now occupy a significant place in global finance. Despite this shift, economic theory has yet to catch up. Traditional monetary frameworks, designed around fiat currencies and central banks, often fall short in addressing the decentralised and algorithm-driven nature of cryptocurrencies.

The urgency for economists to construct a robust monetary theory of crypto has become even more evident with US President Donald Trump’s recent announcement of a proposed national cryptocurrency reserve. Under the plan, the US government would hold Bitcoin, Ether, XRP, Solana, and Cardano as part of its financial reserves, underscoring the growing strategic importance of digital assets.

At the same time, China—despite its official ban on crypto trading and mining—continues to dominate Bitcoin mining globally, controlling over 55% of the total hash rate. Reports suggest that China is quietly accumulating Bitcoin through offshore entities, raising questions about the future of monetary sovereignty in an era where digital currencies operate outside government control. If two of the world’s largest economies are moving, overtly or surreptitiously, towards integrating crypto into their national strategies, the need for an academic and policy-driven understanding of its implications is more pressing than ever.

Crypto Money
Robert DK Kirkby’s Monetary Theory of Cryptocurrencies offers a starting point for defining the unique characteristics of these digital assets. Unlike fiat currencies, value stems from government backing and public trust, cryptocurrencies rely on blockchain technology, programmed scarcity, and decentralised networks for their value. This represents a significant departure from traditional monetary systems, raising profound questions about trust, value, and economic control in the digital age.

Modern monetary theory, including the search-money framework proposed by Fernandez-Villaverde and Sanches (2018), suggests that a large number of competing cryptocurrencies could coexist alongside fiat currencies in a stable equilibrium. However, the theory also implies that government-issued fiat money will remain dominant—provided inflation remains controlled. Simply put, cryptocurrencies are unlikely to replace a well-managed national currency but may become dominant in economies where fiat money is mismanaged. This is evident in nations like Venezuela and Argentina, where hyperinflation has driven citizens toward Bitcoin and stablecoins as alternative stores of value.

Hedge or Gamble?
One of the most discussed attributes of cryptocurrencies like Bitcoin is their potential role as a hedge against inflation. Unlike fiat money, which can be printed indefinitely, Bitcoin’s supply is capped at 21 million coins. This scarcity-based model theoretically protects against devaluation caused by excessive money printing. During periods of high inflation, as seen in Argentina and Turkey, Bitcoin adoption has surged as people seek refuge in a deflationary asset.

However, this narrative is not without complications. While Bitcoin and similar cryptocurrencies offer an alternative to inflation-prone fiat currencies, they remain highly volatile. Unlike gold, which has thousands of years of historical price stability, Bitcoin's price swings wildly due to speculation, regulatory shifts, and technological developments. Economists need to develop models that balance these inflation-hedging properties with the inherent risks associated with crypto volatility.

Stablecoins—cryptocurrencies pegged to fiat currencies or other assets—offer a potential solution. However, they introduce another layer of complexity. Their stability depends on the credibility of the issuing entity and the reserves backing them. The collapse of algorithmic stablecoin TerraUSD in 2022 serves as a cautionary tale, emphasising the need for robust economic frameworks to evaluate their reliability.

One major challenge facing cryptocurrencies—particularly those utilising proof-of-work mechanisms like Bitcoin—is their environmental impact. Bitcoin mining requires massive amounts of computational power, consuming more electricity annually than some small countries. According to the Cambridge Bitcoin Electricity Consumption Index, Bitcoin’s carbon footprint remains a significant concern for policymakers and environmentalists alike.

Ethereum’s transition to a proof-of-stake model in 2022, which reduced its energy consumption by over 99%, demonstrates that blockchain technology can evolve towards sustainability. However, this shift also raises economic questions about trade-offs between decentralization, security, and efficiency. Economists must analyse these factors to provide insights into whether alternative consensus mechanisms can maintain the integrity of decentralised networks while mitigating environmental harm.

Decentralised Finance 
Another area that demands economic analysis is decentralised finance. Built primarily on Ethereum, DeFi platforms offer peer-to-peer lending, borrowing, and trading services without intermediaries. While this innovation democratizes access to financial services, it also introduces new risks. Smart contract vulnerabilities, price manipulation, and the absence of consumer protections have led to significant losses in the DeFi space.

Kirkby suggests that DeFi represents a natural evolution of monetary systems, where trust is placed in code rather than institutions. However, trust in code is not infallible—exploits and regulatory gaps could undermine the system’s viability. Economists must work alongside policymakers and technologists to create frameworks that balance innovation with financial stability. Without proper oversight, DeFi could become a double-edged sword, offering financial freedom while exposing users to high levels of risk.

Crypto Reserves
Trump’s proposed cryptocurrency reserve signals a potential paradigm shift in monetary policy. By holding digital assets like Bitcoin and Ethereum, nations could diversify their monetary reserves and hedge against inflationary pressures. This concept mirrors gold reserves, which have historically provided financial stability during times of economic uncertainty.

However, integrating crypto into national reserves raises several questions. How will governments manage the risks associated with crypto volatility? Can a nation’s monetary policy remain effective when part of its reserves is tied to an asset governed by decentralised networks? The experience of El Salvador, which made Bitcoin legal tender in 2021, offers mixed results—while the move attracted investment, it also exposed the country to extreme price swings.

China’s rumoured interest in a strategic Bitcoin reserve adds another layer of complexity. Despite its official crackdown on crypto trading, China remains a dominant player in Bitcoin mining. If China were to leverage Bitcoin as part of its monetary strategy, it could challenge the U.S. dollar’s hegemony in global trade. Economists must analyze these developments to understand the long-term geopolitical and economic implications of state-backed crypto reserves.

The time has come for economists to take cryptocurrencies seriously. They are not just speculative assets or tools for illicit finance; they represent a fundamental evolution in monetary theory. Without a structured economic framework, policymakers risk making uninformed decisions that could either stifle innovation or expose economies to unnecessary risks.

Economists must engage with this rapidly evolving field, addressing questions of inflation, volatility, financial stability, and national reserves. The future of money is being rewritten, and digital assets are at the forefront of this transformation. It is time for economic theory to catch up to reality, ensuring that the transition to a digital financial future is both informed and sustainable.