Payments innovation vs. Money innovation

Paypal. Square. M-Pesa. iZettle. Mobile payments. Mobile Cash. Barclays Pingit. These are some of the buzz companies that change the way we are going to transact. But these companies are disrupting only the payment space, which is a sub section of the social tool Money.

Money is a concept. It’s like Language. It’s not really possible to “innovate” the concept. Language is a social tool for communication, Money is a social tool for commerce. Currency is the thing that enables the use of the concept Money the same way words enable the use of Language. How do you transmit words from one person to another? Using your voice. Using a written documents. Etc. Telephone was an innovation that changed the way we can transmit words from one another. The text message changed the way we transmit words from one another. But neither the telephone nor the text message changes the concept of Language nor the words themselves. There was some change to words, for example the extensive use of shortcuts, like “how R U ?” etc. but these are minor modifications.

Money is like Language. Currency is like Words. And payment platforms are like the telephone or text messages.

Square and Paypal innovate the payment space. Bitcoin innovates the Currency space. Both Square and Paypal would be able to change the way we transact Fiat Currencies, and the way we transact Decentralised Crypto Currencies.

Money is Money is Money. It’s a social tool, it’s a concept that needs Currency in order to be operational in the real world. Currency is the technology, the infrastructure, the ecosystem to operate the concept of Money. Every Currency, Commodity Currency (Like gold), Fiat Currency (Like Dollar), or Decentralised Crypto Currency (Like Bitcoin) have many components, many parts of the infrastructure. Payments is just one part of this infrastructure.

 

 

“It’s the purchasing power, stupid”

What is Money? It’s a social tool to facilitate commerce at large scale. What is Currency? Currency, are chips / symbols, things that facilitate the use of the concept Money. Currency to Money is like Words to Language. Like building blocks to the concept of House. Currency are chips / symbols that represent…. represent what?

People will say that Currency units represent value, represent faith, represent some ownership of mysterious assets held by the government and back the Currency. Are they? The answer is much simpler. Currency represent purchasing power. Currency is just a ledger, an abacus, a sheet of paper with notes, signs on a tree that represent what I can claim and what you can claim.

Imagine that you and I are living on an island. We both work. We produce things that we need. We collect Coconuts. You work hard. You collect More Coconuts than me. Every day at 5pm we bring all the Coconuts to our warehouse and mark signs on a tree. On the left, you mark the Coconuts that you brought. On the right I mark the Coconuts that I brought. What we are doing is using Money! The marks are our Currency!

It’s a horrible Currency. It’s not Scarce because I can come at night and counterfeit more marks… it’s Fungible OK, because each mark is like any other mark… but it’s not really Divisible, I can’t easily divide each mark to smaller marks… it’s not Durable as the marks will disappear with time… and it’s not Transferable… if we leave the island we can’t really take the marks with us…

But it’s Currency. Whenever I feel like eating a Coconut, I go to the warehouse, take a Coconut and cross one of my marks. I used my Currency. This is obviously a simplification, don’t try to develop the analogy too much, but the idea is clear. What matters is that the marks on the tree represent the purchasing power I can command over the pile of Coconuts.

The same way the Dollars you hold represent the purchasing power you command over goods and services in the economy. The Dollars themselves are just signs, symbols, they are not part of the wealth. If you are stuck on an isolated island, one million Dollars won’t really help you… Money is a social tool, if you hold Currency, but there are no other people, then it’s useless.

People ask, well what about gold? Gold was used as a Currency and has an intrinsic value. People used if for decoration, to symbolise power, it’s a metal we use in industry, how can you say that Currency has no intrinsic value at all?

Well the answer is simple. In order to use the tool Money, people need Currency. You can’t speak without words, you can’t use Money without Currency. And you need something that is scarce, fungible, divisible, durable, and transferable. People use Gold, or sugar as Currency because they have these five properties to some extent. They don’t use Gold or Cigarettes as Currency because they have value, they use them as Currency because to some extent they are scarce, fungible, divisible, durable, and transferable. The Dollar is an invention, a very sophisticated one, a sophisticated technology that  produces tokens, symbols, things that to some extent are scarce, divisible, fungible, durable, and transferable and therefore can serve as Currency and operate the social tool Money in an economy. Bitcoin is also a technology that produces Bitcoins, Currency units that can and will serve as Currency to operate the social tool Money.

If you want to know if something is a Currency, try to think if it has, will have or had purchasing power. Don’t ask yourself if it holds any intrinsic value, if it can store value, or if anyone backs it. These are interesting questions, but not the right ones. And if you want to know what is the purchasing power of a Currency? What is the “value” of a Currency? What is the exchange rate and how is it been determined? Well “it’s the supply and demand, stupid” but this is for another post!

3 ways in which Bitcoin will change the economy

#1 Redistribution of wealth

Bitcoin is like digital gold. Early geeks adopting Bitcoins, risk taker investors buying early coins, thieves stealing unprotect wallets – they will all accumulate a great purchasing power while holders of Fiat Currencies and Fixed Income assets will lose their relative purchasing power in a great inflation. Not all the wealth in the world will be distributed. Only 5 percent of wealth is represented by Currencies. And since gold will be still gold, it’s a good assumption that a maximum of about 2.5 percent of the world wealth is likely to be represented by Bitcoins. The total world wealth is about 200Tr when denominated in 2013 Dollars, therefore, the total amount of Bitcoins will be probably worth a maximum of 5Tr 2013 Dollars (2.5% of 200Tr) which gives each Bitcoin a maximum purchasing power of about $238,000 in today’s Dollar terms (5Tr divided by the final number of 21,000,000 Bitcoins in circulation).

#2 Momentary pause in debt driven economy

Inflationary Currencies like Fiat Currencies encourage loan taking rather than saving. In an inflationary economy, the purchasing power of a Currency diminishes with time while in an deflationary economy it increases with time. People tend to confuse growth with inflation, but human progress is driven by ambition rather than by debt. In a deflationary economy people will be encouraged to save rather than to spend, but entrepreneurs will still try to change the world. The only difference will be that more value creating projects will be financed and less value destroying project will be financed.

Even in a deflationary economy, savings will generate a maximum of only 5% returns (increase in purchasing power rather than in nominal amounts) while value creating projects will generate higher returns. Therefore, investors are still better off investing in value creating project, it’s just that the scrutiny will be thorougher.

In an inflationary economy, even value destroying projects can be financed as they destroy less value than the value destroyed by the inflationary Currency. This is an absurd which need nothing but disappear (it will be back at some point when political powers find ways to devalue decentralised crypto Currencies, but it may take many years – that’s the way of the world).

#3 Shifting risk from retailers to consumers

One of the issues in today’s e-commerce economy is that most items are delivered before the Currency changes hands. This poses risks to retails that lose about 2-5% of revenues from bad debts.

Bitcoin transactions are direct and relatively immediate. As Bitcoin transactions are nonreversible, retailers are able to send products only after receiving Currency from customers and eliminate the risk of bad debt. 

Of course that the risk will shift to consumers that may lose Bitcoins to fraudulent retailers. But even though we hear more about rough retailers because their stories are sexier and we can empathy with the poor consumers, in actuality, the loss for the economy is way larger from fraudulent consumers rather than from fraudulent retailers. Furthermore, in a digital economy the reputational risk for fraudulent retailers is huge and any misbehaviours will drive retailers out of business. Fast.

The five properties of Currency (not Money…)

In order to use the social tool, Money, we need Currency. Currency to Money is what Words are to a language. But what could serve as Currency? During history, many different things served as Currency: cigarettes, salt, feather, gold, silver, stone disks, notes, coins, digital bits, and many more. Currency is things that serve as symbols. The same way the word “Table” symbolises a physical table so a unit of Currency symbolises value. If to use the measurement of length analogy, then one meter is the symbol that symbolises the physical property of one meter length. A ruler in this case could be the analog for Currency.

What are therefore the characteristics of a Currency, and what would be considered a good Currency verses Bad Currency? Well, Currency has to have the following 5 properties:

(-) Scarcity: final number of the symbols

(-) Fungibility: all symbols are interchangeable, commodity like. Symbol A is identical to symbol B, and vice versa.

(-) Divisibility: the symbols are easily divisible, so you can divide them to smaller and smaller portions

(-) Durability: the symbols can survive the test of time and weahther and won’t be worn out or disappear

(-) Transferability: the symbols can be easily transferred between owners

SCARCITY

Currency should be scarce. The amount of Currency you hold represents your purchasing power. The more Currency you have the more you are likely to be able to purchase. But this is a relative game. The amount of things that can be bought is final and equal the total wealth in the economy. All the Currency in the economy could usually purchase 5% of the wealth in the economy. So if you have a certain amount of Currency, you don’t want your neighbour to just find / produce / counterfeit more Currency since if he does, he would be able to purchase all the wealth and your purchasing power will diminish significantly.

Let’s demonstrate this property using the differences between the Currencies Gold (Commodity Currency), USD (Digital Fiat Currency), and Bitcoin (Decentralised Crypto Digital Currency).

Gold, Commodity Currency:  indeed scarce. Hard to find, hard to produce. Seems to be of final amount on earth, very hard to counterfeit.

USD, Digital Fiat Currency: not scarce at all. It is produced by the government / central bank and can be counterfeit by them to an infinite amount at any time (the root of hyper inflations)

Bitcoin, Decentralised Crypto Digital Currency: rare. Only 21 million Bitcoins will ever exist.

FUNGIBILITY

All the symbols of the Currency should be interchangeable. You shouldn’t care if you have one symbol or the other. In order to use the Currency, owners should not be attached to one symbol. Think about Words. You and I can use the word “Table” the word you use and the word I use are not the same thing as you pronounce the one and I pronounce the other, but both represent the same thing. 

Gold, Commodity Currency:  fungible. Gold is a very coherent commodity. You don’t care if you hold one portion or another portion.

USD, Digital Fiat Currency: fungible. All the digital bits are the same. All the notes, and the coins are the same.

Bitcoin, Decentralised Crypto Digital Currency: fungible. All Bitcoins are interchangeable, there are 21 million Bitcoins and they are all the same. Just strings of numbers. One string is exactly like any another string.

DIVISIBILITY

One of the biggest advantages of the Money system is that it can compare different things on an apples to apples basis, i.e. using a common denominator. It is very hard to compare cars and tomatoes, but it’s easy to denominate the cars in Currency terms i.e. $20,000 and the tomatoes in Currency terms i.e. $1 and then compare the two numbers. The same way the Currency symbols should be dividable to small units so that they can represent even very small things like a bus ticket, or a bottle of water.

If the Currency is not divisible it’s very hard to exchange items because it will not be easy to exchange the right amount of Currency with any goods and services in the economy.

Gold, Commodity Currency:  divisible but not easily. Gold is a soft metal and therefore can be divided, but not so easily. Dividing gold accurately requires the use of scales, etc.

USD, Digital Fiat Currency: very easily divisible. Every Dollar can be divide into 100 cents.

Bitcoin, Decentralised Crypto Digital Currency: infinitely divisible. Every Bitcoin can be divided into 100,000 portions to what is called a Satoshi. But the Bitcoin protocol can be extended to enable devision for even smaller portions of Bticoins.

DURABILITY 

Every Currency should survive the tests of time and weather. You don’t want to receive Currency and discover that it was dissolved, broken, or was worn out after a year. If you want to leave it to your family, you want it to survive the test of time and bad weather. You want it to stay constant.

Gold, Commodity Currency:  very durable metal. Can survive thousands of years and extreme weather condition.

USD, Digital Fiat Currency: 95% of the Currency is a digital bits and will survive as long as the network survives. Very durable Currency.

Bitcoin, Decentralised Crypto Digital Currency: 100% of the Currency is digital and will survive as long as the network survives. The network itself is decentralised and therefore is very hard to be destroyed. Very durable Currency.

TRANSFERABILITY

The whole concept of Money is based on people or entities that exchange Currencies between each other. Therefore, Currencies should be easily transferable from one person the another. Truth to be said, even if the Currency is very hard to be transferred like in the case of the Rai stones, the huge stone disks on the island Yap, it can still serve as Currency. In Yap, even though some of the disks couldn’t be moved, their ownership was transferred between individuals and / or families.

Gold, Commodity Currency:  not so easy to store and transfer. Most of the Gold is being held in huge vaults and the ownership is represented by legal documents.

USD, Digital Fiat Currency: easy to transfer. Notes and coins are pretty easy to transfer and in any case most of the Currency is held as digital bits which are very easy to be transferred by digital networks.

Bitcoin, Decentralised Crypto Digital Currency: easy to transfer. Every person with an access to the internet can transfer Bitcoins.

People confuse Money and Currency – it’s not the same thing!

Don’t confuse Money and Currency. It’s like saying that Language and Words are the same thing! Language is a social tool. It’s an abstract concept. Words are the things that comprise this tool. House is not the bricks and the windows, house is the whole thing.

Money is a social tool to facilitate commerce at large scale. How does this tool work? Well this is a little complicated, but to simplify:

(-) You define a unit – let’s say one Dollar

(-) You define a way to represent this units – let’s say physical green bucks, or green bits on a computer

That’s it. People exchange these bucks or bits because it’s easier to exchange them than to exchange sugar or cars or cheese and when they need something they exchange the bucks and bits with things that they need. They exchange the bucks and bits with a portion of the total wealth of the economy.

So Money is a concept, and green bucks and green bits are Currency. Currency is the thing that comprises Money . It’s like the Words in a Language.

Both US and China use the tool Money. And both use the type of Money that is called Fiat, but the US uses the Currency Dollar, and China uses the Currency Renminbi.

It’s important – don’t confuse Money and Currency. Don’t confuse Language with Words, it’s not the same thing!

The USD is the real Ponzi Scheme

People follow the Bitcoin development and wonder wether is’t a Ponzi Scheme or not. I follow the USD and wonder whether it’s a Ponzi Scehem or not.

The amount of Currency you have represents your purchasing power. The economy is full with things that we need (and sometime not really need) this is wealth. Wealth is owned by people, or entities, usually using a social tool that is called Law. In order to measure wealth we use another tool which is called Money.

Most wealth is not very liquid. If you take all the Currency in an economy you are likely to be able to purchase about 5% of the wealth. It’s a rule of thumb. About 5% of the economy exchanges hands on a frequent basis, the other 95% is owned by the same people or entities for a long time.

Think about a huge private company. It is not really tradable. You can’t really take Currency and buy part of this company. It’s not traded on any stock exchange. It’s part of the 95%. Think about Google shares, some of them are easily tradable on NASDQ, this is part of the 5%.

You can’t trade sugar with a Google share. You need a tool to facilitate it, this is Money. So all the Dollars in the world can buy probably 5% of the US economy. It’s a rule of thumb. What happens when there is more and more Currency in the system, can you buy more than 5% of the economy? Nope! This is exactly the tricky point, if you produce more Currency nothing happens to wealth, wealth is the same. Currency is not wealth, it’s a tool to exchange wealth between people and in its entirety represents by and large the ability to purchase about 5% of the economy. (If Money is Language and Currency is Cords, then sometime if you just talk and talk and talk it doesn’t really help to communicate better it’s just adding more words to the same message… it’s like printing Currency. More things to represent the same purchasing power to buy 5% of the economy, the economy hasn’t changed!).

To make it simple, if there are $5 is the economy, each Dollar can buy 1% of the economy. If there are $10 in the economy each Dollar can buy only 0.5% of the economy (5% / 10 = 0.5%) if there are 100$ in the economy every Dollar can buy 0.05% of the economy (5% / 100 = 0.05%). So if you have 1$ at first you could have bought 1% of the economy, then only 0.5% of the economy, and then only 0.05% of the economy. Got it? If the government prints more Currency, you are worse off! You should not hold Dollars.

But it takes time to take effect. All these Dollars are owned by Chinese, Banks, and the minute they will realise the Dollar is a bout to collapse they will buy assets like crazy, prices will rise, and your Dollars will buy less. But don’t worry, they can’t buy everything, told you, all the Dollars in the world can buy only about 5% of the Dollar economy, i.e. the US.

So is the Dollar the real Ponzi Scheme? Without getting into much of a definition effort, I would’t advise to hold all your wealth as Currency. Better stick to real assets, like gold, houses, shares in companies, or even Bticoins, they will maintain their purchasing power even if the government will print gazillion Dollars. A  house is a house is a house.

Why Money is not a store-of-value

The most common misconception about Money is that it is a store of value. Money is not a store-of-value. Money is a social tool. Try to make a mental experiment. Take an isolated island – will you find Money there? Probably not. Take an isolated island with one person – are you likely to find Money there? Probably not. Why?

If Money is a store-of-value then one person can use it to store value. He will work hard, accumulate things that he needs (i.e. wealth) and then will store them in Money. But it doesn’t make sense, isn’t it? Why? Because Money is not a store-of-value! Money is a social tool.

Take an isolated island with two people, do you think that you are likely to find Money there? Probably not. BUT, you may find Money there. Why? Because Money will help these two people to remember who entitled for what. They both work hard to create things that they need (i.e. wealth), but one worked harder and is entitled for more. But for how much more? How do you measure it? Not easy, but Money can help.

Take an isolated island with thousands of people. Are you likely to find Money there? Probably yes. In fact in 1903 an American anthropologist visiting the remote island Yap was amazed to see huge stone disks that served as Money, the Rai stones!

So on deserted island we don’t have Money. On an island with one person we don’t have Money. On an island with two people or an an island with thousands of people we do have Money. Conclusion, Money is a social tool.

But tool for what?

Money is one of the most misunderstood things is the world. We all use it. We all want it. But we don’t know what it is. (What we actually want is not Money. What we want is Currency, this thing that represents purchasing power in the real world).

Money is a social tool to facilitate commerce in large scale.

Money touches many other aspects of the economy, like denominating the value of things, or the value of financial assets. But it is not a store-of-value. Saying that money is a store-of-value is like saying that Language is the store of wisdom. It’s not. It’s just a tool for communication. It’s a social tool. Language and Money are social tools. Got it?

English and Chinese are Languages the same way Dollar and Renminbi are Money. A spoken Language and the Sign Language are a Languages the same way Commodity Money (i.e. feathers or gold) and Fiat Money (i.e. Dollar) are Money. But this is for another post.