Crypto Dip-Toe Part 3: A (Digital) Currency Caper

“Bitcoin and digital currency is just this thing that was always going to happen.” – Tyler Winklevoss

The digital currency movement (including Bitcoin) is undoubtedly “a thing” that is happening, but I think the jury is still out on where it all goes. Will it:

1. Take over the world of fiat currencies and function as the dominant form of global reserves?
2. Find a place coexisting within our current system of centralized, country-specific money?
3. Fizzle out?

If you forced my hand, I’d choose “d” – some combination of the above that plays out in ways we’d never guess at this point. As we’ve touched on in the past, humans aren’t good at predicting the future, and tempering our expectations (in either direction) is probably a reasonable thing to do. Although we have no idea what the future of currency will be, we can take a brief look back to see where it’s been to have a firmer basis for thinking more critically about it.

Money 101: Seeking Context

It’s safe to say most of us understand the evolution of money at a basic level. At one point in history, there was only bartering. But it could be tricky to trade in random increments of swords, horseshoes, animals, or bushels for the other goods/services that one needed. I have to say I enjoyed this Investopedia article’s description of a particular trade arrangement: “If you are exchanging an ax as part of an agreement in which the other party is supposed to kill a woolly mammoth, you have to find someone who thinks an ax is a fair trade for having to face down the 12-foot tusks of a mammoth.” Easy, right?

That same article provides a couple of interesting insights. First, there is arguably a distinction between money (intangible) and currency (money’s “physical tangible manifestation”). More importantly, bartering evolved into units that functioned more like currency (“animal skins, salt, weapons”) to facilitate trading, then (most likely) there were a few milestones along the way to creating what we think of as money today:

• The first minted currency emerged in China around 640 BC in the form of spade coins.
• The first official currency – the Lydian stater – followed shortly thereafter (~600 BC) and sounds to me like it was pretty modern already. These coins “were made from electrum, a mixture of silver and gold that occurs naturally, and the coins were stamped with pictures that acted as denominations.”
• China transitioned to paper money around 700 BC – well ahead of Europe.
• Our paper money evolved from the idea of “banknotes” (paper that banks privately issued because it was easier to carry around) and paper IOUs used to help facilitate cross-Atlantic trading between Europe and North America.

With the advent of computers, money has become increasingly accepted as an electronic accounting system. Our paychecks increase the numbers in our bank accounts on our screens, and expenses reduce those values. When I was a kid, payments used to be made mainly by writing physical checks and sending them via snail mail. Now (for most of us), bills are simply paid online, often automatically. Balancing a checkbook – once a critical skill set to possess – is a thing of the past (unless you’re my mother 😊), and it’s something I don’t expect my daughters ever to learn. Another development is that we can use our smartphones to physically tap merchant devices for payment – like holding a stack of cash in your hands at all times with no ATM required. 

Enter Virtual Currency

Although our financial transactions have become increasingly electronic, until recently they’ve all shared the same underlying central-bank currencies we’ve used for many years – US dollars, euros, pesos, etc. Thus, while our banking is virtually all done electronically, it hasn’t required a substantial mental leap like the notion of an entirely virtual currency (e.g., cryptocurrency or Bitcoin) does. If currency seemingly created out of thin air that only exists in computers hurts your brain when trying to make sense of it, I bet you’re not alone.

We’ve already had to modify our thinking of currency over the years, as it has progressed from physical items with measurable utility (e.g., salt or weapons, as above) to physical items with some degree of scarcity (e.g., coins) to physical paper/coins backed by scarce physical reserves (gold-backed currency, aka “representative money”) to paper that is based more on faith (e.g., current US dollars, aka “fiat money”). That transformation is begging us to explore the necessary attributes and functions of a currency since that may help on our quest to find crypto enlightenment.

Money Functions vs. Attributes

Note: We touched on the nuance of money (intangible) vs. currency (tangible) above, but I will use the terms more interchangeably in this section for simplicity, as some references do the same.

In this article from the St. Louis Fed, the characteristics of money are explored using a comparison of cows and 20-dollar bills, and their takeaway is that “20-dollar bills are a much better form of money than cattle.” The listed characteristics are “durability, portability, divisibility, uniformity (fungibility), limited supply, and acceptability.” I think it’s easy to make the case that cryptocurrency can meet most of those functional needs pretty well, except that of acceptability. I’ve witnessed increased acceptability over the past several years, as crypto has emerged from being a notion of the lunatic fringe to gaining institutional investment and obtaining ETF approval. However, it still has a long way to go. [BTW, Lunatic Fringe is a decent classic rock song by Red Rider, which was fronted by Tom Cochrane, who you may remember from the early 90s song and video, Life is a Highway – he’s a rare “double one-hit-wonder.” And, for full disclosure, I incorrectly assumed it was a Pink Floyd song for many of my teenage years, so feel free to hold that against me.]

What some may deem to be a glaring omission from the above list, but this Investopedia article astutely captures, is the additional characteristic of stability. To be fair to the author of the St.-Louis-Fed article, being a “store of value” is cited as a fundamental tenant of money in the earlier part of their text. But I think we need to overtly include it in our list of characteristics, as it’s a vital currency function. It’s also a particular sticking point of the ongoing cryptocurrency discussion.

What I found to be more interesting are the attributes of money, as described in another article, The 5 Attributes of Money, Part I: What Makes Money Money, by Charles Cascarilla. It struck a chord with me because these attributes are not necessarily requirements of money or currency but rather are descriptions of various forms of money/currency; that broadens the scope of what can qualify as money and gives us a toolbox to discuss it more accurately. Below is a summary of Cascarilla’s perspective on those five attributes:

1. Anonymity: transactions range from fully anonymous (e.g., cash) to pseudonymous (publicly accessible transactions – Bitcoin falls into this category) to fully traceable.
2. Centralization: Who controls the ledger? Centralized (e.g., a central bank) or Decentralized (e.g., distributed ledger technology, which we covered in Part II of this series).
3. Openness: The degree of ledger access – open or closed. Perhaps not intuitively, cash, bitcoin, and gold all fall under the “open” category. “Closed” is limited to central bank transactions and such things.
4. Limit of Supply: This can be constrained or unconstrained.
5. Physicality: Digital vs. Physical

Money Vocab

Bringing this full circle back to today’s mission, what we’ve learned is a more consistent way to describe various forms of money/currency so we can add context to the crypto discussion. With that in mind, the following are a couple of examples using our new vocabulary and how it highlights similarities and differences between these currencies:

US dollars are a good form of currency because of their functional characteristics – i.e., they are Portable, Limited in supply, Uniform, Divisible, Accepted, Durable, and Stable. If we had to study for a test, we may use the acronym PLUDADS to remember these (like what Paul Reiser and Greg Evigan would have on their vanity plate if they lived on Pluto?). The same may eventually be said for some virtual currencies, but they still have a long way to go in terms of both acceptability and especially stability. In the next edition, I’ll shed some light on the advantages and disadvantages of the above attributes. Then (finally), we can speak more intelligently about why some people believe digital currencies are exciting and take a look at some examples.

Until next time, this is the end of alt.Blend.

Thanks for reading,

Steve