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« Why? | Main | One of these days, this sort of thing will get me into trouble »

Form and function

By Dave Birch posted Nov 24 2010 at 10:00 PM

[Dave Birch] Money has several different functions in society.

All of these functions are bundled together into a single (for lack of a better word) asset: currency. Sometimes, these functions are complementary [and sometimes the] functions of money conflict with one another.

[From Umair Haque / Bubblegeneration]

Umair is spot on, and to back him up I thought I'd blog an extract from some pieces I wrote a few years ago to try to explain to a business audience why the digitisation of money might lead to these functions being implemented very differently in the future. The beginning of the extract comes from a paper call "E-Cash, So What?" that I presented at "Digital Cash and Micropayments, Unicom (London: February 1997)", the second part is from a paper that Neil McEvoy and I wrote called "Electronic Cash - Technology will denationalise money" that I presented at "Financial Cryptography (Anguilla: February 1997)" and the more detailed final section comes from an unpublished chapter of a book I'm working on.

Since a great deal of the debate about electronic money and Internet commerce is confused because of a lack of understanding about the nature of money, let us begin by delving into the subject. As any text about money begins by stating, money has four basic functions:

  • A Unit of Account. The unit of account does not, of course, have to have any physical reality. We receive orders and issue invoices denominated in European Currency Units (ECUs), despite the fact that we have never seen one.
  • An Acceptable Medium. Money is useless as a medium of exchange unless it is acceptable to both parties to a transaction.
  • A Store of Value. Unfortunately, inflation can erode the value of stored money no matter what medium is chosen!
  • A Means for Deferred Payment. In order for a society to function, it must support contracts between parties that include provision for future payment.

Each of these functions may be implemented in a different way. Consider the example of the American colonies at the turn of the 18th century. The colonists used sea shells (known as “wampun”) for their medium of exchange, a form of cash borrowed from the Native Americans (who were, in effect, the central bankers of this monetary system, converting the shells into animal pelts which were used to store wealth and for external trade). The unit of account was the English Pound (despite the fact that most of the colonists had never even seen one) and the means for deferred payment was bullion.

A contract, then, might run like this: Person A would contract with Person B to pay “£1 in gold per annum for rent of the field” or whatever. When the rent fell due, it would be commuted to £1 worth of wampun (since no–one actually had any gold or silver, as the English refused to export bullion to the colonies). Accumulated wampun was traded for beaver pelts and these were kept as a store of value.

The economy worked and the “money supply” was based on commodities (the pelts, generally) and stable for many years, until over–harvesting lead to a decline in the beaver population: as pelts became scarce, the “exchange rate” for wampun against pelts rocketed, eventually rendering it a useless medium for exchange. Can we continue with the story of the colonies to see if we can find another analogy -- between Britain's view of North America in the early 18th century and our view of the virtual space today -- that might tell us something more about future trends in money? How about this one?

A superpower is bogged down in a distant guerrilla war. The superpower must resupply its army (victorious for a generation) thousands of miles from home and it’s become a costly endeavour. Support for the war is tentative, dividing both the people and the political leadership. The guerrillas are supported—financially and militarily—by the superpower’s greatest enemy. The war drags on as casualties mount and generals are disgraced. The rebels continue to gain momentum, even though they are occasionally beaten. Vietnam? No: this is historian Kenneth Davis' brilliant description of British North America in 1782. This analogy, worth serious examination, tells us that inappropriate taxation and unenforceable unfair legislation cause disputes that will lead to secession. It’s easy to see the roots of these disputes emerging:

  • A distant colony where conditions are different;
  • Politicians taking actions they feel constrained to implement even while they are being advised that they are acting against the nation’s best interests. In 1774 Viscount Rockingham, Britain’s ‘Minister of War’, said that a land war in America would be useless, costly and impossible to win;
  • Legislators trying to fit something they don’t understand into existing models. British politicians operated in almost complete ignorance of America. None of them had ever been there, they knew no Americans (unlike the merchant classes) and made no effort to learn anything about it.

The colony analogy also tells us that the world of banking and finance may be changed as much as the world of politics and commerce. In the American colonies bullion for coins was scarce because Britain wouldn’t export any, an action that led to one of the great revolutions in money: the issuing of banknotes not as a means of substituting for some otherwise inconvenient means of exchange but as a means of creating money. Starting with the Massachusetts Bay Colony in 1690, banknotes were issued by impoverished authorities to avoid the high costs and uncertainties associated with borrowing and the need to impose taxation.

The entry level barriers to virtual financial businesses are very low, so one might expect to see monetary experimentation on par with the young United States. Thus it’s possible that the most revolutionary impact of e–cash will come from its ability to monetise new stores of value rather than its ability to act as a useful means of exchange. What would it mean to create new stores of value? On the frontier and in the colonies the store of value was related to some physical good: often, but not always, gold. The United States was on a tobacco standard for twice as long as it was on a gold standard. Tobacco was made legal tender in Virginia in 1642, by the outlawing of contracts calling for payments made in gold or silver, and remained so for two centuries. The US gold standard, by contrast, lasted only from 1879 to 1971. Who would bet against a new standard emerging in cyberspace—the Energy Standard, for example—that is not related to first– or second–wave commodities but claims against the future production of goods or delivery of services?

If the colony analogy holds, we would expect just such a development and the emergence of a whole new virtual finance industry, as different from our existing finance industry as fractional reserve banking was from the striking of electrum coins in Lydia. There is a very interesting parallel between the row going on about encryption on the Net and the row that went on in the colonies about taxation. In 1760s, the British government introduced the Writs of Assistance to clamp down on the evasion of customs duties. These didn’t work, of course, because the cost of enforcement vastly outweighed the revenues collected (as will undoubtedly be the case for stamping out unauthorised copying).

Incidentally, the Writs were not peculiar to America and similar legislation was introduced in England: the hated Cider Tax, which prompted William Pitt’s famous tirade in opposition:

The poorest man in his cottage may bid defiance to all the force of the Crown. It may be frail; its roof may leak; the wind may blow through it; the storms may enter; the rain may enter—but the King of England cannot enter; all his forces dare not cross the threshold of the ruined tenement!

This is as good a call for strong cryptography as anything since. Meanwhile across the pond, the British government was still concerned that the colonies might be overrun by their 18th century equivalent of today’s money launderers, drug dealers and child pornographers: the French, who still had a toehold in Louisiana. Britain tried to get the colonies to pay for defence, and they wouldn’t. Things went from bad to worse. As American historian Barbara Tuchman has written, a consistent feature of the dealings between the British and the Americans in this period was that each side over–estimated the goals of the other. The Americans thought that the British were concocting a huge conspiracy to enslave and subdue them when in fact the British were just being stupid. The British thought the Americans were aiming to subvert the Crown when they just wanted fair treatment. British intransigence, when compromise was both sensible and feasible, created rebels where there were none before. Is this that different from the current situation, where the netiscenti suspect the NSA and GCHQ of wanting to read their e–mail while the Home Office sees subjects suspicious of key escrow as agents of anarchy. There’s no need to labour the analogy: as we all know, the colonists decided against the many benefits of British rule.

As Edmund Burke was later to observe The retention of America was worth far more to the mother country economically, politically and even morally than any sum which might have been raised by taxation, or even any principle of so–called Constitution. Will we be thinking the same about "cyberspace" a generation from now, using worthless fiat currencies to scratch out an existence while the new wealthy have their money in Facebook Credits, KVAs and Bandwidth?

These opinions are my own (I think) and presented solely in my capacity as an interested member of the general public [posted with ecto]


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Hi, I am very happy to read this site.There is a very interesting parallel between the row going on about encryption on the Net and the row.
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