A Crash Course on Digital Cash (Part 1)
We use a number of terms for what may seem to be the same thing: cash, money, currency, tender, and the list goes on. The nuances behind these terms are important when it comes to tokenized assets.
For clarity, these are my personal views as a private citizen and do not carry the endorsement or representation of any of my current or previous professional engagements.
Being in the business of driving change typically means that finishing a job is the very definition of success and a moment to celebrate. However, every so often there is an initiative that you really care about and therefore wish you could hold on to a little longer. Fnality is such an example for me, a remarkable company aiming to introduce a blockchain-based wholesale payment solution. This got me thinking about the journey so far and what is yet to come.
All currencies are equal, but some currencies are more equal than others.
We live in a world that differentiates between central bank money and commercial bank money. We use a number of terms for what may seem to be the same thing: cash, money, currency, tender, and the list goes on. However, when you look at your bank statement and think, 'Hey, I own this,' you're mistaken because what you have there is different from a scenario where you would be saying, 'Hey, I own this Frappuccino I just bought. So yummy!' These nuances are very important when it comes to tokenized assets. It's an urgent time for a crash course in 'digital cash language.’
Don't 'Half' to Tell Me Twice - I Won't Be Late
I have lived abroad for many years, but there is one particular thing about English that always confuses me: the dreaded word 'half.' Imagine having a pleasant chat with a friend who suddenly suggests, "Let’s meet for dinner tomorrow, say half seven." In English, this means half past seven. However, my German brain processes that information as only it can. Half seven surely means 6.30, as that’s how the term 'half' is used in German. Replace plans for dinner with the idea of catching a flight somewhere, and the dilemma of arriving either way too early or too late determines which of these two charming cartoon figures accurately represents me.
The scenario I described resembles a foundational question to a market based economy. It is the issue of ensuring that two parties can effectively agree on the terms of a trade and maintain records of what was agreed upon. This is a question of fairness as much as it is about efficiency. But it doesn't end there.
Stirring Up Solutions to Fix the Oracle Problem
In 500 BC, the King of Lydia faced a threat from the burgeoning Persian empire. Croesus, a well-versed business executive, decided to seek expert advice while exercising due diligence before choosing a vendor for his oracle problem (no, not this one). His approach was to send someone to ask each of the seven major Greek oracles a simple question in three months time: "What am I doing right now?" The oracle with the correct answer would win the mandate. Greek antiquity lacked a consistent calendar system, so ensuring the proper execution of this idea by the operations department required a clear process definition. This meant for his sales & relationship management team counting 100 days from the moment of departure from his palace. The only other point about this anecdote I want to mention is that the Oracle of Delphi's correct response was that he had chosen to cook a stew of lamb and tortoise. What an unusual way for a king to mark a special occasion. Did he forget?
The problems mythical kings face are not too dissimilar from the daily challenges of a banking professional in our time. Take something as simple as this example: two parties agree to enter into a loan for £100 at 10 percent interest per annum, for 3 months. Deciphering what that truly entails with precision to avoid disputes among the parties involved is the result of decades of work.
Let’s consider the loan covering three months: December, January, and February. Here's the exam question: How much interest is due for this period?
1 December 2023 to 31 December 2023 = 31 days
1 January 2024 to 31 January 2024 = 31 days
1 February 2024 to 29 February 2024 = 29 days
Hint: This totals to 91 days.
Reader: “So 10% times 91 divided by …one sec”
Me: Quick, quick - what is the right answer? Come on?? 😤😋
Counting days was not a successful strategy in ancient times. Croesus followed the Oracle’s advice and lost his kingdom. It's not enough to find the right solution this time either. The answer: it depends on the interest calculation method chosen. That wasn't so tough, was it?
And what does any of this have to do with digital cash? Absolutely everything. What do we mean when we talk about stable coins, cash tokens, and the like? Moreover, how do we ensure mutual agreement among counterparties and effectively manage disputes? More interestingly, however, is the question of what one can learn from thinking about digital assets from this perspective. Not in terms of day count conventions, but what is required to ensure a 'meeting of the minds' among the involved parties. This is what a contract lawyer would ask to determine whether contractual terms are valid. Without keeping this in mind when designing any kind of solution, the idea of a digital asset market will remain elusive.
Digital Alchemy is a real thing, actually
Crypto is often criticised for lacking intrinsic value. I don’t disagree with this observation, although I find many aspects of this debate confusing.
The term ‘intrinsic value’ formally entered economic theory in the 19th century to describe an intangible asset, very similar to the idea of what we call intellectual property. We can’t agree on much, but saying Bitcoin is an intangible asset, I think, wins the popular contest more often than not. Ironic, huh?
Financial theory came to know this term much later in the context of stock market valuation to explain differences between the market value of a stock compared to fundamental value. Talking about the fundamental value of currencies in the FX market, as bankers often do, is at odds with a strict interpretation of the origins of this framework dealing with securities portfolios.
And since modern ‘real world’ currencies are so-called fiat money, they have, per definition, no intrinsic value. Bitcoin and USD are both members of the same “we got strictly no intrinsic value” private club.
Let’s quickly rattle through a few counterarguments:
People may say: “Ha, what you didn’t think of was that a dollar gets you interest income. That’s a cash flow, you can discount that and that’s how we roll: intrinsic value sorted.” Good point! No, not really. Take a proof-of-stake crypto such as ETH, staking rewards can be turned into a cash flow. So why is it that no-one says at the very minimum ETH has intrinsic value?
“Hmm, ok, but there is a major difference still. A ‘real world’ fiat currency is backed by the central bank. Bitcoin is not. Case closed.” This is a fascinating statement because it is true. But it is also wrong depending on what one means by it. When a modern central bank backs its domestic currency, what does that mean in reality? When there was a gold standard, a banknote gave you the right to “demand immediate payment in bullion at a fixed conversion rate.” Those days are gone. Central banks perform very important tasks in terms of money supply and liquidity provisions. But you and I cannot demand it. So when it says on a £10 banknote issued by the Bank of England that you can demand to get paid £10, then they mean what they say. You can convert an old banknote to a new one at face value. So £10 are always worth £10. In the same way that 10 BTC are always worth 10 BTC, I may add.
“Yeah, but banknotes have issuers, BTC don’t, so..” Yes, exactly! That is indeed a very important difference. But the opposite of fiat money is intrinsic money. Saying a currency is backed is very different from saying somebody is issuing a payment instrument, say - V-bucks for the Fortnite video game - and is managing the infrastructure, i.e. making sure your online password works (FYI - I am not a gamer, so if this is outdated I apologize). A stable coin backed with real-world assets needs an issuer, as long as access to banking is subject to AML/KYC rules. Native cryptocurrencies without an issuer are more than just an anomaly in our current understanding of investments in financial instruments; they are the blue screen of death for modern financial theory. So, let's fix that; it has intrinsic value in doing so.
And here the whole debate becomes quite interesting. “Cyptocurrencies are not supported by a underlying asset and so have no intrinsic value,“ we learn. ETH has no intrinsic value. Backing a token running on Ethereum with ‘real world’ fiat currency, which has no intrinsic value either, turns an unbacked crypto into a backed crypto. How did this create intrinsic value? So have we found the philosopher’s stone to turn intangible assets into digital gold? Let’s delve a bit deeper into digital cash concepts and what they really are, shall we?
End of part 1
