A Blog by Jonathan Low

 

Nov 27, 2014

Digitizing Value and Trust: The Future of Money

Happy Thanksgiving. When we celebrate all for which we should be thankful. But then there's tomorrow, when we start worrying again. About the future and what it holds. We worry a lot because we are less certain than we may have been in times past about, well, the fact that we are uncertain.

And we are uncertain because the past has taught us that little is stable and that for all the change we have experienced and the benefits technology has brought us, more appears to have flown to the few than to the many.

The good news is that this may yet change again. Optimism is in our DNA. But we are not as trusting as we once might have been because we have seen the rug pulled or the lights shut one too many times not to be just a teensy bit nervous about it. Which brings us to the future of money.

Money has already been digitized in many ways. We pay for stuff electronically almost without thinking. Our savings and bank accounts and investments are all digitally denominated, except for those who maintain safe deposit boxes or bury treasure in the backyard. And even they, having pulled the tangible stuff out, will almost certainly go online to determine the global market value of whatever they have squirreled away.

But even greater transformations may be in store (literally and figuratively) as what we value and how we assess its meaning to us is further transformed by the mobile and social world in which we live - and the economy that reflects that reality.

The future of money is going to be technologically driven and denominated, for sure, but as such, it is going to be more convenient, more accessible and, therefore, more democratic (note: small d). Which means more people may accumulate more of it. In order for this brilliant future to happen, though, there is going to have to be trust in the systems by which money is distributed, both technological and social.

All of which suggests that this technologically -driven money may actually be quite a bit more disruptive and even subversive than we have previously understood. Which is both the point - and the opportunity. JL

Greg Satell comments in Digital Tonto:

Digital currency represents a decentralized form of money that is more secure, more fungible and more functional than anything we’ve seen before.  More than a mere store of value or medium of exchange, digital money has the potential to be more transformative than anything we’ve seen before.
In the early 1970’s, the financial industry was transformed by a strange confluence of events.  In 1973, The Chicago Board of Trade opened the first options trading floor and, almost as if on cue, just a month later, the Nobel prizewinning Black Scholes options pricing model was published.
Soon after, Hewlett Packard came out with the first pocket computer small enough for traders to use on the floor and that, combined with a glut of engineering talent made available by the closing of the Apollo space program, created a wave of revolutionary change that is still being felt even today.
Almost overnight, finance was transformed from a clubby world of cozy relationships to a mathematical one of complex securities, abstract formulas and computing power.  Now, a generation later, the financial industry is about to be remade once again, except this time, it is not obscure financial securities that are being transformed, but very nature of money itself.
What is Money?
The concept of money dates back to the beginning of civilization.  The Israeli currency, the shekel, was originally a measure of weight (11 grams) and each shekel coin originally corresponded to that amount of silver.  Coins were stamped to certify that they contained the required weight, infusing transactions, even among strangers, with an element of trust.
It’s easy to see how money caught on.  It was a much more efficient way to transact business than bartering one good for another.  Money was also a useful store of wealth, certainly more convenient than livestock or grains.  These two core functions—a medium of exchange and a store of value—still define money today.
The nature of money changed after the Bretton Woods Conference in 1944, when most countries tied the value of their currencies to the US dollar, rather than to gold or silver.  When the US went off the gold standard in 1971, all currencies essential became fiat moneys, with their value derived from the governments that issue them rather than from commodities.
Many people object to the concept of fiat money because of the control governments have over it.  Central banks can increase or decrease the money supply at will, giving them enormous control over economic activity. In extreme cases, hyperinflation can ensue, debasing the currency and wreaking havoc.
So it’s not surprising that innovating the concept of money through a digital currency has been a recurring theme in technology circles.  Intuitively, it seems that the global financial system should be based on more than the judgments of a small group of central bankers. Yet only recently has digital money actually become possible.
A Mathematical Problem Of Trust
As Marc Andreessen points out in his excellent NY Times piece, the best way to understand digital currency is through the Byzantine Generals Problem. Imagine a group of generals that needs to coordinate an attack, but must do so only through intermediaries.  Clearly, trust becomes an issue, because of the possibility that their communication will be sabotaged.
One way of solving the Byzantine Generals Problem is by establishing a trusted third party—which is the role that governments and banks have traditionally played in financial transactions.  Yet a third party is not a true solution, because there’s always the possibility that the third party can be corrupted as well.  In effect, it merely assumes away the problem.
Another solution would be to create unforgeable signatures, which is what digital technology makes possible (digital signatures have been around for some time).  Moreover, in digital form, these signatures can be distributed—both instantly and ubiquitously—making it an ideal vehicle for an alternative currency to fiat money.
These types of currencies are called cryptographic currencies, the most famous of which is Bitcoin.  It works through a widely distributed digital ledger, which makes it not only super secure, but also incredibly efficient because payment processing is automatic.
Storing And Protecting Value
The most publicized aspect of Bitcoin is its function as a store of value.  Bitcoins can only be created by mining, which is done by solving complicated mathematical problems.  The supply of Bitcoin is also capped.  So no one, not even its inventor, can create unlimited Bitcoins. There’s no Federal Reserve or other central bank that can intervene.
This made Bitcoin supremely popular among Silicon Valley’s libertarian set who don’t trust government entities.  The idea of a currency impervious to debasement, ruled by algorithms instead of humans, has intuitive appeal.  Establishment figures initially feared Bitcoin for many of the same reasons.
Yet as it turns out, Bitcoin is not a particularly good store of value.  Its popularity led to a massive speculative bubble, rising in value to almost $1000 and then crashing down to under $400.  The truth is that algorithms are no better—and possibly much worse— at managing currency than humans are.
Further, it is unlikely that a digital currency will ever displace national ones like the dollar.  As long as governments have the power to tax, they have the power to demand payment in whatever form they choose.  Invariably, that will be a national currency.
Facilitating Transactions
While digital currencies are unlikely to impact national currencies’ role as a store of value, there is vast potential in using vehicles like Bitcoin as a medium of exchange.  Consider that Visa and Mastercard make over $30 billion per year in interchange fees and you can see the possibilities.  Bitcoin can do a far better job at a much lower cost.
Remember that Bitcoin has a widely distributed ledger, so it’s much more impervious to attack than a centralized institution like a bank.  It also transacts business instantaneously, so there is no “float” (i.e. the bank can’t keep your money in limbo while it earns interest on it) and because processing is automated, fees can be lowered substantially.
A recent article in TechCrunch describes another interesting aspect of digital currencies, the ability to program currency to create new financial products with functionality built in.  Imagine being able to set up an automated escrow account or a trust on your smartphone, with no lawyers involved.
Digital currency is still a very new concept and these are merely initial ideas.  Surely, as the market and technology matures, more useful applications will arise.
The Democratization Of Finance
Money has always been intertwined with centralized power.  Only governments could issue it and only banks had the resources to facilitate transactions.  That model worked well enough, but had obvious drawbacks.  Many were shut out of the system while others earned fortunes as gatekeepers.
The revolution underway in finance going on now has the potential to be even more consequential than the one that happened back in the 70′s.  While financial innovation transformed many practices in the industry, its institutions remained intact.  The financial world today is still lorded over by a relatively small collection of bankers, clearing houses and regulators.
Digital technology, however, is making finance exponentially more democratic. Crowdfunding and microlending have made it possible for people to acquire financing who never could before.  New payment systems like SquarePaypal and Apple Pay have made it easier for merchants to accept electronic payment.
Yet digital currency is something else altogether because it represents a decentralized form of money that is more secure, more fungible and more functional than anything we’ve seen before.  More than a mere store of value or medium of exchange, digital money has the potential to be more transformative than anything we’ve seen before.

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