From Cowrie to crypto: Making cents of modern money

Publish in The Beacon, 11-Aug-23

Examples of the different forms of money that have been used over time.

If you use money but have never wondered what it actually is, then you have a serious problem. Bread, cash, dosh, dough, loot, lucre, dinero, moolah, readies, the wherewithal: call it what you like, money matters and you need to know about it.

The academic definition of money is 1) a medium of exchange, 2) a store of value, and 3) a unit of account.

Many items meeting these criteria, whole or in part, have functioned as money over the ages.

The barter system probably represented the first method of exchanging goods and services, and although it was clumsy, it worked. Problems would have arisen when one needed to define how many rabbits one got for say a fish? A fish doesn’t store value for long because after a while it starts to stink. What would I do if I wanted half a dozen eggs and the other bloke had a cow? The cow is not a good unit of account.

Over recent human history we have moved from cows to Cowry shells (see Figure), to the metal and paper currency that we know today and will come to remember with fondness and nostalgia since the process of phasing them out is well underway. Digital currencies such as credit and debit cards and bank accounts are already probably the main forms of money. The money you have in your bank account right now is essentially digital money since it is stored as ones and zeros in a bank’s computer memory. All of these types of money are called fiat money. The word fiat, is Latin for “let it be done” because this money is simply created from nothing and is backed by nothing more than one’s faith in the issuer.

Physical (cash) money was a great, probably Samarian or Chinese, innovation. It enabled the transfer of value that fulfilled all the properties of money as described above. If you have it in your hand or wallet, it is yours, and there is no valuable identity information associated with it.

You can take paper money from your wallet and transfer a fixed number of bills to a person or a vendor of goods or services. The problem with this physical fiat money is that you can’t easily even transfer it across a room let alone across the planet. And if you’re buying something large, you would need a briefcase or duffle bag of the stuff and that is a security problem.

For example, if you needed to pay for a shipload of milk powder it would be very awkward indeed to send bags of cash or coin. If you needed to buy an item from an overseas vendor then the entire cash payment process would be pretty clumsy and take a long time. No one in New Zealand settles the payment for a house purchase in cash anymore.

Cash is useful for those engaging in criminal activities since it has no identity information associated with it and since it can’t easily be traced. For similar reasons, cash is also king if you are in the business of tax evasion.

These are the reasons why during my lifetime I have seen coins and paper money be gradually replaced by digital money. I barely use cash these days. Such physical forms of money are not suitable in an increasingly globalized world.

Digital money became commonplace essentially when computers became ubiquitous. When you have an account with a 3^rd party like a bank, the bank essentially keeps a digital ledger of how much is in your account. When you buy something from a merchant with a digital form of payment like a credit card, your bank account (ledger) is deducted the amount, and the ledger at the vendor’s bank is credited. That is, the two banks cooperate in a process that depends on our trust in banking institutions that are supposedly regulated by the Government. The process works because we trust the Government and its ability to regulate banks and also the ability of banks to keep these ledgers in an accurate way. That is, the banks act as a trusted third party.

A graphical depiction of the SWIFT system.

The SWIFT (Society for Worldwide Interbank Financial Telecommunication) system of international exchange was introduced in 1973 and is still the standard method of international exchange. SWIFT enables all financial institutions to make secured financial transactions in a reliable environment across the globe. But these transactions are realized through intermediary financial institutions like banks, which of course, take their cut along the way. Banks are essentially in control as only they control the ledgers or accounts. They also participate intimately in the money creation process. Every time a commercial bank in New Zealand makes a loan it essentially creates money from thin air. This power is given to it by a sovereign state that issues its own currency.

Bitcoin is another form digital currency that was launched in 2009 by a mysterious person (or persons) known only by the pseudonym Satoshi Nakamoto. Nakamoto first described the technology in a white paper that can be found on the internet. Coincidentally, Bitcoin launched in October of 2008, the month following the Lehman Brothers bankruptcy that marked the Great Financial Crisis.

Bitcoin is the first known digital currency that is running on a technology called blockchain. It is entirely decentralized and no one has control of it. It is a peer-to-peer payment system and involves no intermediary – the privileged role that the banks play today would be totally subverted. Bitcoin has increased its value faster and higher than what we have ever experienced with any other currency.

You can create crypto currency only by mining it or you can buy it by trading on a crypto exchange much like a stock exchange. It is a bit (excuse the pun) like gold mining except no shovel is ever used. I should mention that since crypto mining utilizes a considerable amount of computer power, it doesn’t do much to limit climate change unless the power used to run the computers that do the mining derives from renewable energy sources. Today the amount of electricity used to mine crypto currencies is equivalent to the energy consumption of Switzerland.

Ledger entries are created through strict computer protocols (software). The bitcoin ledger known as the blockchain can only be updated by guessing a random number that solves an equation generated by the system. The guessing is done by a computer and the software and the more powerful the computer the more guesses you can make. Bitcoin relies on cryptographic proof for a transaction rather than trust in a financial institution. That is, we trust the math rather than the intermediary bank.

Well-known blockchain protocols include Bitcoin, Ethereum, Ripple, Hyperledger, and Factom. There are many more.

Bitcoin and Ether are two of the better-known cryptocurrencies or coins (note that the coin on the Ethereum network is called Ether, although it is often misnamed in the media as ‘Ethereum’).

Crypto currencies are assets or items of value that exist digitally, not physically, and are created by software. They have no issuer as such. No person, company, or entity backs them, and there are no terms of service or guarantees associated with them. Like physical gold, digital currencies simply exist.

All transactions related to these coins and tokens, including their creation, destruction, changes of ownership, and other logic or future obligations, are recorded on blockchains: replicated databases that act as the ultimate books and records - the ‘golden source’ that represents the universal understanding of the current status of all units of the digital asset. Lewis (2018) 

A block is a list of transactions that are grouped together on the ledger. The hash is what links the blocks together in the chain. A hash is a mathematical one-way function created from the previous block in the chain and is like a fingerprint and locks the block in order and time.

The advantage of crypto currency for the general population is that no one entity actually has control. The disadvantage for governments is that no one entity has control since the power to create money is what gives governments authority. This is the power of Government.

Central Bank Digital Currency (CBDC) is digital money like crypto except that it is issued by a government’s central bank rather than a commercial bank. I think that in the next few years we are going to see the widespread introduction of CBDC. About 9% of countries have already introduced CBDC with China being at the vanguard. As such CBDC is under complete government control rather than partial control as in the present system which relies on the participation of commercial banks and government regulation.

Aside from countries that have already introduced a CBDC, 14% of countries have a CBDC in the pilot phase, 23% are developing a CBDC and 41% of countries are researching.

Under the current system of money only commercial banks can have an account with the central bank. Your account is with the commercial bank and when you pay for something, transactions occur between commercial banks of the vender and purchaser. The central bank has nothing to do with the transaction.

Under the new system of CBDC anyone will be able to have an account directly with the central bank. Transactions will occur directly with the central bank and transactions verified using the bank’s own block chain which will be private as opposed to public such as is the case with crypto currencies.

This new system of CBDC will likely revolutionize the very nature of money and we would all do well to educate ourselves about it. No one will escape this revolution in money.

Another feature of CBDC is that the central bank will know everything about every transaction you make. That gives the authorities in control of CBDC an enormous amount of power over your life.

References

The end of privacy? Central banks plan to launch digital coins 

Eva Szalay in London, Colby Smith in New York and Thomas Hale in Hong Kong

14-Jun-21.

Franco, P. Understanding Bitcoin. Cryptography, Engineering and Economics. Wiley 2015.

Lee, B. Blockchain. Understanding the technology of Bitcoin and cryptocurrency.

Rose, A.M. , Vengatesh, T.P. Understanding Cryptocurrency and Blockchain Technology: A Comprehensive Overview. 2023.

Tripathi, G., Mohd Abdul Ahad, Casalino, G. A comprehensive review of blockchain technology: Underlying principles and historical background with future challenges.

Decision Analytics Journal 2023, 9, 100344. ISSN 2772-6622.

https://doi.org/10.1016/j.dajour.2023.100344.

NOTES

Source: https://www.visualcapitalist.com/visualized-the-state-of-central-bank-digital-currencies/

International Transfers

Project mBridge

A multi-central bank digital currency (mCBDC) platform for real-time cross-border payments and foreign exchange transactions. Developed using Distributed Ledger Technology (DLT), the platform aims to create a more efficient, low-cost alternative to the existing correspondent banking network.

BRICS Pay

A proposed payment system designed by the BRICS consortium to create an independent, decentralized, and secure alternative to the US dollar's dominance in international payments, aiming for fast, affordable, and seamless cross-border transactions using technologies like blockchain and QR codes.

UNIT

New reserve currency for international trade reportedly called the United New International Trade (UNIT) may be 40% backed by gold as a US dollar alternative.

The topic was key at the 2024 BRICS Summit, which took place from October 22 to 24 in Kazan, Russia.