digital currency

Journal of Payments Strategy & Systems Volume 12 Number 3

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Journal of Payments Strategy & Systems Vol. 12, No. 3 2018, pp. 213–231 © Henry Stewart Publications, 1750-1806

Digital currencies and the concept of money as a social agreement

Udo Milkau* and Jürgen Bott** Received (in revised form): 15th August, 2018 *Goethe University Frankfurt, 60323 Frankfurt am Main, Germany; DZ BANK AG, Platz der Republik, Frankfurt am Main 60265, Germany E-mail: [email protected] **University of Applied Sciences Kaiserslautern — Zweibrücken, Amerikastraße 1, Zweibrücken 66482, Germany E-mail: [email protected]

Udo Milkau is Chief Digital Officer, Transaction Banking at DZ BANK. He has a PhD from Goethe University, Frankfurt, and has worked as a research scientist at such major European research centres as CERN, CEA de Saclay and GSI. He has been a part­time lecturer at Goethe University Frankfurt and Frankfurt School of Finance and Management. He also chairs the Digitalisation Working Group and is a member of the Payments Services Working Group of the European Association of Cooperative Banks in Brussels, as well as a member of the Operation Managers Group of the European Central Bank.

Jürgen Bott is Professor of Finance Manage­ ment at the University of Applied Sciences in Kaiserslautern and a visiting professor and guest lecturer at various other universities and business schools. He studied business administration at the Julius Echter University of Würzburg, and statis­ tics and operations research at Cornell University. He received his doctorate from Goethe University Frankfurt. He has worked with J.P. Morgan, Deut­ sche Bundesbank and McKinsey & Company, and has been involved in projects for the International Monetary Fund and the European Commission. He continues to be an academic adviser to the European Commission.

AbstRAct The first appearance of digital ‘currency’ tokens fol- lowing the implementation of Bitcoin was a catalyst for discussion about the nature of money and the

future development of both fiat monies and central bank money. Indeed, the discussion today remains dominated by arguments concerning the definition of money and the role of central banks. However, ‘money’ must be understood as a social agreement between economic agents who confer legitimacy and value upon it by agreeing to accept it, both now and in the future. This paper presents a framework to understand money as a social agreement in the age of digitisation using four different mechanisms: game theory with tokens, market-driven development of account-based money, liabilities (of banks to their clients and central banks to commercial banks), and a trust-based mechanism for digital coins provided by a central institution. Any development of money in the digital age must consider its users’ perception of stability, security, convenience, freedom of choice and trust in its ‘reusability’. Complementing the current discussion within central banks, this paper considers how social dynamics in the 21st century might challenge the traditional definition and acceptance of money.

Keywords: digital currency, digital tokens, Bitcoin, nature of money, central bank digital currency

INTRODUCTION On one of the world’s oldest coins, the Phanos Stater, dated 625–600 BC, one can read the legend ‘Phanos emi Seima’ [‘I am the badge of Phanes/Phano’]1. One can assume

Jürgen Bott

Udo Milkau

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payments to hackers. Bitcoin also provides (technical) evidence for the thesis of Niklas Luhmann6 that trust is a mechanism to reduce complexity. The concept of Bitcoin with the probabilistic ‘proof-of-work’ con- sensus mechanism requires huge resources of computer power and electricity. A technical emulation of ‘trust’ has a price to be paid.

The latest step in the development — triggered by Bitcoin and the various deriv- atives of blockchain-based ‘coins’ — is the discussion about central bank digital cur- rencies, which was recently summarised in a speech by Agustín Carstens7 and a working paper published by the Bank for Interna- tional Settlements (BIS).8

As a complementary approach to the dif- ferent ontologies of money, this paper starts with a brief historical journey through the centuries to arrive in the digital age. In the 21st century, the majority money is already ‘digitised’ — from fiat money in bank accounts to ‘mobile’ money in closed-loop payments systems such as AliPay or WeChat Pay — although there is still cash in circulation. Based on a positive framework of monies, the different underlying social mechanisms of money in the digital age will be compared. Finally, the concept of money as a social agreement is applied to the question of central bank digital currencies.

A HISTORICAL JOURNEY OF MONIES IN EUROPE It is astonishing that the question ‘What is money?’ is still an issue of academic research. W.S. Jevons8 would have said that money is an economic lubricant and means to overcome the double coincidence of wants in agri- cultural economies based on barter trade. Money seems to be a null hypothesis of economic models: no advanced economy works without money — including the 20th-century communist economic ‘experiments’. One might also ask whether it was by chance that the innovation of the first

that the trust in prince Phanes’ or goddess Phano’s name (and power) was good enough to guarantee the innovation of early ‘cash’ in the form of this token. Although precious metals had long been used as ‘money’, the new idea of using a standardised coin as money, rather than weighing metal, required the trust provided by a social agreement. It also provides mankind’s earliest example of the duality of metallism and chartalism.

In modern times, coins and banknotes do not carry their material value literally. Today’s cash is a ‘token’ for a claim against a central bank and/or a government — depending on the institution which formally guarantees the currency — and its usage depends on an implicit agreement between all users that this type of cash will be univer- sally recognised both now and in the future. Should this trust regarding general accep- tance get lost, people will start to use the currencies of other countries, semi-privately issued coupons or even cigarettes as money. In the 1970s, Friedrich August von Hayek2 envisioned the idea of competitively issued monies with a liberal market-driven mech- anism so that social trust converged on a manageable number of monies in use.

Then Bitcoin was born. The original (game theoretical) concept3 of Bitcoin, published under the pseudonym ‘Satoshi Nagamoto’, provided an innovative solution to a (technically) insoluble problem, ie to create ‘electronic cash’ in an open peer- to-peer network without any kind of central intermediaries. Such networks are described as ‘trustless’ — to be understood in the sense of unknown network nodes between a sender and a receiver/beneficiary). Interest- ingly, Bitcoin did not develop into a competitor of existing currencies, but rather to a digital alternative of Hawala-like4,5 payment systems. Aside from speculation, Bitcoin is these days predominantly used for illegal money transfer, criminal money laundering, evading capital controls, pay- ments for darknet transactions and ransom

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money in the 7th century BC is coincidental with the Greek colonisation of the Eastern Mediterranean and the dawn of economic ‘globalisation’.

Peter Temin10 suggests that money played a rather modern role in the Roman market economy, where there was an advanced system of financial intermediation11 based on customer accounts, backed by a sophis- ticated legal system, where money was also the basis for tax collection. After a break in the late antiquity, Italian city republics such as Amalfi, Gaeta and Venice started to dominate Mediterranean maritime trade from the 8th and 9th century, joined by the North Italian city republics from the 12th century. These republics developed as ‘states of credit’,12 with money, typically provided by merchants, used as public debt.

Advanced double-entry book-keeping was developed during the 13th and 14th century in Northern Italy.13,14 In parallel, municipal deposit banks started to appear in the 15th century in Spain and Italy. The Taula de Canvi (the Exchange Bank of Bar- celona) was established in 1401 to solve local problems in the early banking and public debt system. The Taula de Canvi provided reliable payment services based on deposits of specie and subsequent money transfer from account to account, and was soon fol- lowed by Casa di San Giorgio in Genoa in 1407/8.15 A blueprint for this type of ‘ledger money’ was first proposed in Venice in 1356, but it took two centuries until the Venetian Banco della Piazza di Rialto was estab- lished in 1587. During the South–North shift of medieval trade centres, merchants had to solve the problems of long distance/cross-border trade in times of insufficient legal institutions. The solution was achieved with a bilateral settlement net- work backed by long-term relationships as ‘honourable merchants’ within a closed com- munity. The centre of financial innovation moved to the Netherlands, where the Bank of Amsterdam (Wisselbank) began operating

in 1609 as a public deposit bank on behalf of merchants.16 The Bank of Amsterdam guar- anteed ‘collateralised’ payment settlement in ‘bank money’ between account holders in time of war, plague, hyperinf lation and the Kipper- und Wipperzeit,17 when sovereigns and private mints began debasing currency to raise revenue for the Thirty-Year War.

A next step was the first issuances of paper banknotes in Massachusetts18 in 1660, by Stockholms Banco in 1661 and by John Law’s French Banque Générale in 1715 — followed by the related scandals. The idea of privately-issued banknotes continued with the episodes of so-called ‘free banking’ in Scotland (from 1716/1727 until suppressed by the Peel Act in 1845) and in the USA between 1837 and 1862, when private banknotes were allowed if ‘collateralised’ by deposits and/or governmental bonds, but failed for a number of reasons.19,20

Jumping to the 20th century, the change in the official definition of the dollar by the US government in 1976 removed the last references to gold. This change of paradigm to pure fiat money marked the end of the Bretton Woods international monetary agreement of 1944 and of the gold (exchange) standard.

In the 21st century, money finds new challenges. The current and still growing TARGET2 account imbalances, first dis- cussed by Hans-Werner Sinn,21 documented a new type of monetary tension in a system of central bank money. Last but not least, the recent development of ‘initial coin offer- ings’ questions the traditional understanding about the nature of a ‘coin’ from a new ‘digital’ perspective.

Since the industrialisation of the end of the 19th century and turn of the 20th century — a rather ‘mechanical’ — functional per- spective has been applied to define money, originating from Francis Amasa Walker’s22 quote, ‘Money is what money does’. Notwithstanding the long development of the concept of ‘money’, many ontological

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perspectives for the origin of money have been proposed: either from trade (with barter of precious metals) or from the point of view of chartalism (and especially Georg Friedrich Knapp’s institutional perspective23), which argues that money originated with governments’ attempts to pay sovereign debt, or from a pure legal definition of money (money as legal tender defined in governmental law). Money has also been described from a horizontal point of view as medium of exchange, unit of value and store of value, or as a vertical mechanism24 for credit generation, or from a central bank perspective according to the monetary transmission25,26 (see Figure 1).

In contrast to such ontological definitions is the concept of ‘money as social agreement’ developed during the last decade and discussed by, among others:

● Geoffrey Ingham27 (‘money as a social phenomenon’);

● Agustín Carstens28 (‘money is an indis- pensable social convention backed by an accountable institution within the State that enjoys public trust’); and

● Isabel Schnabel and Hyun Song Shin29 (‘Money is a social convention where one party accepts it as payment in the expecta- tion that others will do so too’).

With ‘money as a social agreement’, the perspective shifts from an intrinsic definition to social interaction between agents in an economy agreeing about an arrangement of ‘money’ in a certain economical and historical context. In this sense, ‘money’ is the result of society’s search for the most suitable economic lubricant.

THE DEVELOPMENT OF MONEY IN CHINA: THE SOCIAL PERSPECTIVE The social perspective can be illustrated with the development of money in China, which took another route but with com- parable problems. As Richard von Glahn30 elaborates, China did not start with the Aristotelian tradition of money with a material value (gold, silver), but regarded money as an artif icial ‘token’ of the rul- ing authority: coins were made of copper, bronze, brass and even iron during the

Figure 1: Schematic classification of money from the perspectives of ontology, function and technology

Technical Perspective

Fu nc

tio na

l P er

sp ec

tiv e

Distributed Ledgers (information technology)

Accounts (information technology)

Accounts (book keeping)

Ho riz

on ta l

(P ay

m en

ts)

Ve rti ca

l

(D ep

os its

/C re dit

) Cash (coins/notes)

Exchange/Barter Chartalism

Ontological Perspective

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various imperial dynasties. The Tang gov- ernment in the early 9th century allowed merchants to create the f irst forms of paper-based promissory notes ( feiqian, ‘f lying money’) to simplify long-distance trade payments (mainly tea). In Sichuan, the use of heavy iron coins inspired local merchants at the end of the 10th century to replace higher sums of ‘heavy’ money with paper money: the jiaozi, which was basically a certif icate for iron coin depos- its at a jiaozi pu ( jiaozi shop or deposit bank). Unlike in Europe, no precious metal was deposited; instead, privately- issued paper ‘tokens’ certif icated coarse metal ‘tokens’. The widespread misuse of those deposits lead to governmental regulation in 1005, the licensing of 16 merchant houses, and the standardisation of notes. In 1023, the new emperor issued a decree that his ministry alone could print off icial jiaozi. The off icial jiaozi money proved popular with Sichuan tea merchants and was often traded at a premium (agio). In 1107, jiaozi was renamed to qianyin, the ‘iron standard’ effectively ended, and qianyin became a modern f iat money in Sichuan until 1279. Similar development happened in other provinces during the Song dynasty, with merchant-issued paper money called huizi. Paper f iat money was not only used in commercial trade, but also for governmental tax payments.

During later fiscal crisis, the Song dynasty — and likewise the Jin, Yuan and Ming — fell prey to temptation with the printing press and ruined each type of paper-based fiat currency in China. During the times of the Mongol conquest in China, a transition to a ‘new money’ in the form of silver money on account31 — but not used as specie — happened first in North China and afterwards extended to the South. It culminated in the establishment of a dual paper-money system based on silver money on account and an actual circulating paper currency denominated in bronze coins but

linked to silver. After 1350, the issuance of huge amounts of notes by the government undermined public trust in state-issued fiat money. Silver specie (together with a renais- sance of bronze coins) emerged and in the Ming and Qing dynasties following the Mongol yuan, silver was the principle form of money. The end of paper money in China followed fiscal deficits and extensive money printing by the first Ming emperors, and paper money was abandoned in the 1430s. The development in China — from copper coins (‘tokens’) to paper-based fiat money to a silver standard — differs largely from the progression in Europe. This illustrates the sensitive relationship between fiscal policy and public acceptance of money, and highlights the possible alternative monetary concepts.

AN ALTERNATIVE FRAMEWORK FOR MONEY IN THE DIGITAL AGE With all those historical discovery pro- cesses to find a stable social agreement about ‘money’ in mind, and avoiding the danger of excessive ontology, a framework for money in the digital age can be derived with two dimensions:

● structure of interaction: tokens for ‘peer-to- peer’ transactions (without records of past transactions, but faith in future acceptance) versus accounts for long-term relationships (but with counterparty risk); and

● structure of network of social agents: decentralised private systems with typically closed-loop characteristics versus centralised systems with intermediaries in a hierarchical structure, such as central banks as hubs to facilitate interoperability.

Such a framework does not explicitly exclude inter alia cash in the modern form of a token without intrinsic value, but represents the liability of a central bank. Within this frame- work, central bank digital currencies could

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also be interpreted as central bank digital coins (or centrally-issued digital tokens). The framework of ‘money as social agreement’ complements recent analysis provided by and from the point of view of central banks (eg ‘money f lower’32) and is an alternative approach to the current discussion about digital currency-like tokens.

With the two dimensions of social agreements, money in the digital age can be classif ied into four categories (see Figure 2):

● tokens based on a game-theoretical approach with rational agents playing the game according to accepted rules with no additional information about each other: Bitcoin provides prototype example for

such electronic cash in (technically) ‘trust- less’ networks;

● privately-issued monies in competition for the market used by individuals with limited information: this could be either Hayek’s ‘denationalised money33’, or private currency-like ‘mobile money’ like AliPay or WeChat Pay in China;

● monetary agreements (‘currencies’) which are highly regulated and based on legal sys- tems with stable institutions: fiat money as a customer claim against commercial banks backed by commercial banks’ claims against central banks; and

● trust-based (digital) coins: the problem being whether other agents will accept those tokens as payment (and, with the example of the development of money

Figure 2: Illustrative classification of money in the age of digitisation

Account2

Token1

Decentralised (‘private closed-loops’)

Centralised (‘central banks as hubs’)

Liabilities (ie consumers’ legal

claims to fiat money on bank accounts backed by central bank money

and deposit protection by law)

Market (rational actors with

fragmented information3 in competitive situations eg for 'mobile money')

Game Theory (rational players

with no additional information;

eg in the Bitcoin concept)

Trust (in a situation with limited experience about other agents; eg that other

agents will accept a token as payment4)

1. for transactions with 'anonymous' coins without 'history' 2. for book keeping with claims versus liability and a counterparty risk 3. eg as discussed in Hayek’s proposal for a 'Denationalisation of Money' https://nakamotoinstitute.org/static/docs/denationalisation.pdf 4. taking into account historical cases, when 'official' cash was not accepted (from John Law default 1720 to the 'cigarette currency' time after WW-II) 5. cash as a hybrid, ie coins and notes without material value, but as liability of central banks 6. payment platforms (PayPal, AliPay, WeChat Pay et cetera) as closed-loop systems, but pre-paid in 'official' money from bank accounts 7. at least in theory, as Bitcoin token transaction are recorded with public transparency, but with pseudo-anonymity (no names, only addresses).

Money as a Social Agreement

5

6

Transaction based: peer-to-peer exchange believe in future acceptance anonymity7

Relationship based: record keeping future obligations counterparty risk

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in China, that the usage of ‘official’ tokens in transactions depends on consumer experience).

These four categories neither regard cen- tral bank money — a priori — as providing an eff icient, stable or desirable equilib- rium; neither do they reject private money due to the uncertainties associated with a market-based system. In the digital age, it is possible to implement money in any number of forms (see, for example M-Pesa, Air Miles etc). As Charles Proctor summarised in ‘Mann on the Legal Aspect of Money’:

‘Whether a particular asset or instrument constitutes “money” in the sense that it can be used as a means of payment must be determined on a case-by-case basis and may in part depend upon changes in banking practice and technological devel- opments; the nature of the instruments which fall within this definition may thus change from time to time. New forms of money may emerge as a means of payment as they gain a sufficient level of acceptance within the business world or the commu- nity generally’.34

From this point of view, any classification of a new digital means of payments must be made with a clear understanding about the overall economic context:

● Bitcoin, as the prototype of so-called ‘dig- ital currencies’, does not fulfil the tradi- tional definition for a currency35 (medium of exchange, unit of value and store of value) as it is not generally accepted, not used as a value of account and exhibits huge volatility. Bitcoin is also extremely inef- ficient due to the conceptual implemen- tation of the ‘proof-of-work’ probabilistic consensus mechanism, which requires huge amounts of computer resources. It is indeed used as a means of payments, but

primarily as a substitution for Hawala, tax evasion, money laundering and criminal finance. Only in states with failed monetary institutions, hyperinflation and/or governmental currency mani- pulation could Bitcoin could achieve real-world usage. In the rest of the world, non-criminal Bitcoin transactions are primarily speculative in nature.

● In states with established institutions, advanced legal systems and performing banks, independent central banks can guar- antee stable and functional currencies, and provide highly efficient and secure pay- ment systems. From a historical perspective, this assumption is more the exception than the rule; furthermore, state money can lose public acceptance when trust in the public institution is lost. As the historical exam- ple in China illustrates, the ‘voice of the citizens’ can act as a corrective, with trust reintroduced via alternative means of payments.

● In Sweden, the Riksbank is investigating whether it would be possible to issue a digital complement to cash (so-called e-kronas) to prevent the potential problems that could arise as the use of cash — as the legal tender — declines.36

As there are many other examples or possi- ble scenarios, the proposed framework can help to understand the social mechanisms that determine the various types of digital money.

SOCIAL MECHANISMS OF DIGITAL MONEY The public perception of digital tokens, most notably Bitcoin, and the underlying techno- logical tool-set (aka blockchain, although the ‘blockchain’ is neither a single tool37 nor is the term used consistently) is biased by headlines like ‘The Trust Machine’38 and ‘The Truth Machine’39 If the blockchain could actually generate ‘trust’ and ‘truth’,

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Bitcoin’s digital tokens would become the first money based purely on ‘neutral’ technology rather than social agreement.

Nonetheless, Bitcoin (and other digital tokens) represent only one of four possible types of digital monies with different social underlying mechanisms.

Game theory The blockchain technology — as intro- duced with Bitcoin — had one goal: to provide a pragmatic solution for the problem of ‘electronic cash’ in an open network, in which no central intermediary exists and in which the nodes are not reliable (nodes can come and go, could be manipulative, or can fault). The two well-known challenges are the Byzantine general problem (synchroni- sation of sender and receiver over a network of unknown nodes, ie in a ‘trustless’ net- work) and the double spending problem, that is, the possibility of replicating digital cash tokens as long as there is no central ‘time stamp’ service to distinguish between the (first) original and (second) copy. According to the Fischer-Lynch-Paterson40 theorem of ‘impossibility of distributed consensus with one faulty process’, it is not possible to resolve this problem within a finite time.

The Bitcoin approach provides a work- around for this technical impossibility with a game-theoretical approach. In the non- cooperative repeated ‘game’ of Bitcoin, it is more benef icial for rational players to follow the rules than to cheat.41 This solution comes with a whole number of conceptual limitations. As Bitcoin is based on a probabilistic consensus mech- anism, there is no ‘truth’, just asymptotic eventual consistency.42 Additionally, the Bitcoin system does not provide ‘digi- tal vaults’ for the users to ‘store’ Bitcoins individually, but rather provides a record with multiple decentralised facsimiles, in which all transactions are recorded for

everyone to see (ie antagonistic to parallel computing with best usage of resources in a network).

In reality, the development of the Bitcoin system has revealed the instability of this approach. The development shows a signi- ficant ‘recentralisation’ jeopardising the original vision. The network resources43 required for the consensus mechanism are dominated by a few so-called ‘mining pools’, which act as rent-seeking entrepreneurs (with a strong incongruity between the required energy consumption for individual rents versus a socially/environmentally opti- mum of resource allocation). The volume of Bitcoin in circulation is very concentrated, with about 90 per cent of all Bitcoins held in 1 per cent of the active wallets; this is atypical for a means of payment and enables the possibility of market price manipula- tion.44 The governance lies in the hands of few self-proclaimed ‘core developers’, who ‘regulate’ any change. Bitcoin has decom- posed from the concept of peer-to-peer electronic cash to an onion-like payment system (users with wallets — exchanges — mining pools — core developers). The technological limitations of blockchain were finally exposed in May 2018, following the first successful ‘51 per cent attacks’ on two minor coins, demonstrating a vulnerability in the consensus mechanism that was previously considered theoretical. An attack with at least 51 per cent of the network’s ‘hashpower’ accomplished a double spend attack on Bitcoin Gold, while Monacoin in Japan suffered from a block withholding attack after one miner achieved 57 per cent ‘hashpower’. Agustín Carstens summarised trenchantly:

‘while perhaps intended as an alternative payment system with no government involvement, it has become a combination of a bubble, a Ponzi scheme and an envi- ronmental disaster. The volatility of Bit- coin renders it a poor means of payment

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and a crazy way to store value. Very few people use it for payments or as a unit of account’.45

Likewise, other blockchain technologies have mutated into cloud computing plat- forms. On the Ethereum platform, for example, users can run computer scripts (so-called smart contracts) and have to pay the miners (ie the providers of the resources for the consensus mechanism) a fee in an internal currency called ‘gas’, which must be procured in advance by exchanging ‘ether’ (ie ‘coins’ in Ethereum) or dollars, euros etc. From a banking point of view, this operat- ing model can be described as commercial outsourcing of processing, but to unknown operators. Recently, the Ethereum platform became a factory for ‘initial coin offer- ings’ (ICO) based on the Ethereum’s ERC20/ERC223 definition regarding the issue of secondary ‘tokens’ — whether those tokens be for lunch vouchers, circumvent- ing security regulations, or scams of one description or another.

Finally, any change to the Bitcoin system as a balanced compromise of different tech- nological requirements is always a trade-off of between improvements against deteriora- tions and the original concept. To this end,

the present paper uses ‘Bitcoin’ as an arche- type for digital tokens, all of which have assumptions and limitations. Whether dig- ital tokens like Bitcoin, Ethereum or other ‘coins’ represent a new type of asset and ref lect a (real) value beyond pure specula- tion is a fine question, but outside the scope of this paper.

Market-based mobile money Mobile services like AliPay or WeChat Pay started from very different origins, but con- verged to a model that could be called ‘mobile money’ or money-type instruments.46 These systems work with registered participants, typically take deposits to load user accounts (like the deposit banks of the 17th century) and provide convenient user access (like jiaozi/huizi) primarily from mobile devices. Although the accounts of these non-banks are denominated in domestic currencies, the closed-loop nature of the systems and the almost direct substitution for cash allows them to be classified as ‘mobile money’. The market-based characteristics of mobile money compared with other types of money and/or means of payment can be illustrated by a recent study into the different means of payment at POS in the metropolitan regions

UnionQuick (0.7%)

Prepaid (4.6%)

Others (0.6%)

Cash (17.8%)

Debit Card (10.4%)

Credit Card (9.6%)

AliPay (39.5%)

WePay (16.6%)

Figure 3: POS pay­ ments in China with ‘mobile money’, ‘electronic money’ and ‘paper money’

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of Shanghai, Peking and Hangzhou (see Figure 3).47 The results show competition at the POS between mobile money, card payment in fiat money and cash issued by the central bank.

It is worth noting that the situation is quite different in Japan, even though Japan is often seen as a technologically sophisti- cated country. According to the Japanese Ministry of Economy, Trade and Industry, just 18.4 per cent of payments in Japan were made without cash in 2015; this is expected to increase to 40 per cent in 2025.48 Likewise, mobile money in the USA and Europe is yet to enjoy the same status as it does in China. Both e-commerce payment systems like PayPal (USA) and iDEAL (Netherlands), as well as peer-to-peer pay- ment systems like Venmo and Square Cash (both USA) and Swish (Sweden) are still rather traditional payment schemes based on money-on-account, and do not provide the alternatives to cash that one can f ind in China. Only Safaricom’s M-Pesa49 in Kenya (started in 2007; with minor expansions to other African countries) is in any way comparable to mobile money in China. One explanation is that when the prolif- eration of smartphones began in the late 2000s, both China and Kenya still had an underdeveloped banking system where the majority of citizens were non-banked. Nonetheless, this hypothesis does not answer suff iciently why other countries with similar situations in Sub-Saharan Africa or South-Eastern Asia have not followed the same path.

The development of mobile money is driven by the digitisation of user access but is denominated in official currency (although there are also loyalty systems, such as Air Miles etc). This does not disprove Hayek’s idea of a ‘denationalisation of money’.50 Hayek started from two positive questions: a long-term historical perspective (including the problem of state money in the Middle Ages) and a short-term historical perspective

(with his opinion that a ‘Euro’ currency would be utopian). He advocated a system of private monies, in which private institu- tions compete for user acceptance according to what the users value most. Although he assumed that users would favour the cur- rency with the greatest stability, the current market suggests that convenience is the key selection criterion between mobile money, cash and electronic bank money.

Liability-based money in the age of digitisation It is well known that Milton Friedman did not share Hayek’s position. Indeed, he argued that51

‘a moderately stable monetary frame- work seems an essential prerequisite for the effective operation of a private market economy. It is dubious that the market can by itself provide such a framework. Hence, the function of providing one is an essen- tial governmental function on a par with the provision of a stable legal framework’.

Nevertheless, Friedman did implicitly pre- sume that only government (or independent central banks) can provide long-term stabil- ity. Together with Hayek, he did not discuss other decision criteria, which could inf lu- ence users in their decision to accept and/or select monies.

Given the right conditions for a well- performing central bank system, the existing model of electronic money combined with bank money backed by central bank money plus deposit protection as a chain of liabilities is highly efficient. As this was analysed in detail, including a discussion about interest, risk and financial stability, in a recent BIS paper8 about central bank digital currencies, the present work will refer to that analysis and only point to one additional issue: the ramifications of real-time payment systems for electronic money.

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The combination of SEPA Instant Payments52 and Eurosystem’s TIPS (TARGET Instant Payment Settlement53) will result in a new ‘digital’ benchmark for electronic money. This will initially enable transactions of up to €15,000 to be completed in under ten seconds, 24/7, 365 days a year. Transfers will also benefit from bidirectional syn- chronisation, irrevocability and immediate settlement in central bank money. Although customers’ money will stay on commercial bank accounts, the permanent transferability with settlement in central bank money emulates direct access to ‘digital base money’. Assuming the existence of independent central bank together with legal system and deposit guarantee schemes, the combination of SEPA Instant Payments and TIPS estab- lishes a benchmark for ‘digital currencies’ against which any other proposal must be measured.54

Another current example of the attrac- tiveness of ‘real-time money’ is the rapid adoption of Swish, the Swedish real-time payment system. Swish started as mobile-to- mobile application, but has been available at POS since March 2018, with mobile-to- POS Swish transactions accounting for 30 per cent of transactions among participating merchants by May 2018.55 The UK Faster Payment system (launched in 2008 and focused on account-to-account electronic payment, with transaction limits increased to £250,000 in 2015) has enjoyed a similar experience, as has the New Payments Platform Australia (launched in February 2018 to provide consumers, businesses and government departments a platform to make fast, versatile and data-rich payments). Meanwhile, Nordic banks are planning to launch the integrated, real-time P27 payment project (named after the 27 million citizens in Sweden, Norway, Denmark and Finland), which will build on the success of smart-phone payment applications like Swish, Vipps in Norway, and MobilePay in Denmark. In the USA, the situation is more

fragmented: The Clearing House — the banking association and payments company owned by the country’s largest commercial banks — launched a real-time payments system in 2017, while the Zelle P2P payment network operated by Early Warning processed more than 320 million transactions in its first year.

When one considers this benchmark and the convenience of electronic real-time pay- ments, many of the current proposals to fix the deficits of the Bitcoin system56,57 simply prompt questions about its tangible benefits, not to mention the academic challenges. In the long term, however, the pool of creativity and the dynamics of open source development will undoubtedly drive technical developments in financial services and especially payments.

The question of central bank digital coins and trust in peer-to-peer transactions In the words of Niklas Luhmann: ‘We are now in a position to formulate the prob- lem of trust as an advance payment … Additional chances of a more complex rationality would arise, if I were to place my trust in a given future course of action of others’.58

When one accepts a token as ‘money’ now, it is impossible to know whether other agents will likewise accept it as money in a future transaction, as all other agents are free to decide. One’s decision must be made in the present, based on one’s ‘trust’ that other agents will behave cooperatively in the future. Accepting a centrally-issued token with no ‘memory’ (ie no account-keeping with legal liabilities) as ‘money’ does not mean trust in the central issuer, but primar- ily trust in one’s peers that they will accept these tokens in an uncertain future. As the historical example of China illustrates, the users of money can nullify an official token by switching to an alternative (in this case, silver) should the long-term trust evaporate.

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A further example of ‘experience-related trust’ can be observed in the Nordic coun- tries between 2001 and 2016.59 At the start of this period, the cash-to-GDP ratio in Sweden and Norway stood at 3–4 per cent, dropping below 2 per cent by 2016; Den- mark, meanwhile, stayed relatively constant at 3.5 per cent; in Iceland, however, the banking crisis prompted a steep rise from 1.2 per cent in 2001 to about 2.5 per cent in 2016.

CENTRAL BANK DIGITAL COINS FROM THE USER’S PERSPECTIVE Given the social mechanisms of digital money, the current discussion about central bank digital currencies suffers from a rather technological perspective. This is not the first time that an innovative ‘money’ tech- nology has been introduced without taking the user’s perspective into account.

In Germany, for example, the ‘Geldkarte’ — a debit card with a loadable chip — was developed in 1995 and rolled out from 1996. From the outset, however, neither merchants nor consumers showed strong acceptance. Indeed, the Geldkarte’s success was largely limited to parking meters and cigarette machines. None- theless, this chip-based technology with pre-loaded money was the f irst technical equivalent to cash, and due to the direct link from the Geldkarte to the payment terminal, was highly eff icient for small- value transactions. Nonetheless, technical feasibility is no guarantee of success.

On the other side, digital coins like Rip- ple’s XRP demonstrate how ‘coins’ may be generated in advance and introduced in the market as needed. This can be likened to the anticipatory printing of banknotes as ‘printed paper’ in the vaults of a central bank, prior to their release as legal tender. That said, Gary Gensler, the former Chairman of the US Commodity Futures Trading Commission, has argued that XRP should be classified as

a form of securities on account of the way the coins are originated.60

In summary, the following observations should be noted:

● Technical feasibility does not imply economic meaningfulness and/or user acceptance.

● A ‘coin’ is not necessarily ‘money’. ● Central bank money for the public has always been a token, whether a physical coin, a ‘paper’ banknote or even a digital string of zeros and ones stored on a chip.

● Central bank money for wholesale inter- bank operations is digital money on central banks’ accounts.

Complementing the mission of (indepen- dent) central banks, the notion of money as a social agreement leads to three questions: What is the ‘unit of account’? Does the con- sumer consider the token convenient? What is the consumer’s choice concerning conve- nience in their daily use of the token? What do consumers trust that other agents will accept as ‘money’ in the future?

Even in Germany prior to the euro, the average citizen had less ‘trust’ in the abstract albeit sophisticated monetary policy made in Frankfurt than they did in the tangible Deutsche Mark in their pockets, and that said Deutsche Mark would continue to be accepted by all other citizens and merchants in the future (unlike during the hyperinf lation of the 1920s or the postwar Währungsreform). Understanding money as a social agreement, any ‘digital’ coin must provide sufficient ‘tangibility’ to carry trust in an ‘intertemporal’ usability in the future.

THE OPEN QUESTIONS OF ‘TOKEN-BASED MONEY’ The first question is whether any digital token can provide the necessary ‘tangibility’ to provide a basis for social agreement. This is question requires more research about the

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social and socio-psychological requirements that would qualify a (central bank issued) ‘digital’ coin as such an ‘analogue’ carrier. While gold and silver (and even cigarettes following the Second World War) provided a mutual understanding of ‘long-lasting value’, no experience is available about digital manifestations of social agreements.

The second open question asks whether in the future a ‘digital community’ might favour digital tokens to traditional concepts of money. According to the game- theoretical approach of the blockchain, no token can provide ‘trust’ or ‘truth’; however, the current public discussion about ‘blockchain as a trust machine’ is a proxy for the contemporary desire for ‘trust’ or ‘truth’ in today’s world of volatility, uncer- tainty, complexity and ambiguity.61 A world without complexity — as in former times of tribes and simple relationships — may seem desirable to many people. The visions of the blockchain — not the technical capabilities, but the discussion in public media — promise a world in which ‘Code is Law’ makes it easy for people those uncertainties. Lawrence Lessig warned against this in 2000: ‘We will miss the threat that this age presents to the liberties and values that we have inherited. The law of cyberspace will be how cyberspace codes it, but we will have lost our role in setting that law’.62

Neha Narula, Director of the Digital Currency Initiative at MIT MediaLab, picked up this idea, but without the warn- ing, commenting: ‘I think much of this technology will resist being regulated in the current regulatory paradigm, or might require completely different types of regulation; sometimes, regulation is built into technology’.63

Meanwhile, Primavera De Filippi and Aaron Wrightwrote have commented that: ‘With blockchain, people can construct their own system of rules or smart contracts, enforced by the underlying protocol of a blockchain-based network. These systems

create order without law … as lex cryp tographica’.64

This description defines an ideal world that runs like clockwork, without errors, misunderstandings or limited knowledge. Such an approach excludes all social developments and decisions of human economic agents under uncertainty. History has demonstrated that no type of ‘technol- ogy’ used for money (minted metal, printed paper, public bank accounts etc) has succeeded without social agreement, and none has been infinitely sustainable (indeed, many have failed quickly). Besides the ques- tion about the operating model (against the background of Bitcoin’s re-centralisation to rent-seeking mining pools), the vision of a lex cryptograpghica f loodlights a road to a future when humans live in a perfectly predictable world with no need for free, individual deci- sion making, and trust is no longer required for complex social agreements. While the functional features of central bank digital coins are already in discussion, the question of ‘trust’ in a digital world — and the ques- tion how central banks can provide ‘trusted digital coins’ — goes beyond the current discussion and requires more interdisciplin- ary research.

CONCLUSION In developed countries, the predominant types of money are central bank money (coins and banknotes, together with reserve balances at central bank accounts) and fiat money in form of transaction balances on commercial bank accounts. The appearance of digital tokens (a better term than ‘crypto- currencies’, as many of today’s tokens demonstrate little in the way of ‘crypto’ or ‘currency’) was a catalyst for discus- sion about the nature of money and future developments.

A historical perspective reveals that the modern arrangement with central bank money has generally proven quite stable

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(at least for the leading currencies such as dollar, euro, yen, sterling or renminbi, but less so for minor currencies such as the Venezuelan bolivar, which has been recorded as trading 6.8 times lower than the in-game currency used in the ‘World of Warcraft’ game65). As Agustín Carstens has summarised: ‘Histor- ically, fiat money was at best a temporary war expedient and at worst a breach of trust. Today, institutional credibility grounds price expectations, not gold’.66 Historically, episodes of instability were locally focused. However, recent proposals by populistic politicians67 to introduce parallel currencies in Europe (for example, so-called ‘Mini- BOTs’ for ‘Buoni del Tesoro’) might trigger concerns about future developments.

To complement the central banks’ per- spective, a framework of ‘money as a social agreement’ was introduced to include the potential alternatives of crypto tokens, market-based mobile money and central bank digital coins in the digital age. Both these new developments and real-world experiments show large ambiguity. On the one side, Bitcoin has mutated from an idealistic, non-hierarchical vision with a game-theoretical foundation to a centralised, Hawala-like payment systems, while on the other side, global (non-bank) tech platforms have provided successful money-like instru- ments in a new combination of ‘mobile money’ denominated in official currency as the unit of account.

These different forms of ‘monies’ compete in a complex and non-equilibrium development, which depends strongly on the scope of the ‘market’. The situation at the Chinese POS differs from the SEPA area with the roll-out of SEPA instant payments and from the competition within informal money transfer systems like Hawala. Inter- estingly, recent research has shed some light on the competition between Bitcoin and newer (even more opaque) digital coins: with Bitcoin gaining much speculative interest, illegal activities have shifted to

newer substitutes.68 While first models are available,69,70 more research and a compari- son of real developments versus theoretical models is required.

None of these new types of ‘money’ is fully described in traditional textbooks about money and payments. However, this new development in the digital age ref lects Eugene Fama’s71 ideas vis-à-vis separating the medium of exchange and the medium of account. The current ‘digital’ development scrutinises traditional ways of thinking and considers old questions in fresh light.

Historical experience and recent devel- opments have one thing in common: the real value of money does not arise from any technology (whether minting coins from precious metals or ‘mining’ Bitcoin in a ‘trustless’ network of rational agents). The fundamental question is whether the money we accept now will be accepted by someone else in the future based on an intertemporal social agreement independent of any defi- nition of ‘legal tender’. Any development of money in the digital age must be evaluated from the perspective of people’s perception of stability, security, convenience, freedom of choice and trust into the ‘reusability’ of money in an uncertain future.

Within central banks, the discussion about central bank digital currencies is cur- rently conducted within the context of those banks’ defined mandate. Recent deve lop- ments can be summarised as follows:

● Yves Mersch (European Central Bank) suggested that: ‘virtual currencies are a misnomer in the first place. They are not money, nor will they become money in the foreseeable future … But this can change’.72

● Benoît Coeuré (European Central Bank) argued that: ‘financial structures should be the outcome of market forces. They should be driven by consumer preferences and technological change, and constrained as needed by regulation, including anti- trust law’.73

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● Masayoshi Amamiya (Bank of Japan) pointed to the issue that: ‘The issuance of central bank digital currencies could also affect such a role-sharing structure for utilising information’.74

● Lael Brainard (Federal Reserve Bank) highlighted the vulnerability of technical blockchain systems with an onion-like infrastructure (fraud, hacking, errors) in comparison to the resiliency of distributed computing (Byzantine fault tolerance).75

● Yao Qian (People’s Bank of China) argued that in the long run, any digital currency issued by the Chinese central bank should include certain key cryptocurrency features.76

● Jack Meaning et al. (Bank of England) described account-based central bank digi- tal currencies as ‘electronic narrow money’ from the perspective of their impact on the monetary transmission mechanism.77

● Michael Kumhof and Clare Noone (Bank of England) discussed the balance sheet implications of central bank digital currencies.78

● Øystein Olsen et al. (Norges Bank) exam- ined the situation in Norway: ‘when cash usage declines, a central bank digital currency can be an alternative to deposit money. The primary purpose of a central bank digital currency is to ensure confidence in money and the monetary system … However, the working group does not consider DLT to be a relevant technology for a central bank digital currency in the near and medium term. The technology is generally immature’.79

Meanwhile, ‘private coins’ are typically linked directly to national currencies such as the dollar, yen or euro as collateral. Recent developments can be summarised as follows:

● For Japan, it was reported that Mitsubishi UFJ Financial Group would test an own digital currency ‘MUFG Coin’ linked 1:1 to the Japanese currency as early as 2019.80

● Digital currency start-up Circle raised US$110m in an investment round led by Chinese coin-mining hardware giant Bit- main Technologies. Circle announced that its ‘Circle USD Coin’ would be backed by US dollar reserves.81

● The Utility Settlement Coin was proposed by major global banks with the aim of tokenising central bank money82 for deliv- ery versus payment.

● Lipton et al. (Massachusetts Institute of Technology) proposed the ‘MIT Digital Tradecoin’.83,84

Note that the above lists do not include the various experiments made by central banks with blockchain as potential technological alternative for current payment systems.85–91

Social dynamics in the 21st century may challenge the fundamental social agreement about money as people long- ing for easy answers such as ‘code is law’. In times when public trust may drift to technology instead of institutions, a new basis for money as a social agreement might be discovered outside the text- books. In the absence of a simple answer, the discussion about central bank digital currency/coins is central to any future understanding of the nature of money. As Mark Twain and Charles Dudley Warner wrote back in 1874: ‘History never repeats itself, but the kaleidoscopic combinations of the pictured present often seem to be constructed out of the broken fragments of antique legends’.92 The more we under- stand the dynamics of money, banking and central banks,93 the more important the promise ‘Phanos emi Seima’ becomes to any discussion on the def inition of money.

ACKNOWLEDGMENTS The authors thank the anonymous reviewers and Ritva Tikkanen ( Justus-Liebig- University Gießen, Germany) for valuable comments.

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AUTHORS’ NOTE The views expressed in this paper are those of the authors and not necessarily those of the organisations mentioned.

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