It’s Just Money

When cows were used as a medium of exchange, nobody called it “biocurrency.” In the cultures that traded seashells to escape the inefficiency of barter, they didn’t call it “calcicurrency.” It was just money.

New forms of money such as bitcoin are exciting for their technical underpinnings, but we might not want to make them more forbidding by calling them “cryptocurrency.” Cryptography is an important part of many digital currencies’ administration, and it is central to bitcoin, but at their core they are all just money.

Digital forms of money may have substantial effects on government’s relationship to money, on financial services providers, and on the public-private partnership between government and the financial services industry. “Too big to fail” and mass financial surveillance? Meet disintermediation.

Governments probably can’t stop digital currency. The “crypto wars” show that a community of determined information technology users cannot be beaten. And that’s good because, like cryptography generally, the societal benefits of “cryptocurrencies” will almost certainly exceed their costs. The open question is whether the government and financial services sector will try to hold digital currencies at bay, or whether they will willingly embrace all the benefits of a new era in money.


The concepts around money are forbidding for most people, which is surprising considering that we use currency every day. Economists and policymakers debate money’s origins and theory with fervor and devotion, but the simple story is that money arises to make trade more efficient. A dairy farmer who needs new boots doesn’t have to find a cobbler thirsty for milk. He can find anyone who wants milk, exchange his milk for money and then bring the money to the cobbler to pay for footwear. Money’s basic value is as a universal lubricant for trade. It’s an incredibly valuable social tool.

Anything can be money, including arrangements of bits. But to qualify as money in the eyes of traders, money has to have the mix of qualities that serves them best. These qualities include such things as:

  • wide or universal acceptance
  • resistance to replication/counterfeiting
  • divisibility into standardized units
  • transferability, such as on delivery
  • amenability to holding securely
  • high ratio of value to weight or volume
  • transportability
  • durability
  • high holdings relative to new creation; and
  • low storage costs.

The digital form taken by bitcoin and similar currencies make them excellent money along some dimensions, but quite poor along others. Digital currencies are unrivaled in their transportability, for example, as they can travel almost instantly to wherever someone has an Internet connection and a suitable digital device, regardless of borders. Their ratio of value to weight is close enough to infinite, their storage costs are close enough to zero, and they are perfectly standardized.

The math underlying bitcoin is brilliant. Assuming it continues to work as it has at higher scale, it controls the rate of new bitcoin creation and it immunizes bitcoins from counterfeiting. This makes it equal or superior to government currency by most people’s accounts. (A significant number see bitcoin’s fixed, unmanaged growth rate as a liability.)

But bitcoin is hard to secure. Its holders have suffered routine shocks when exchanges have been hacked, and the probability is high that Internet worms designed to steal this form of money will become widespread. Banking and payment systems denominated in dollars are also exposed to hacking, but these risks seem relatively well contained.

Digital currencies suffer from low acceptance compared to other, more popular forms of money, obviously. Criticisms of bitcoin based on its price volatility are really a proxy for its small, illiquid market. But because its digital protocols are available worldwide, its potential market is the entire world. If it became a worldwide currency, it would make dollars and Euros—to say nothing of guaranís—look volatile and unreliable by comparison.

Digital currencies’ qualities are contingent on unfolding developments in technology and society. The acceptance of bitcoin and similar currencies will change, as will people’s ability to hold them securely, the susceptibility of such currencies to inflation’s effects, their susceptibility to deflation, and other dimensions of quality in the eyes of traders.

Ideally, public policy would be indifferent to societies’ choices in money, letting the best form of money rise to the top. But public policy is in no sense indifferent to the money question. Rulers and governments have had their hands on the money for at least 4,000 years. And they will put their hands on digital money, too.

Governments and Money: Service Providers and Flim-Flam Artists

In his detailed and fascinating study, Fiat Paper Money: The History and Evolution of Our Currency, Ralph T. Foster documents much of the history of government money. Through the ages, governments have been at once helpful monetary service providers and shady flim-flam artists.

As rudimentary trade grew centuries ago, there was natural migration toward treating precious metals as money due to their high value-to-weight ratio, their transportability, acceptance, and durability. But lumps of gold and silver are not monetary perfection. In the absence of standards for purity and weight, metal money was less reliable and thus less efficient than it could be.

Governments filled this void by providing standardized coinage. Unique markings on coins could indicate provenance and thus purity and weight. Other minting techniques, such as ridged edges, were ingenious tools for assuring traders across vast expanses that they were accepting whole copies of these reliable stores of value.

But governments and rulers who issued coins were not doing so simply out of a charitable impulse or tender feelings toward the economies under their dominion. “Seigniorage” is profit going to producers of money for the service they provide. A government issuing coins that trade for greater value than the cost of their production could enjoy significant returns. The temptation to deviate from standards sometimes produced excess profits for governments that issued money with slightly less value in metal than their labeling indicated: the service provider as flim-flam artist.

Coins and other forms of physical money are difficult to transport and secure, so leaving the money in a bank and trading notes redeemable for money was a natural monetary innovation. The rise of paper money is the subject of long and detailed histories, but the short story, again, is that a written document could stand in for coin and other forms of money if it provided a reliable promise that it could be redeemed for the underlying money. As with metals, private paper money suffered from nonstandardization and susceptibility to counterfeiting that the relatively sophisticated administrative systems in governments were better positioned to control. They could also tax and outlaw competitive money. Prohibitive taxes and bond-collateral requirements dating to the Civil War have long prevented U.S. financial firms from challenging the Federal Reserve’s currency monopoly.

While some people talk about coinage and other forms of commodity money having “intrinsic” value, there is nothing intrinsic about it. The value of all things is contingent on perceptions of usefulness, and money of any kind has value based on the prospect that it can be traded for something. So it was an unsurprising step that paper money should break loose from having value in redeemability and take on freestanding value of its own.

Governments, having standardized redeemable paper money, eventually came to issue paper money not backed by gold, silver, or other valuable things. In the United States, President Richard Nixon “closed the gold window,” refusing to let foreign central banks redeem their dollars for gold, in August, 1971. Today, no major currency is backed by any commodity. This money is said to have value because of government fiat.

Government Fiat and Monetary Management

In some respects, fiat currency is better money. Fiat currency can exist in quantities large enough to lubricate a large and growing economy. Physical commodity money may not be able to serve such a role because of small quantities, indivisibility, and other inherent restraints. But government’s provision of fiat currency also opens the door to some very serious flim-flam.

Because of the massive seigniorage available for those that do so, governments have routinely created fiat money in excess. Such action undercuts the value of currency in circulation, causing serious economic dislocation. More money chasing other valued goods and services causes prices to rise. This means that stored money—savings—loses its value, unjustly depriving savers and people on fixed incomes of wealth while unjustly enriching debtors (including governments). By one measure, the U.S. dollar has lost more than 95% of its value since 1913. Unsophisticated savers and investors who have held U.S. currency may retain the same number of dollars—even earning modest investment earnings that create the appearance of greater wealth—but the value of their money has been stolen fair and square by inflation.

Government management of money has significant costs because of its effect on investment and the economy as a whole. The possibility that monetary policy may change makes it harder to make long-term calculations about investment and debt. Accordingly, investments are more modest and debt obligations taken on more reluctantly. Uncertainty about government monetary policy confounds planning and causes prudent investors and business people to be more conservative, restraining economic growth. The fact of having government-managed fiat currency may produce huge opportunity costs to the economy and society.

Throughout history, governments have financed profligacy with fiat paper money, doing so until confidence in their currency wanes and the currency collapses. Steve Hanke counts 56 such episodes in the 20th and early 21st centuries in his paper with Nicholas Krus, World Hyperinflations. Ralph Foster counts many more.

On the other side of inflation is the possibility of deflation. “Good deflation” is the gradual fall of prices due to increased productivity. But deflation goes bad when people anticipating its rise in value hold money to the point where economic activity significantly slows. Held money, of course, is often put to productive use, re-circulated as loans, for example, thanks to fractional reserve banking. Money “on deposit” in one bank account is often also on loan and in the hands of a local business to finance an expansion, perhaps. It is hard to conceive of an economy being harmed over the long term by an excess of savings. But arriving at a new equilibrium value for a currency that could no longer be inflated—such as would happen if the dollar were to go back on an inappropriately pegged gold standard—could cause quite a hangover in an economy that has been running high on inflated sugar-money.

It was a historical accident that governments took over the provision of money. They were often the organizations with the wherewithal to produce money that was reliable and thus acceptable to traders—and they have had plenty of power to push aside competing money. The move from physical commodity money to paper money put governments in a position to manage money supplies, for good or bad.

Digital currencies undercut the contingencies that originally put the money in governments’ hands. They do not require governments to standardize them or ensure against counterfeiting—private administrative systems (including open source code) can handle these tasks. Digital currencies also threaten governments’ ability to collect seigniorage of all kinds, from the modest return on minting and printing to the exorbitant gains in inflating currency to monetize debt.

But this is not the only way that digital currencies threaten the status quo. Governments exercise close control over financial services providers for a variety of reasons. As they remake parts of the financial services industry, digital currencies will threaten interests that governments hold dear, including consumer protection and financial surveillance.

Government, Money, and Surveillance

Banking emerged to serve a market demand for storage of physical commodity money and later paper money, both of which are hard to store securely in large quantities. Fractional reserve banking made a profit-center of taking depositors’ money and loaning it out again, to the point where savers could be paid a share of the profits in the form of interest.

A related service, payments, emerged to meet the challenge of transporting coin and paper money as markets grew to span broad territories. The payments industry uses a variety of methods to transmit money, including checks, credit cards, debit cards, and wire transfers. There are many more, and more complex, financial services than only these, of course. Financial services generally have large economies of scale because of efficiencies that larger institutions can generate. As to payments, for example, moving rights to money within a single enterprise is far more efficient than securely transferring money among smaller ones.

Governments have become deeply involved in banking, payments, and other financial services, and not only because of their role in providing money. Consumer protection is an important justification for regulating financial services providers, for example, because they may literally affect individuals’ entire nest eggs. The effectiveness of government regulation is not a given, of course, and example after example in recent history illustrate failures of consumer protection regulation.

But governments’ tight attendance to money is not only explained by their consumer watchdog role. Money is a window onto people’s lives. Spending reveals the priorities and preferences of people and the choices they make across every domain of living. Subject to consumer protection regulations that determine whether they live or die, U.S. financial institutions are highly amenable to reporting movements of money—more amenable, it is almost certain, than telecommunications providers. Senators Ron Wyden (D-OR) and Mark Udall (D-CO) recently suggested that secret U.S. government surveillance could include “information on credit card purchases, medical records, library records, firearm sales records, financial information and a range of other sensitive subjects.” By following the money, governments can assure themselves with the least possible effort that people are meeting their tax obligations and obeying manifold legal restrictions.

Since at least the passage of the Bank Secrecy Act in 1970, banks have been required to keep records of cash purchases of negotiable instruments and file reports of cash purchases of these negotiable instruments of more than $10,000. Banks are obliged to report suspicious activity that might indicate money laundering, tax evasion, or other criminal activities. As an informal requirement before 9/11, and mandatory since passage of the USA-PATRIOT Act, financial services providers of all kinds must identify their customers so that all banking, payments, and other uses of financial services can be tracked. As a result, financial services providers are a conscript regiment in the U.S. government’s War on Drugs. Government surveillance through the medium of money is pervasive.

The natural scale of financial services providers and the keen interest of governments in money make for quite a public-private partnership. It was exactly the kind of partnership that guaranteed, for example, that Cypriot banks would turn over account holders’ funds on government demand during that country’s financial crisis. Large financial services providers reap super-normal profits while they nestle in government protection. In exchange, they serve governments’ need for financial surveillance and control.

The premises behind this symbiosis will not survive well in the era of digital money.

The Future of Digital Currencies: Bright but Uncertain

Government money arose historically because governments and rulers beat out private institutions at producing sufficiently reliable money. Digital currencies weaken that rationale because private institutions—in the case of bitcoin, code—can provide most qualities that traders look for in money. Government money enjoys universal acceptance, and would seem to have a permanent advantage, but what people think of as money can change.

The banking and payments industries likewise arose because physical money, whether coin or paper, was hard to store and transport securely in large quantities. Digital money is very lightweight. It is possible to secure, even in vast amounts, without a vault. And it is instantly transportable anywhere the Internet goes. Banking and payments won’t go away, but digital currencies undercut some of the rationale for these industries and should dramatically reshape them.

But don’t expect the alliance between government and today’s financial services industry to go gentle into that good night. A lot of money and power is at stake.

Early signs of rage against the dying of the status quo are all around. Witness the California Department of Financial Institutions’ wanton issuance of “cease and desist” letters in mid-June, including against the Bitcoin Foundation, which is not a financial services provider at all, but rather an advocacy group that encourages the use of bitcoin. In May, the U.S. Department of Homeland Security seized the Dwolla electronic payments account of leading bitcoin exchange MtGox because of paperwork violations related to the opening of a subsidiary’s U.S. bank account. The consumer protection rationale for government involvement in money is not well served by a regulator whose first response to financial services innovation is to yell “STOP!”

Earlier in June, the International Center for Missing and Exploited Children hosted a conference premised on the use of digital currencies for funding child pornography, human trafficking, and child exploitation (without evidence that bitcoin has ever been used for these purposes). And a federal money laundering enforcement against a Costa Rica–based virtual currency called Liberty Reserve was taken by some as a signal aimed at bitcoin—never mind that Liberty Reserve moved $6 billion in the last few years, more than twice the value of all bitcoin at its highest valuation in April, and six times the value of all bitcoin today. 

Digital currencies may be used, like cash, to fund illegal transactions, though early the rumors of bitcoin being fully anonymous are untrue. This is data to consider when balancing the benefits of digital currencies for societal welfare against their costs.

If M-PESA is any sign, there are tremendous benefits available from the use of digital currencies. “Pesa” is Swahili for money, and in Kenya, mobile-pesa, a phone-based payments system, has arisen from the relatively extensive mobile phone infrastructure. And it has given Kenyans access to financial services that they otherwise lacked. In some places, mobile phone users began to transfer value using pre-paid mobile phone credits sent via Short Message Service (SMS). Kenya’s leading mobile service provider, Safaricom, sought to formalize this process with M-PESA, its SMS-based money transfer system that allows individuals to deposit, send, and withdraw funds.

By the end of 2009, M-PESA had reached 65 percent of Kenyan households, and the Economist reported that Kenyan households using M-PESA saw their incomes increase from 5 percent to as much as 30 percent after beginning to use mobile banking. Worldwide, only about one billion have bank accounts, but three billion—nearly half—have mobile phones. Just think of the reductions in crime, human trafficking, and child exploitation that might occur as societies grew wealthy enough to empower both parents and local law enforcement with tools to protect the innocent. Interfering with financial innovation to stanch criminal payments is penny-wise and pound-foolish.

If digital currencies are suppressed in western markets because powerful government and business interests ally against them, their adoption path will travel through the global south. While they uplift societies badly in need by giving people access to wealth accumulation tools, digital currencies like bitcoin will be impossible to exclude from the rest of the world because they literally can travel unseen wherever the Internet goes. Encryption and a variety of techniques make it impossible to prevent otherwise free people from storing, transmitting, and trading bitcoin if they want to.

The “crypto wars” in the United States began in the 1970s, when publicly available encryption technology began to rival the government’s ability to break cryptographic codes. The U.S. government treated cryptographic algorithms and software as munitions, going so far as to investigate cryptographer Phil Zimmermann for violating the Arms Export Control Act when he released a free version of software he wrote called PGP (Pretty Good Privacy). In the early 1990s, as the Internet rose to prominence, the Clinton administration tried to get industry to adopt the Clipper chip, an encryption chip to which the government would have back-door access. When this failed, they tried to introduce key escrow, the policy of requiring all encryption systems to leave a spare key with a “trusted third party” who could make it available to the government.

The government rightly lost the crypto wars because the benefits of having strong encryption in the hands of good actors—for privacy, commerce, free speech, and so on—exceeded the costs of trying and failing to keep strong encryption out of the hands of bad actors. This history illustrates the choice before policymakers and financial business strategists with regard to digital currencies. Like cryptography, digital currency cannot be bottled up if a community truly wants to use it.

The choice is not whether to have digital currencies. The choice is between adopting digital currencies the hard way or the easy way. The hard way is trying to outlaw banking, payments, and other financial services denominated in new currencies. The easy way is embracing them, making them part of mainstream financial systems, and accepting the greater liberty, power, and privacy they accord to individuals.

Also from this issue

Lead Essay

  • Jim Harper reviews the traits that make a given class of items either useful as money or not. These are the traits that, for example, made gold and silver historically such widespread monetary standards. He finds that bitcoin possesses many of them to a very high degree, but that it very importantly fails on some. Bitcoin’s future is unclear in another respect as well: Established government and financial industry interests will do whatever they can to preserve what they view as their own turf. Still, the greatly increased use of digital currency seems inevitable to him in some form or another, and that form could well be private.

Response Essays

  • Dan Kaminsky argues that bitcoin’s success so far stems from the success of the Internet itself, and also from the failures of plain old money. Traditional payment methods all face serious challenges in our digitally connected world, and transaction costs to maintain our financial network make plain old money less and less attractive in contrast to its digital counterpart. But bitcoin isn’t perfect either, and the threat of large conglomerates abusing their power isn’t limited to plain old money. It can happen in the bitcoin network too.

  • Jerry Brito argues that bitcoin is far more than just money. It’s also a distributed-ledger payment system, which means it’s a lot like Visa, MasterCard, or PayPal, but with one key difference: There is no central authority managing the payments. As a result, bitcoin is open to becoming a lot more than “just” money. It can also be used as a token to represent claims on other items. As such, very small fractional bitcoins can function as bonds, stock certificates, property deeds, IOUs, or even decentralized futures markets. The full scope of these possibilities is vast, and we are only beginning to grasp the implications of bitcoin.

  • Chuck Moulton argues that bitcoin is a sound form of money. Its quantity is known, it expands at a known rate, and it will eventually stop expanding. As a result, fluctuations in the value of bitcoin are almost entirely a function of demand. Moulton suggests fractional reserve banking as a way of stabilizing bitcoin’s value. He goes on to suggest that nations might consider dollarizing to bitcoin as a way of preventing inflation, with the very significant caveat that “a second or third generation cryptocurrency may be the one to finally take hold.”

  • We are pleased to publish this contribution from Patrick Murck, Bitcoin Foundation General Counsel, who argues digital currency will disrupt traditional finance. This disruption is both very much intentional and likely to empower consumers who have not been able to take advantage of traditional financial services. Older financial system players are likely to resist, of course: They have a stake in the status quo.