Yuan dynasty banknote with its printing plate

Money and markets: Cryptocurrencies and the rise of paperless finance

Money has morphed from a physical lump of metal to a piece of paper bearing a promise, then to a digital entry in a virtual ledger. Now with the rise of cryptocurrency it is changing once again.

As E&T goes digital-only for this issue, I am reminded that technology also drives money into the ether. When Greek kings started stamping the gods and their own likenesses into gold and silver, the first money was created. It was a very physical thing.

The Chinese were the first to work out that money could be a promise printed on paper, a medium with no intrinsic value. With one innovation, money had transformed from a prized metal to a valued promise and so-called ‘fiat’ was born. ‘Fiat money’ is money whose value is mandated by order of the issuer; it’s the printed currency we all use.

The driver for the creation of paper money was the same in China as it was hundreds of years later in Europe. The rich didn’t want to lug their money around with them and so they lodged it with safekeepers. The safekeepers issued receipts and the rich began trading these deposit receipts. At some point the safekeepers morphed into banks and began to issue these receipts with little or no backing of deposits.

Even today, many savers - especially in America - mumble that paper money is a con trick and I’m sure it felt like such throughout the ages, especially when the issuer defaulted on their ‘valued promise’.

As soon as money issuers issue unbanked bank receipts, large amounts of the money supply dematerialises. The money of which the issuer has a reserve is latent money, which amounts to what they can get away with promising. If they can get away with ten times as much paper money as they have deposits, every extra deposit immediately equates to ten times its value in latent money. That ethereal money can be called into existence from nothing by the stroke of a pen, the turn of a printing press or a record on a ledger.

This unsettling prospect is core to much economics, from bank runs, hyper inflations, bail-outs and quantitative easing to simple day-to-day printing of bank notes.

With the ability to spirit money from nowhere, all sorts of assets based on promises can be called into existence and they have no meaning or value beyond the consensus of the participants. These assets are mere records and in reduction, simple dots of magnetised rust on spinning hard-drive plates in a database of a ledger. As a record on an SSD drive, the existence of that money becomes even more ethereal.

This precarious digital state for the vast majority of the globe’s assets is a far better engineered solution than it being held as ink on paper.

The US has $13bn of cash and near cash, called M2, which in $20 notes is 650,000 tonnes of bills. With $300-600tr in global assets, a paper-based reality would be a giant physical drag on the global economy.

A neat example of the dematerialisation of assets is the stock market. In the UK few now hold their shares in paper form. You can, but the cost is high and the inconvenience real. Most shares are held in what are called nominee accounts, ledgers of pools of shares, where a company holds shares on behalf of many shareholders. This company links in with a company called Crest, which makes sure everybody ends up with the right number of shares and that all the transactions are recorded and cleared. It also makes sure the right people get the right dividends from the shares they hold.

While shares were once fancily designed certificates, still collected by scripophilists, they are now almost entirely simple computer records, like our savings and overdrafts.

Paper, however flimsy, is still a material object and people have a natural lust for things physical. Stamps, banknotes and share certificates are all still collected. People like and desire something physical, be it gold money or even paper notes rather than plastic ones. However, this yearning is overwhelmed by the utility of a digital environment. Cheapness and utility decide that digital wins over paper, be it money, mortgages or magazines.

Money, like digital E&T, is just information and freed up from a physical form that can flow fast and freely. Without the bounds of atoms the ability of information to travel at the speed of light is transformative.

As I write, the rise of cryptocurrencies and the blockchain is an example of how digitisation can change everything. Outside the digital domain there is no blockchain technology. Media enables, morphs and often defines the information it carries.

A board game is not a computer game. A movie on the media of TV is not the same movie played on  an IMAX cinema screen. Email on an iPhone is not the same as email on a desktop even if it is the same message. Media is the context of information’s content. As media shifts so does the metaphor.

Money on a blockchain will not be the same as money on paper or in your bank account, in the same way as E&T on your iPad will not be the same as E&T the glossy magazine. Fiat money is not cryptocurrency or the technology behind the enabling blockchain. In the same way that the goldsmiths created a new economic landscape with paper money, digital money is creating new opportunities.

Developments aren’t always for the better. For example, in a digital E&T I could be reading you this article via YouTube – and that kind of outrage needs to be avoided at all costs.

Clem Chambers’ new book ‘Trading Cryptocurrencies: A Beginner’s Guide’ is available now from Amazon

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