The Evolution of Money

by David Orrell

  Box 8.2

  Time Is Money

  In the early 2000s, a sort of alternative currency became popular for making money transfers in a number of African countries: airtime on mobile phones. If a person wanted to send money to another, he could transfer (by text message) some of his airtime to the other person’s phone. That person could either use it or sell it to someone else. In areas where more people had mobile phones than bank accounts or credit cards, the ability to transfer funds in this way was extremely useful. And migrants living abroad could send funds home as easily as texting, rather than using intermediary institutions that charged exorbitant rates.

  Once mobile phone companies got wind of this, some of them decided to branch out into financial technology—instead of sending time, phones could be used to send money directly. M-Pesa (for mobile-money, in Swahili) was launched in 2007 by Vodafone. Users make a lump-sum payment to the mobile operator through agents such as retail outlets. They can then make purchases by typing in the merchant’s account number (even street vendors have them) followed by a PIN. Each party receives a text message confirming the transaction. The system is very secure, and one of its benefits is that crime rates have fallen because businesses can have less cash on their premises. The service was later extended to allow for things like savings accounts and loans and spread to other regions, including India, Afghanistan, and parts of eastern Europe.

  An area with one of the highest rates of digital transactions in the world—most of which are carried out in U.S. dollars on a system called Zaad—is Somaliland. Adan Abokor, who is a local scholar and democracy activist, says “I don’t even carry money any more.”* It might seem surprising that this revolution in financial technology (or “fintech”) is bigger in a breakaway region of Somalia than in Silicon Valley, London, or Berlin. But the need for handling remittances, combined with lax regulation of the telecommunications sector, a weak local shilling, and the fact, as Abokor puts it, that “Somali society is an oral culture, so everyone needs a mobile phone,” turned the area into a perfect laboratory for innovation. A switch to a purely digital currency, such as the proposed pan-African impala currency, would be a natural next step.†

  Similar mobile payment systems are now also taking off—even in the developed world. In Britain, for example, Paym and Barclay’s Pingit link mobile phone numbers to bank accounts. China has Alibaba’s AliPay and Tencent’s WeChat messaging app, which allow digital payments. And then there is Apple’s iPhone, which has its own digital wallet. If money is a means of communication, the phone may be the ideal payment device.

  *Geoffrey York, “How Mobile Phones Are Making Cash Obsolete In Africa,” Globe and Mail, June 22, 2013.

  †Jonathan Ledgard and John Clippinger, “How a Digital Currency Could Transform Africa,” Financial Times, October 29, 2013.

  “Private banks issued gold backed currency a hundred years ago for ease of use in everyday transactions. Corporates will be issuing Bitcoin backed rewards/loyalty/gamification tokens in the near future,” predicted Jack Liu, head of institutional development of OKCoin, which used to be the largest Chinese Bitcoin exchange, adding that in this way companies large and small would explicitly guarantee the stability of one’s investment.38

  Diversity for Better, Diversity for Worse

  It is not just nonbanks that are branching out. Some commercial banks have decided to explore the uncharted waters as well. As discussed in the chapter 9, JP Morgan and others are closely monitoring the latest developments related to Bitcoin and the technology at its heart. At the same time, large banks such as Russian Sberbank are considering their own currencies. Any bank “could create its own currency, with all of the accompanying services such as bank deposit accounts, payment services, checks, credit cards, debit cards, electronic transfers via smartphone or whatever, and also physical banknotes and coins,” argues Nathan Lewis, adding that banks in Hong Kong already issue their own money based on the U.S. dollar.39

  This only confirms that after a period of centralization, when money creation and distribution largely became the domain of central and commercial banks, the time of decentralization has come, propelled by the instability of the environment on the one hand and new technologies on the other. This momentum yields a potential for the creation of a richer and thus more robust as well as accommodative environment, but it also constitutes a threat of too much fragmentation, which would be harmful. The pendulum, in other words, can swing toward an extreme the world has already experienced. In Japan, for instance, there were 1,694 paper moneys based, among other things, on precious metals, rice, potter’s wheels, and umbrellas in the 1850s. Friedrich Hayek’s idea of “denationalized money” with a free-for-all of multiple competing currencies suffers from the same problem as denationalizing railways—sometimes an integrated system works best. Just as a transport system can be improved by integrating different types of transport—walking, bicycle, car, bus, rail, plane, and so on—so the monetary system can be improved by integrating moneys that operate on different scales, from local to global.

  Many people all around the world already use various moneys every day, but fully exploiting their potential requires a changed attitude not only of policy makers but also of the general public. As Bernard Lietaer puts it, “We are boxed, trained to believe that the only way to manage the economy is with a single currency.”40 The change of perception, one must add, should then not be necessarily confined within the realm of the economy where (almost) everything is monetized, where money functions as the glue that holds the whole structure together. Historically there were moneyless societies and economies and, as discussed later, this idea has its followers even today.

  To summarize, we have seen in this chapter that alternative currency arrangements usually arise when the official currency begins to lose its status or luster. The ultimate such breakdown, which remains to be fully processed by the collective monetary consciousness, was the Nixon shock of 1971, when mainstream gold-backed currencies were suddenly converted to fiat currencies. The conditions that justified the cozy public–private partnership of the gold standard no longer applied. The arrangement came under further stress in the GFC, which in turn laid the ground for eurozone crisis. It is not surprising that during this time a plethora of new currencies has emerged, being offered by anyone from community organizers to airlines. Their development has been abetted by new technologies such as the Internet and smartphones. In the process, the basic assumptions of money—that is, that it must be created by monetizing government debt in concert with the private sector—have been completely overturned, along with foundational economic concepts and the emphasis on scarcity and competition.

  Once we accept that money is virtual and can exist in a variety of forms, we are free—at least in theory—to mix and match between the different possibilities. For example, as mentioned earlier, the strongest impediment to basic income is psychological—it seems unfair to give scarce funds away for nothing. But if basic income were delivered using a complementary currency, similar to Alberta’s old Prosperity Certificates, it would be more clear that the funds represent a kind of birthright. If the funds were electronic, it would be simple to apply a small negative interest rate to discourage hoarding and cover administration costs (no stamps required). In practice this charge would be equivalent to a normal account fee, with the difference that the charge scales with the amount held. The currency could also borrow ideas from corporate currencies to help achieve agreed goals such as carbon reduction or debt cancellation.41

  Local currencies or mutual credit schemes—which can exist independent of either the state or private banks—do not threaten to replace national currencies but can play an important complementary role. As we’ve seen, their use can be encouraged simply by the local government accepting them as payment for taxes. In some respects the situation today resembles the Middle Ages, with multiple overlapping currency zones. That period saw the advent of virtual instruments such as bills of exchange, whi
ch ultimately reshaped the world financial order. In the next chapter, we consider an alternative, deliberately scarce virtual currency that is truly international (or postnational)—and which its advocates believe will provide the gold standard for the global village.

  9

  Changing the Dominant Monetary Regime, Bit by Bitcoin

  I think that the Internet is going to be one of the major forces for reducing the role of government. And the one thing that’s missing, but that will soon be developed, is a reliable e-cash, a method whereby on the Internet you can transfer funds from A to B, without A knowing B or B knowing A, the way in which I can take a 20 dollar bill and hand it over to you and there’s no record of where it came from. … Of course, it has its negative side. It means the gangsters, the people who are engaged in illegal transactions, will also have an easier way to carry on their business.

  MILTON FRIEDMAN, “FULL INTERVIEW ON ANTI-TRUST AND TECH”

  The root problem with conventional currency is all the trust that’s required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve. We have to trust them with our privacy, trust them not to let identity thieves drain our accounts. … With e-currency based on cryptographic proof, without the need to trust a third party middleman, money can be secure and transactions effortless.

  SATOSHI NAKAMOTO, “BITCOIN OPEN SOURCE IMPLEMENTATION OF P2P CURRENCY”

  The state/bank’s shared monopoly over money has suddenly been challenged by what first appeared to be a mere toy of geeks and cyberanarchists in 2008. At second glance, Bitcoin, and more generally cybercurrencies, seemed to be a perfect answer to much of the malaise of the current economic regime that people started to recognize and criticize as a result of the crisis. And thus, like lightning out of a blue sky, these moneys started to be seriously discussed by mainstream media and Wall Streeters alike. Some predicted an ephemeral life for them, while others praised their revolutionary potential—or warned against it. Several years down the road, Bitcoin, the symbol of cybercurrencies, is still largely perceived as a means to get guns and drugs from the darkest corners of the Net. At the same time, however, the biggest corporates—including banks like JP Morgan—are getting their hands dirty, either accepting it or exploring its logic.

  The Great Financial Crisis of 2007/2008 put a lot of people off the world’s financial system, and even the concept of money itself. But one person or group (for grammatical convenience we’ll assume it’s a guy), operating under the male Japanese pseudonym Satoshi Nakamoto, decided to take matters into his own hands by designing a completely new currency that would be minted neither by central banks, nor by private banks, but by the people. Or to be more accurate, by the people’s computers.

  The electronic currency known as Bitcoin was first proposed in a paper posted online by the elusive Nakamoto in November 2008, and open-source software to run it became available at the start of the new year.1 On January 3, to time-stamp the code creating the first coins (the so-called Genesis block), he included a headline from the Times that captured the spirit of the age: “Chancellor on Brink of Second Bailout for Banks.”

  Other cybercurrencies had been proposed in the past, and many of Bitcoin’s design elements grew out of the anarchist/cryptographic Cypherpunk movement in the 1990s, which also spawned Julian Assange’s WikiLeaks. But Nakamoto was the first to make it work. His invention also came at exactly the right time. Just when trust in the finance system was at its lowest ebb, here was a currency that only required trust in an algorithm. As he put it in an introductory post, “With e-currency based on cryptographic proof, without the need to trust a third party middleman, money can be secure and transactions effortless.”

  Bitcoin didn’t take off straight away. That January, Nakamoto ran his own program and produced or “mined” himself about 43,000 bitcoins. As will be discussed, the point of the mining algorithm is to maintain the payment system, and the bitcoins are a reward. Of course they had no value, because there was nothing to spend them on, so he gave ten of them to a coder called Hal Finney who he’d met on a discussion forum. Finney tried out the mining algorithm, helped debug it, let it run for about a week, and produced about 1,000 coins—then stopped when the intensive number crunching appeared to be wearing out the fan on his computer.2

  By then, a community of users was developing. (Finney died in 2014 from the degenerative disease ALS; his Bitcoin hoard was used to keep his body cryogenically frozen, in the hope that a cure is found and he can be revived.) Each time a computer was added to the network, the mining task became incrementally more difficult, requiring a little more computer power and electricity to produce the same number of coins. In October, users set up a website quoting a price that corresponded to the cost of electricity required to mint a coin. This worked out at the time to about $0.0008 per bitcoin, so 1,000 coins was worth about $0.80. With Bitcoin, a labor theory of value is appropriate—if you count the labor of computers.

  Once a price was available, people began to trade. The price became extremely volatile, but it was still just a game. At least until May 22, 2010, when a software engineer in Florida called Laszlo Hanyecz managed to buy two pizzas for 10,000 bitcoins, by posting a request on the Bitcoin forum. Someone in Britain accepted the bitcoins and ordered the pizzas from a restaurant in Jacksonville using a credit card.

  Bitcoins were taking their first tentative steps out of the virtual world, into the real world—they were becoming things. And they never looked back. At the time of this writing, the price paid for one of those pizzas works out to more than $1 million.

  Bitcons

  Hanyecz had plenty of bitcoins, because he had worked out how to speed up the mining process by programming his computer’s graphic card to handle the computations. This was the digital equivalent of inventing a new prospecting technique and sparked a competitive race among miners that became increasingly intense as the price started to climb. And climb. However, the killer app for Bitcoin, which brought it into widespread use, turned out to be not pizza delivery but drugs (and a few killers).

  As Milton Friedman had predicted, foremost among the early adopters were “the gangsters, the people who are engaged in illegal transactions.” The most notorious example was the Bitcoin-driven website known as Silk Road, which specialized in narcotics. Set up in March 2011, it soon became very popular, with about 1 million accounts, and did a roaring trade right up until October 2013 when the FBI acted to close down the site. Its founder, Ross Ulbricht, was charged with money laundering, conspiracy to traffic narcotics, and trying to arrange no fewer than six hits. No evidence that the murders were actually carried out was provided—although the very next month a new site called Kuwabatake Sanjuro was set up to cater to that need.

  One of the clearer expositions of how Bitcoin works was provided in the FBI’s testimony to a district court in New York. As the FBI explained to the judge and jury, who probably thought they were learning about some new hallucinogenic substance, Bitcoin is a “decentralized form of electronic currency, existing entirely on the Internet and not in any physical form. The currency is not issued by any government, bank, or company, but rather is generated and controlled automatically through computer software operating on a ‘peer-to-peer’ network.”3 Thus, instead of swapping songs, as in the defunct Napster, people swap virtual money, which can be used to buy real things, such as pizza or drugs. To acquire bitcoins (the technology has a capital B; the currency unit, a lower-case b), a user typically must purchase them from a Bitcoin ‘exchanger.’ In return for a commission, Bitcoin exchangers accept payments of currency in some conventional form (cash, wire transfer, etc.) and exchange the money for a corresponding number of bitcoins, based on a fluctuating exchange rate. Exchangers also accept payments of bitcoins and exchange the bitcoins
back for conventional currency, again charging a commission for the service.” The bitcoins are stored in a Bitcoin wallet, which is a kind of secure account accessed by a private key contained in a text file.

  To make a payment, the user’s computer releases the transaction details to the peer-to-peer network. The information is bundled together with an electronic signature that identifies the issuer’s account but not his or her personal identity. Bitcoin is sometimes known as a “cryptocurrency,” because it uses cryptographic techniques to ensure security and anonymity: “Only if one knows the identities associated with each Bitcoin address involved in a set of transactions is it possible to meaningfully trace funds through the system.” However, exchanges often require personal information to open an account. Other computers in the network, the miners, check the payment details and incorporate them into a public ledger known as the “blockchain,” which serves as a record of all Bitcoin transactions that have occurred in the system’s history. It is a database that keeps track of changes, not by erasing or modifying entries, but by growing larger. Its memory goes all the way back to the Genesis block, so it never forgets where the coins are or where they came from. The blockchain was the key innovation that made Bitcoin possible, because by tracking every coin in existence, as the FBI noted, it protects against fraud and “serves to prevent a user from spending the same bitcoins more than once.” About every ten minutes, a block of transactions is confirmed, time-stamped, and added to the blockchain. As of early-2016, the size of the blockchain is over 50 gigabytes and counting.4 Bitcoin is therefore both public and private—the ledger is public, but the addresses it contains are anonymous and private.