Stability Challenges of Decentralized Currency

Currency, as the foundation of economic activity, its effectiveness depends on multiple key characteristics. With the rise of digital currency, we need to reevaluate the fundamental functions of currency in the modern economy. History shows that the definition of currency lies not only in its technical features but also in its ability to adapt to different stages of development. True currency must undergo a challenging evolutionary path, which many emerging coins find difficult to achieve.

The Complete Lifecycle of a Coin

To become a fully functional currency, an asset must successfully complete four development stages:

1. Attract Value

First, a currency must attract capital and attention. Whether through precious metals, government backing, or potential appreciation, all successful currencies begin by attracting people to hold them. This initial appeal lays the foundation for subsequent development. Many digital currencies excel at this stage, leveraging speculation and network effects to establish initial adoption and liquidity.

2. Scale Development

Secondly, the currency must achieve sufficient scale and liquidity to support meaningful economic activities. It needs enough market depth to avoid excessive volatility caused by transactions; it also requires sufficient distribution to ensure that finding counterparties is not overly difficult. Scale brings credibility, network effects, and the necessary liquidity for broader applications. Some major cryptocurrencies have successfully passed this stage, reaching a market capitalization of trillions of dollars.

3. Stability Mechanism

Third, the currency must develop a stable mechanism that makes it reliable in commerce and contracts. Stability does not mean fixed value, but rather predictability and resilience under market pressure. This requires technical mechanisms and institutional support. Many emerging coins fail at this stage. True stability requires a system that can operate normally under various market conditions, without collapsing or needing external intervention.

4. Economic Utility

Finally, the currency must be truly practical in ordinary economic activities that go beyond speculation. It must serve as a reliable unit of account, medium of exchange, and store of value in various economic environments. True practicality means supporting all the financial functions required by the modern economy: efficient payments, reliable contracts, reasonable lending markets, and stable planning cycles.

Coordination Issues

People often fail to realize that the later stages require addressing fundamental coordination problems that become more difficult as the scale of the system expands. Consider the basic functions of currency, such as providing a last resort function, implementing emergency stabilization measures, or intervening during a crisis. These functions are essentially public goods. They require entities to place the stability of the system above their own self-interest—taking on personal risks for the collective good.

In a purely self-interest driven Decentralization system, these key functions lack structural support. The system might operate well under normal circumstances, but it can collapse when stability is crucial. We have repeatedly seen this vulnerability in the cryptocurrency market:

• In the crash of March 2020, some exchanges had to suspend trading to prevent a liquidation cascade that threatened to completely collapse the entire ecosystem.
• On "Black Thursday", a stablecoin system required an emergency governance response and community assistance due to insufficient collateral.
• A certain algorithmic stablecoin initially weathered market pressure through large-scale intervention by well-funded participants, but completely collapsed when its scale grew beyond the ability of even these supporters to stabilize.

These examples reveal a profound truth: although cryptocurrencies theoretically advocate for trustless systems, their survival in crises repeatedly relies on the discretionary intervention of implicit trust participants.

Capital Formation Requirements

In addition to stability, a sound currency must support capital formation—facilitating the lending process that drives economic productivity. This is precisely another fundamental limitation faced by existing cryptocurrencies. The use of crypto assets as collateral is increasing, but they are rarely used as a pricing asset for debt. Few are willing to borrow against mainstream cryptocurrencies, as their uncertainty presents unmanageable risks for both borrowers and lenders.

A fully functional currency must provide a stable unit of account for cross-temporal agreements. Whether it is borrowers building houses, financing businesses, or developing infrastructure, they all need reasonable certainty about the future value of their debts.

Design a complete currency system

The limitations of existing cryptocurrencies are not a temporary issue, but rather a fundamental design constraint. Major cryptocurrencies are primarily designed for the first two stages of development - attracting value and scaling. Their fixed or highly constrained supply models create strong incentives for early adoption and speculation. This design performs excellently in initiating value and achieving initial scale, but becomes a burden when stability and practicality are needed for broader adoption.

If there is no mechanism to adapt to the constantly changing economic conditions, provide a last resort function, or stabilize the mechanism during crises, these systems are fundamentally incomplete monetary systems. They operate well as ownership ledgers, but struggle to become fully functional currency.

Complete Architecture of Sound Money

Based on these observations, we can define the requirements for a complete architecture of a currency:

1. Adaptive supply mechanism: A healthy currency must be able to expand when demand exceeds supply and contract when supply exceeds demand, creating natural stabilizing pressure.
2. Last resort function: A healthy coin needs to have built-in mechanisms to provide liquidity, stability, and intervention under market pressure without external coordination.
3. Productive reserve utilization: A good currency should use its accumulated value for productive purposes, rather than letting it be idle or dissipated, creating sustainable value for the system.
4. Basics of the Lending Market: A sound currency must provide the stability required for the development of a functional lending market, allowing for capital formation without incurring excessive risk.
5. Transparent health indicators: A healthy coin should provide clear indicators of system health, allowing participants to make informed decisions based on fundamental strength rather than merely market sentiment.

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

Bridging the Gap

This analysis does not deny the achievements of cryptocurrencies. Major cryptocurrencies have made extraordinary accomplishments by successfully completing the first two stages of development—proving that it is possible to initiate a non-sovereign currency system through market incentives. Their success has provided crucial strategies for the initial stages of currency evolution. The core insight is that a complete currency system needs to consider its final mature state during its design, while still being able to cope with the early stages of evolution.

Monetary technology needs to balance initial growth and speculative mechanisms while providing a path to stability and practicality once sufficient scale is achieved. They need to combine the launch capabilities that have made cryptocurrency successful with the currently lacking adaptive mechanisms.

Conclusion: The Path to Sound Currency

The evolution of currency is not only a technical issue but also a solution to the coordination problems that increase with scale. A sound currency must be designed to function throughout its entire lifecycle—from initial adoption to mature application—equipped with mechanisms to adapt to changing conditions without the need for ongoing external intervention.

This does not mean returning to a completely centralized system, but rather designing a system with a complete architecture and incorporating the mechanisms necessary for the operation of the currency. This means that the created currency 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 to assess their potential. We should not only focus on technical features or short-term price appreciation but should consider whether a coin has the complete architectural elements necessary to serve as a high-quality currency throughout its entire evolution.

The future of currency does not belong to those systems with the most advanced technology or the strongest initial growth, but to those systems that fully understand the actual mechanisms of currency operation at the time of design.