Image from Binkabi Medium
It is reported that around 1900, the famous physicist Lord Kelvin said ‘There is nothing new to be discovered in physics now. All that remains is more and more precise measurement.’
Of course, we all know what happened next. Classical (Newtonian) physics was completely upended by Einstein and we are still grappling (120 years later) with how the universe actually works.
We are at a similar inflection point with our thinking about the monetary system.
When I was in Economics grad school in 1980, everyone seemed to think we had pretty much worked out monetary theory. The Fisher equation — MV = PT explained price levels and Milton Friedman proclaimed ‘Inflation is always and everywhere a monetary phenomenon’ …
The heart of the monetary system was the concept that money is only created by a central authority. By 1980, the gold standard had been dead for almost a decade and we all understood the money was fiat money — that is, backed by nothing except that others would take it from you to settle obligations. So for fiat currency to have universal acceptance, it had to be authorized by the central authority … essentially providing an imprateur of officialdom
The central authority then granted certain players — commercial banks — the right to further create money through fractional reserve banking. That is, the commercial bank did not have to keep all of its deposits in the bank — it made money by lending out a certain proportion of its deposits to others, who of course had to deposit the loan into a commercial bank to use it. Hence creating more money.
The system has evolved of course, with many more non-bank lenders (the so called shadow banking system, though many of these in fact get the funds to lend from the commercial banking system), but the key principle of the system remains that creating money is the monopoly of the central bank, who sub-contracts part of the task to commercial banks.
And this also means that commercial banks are generally wildly profitable (except of course when they stretch too far, and have to be bailed out by the central authority, like in the Great Financial Crisis in 2008–9).
Of course, being able to create money is a wonderful right. Picasso never paid his lunch bill … he would simply sketch something on the back of a matchbook cover, effectively creating Picasso Pesos. Elvis Presley would write a check. with his signature, the check is never cashed, so Elvis was effectively a central bank printing his own currency: King Kash.
When we reflect on this, I don’t think it is too much to say whoever controls the creation of money controls the world …
And this is why cryptocurrency so controversial? In the same way that Einstein’s Theory of Relativity challenged Newtonian physics, cryptocurrency challenges at the most fundamental level the way the economic system works. Bitcoin comes along and early adopters show in a rudimentary way that it is possible for private actors to create money (at least with some features of money), threatening the current powers that create money. And while BTC has a number of drawbacks (not surprising given how new and innovative it is), BTC has at least 4 fundamental advantages over money created by the central authority:
- When I have BTC, the BTC is mine; my ownership of BTC does not depend on a ledger entry in someone’s private ledger.
- The amount of BTC is limited so it has value, that value will not be eroded by inflation (which has hit 2.5% in the USA, which means you lose 22% of the value in 10 years by holding fiat USD).
- I can transfer this value to someone else with no intermediaries.
- The cryptographically assured distributed ledger gives us a level of security and accuracy in one’s ownership of assets that no previous technology has ever provided
These 4 advantages are a major step forward for an individuals’ control over his/her financial life and it is remarkable that in the very first iteration of a new technology that so much has been achieved.
The multiple concepts here are so intriguing that it is not a surprise that BTC has been followed by the plethora (1,565 at last count) of crypto-currencies,-tokens, -assets as the boundaries in creating private money are rapidly tested.
Of course, the existing authorities that create money, and the entities that benefit from this (for example, the commercial banks) are not going to cede ground without a fight … a fight to see how money is controlled in the world.
So strap in … all of us are now part of the next decade’s Infinity War.
More to follow…
This post also appears on the Binkabi Medium Page.
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