More on Money

There are a number of things about money that I did not discuss in my previous post and perhaps should have, some of which came up in comments on my post and my responses. Hence this post … and perhaps one more.

Unit of value vs currency

A dollar is a unit of value, used to state prices, do accounting. Using dollars as a unit of value does not require that you have some, any more than using inches as a unit of length requires you to have a stock of inches. Dollars are also currency, used to buy things. To use dollars to buy things you do have to have some.

Different features of a money are relevant to these two functions. If I am using money as currency, it does not matter very much how stable its value is — sometimes prices go down and I gain a little in the value of the money in my wallet, sometimes prices go up and I lose a little. Short of hyperinflation, both gains and losses are small.

Stability is important for money as a unit of value, just as it is important that miles and degrees Centigrade keep the same meaning over time. A money that is unstable in the short run makes it difficult to keep track of prices, to know if the price of something you want to buy or sell is higher or lower than usual, a bad deal or a good one. A money that is unstable in the long run makes long term contracting in that money difficult since you don’t know what the amounts you agree to now will be worth then.

Until recently, one important feature of a money was that it was the same one used by the people you interacted with. That has become less important now that many of our transactions go through computers; currency conversion is arithmetic, which computers do fast and cheap. When traveling in Europe I can, using my debit card, pay a bill in pounds or Euros from an account in dollars. It is still convenient for prices — I have to do some quick mental arithmetic to know how expensive a restaurant or hotel abroad is. That may cease to be true in the future, as more and more transactions move online:

I live in the United States; you live in India. You have goods to sell, displayed on a web page, with prices in rupees. I view that page through my brand new browser – Firefox v 9.0. One feature of the new browser is that it is currency transparent. You post your prices in rupees but I see them in dollars. The browser does the conversion on the fly, using exchange rates read, minute by minute, from my bank’s web page. If I want to buy your goods, I pay in dollar-denominated ecash; my browser sends it to my bank, which sends rupee-denominated ecash to you. I neither know nor care what country you are in or what money you use – it’s all dollars to me. (Future Imperfect, Chapter 6)

If the money used by the people around you is unstable you can buy and sell in that, define long-term contracts in something else. In the US it used to be possible to state the terms of a contract in gold rather than dollars; when payment came due it was done in dollars, the number of dollars depending on the dollar price of gold. Elsewhere it is still common to have some categories of contracts stated in dollars.¹

In my previous post I described a hypothetical future monetary system with multiple private issuers. In the Scottish system of the 18^th century that I was modeling it on all banks based their notes on silver; as long as people trusted the banks to redeem, notes of different banks were of the same value. In my system redemption is with a commodity bundle, so different banks could use different bundles and have money of differing value. My guess is that most would coordinate on a single definition to take advantage of standardization. Standardization does not require a government to set the standard; English speakers (and Spanish speakers and German speakers and …) coordinate on the meaning of words in their language, a much more complicated coordination problem, without a government agency to control language.

Except in France.

ECash: Chaumian vs Block Chain

The ideal ecash would make it possible to transfer value by sending a message without any third party able to observe the transaction and without the transacting parties having to know each other’s identities. That would be one of the things that would enable what I have described as a world of strong privacy, what Tim May’s Cryptoanarchism.

David Chaum, a Dutch cryptographer, solved the problem of how to do it in 1982, before block chain currencies existed. To explain how what he was doing is possible without going into the mathematics I came up with my own equivalent, much less convenient than Chaum’s but easier to explain:²

Low-Tech ECash

I randomly create a very long number. I put the number and a dollar bill in an envelope and mail it to the First Bank of Cybercash. The FBC agrees — in a public statement — to do two things with money it receives in this way:

If anyone walks into the FBC and presents the number, he gets the dollar bill associated with that number.

If the FBC receives a message that includes the number associated with a dollar bill it has on deposit, instructing the FBC to change it to a new number, it will make the change and post the fact of the transaction on a publicly observable bulletin board. The dollar bill will now be associated with the new number.

Lets see how this works:

Alice has sent the FBC a dollar, accompanied by the number 59372. She now wants to buy a dollar’s worth of digital images from Bill, so she emails the number to him in payment. Bill emails the FBC, sending them three numbers: 59372, 21754, and 46629.

The FBC checks to see if it has a dollar on deposit with number 59372; it does. It changes the number associated with that dollar bill to 21754, Bill’s second number. Simultaneously, it posts on a publicly observable bulletin board the statement “the transaction identified by 46629 has gone through.” Bill reads that message, which tells him that Alice really had a dollar bill on deposit and it is now his, so he emails her a dollar’s worth of digital images.

Alice no longer has a dollar, since if she tries to spend it again the bank will report that it is not there to be spent – the FBC no longer has a dollar associated with the number she knows. Bill now has a dollar, since the dollar that Alice originally sent in is now associated with a new number and only he and the bank know what it is. He is in precisely the same situation that Alice was in before the transaction, so he can now spend the dollar to buy something from someone else. Like an ordinary paper dollar, the dollar of ecash in my system passes from hand to hand. Eventually someone who has it decides he wants a dollar of ordinary cash instead; he takes his number, the number that Alice’s original dollar is now associated with, to the FBC and exchanges it for a dollar bill.

My ecash may be low tech, but it meets all of the requirements. Payment is made by sending a message. Payer and payee need know nothing about the other’s identity beyond the address to send the message to. The bank need know nothing about either party. When the dollar bill originally came in, the letter had no name on it, only an identifying number. Each time it changed hands, the bank received an email but had no information about who sent it. When the chain of transactions ends and someone comes into the bank to collect the dollar bill he need not identify himself; even if the bank can somehow identify him he has no way of tracing the dollar bill back up the chain. The virtual dollar in my system is just as anonymous as the paper dollars in my wallet. (Future Imperfect, Chapter 6)

Chaumian ecash is fully private; the only problem is that it does not exist. The reason is that it requires an issuer, a bank that can be trusted to redeem its virtual banknotes. If it did exist it would make money laundering laws unenforceable, an outcome which the sorts of countries such a bank could be located in don’t want. The advantage of block chain currencies such as Bitcoin and Ethereum is that they do not require an issuer, do not require permission from any government, and do exist.

Bitcoin was a brilliant idea but has serious limitations as a money. It is the least private money that has ever existed, since every transaction is public information. The transaction is between accounts, not people, but a competent spy can link you to your account by buying something from you with bitcoin and seeing where the money goes. There are complicated ways of preventing this but none, I think, that are entirely bulletproof, cannot be broken by someone with enough information about transactions and willing to put enough processing power into untangling them. There have been a number of projects to create fully anonymous cryptocurrencies and I have not followed them closely enough to judge if any yet can be fully trusted.

A second problem with Bitcoin as money is that its value is unstable. This is a minor inconvenience for using it as a currency, a much greater inconvenience for using it as a unit of value. To have a cryptocurrency that works as both one needs a cryptocurrency that has a constant value, a stablecoin.

There are two possible approaches to creating a stablecoin. The obvious one is to have an issuer or the equivalent, some institution that is willing to redeem its virtual coins for whatever currency or commodity they are stable in. That can work, provided you have a trusted issuer, but can be private only to the extent that the government of the country the issuer is located in lets it be — the same problem as with Chaumian ecash, the original stablecoin.

The more interesting approach is a coin that is algorithmic stable. I proposed one way of doing it some years ago, depending on a ring of issuers whose identity did not have to be known and who did not have to be trusted, since the behavior that keeps the currency stable is in their interest. So far as I know that version has not been implemented by anyone. Other versions have been but I gather from the wiki on the subject that none have yet been entirely successful — I don’t know enough about them to have an opinion of my own.

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1. “For many years Israeli real estate contracts have been denominated in American dollars.” (Old Habits Are Hard to Change: A Case Study of Israeli Real Estate Contracts)

2. An explanation of the real thing.