Currencies (both fiat or otherwise) behave both as stores of value and mediums of exchange. The valuation of currencies as a result has been driven by both of these parameters. Increasingly as many investment avenues are being available to individuals and corporates, the store-of-value utility of fiat currencies is dropping. Eventually currencies will have to be valued as mediums of exchange, unless they are backed by some assets.

Macroeconomic theory has a simple formula to value a currency as medium of exchange:


Where M is total money supply, V is velocity of money (how fast money changes hand), P is the price level (i.e. inverse of value of money) and T is total transaction value in the economy. The equation is quite intuitive and can be derived/explained easily. From this equation the value of the currency 1/P can be written as:

Value of currency = 1/P = T/(MV)

Also to make things more intuitive if we replace 1/V with t: time a user holds on to currency before using it for some economic activity then:

Value of currency = 1/P = T*t/M

Now, the total monetary supply, M, is usually controlled centrally by a central bank or some such govt. entity (in cryptocurrencies its controlled by an algorithm). T is usually driven by economic activity. t on the other hand is purely driven by frictional costs. If money is completely digitised and freely transferable into other commodities or investments, there is no specific reason for consumers to horde on to the currency. Thus, t will tend to 0. In such a case the value of currency will keep getting grounded to zero.

Thus it can be argued that excessive digitization can lead to hyper-inflation if not handled properly. There are several reasons a government wants to make fiat currencies completely digital: 1. for convenience 2. for tracking 3. for imposing negative interest rate regimes. But this can lead to hyper-inflationary scenarios. How can this be managed though? there are several ways, but some off-hand ideas include:

  1. Improve economic activity (too obvious, but there is a limit)
  2. Create frictions in movement of money (some already exist like for example settlement of money does not happen in non-business hours etc.)
  3. Make holding of currency mandatory (for example cash reserve requirements for banks, govt. holding cash etc..)
  4. Continuously decrease money supply as percentage of economic activity