On Electronic Money
© 10 Jan 2017 Luther Tychonievich
Licensed under Creative Commons: CC BY-NC-SA 3.0
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A look at checks, credit, and digital currency.


This is a continuation of the previous post which led up to the claim that money, be it backed by grain, gold, or nothing at all, is valuable precisely because those who have it trust that other people will want it.

Backed by Law

Most cash today is backed not by some physical commodity like wheat, silver, or gold, but instead by law.

Governments issue currency. That currency is supported by government promisses to accept it as payment for taxes, control its supply to avoid too much (or too little) inflation, and support cash-as-value in contract disputes, estates, reparations, and the like. There is often also an accepted mechanism by which the supply of cash can be adjusted, so that when the government decides that more money is needed in the system no one is surprised by where it appears. There are many things that can go wrong with such a system, but these guarantees are about the best that we have in giving us grounds to trust money today.

Some people are more comfortable with a less fluid backing for money, something like a precious metal or gemstone. Although the supply of such backing is more naturally limited, its actual value as a medium of trade is no different from paper money: we value gold not because it is useful Part of the reason gold is not useful is because so many people still think it is money and horde it or display it as outward evidence of wealth. If everyone agreed it was just another metal, gold’s intrinsic usefulness would be much more affordable and likely find many new applications. but because we trust others to value it.


From the base-line trusted value we derive various other trust-based carriers of value. When I give money to a bank, I receive in return a promise that my “‍bank account‍” has the value of the money I give the bank, a trust that is backed by the bank giving me cash in the same way the wheat bank in the previous post backed its notes by giving me wheat. And bank notes still exist, though we now call them cashier’s checks: little hard-to-forge pieces of paper that the bank promises to redeem for cash to anyone who has them.

But banks also give us another wrapper around value. I can write a personal check, which is my promise that the bank has promised me that my account is redeemable for money and that the bank will honor promises I make against that money in my behalf. It’s a bit like the classic “‍calling in a favor‍” idea: a check is a streamlined way of saying “‍bank, you know you owe me; pay some of what you owe me to whoever handed you this and you’ll owe me less.‍”

Balance transfers

The vast majority of the money that I “‍have‍” has no physical form at all. My employer’s bank tells my bank that I have been paid; I tell merchants to ask my bank for the money they say they owe me; the merchants are likewise paid bank to bank; and no paper money is ever produced As a random aside, a 53-foot US-style semi trailer, filled completely with $20 bills, can hold approximately 1.5 billion dollars. My current annual salary is roughly one gallon of $20s. . When I do give a wad of paper money to my bank, the bank can send it to the government to be recycled and can get back the governments’ promise that cash exits I don’t know the details of how banks turn paper into ideas, but I do know how you or I can do it, and likely often do do it: over-pay your taxes and then request a tax refund. In between overpayment and refund, the money exists only in the government’s collective mind. .

In many ways, this is all the correct, ideal form for money to take. Money is the trust we have that others will value the money; trust, as an abstract idea, has no obvious need for any physical form at all.

Pay by Plastic

Most small purchases I make are paid by credit or debit card. This is one place where trust seems to me to be rather strangely placed.

When I write a check, I tell the bank how much to give the holder of the check; I don’t let the person I am paying fill that in for me. I also only give the payee one check, and some effort has gone into making it hard to make a second check from that one. If someone asked me to pay for a purchase by giving them an entire checkbook of signed checks, I’d think them not just almost certainly a criminal, but an insanely naïve criminal.

And yet, when I give a merchant my credit or debit card I give them essentially that book of signed checks. I am, in essence, saying “‍Here’s how to get any money you want from my accounts; please don’t take more than I want you to have.‍” And, because people who do take more than they are supposed to have are sometimes noticed, reported, and prosecuted, most in person merchants do take only what I ask them to take and then forget about the information I gave them. Many online merchants remember the information, promising that they won’t use it until I ask them to.

Part of the motivation for the credit card model was the ability to pay even when off-line. Indeed, early cards only worked this way: the physical card was rubbed on carbon paper, the amount printed on it, and it was signed; the merchant then deposited this piece of paper much like it was an easier-to-forge check. As connectivity has improved this method of payment has become more rare, but I have had my card used for old-style credit card payments several times over the past decade.

I understand the rationale for credit cards and the legal safeguards against plastic overcharge, but I remain surprised that anyone trusts them. I’m even surprised that I trust them myself, though my actions unambiguously indicate that I do trust them.

Online “‍money‍”

There are various forms of online payment that are neither credit-card nor check based.

Money middle-men

PayPal is one of the most popular of the digital intermediary models. Merchant tells PayPal “‍I want $34.23‍”. Purchaser tells PayPal “‍Give this merchant $34.23‍”. PayPal verifies that the purchaser has the money to give, makes the transfer, and informs both merchant and purchaser that it has done so. At no point does the merchant learn the purchaser’s account information nor the purchaser learn the merchant’s. The entire transaction is as secure as the accounts themselves A limited statement, since accounts get hacked. It’s one of the most predictable things about online accounts.

Digital currency

BitCoin is one of the most popular of the “‍new backed currency‍” models. The backing, in BitCoin’s case, is distinct solutions to a strange mathematical equation. Ignoring a lot of details and taking a much simpler equation, if the equation were coprime integers for which x2 + y2 = z2 then the first person to say “‍Aha! x=3, y=4, z=5 is a solution‍” would earn a coin. no one else could earn that coin, but they could earn one for x=5, y=12, z=13.

When you find a solution you submit it as “‍yours‍”; assuming no one else found it first, you’d now have money. You could then spend that money by submitting a transfer request, giving the solution to someone else. Both claims of new solutions and transfers are sent to something like a distributed server, meaning basically the majority of the connected computers have to agree that something happened for it to happen.

Digital currencies suffer from many problems that make me hesitant to suggest them. They are backed, and backed currencies lack the flexibility that current ecenomic theories value. Their initial growth in popularity and value looks to me to be a classic “‍economic bubble‍” of fad-based speculative investment, and bubbles crash. I’m not expert, but it looks to me like their main basis of stability now is criminal backing. Just as governments demanding currency to pay taxes and contracts supports and stabilizes the entire currency market, so to online criminals’ demand for digital currency as payment for ransoms and blackmail seems to be supporting and stabilizing the entire digital currency market.

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