Money isn’t meant to last

Vitalik has a new use case for prediction markets: pegging a cryptocurrency to the cost of living. 

This is a new take on an old idea. With inflation raging in 1780, the state of Massachusetts kept their soldiers from walking off the battlefield by paying them with debt indexed to the value of a basket of corn, beef, wool and leather.  

That’s easy enough for a government to do. When the debt was redeemed, Massachusetts simply printed the money required to buy that basket of goods, however much it cost.

To do the same for non-sovereign cryptocurrency is less practical. Without the authority to collect taxes, printing new units would simply devalue the currency in a doom-loop to zero. 

The only way to maintain its purchasing power is for the issuer to hold the corn, beef, wool and leather that the currency is intended to purchase. 

This is not practical. For one thing, it would be prohibitively expensive to purchase and store those goods. Also, the goods would degrade, rotting away in a warehouse while the currency circulated. 

Vitalik proposes a novel mechanism to avoid these issues. Instead of storing real goods, his cryptocurrency would hold contracts in prediction markets. 

“You have price indices on all major categories of goods and services that people buy,” he explains on X, “and prediction markets on each category.” 

The currency would then maintain its purchasing power by placing bets on each of those categories. If, say, the cost of housing went up, the value of the currency would go up, too, because it would be long housing via prediction markets. 

Better yet, this currency would be personalized with AI: “Each user,” Vitalik adds, “has a local LLM that understands that user’s expenses, and offers the user a personalized basket of prediction market shares.”

It’s a fun idea — everyone holding their own currency, tailored to their own lifestyle. 

It’s also a wildly impractical one. 

Among other issues, Vitalik’s mechanism would seem to be a hedge only against unexpected inflation, not actual inflation. You don’t make much money in prediction markets betting on what everyone knows is going to happen (like houses getting more expensive, for example).

But even if Vitalik could somehow figure it out, would we want him to?

A perfect inflation hedge might preserve today’s purchasing power in the short term, sure. But it does nothing to generate the wealth required to maintain it over the long run (let alone the productivity gains required to grow it).

“This is why we invest,” Professor Michael Mainelli told me in an email. “You have to take risks to justify societal returns that preserve the value of currency over any long-term period.”

In other words, a society can’t just stockpile corn, beef, wool and leather indefinitely. It has to remain productive enough to continually produce those things — and being productive requires taking risks with money. 

Economist Silvio Gesell illustrated this with a parable about Robinson Crusoe, who is visited on his island by a shipwreck survivor asking to borrow clothes, tools and food (to help him get started building a farm).

Crusoe eagerly agrees, imagining he’ll be able to charge interest on the goods — perhaps so much that he won’t have to do any more work himself.

But the stranger asks what will happen to those goods if Crusoe simply holds on to them.

His wheat would rot. His clothes would be eaten by moths. His tools would rust. 

“This capital will be my ruin!” Crusoe suddenly realizes. “If only I could find some method of protecting myself against the thousand destructive forces of nature.”

But there is! The method is to lend your capital to someone who will invest it productively — in some cases, even without asking for interest (if you’re shipwrecked on an island, for example).

The stranger proposes to use Crusoe’s excess capital to build his own farm, clothing, and tools. In return, he promises to repay the loan at an agreed date. Not with the exact things borrowed, of course, but new, possibly better versions of each.

This, Crusoe sees, will save him from ruin. “With all my heart I accept your proposal,” he agrees, “without interest and with my best thanks.”

Now imagine Crusoe had the option of investing in Vitalik’s prediction-market cryptocurrency instead, personalized to match his future cost of living. 

In that case, he’d have no reason to take the risk of lending to a stranger, and the shipwrecked stranger would not be able to build a new farm. 

Worse yet, without the stranger’s new farm to produce the goods backing the cryptocurrency Crusoe is planning to rely on, the cryptocurrency would be worthless.

In the end, Vitalik’s idea leaves them both destitute. 

This is just a thought experiment, of course. In reality, people invest to outperform their cost of living, not just match it.

But Gesell’s point is that money has an inherent advantage over real goods: Unlike goods, the value of money does not necessarily decay over time.

This seems fundamentally unfair. Why should savers simply sitting on their money be preserved from the ravages of time when producers of real goods and services are not?

Vitalik’s proposed money would unfairly advantage idle savers, as Gesell warns — and also discourage the risk-taking that Mainelli says is required to create value over the long term.

Should we even try to peg money to the cost of living, then?

Gesell would say no: “Only money that goes out of date like a newspaper, rots like potatoes, rusts like iron, [and] evaporates like ether is capable of standing the test as an instrument for the exchange of potatoes, newspapers, iron and ether.”

Crypto has long pursued the holy grail of money that never loses its purchasing power — I guess because we don’t like taking risks.

But money is most useful when it’s either spent or invested.  

Money people just sit on is not good money at all.

— Byron Gilliam

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