• Tue. Jan 11th, 2022

    What are the lessons of history for digital currency?

    ByHazel R. Lang

    Jan 10, 2022

    Past experiences suggest that digital currencies – such as Bitcoin, Tether, and Dogecoin – will eventually be regulated or monopolized by central banks.

    Shortly after the tumultuous events of the 2007-09 global financial crisis, Satoshi Nakamoto, a pseudonymous individual or group, released a white paper introducing Bitcoin to the world.

    In a 2009 blog post, Satoshi Nakamoto used the story to justify the creation of Bitcoin: “The fundamental problem with conventional money is all the confidence it takes to make it work. You have to trust the central bank not to depreciate the currency, but the history of fiat currencies is full of attacks on this confidence.

    In this article, we use the prism of history to understand how digital currencies like Bitcoin might evolve in the future, and whether central banks can be trusted.

    Have there ever been any innovations in silver?

    The history of money is that of innovation (Bordo, 2021). Over the past 400 years in the UK we have seen a transition from the use of gold and silver coins to the use of banknotes and deposits redeemable for cash and l ‘gold, to a central bank money exchangeable for gold and silver, and finally to fiat money. – government-issued currency that is not backed by a commodity like gold.

    This process had taken place in 1931. Subsequently, the automatic teller machine (ATM) was introduced in the United Kingdom in 1967 when comedy actor Reg Varney became the first person to withdraw money from an ATM. (Barclays, 2017).

    Then there was the advent of credit and debit cards in 1966 and 1987 respectively. Internet banking services were introduced in the UK in 1997, chip and PIN cards in 2003, and contactless cards in 2007. PayPal was introduced in the UK in 2003. These innovations have led to a reduction use of cash, and in 2017 debit cards overtook cash as the most common form of payment in the UK.

    As shown in Figure 1, cash was only used in 17% of the 35.5 billion payments made in the UK in 2020. So in many ways we already have digital currency. So the question is, how important is the innovation of digital currencies like Bitcoin? Is this just hype? Or will digital currency offer us faster, more secure and more efficient means of payment, accessible to those who are excluded from traditional banking systems?

    Figure 1: Share of total UK payment volumes (excluding CHAPS), 2020

    Source: UK Finances, 2021

    What makes money valuable?

    History sheds light on the importance of what economists call the late monetary problem (Thompson and Hickson, 2000). In other words: in the final transaction, what gives a monetary value? Gold and silver had monetary value because they have value as jewelry and ornaments and have useful industrial properties. Gold and silver were also scarce commodities.

    Paper money issued by banks or central banks in the past was valuable because it was convertible into gold or silver. Fiat money has value because governments demand that future taxes be paid with it. Bank deposits are valuable because they are convertible into fiat currency. So what makes digital money valuable?

    Cryptocurrencies such as Bitcoin are not convertible into anything. Bitcoin advocates suggest that the upper limit of 21 million Bitcoin makes it the digital equivalent of gold. But unlike Bitcoin, gold has a use value outside of its role as currency (Prasad, 2021).

    The history of money raises an existential question about the value of cryptocurrencies. They may have value as a means of engaging in nefarious activity and for criminals to evade anti-money laundering and know-your-customer authorities and regulations (Gerard, 2017; Silverman, 2021). Alternatively, cryptocurrencies have been viewed as decentralized Ponzi schemes or chain letters run by devotees and cult-type opportunists (Koning, 2021; Kelly, 2021).

    Stable coins, such as Tether or USD Coin, on the other hand, have value because they are convertible one-for-one into US dollars or a basket of currencies. This makes most stable coins similar to bank money.

    But there are questions about stablecoin reserves. Tether, in particular, has come under scrutiny because it has obscured the types and amount of reserves it holds (McKenzie, 2019). Instead of holding cash and near-cash instruments, Tether held debt and commercial paper. Therefore, in the event of difficulties in the money market and a rush for its coins, Tether may not have enough reserves to redeem all of its coins.

    Why do governments control the money?

    History also shows that governments control money. For example, they generally had a monopoly on minting coins – although there were some exceptions such as private coins during the US Gold Rush of 1830-63 ( White, 2021).

    Private banks in most economies until the beginning of the 20e century have issued their own notes. In other words, there have been many historical episodes where banks have issued private money. But central banks, starting with the Bank of England, received monopoly privileges from their inception and eventually evolved into having a complete monopoly on issuing currency.

    There are various explanations why governments have controlled money and established central banks across time and space. The first explanation is a fiscal reason – governments control money because they receive seigniorage income on an ongoing basis by issuing currency (Selgin and White, 1999). It is the profit made by generating money, that is, the difference between the value of money and the costs of its production.

    The second explanation, which is related to the first, is that governments control money so that they have access to emergency war funding. For example, the Bank of England was established at the end of the 17e century to help finance the wars against France, and he played a major role in financing the Napoleonic wars and those of the 20e century.

    This original military emergency rationale for government control of money has weakened over time due to the nuclear umbrella and military technology, as well as the fiscal capacity of the modern state ( Glasner, 1989; Eichengreen, 2019). But governments still need access to emergency funds to deal with natural disasters and global pandemics.

    The third explanation, and the most commonly accepted by economists, is that the banking system is inherently unstable, and this instability has such dire consequences for the economy that the production of foreign exchange cannot be left to competing private institutions (Goodhart , 1988; Eichengreen, 2019; Gorton and Zhang, 2021).

    No matter which of these explanations is the correct one, they still apply today. This has major implications for the future of cryptocurrencies. Governments have two choices. The first is that they regulate cryptocurrencies by imposing capital and liquidity requirements on them (President’s Task Force on Financial Markets, 2021). In particular, the main lesson of the issuance of private currency at the 19e century is that stablecoins should be regulated like banks (Gorton and Zhang, 2021).

    The second and growing choice is for central banks to produce their own digital currency (a ‘central bank digital currency’ or CBDC), and thus develop a digital currency monopoly as they have done. with the parts, then Notes. Indeed, for some, the main lesson of history is that currency issuance tends to eventually concentrate in the hands of governments or their central banks (Eichengreen, 2019).

    Figure 2: UK Consumer Price Index, 1209-2016

    Source: Bank of England

    Can we trust central banks?

    One of the reasons Satoshi Nakamoto created Bitcoin was the belief that governments and central banks cannot be trusted to refrain from debasing currency. The etymology of the word degrade refers to base metals added to gold and silver coins to lower their intrinsic value but not their face value. Famous, Henry VIII degraded the currency to help raise funds (Deng, 2011). In a fiat money regime, it is relatively easy for a central bank to issue more money than is demanded, with the result that the currency loses its purchasing power.

    Figure 2 shows that inflation did not take off in the UK until after the introduction of fiat currency in 1931, and really accelerated after the end in 1971 of the Bretton Woods system, which effectively linked the pound sterling to the dollar and the dollar to gold. To buy the same amount of goods that £ 1 would have bought in 1971, it would cost around £ 14.50 today. But that masks the fact that most of the degradation of the past 50 years happened in the 1970s and 1980s.

    Since then, central banks around the world have gained greater independence from governments and have been given inflation targets. These policy changes have helped control soaring inflation in most industrialized economies.

    So, can we trust central banks with CBDCs not to depreciate the currency? The lesson of history is that governments can pledge not to degrade, but the credibility of such pledges depends on the stability of the democratic political constitutions that underpin them.

    Where can I find out more?

    Who are the experts on this issue?

    • John Turner
    • Andrew Urquhart
    • Guillaume Quinn
    • Carol Alexander
    • Marcus Brunnermeier
    • Eswar prasad
    • Rod Garrett
    Author: John D. Turner, Queen’s University Belfast
    Photo by Jonas Leupe on Unsplash

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