Platt Perspective on Business and Technology

Considering the nature and qualities of money 3: regulating bitcoin and its peer currency alternatives

Posted in macroeconomics by Timothy Platt on January 18, 2014

This is my third posting to a series on money and on what monetary value functionally means (see Part 1 and Part 2.)

I stated at the end of Part 2 that I would “consider bitcoin and its peer currency alternatives, and regulatory oversight as it would be applied to them and their valuation.” And I begin that by at least briefly looking into the regulation and regulatory oversight of more conventional, nationally based currencies, and at Gresham’s law as its shapes monetary valuation. I begin with that.

Gresham’s law correlates the value of money: the buying strength of a unit of currency, with the amount of that currency that is in circulation at any given time, given the overall strength of the economy that backs it. More precisely, it correlates the amount of circulating currency with the overall market-driven and business transaction driven strength of the backing nation’s economy. A given unit of currency can be said to be backed by portion of that overall economic strength with that overall economic strength deemed to be evenly apportioned to backing each such unit of currency. So if the strength of the economy stays steady but the overall amount of its circulating currency drops (e.g. less currency is printed than is needed to for example, to replace worn out currency that is removed from circulation), then the value of each unit of that currency goes up from correlation to a larger overall portion of its supporting economy. If more currency is added into circulation, on the other hand, than would be needed simply to maintain equilibrium here, each circulating unit only covers a smaller share of the overall economic strength and the value of a unit of that currency drops proportionately in buying power and value too.

This is often colloquially stated as “bad money drives good money out of the market,” citing the specific context in which a government starts printing more money, expanding and even greatly expanding the overall amount of its currency in circulation – but without any matching overall growth in its economy or its economic strength to match and cover that monetary expansion.

Regulatory oversight and management of nationally based currency is largely about monitoring and managing the production of new units of currency, and both to manage the overall amount of currency in circulation, and to manage its value as a matter of realizable buying power. This, to allow a slight digression, involves controlling the production of new currency to at least closely match the rate at which old money is taken out of circulation. And it involves managing the form that legitimate currency takes so as to limit the impact of counterfeiting, where fake currency in circulation at least incrementally reduces the value of real currency that it is traded as a substitute for. During World War 2, Nazi Germany even mass produced counterfeit currency as a tool for destabilizing the economies of their enemies by reducing the perceived value of their money. They never really implemented this strategy but in principle at least, it could have caused a great deal of confusion and harm.

• I write here about regulatory oversight and control of more conventional national currency, and of formally accepted electronic scrip of the type that I wrote of in Part 2 – where monetary value is de fact tied proportionately to government backed currency and to economic strength.
• How would you regulate a privately issued currency like bitcoin, and how would this regulatory oversight correlate a metric of underlying supporting wealth with this money on anything like a per unit basis?

This brings me to a third basis for determining monetary valuation. I began with valuation of currency as backed by available reserves of some monetary value defining commodity (e.g. gold for countries that back their currency with a gold standard.) I then turned to consider fiat currencies that are backed by the overall economic strength of the issuing country. Now I come to the issue of trust.

Ultimately, a currency has value insofar as the citizens of its country and the participants in its marketplaces – its producers and consumers, believe that it holds that value. When the early United States government first began producing its Continental dollar currency, there was a popular expression, stated in disdain with regard to goods not deemed to hold value that “it’s not worth a Continental.” In Part 1, when I listed commodities that have been used to back the value of money, one of the historical examples that I listed was alcohol. The early United States saw that in the then newly formed state of Pennsylvania with the Whiskey Rebellion. This began as a tax protest in Western Pennsylvania against new taxes imposed by George Washington’s new federal government, but one of the reasons why this protest took the form that it did, was that so many people of Western Pennsylvania saw their new federal government’s currency as useless, that they began issuing their own – and backed not with gold as they did not have that, but with grain alcohol that they could produce.

Ultimately, the value of a currency resides in the trust of those who would use it. And this brings me to the key words that go into defining what a currency such as bitcoin is: it is a peer-to-peer backed currency (see Part 1: standard nationally-based and virtual money 1.)

I am going to continue this discussion in a next series installment in which I will discuss peer-to-peer as a basis of trust and of monetary valuation, and of regulatory oversight as it might serve as an organizing framework for that. I will then, as initially promised in Part 1, reconsider money as information, and more specifically as a form of rivalrous information. And in anticipation of that, I pose a fundamental question. Ultimately, and at the most fundamental level, what is needed to back units of information for them to meaningfully qualify as being money? Meanwhile, you can find this and related postings at Macroeconomics and Business.

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