Walking to the office this morning it struck me that the evolution of (physical) currency in relation to payments could show us the long term development of digital money as well:
The changing manifestation of the money (certificates => banknotes) went hand in hand with more efficient payments for payer and payee. We first put two technical facilitators – money offices, together with the clearing and settlement of positions between the money offices and their certificates (representing the value) – in between the payer and the payee. Then step by step the currency has been developing until at a certain moment in time the transaction could be done directly between the payer and the payee without the money offices being part of the individual transaction.
NB Read also: “From Barter Trade to Bitcoin in 5 Logical Steps” for an introduction of the evolution of money.
The changing manifestation of the electronic money (i.e. personal certificates => digital money) will go hand in hand with more efficient payments for payers and payees alike. As with the physical transactions many roles and functions executed by the parties involved in the traditional electronic payment chain will remain relevant but not as part of the individual transaction any more.
Money held outside of the bank
Let’s zoom in on the evolution of certificates into today’s banknotes first. (NB I am not going to try to be historically super correct for I will be simplifying and condensing heavily as I am trying to establish a pattern.)
Long ago when somebody wanted to transfer a sum of money to somebody else they could only bring it in physical (coins of) gold. Pretty hazardous, making transfers high risk and inefficient.
Step 1) Beneficiary based certificates (bill of exchange)
A system of money offices was set up – what we now would call banks – were the gold could be deposited for safe keeping. The invention came when you could have your local money office issue a certificate in name of the beneficiary who then could collect the money/gold at a specific local money office. The money offices kept note of their transactions and netted their positions amongst each other. The certificate only had value to the specific beneficiary („beneficiary based”).
Step 2) Bearer based certificates
The next major step in the evolution of currency came when the certificate could be used by the bearer of the certificate to pass them on to an other payee without going to the specific money office first. The certificates became „bearer based”. This seems a small steps but it is crucial in the development of currencies not being made from the gold represented by it.
The bearer certificate represented the money in the vault of the money office. The owner of the money office quickly understood that he could give more certificates then he had gold in his vault for only a part of the „owners of the gold” were actually coming to retrieve it from him. (Sounds familiar?)
Step 3: Banknotes (bearer)
The next step was the annexation of the issuing of bearer certificates by governments. Certificates became „banknotes” while still showing the text: „give to bearer”.
Step 4: Banknotes
With dropping of the gold standard the currency itself has become the money. As a consequence the „give to bearer” notices have been removed from our banknotes. If you go to your central bank you can exchange your banknote into the same banknote…
Resume: we first put two technical facilitators – money offices, together with the clearing and settlement of positions between the money offices and their certificates (representing the value) – in between the payer and the payee. Then step by step the currency has been developing until at a certain moment in time the transaction could be done directly between the payer and the payee without the money offices being part of the individual transaction.
We today not hand over lumps of gold any more when buying groceries but use pieces of paper and coins made out of non-precious metals instead. In a sense, we have made a full circle in functionality while adding many beneficial features.
The money offices evolving into banks needed to get the ball rolling are out of the direct transaction while keeping many of their other roles and functions for both payee and payer! For physical money the facilitating parties who were residing between the payer and payee are now behind the payer and the payee.
Important to note: the banks can no longer have their pelican/gatekeeper position in the physical transaction any more, which might be seen as a pity by them but has to be considered as a relevant benefit to society.
In the meantime our social conception of what money is has changed, while the basics of the money being trust) and the purpose of it has remained largely the same the efficiency of the physical payments (and the potential to collaborate = collaborability) has improved inestimable.
NB As I have written before: a bitcoin is only the next step in this evolution for the banknote’s unique number it self can proof it is the currency and does not need the physical elements of the bill any more to proof it.
Ergo: the changing manifestation of the money (certificates => banknotes) went hand in hand with more efficient payments for payer and payee.
Money held inside of the bank
Having accounts at the bank allows the payer and payee to exchange value without having to get the money outside of the „safe” of the bank. These are ledger transactions between banks which are cleared and settled between the banks. Since long banks have catered for these type of transactions, it is their bread and butter.
Most payment methodologies fir via bank transactions (not being with physical coins and bills) are based on the ledger transaction type.
Without wanting to delve into the evolution and diversity of the various payment products / methodologies the basics is pretty much summed up by a traditional electronic payment chain:
First, the payment chain was fully paper based. With the advent of electronic capabilities payments (cards, internet banking, online) and electronic clearing and settlement between banks and even communities of banks we see huge volumes of payments between payer and payee executed electronically. (I use the term electronically deliberately for digital money is something else.
It is not by accident that I use the term certificate both in the physical as in the electronic environment.)
Core to the electronic transaction is the authentication (i.e. tokanisation) of the payment order by the payer. The electronic payment follows basically the paper trail set up for ledger based payments between banks a long time ago.
NB See here for legenda for payments flows
I identify three steps – analogues and pretty parallel to the development of banknotes – where innovation will lead to the creation of direct transactions of digital money between Payer and Payee.
Step 1) Authentication payer = personal certificate
We are today, and over the last three decades in the first stage where every individual transaction via the bank has to be dealt with by a technical facilitators. In time the paper trail has been replaced by an end-2-end electronic payments chain. Crucial in this chain is the authentication of the payer to initiate the payment.
The authentication of the payer (via tokens, pins and we see additional measures like two factor authentication, GPS etc. being added lately) creates a personal payment order which can only be collected by the payee.
Step 2) Certificate to bearer
The game changes fundamentally – like we have seen with physical certificates – if the payee can use the payment order, or part of it, he/she just received to pass on as a payer to yet an other payee. To do so electronic certificates have to be created which can be transferred to real currency by the „bearer” with a „exchanger” of choice. He can do so via a „gateway”.
Authentication of the payer is now necessary to get access to the value available and to start sending value to others. The certificate itself is not anymore bound to the authorization of the payer but is based on a generic certificate which can be freely transferred between payers and payees.
We already have a nice example with MintChip in Canada, created by the Canadian Central Bank. It implies a new payments chain I dubbed the „wallet chain”.
As with physical transactions this is the most fundamental step. Where with paper certificates the evolution was mostly a matter of building trust in a new methodology with the people using certificates we now have to create a technical foundation to create technical trust for the payments which are bound to the electronic infrastructure. (See „Trust in a digital age”). A payments infrastructure which is evolving itself as well.
Step 3) Digital Money (Bitcoin and the like)
While some will see the electronic version of the bearer certificate in MintChip already as digital money, I would prefer to reserve that typology for the next step. In MintChip the bearer certificate is 1:1 linked to the Canadian fiat currency. In that sense it is just an other (technical) representation of the Canadian dollar.
With crypto currencies like Bitcoin we see that the link with currencies based on an outside of the digital network existence – like MintChip – is severed or non existent in the first place. The payment chain topology of the wallet chain introduced in the previous step is maintained but the consequences are that like with physical currency – as explained above – the payer and payee are free to transact efficiently and with extremely low transaction costs.
As with the physical transactions many roles and functions executed by the parties involved in the traditional electronic payment chain will remain relevant but not as part of the individual transaction anymore.
Ergo: the changing manifestation of the electronic money (i.e. personal certificates => digital money) will go hand in hand with more efficient payments for payers and payees alike.
NB The slides above were used at two Dutch primary schools grade 6 and 8 in their „Money week” project. Full presentation (available in English or Dutch) will be sent to you on request (see contact ).
Update30 March 2014
For a concise and more historically correct version of the development of money please read: For Bitcoin Lessons In The History Of Failed Currencies. It reiterates the same notion that we can learn form past experiences, in how people are creating currencies, how governments are taking them under their wings and how payment methodologies are layering each other in time.
Via Forbes: According to Jack Weatherford, author of “The History of Money,”
“So
[Bitcoin] does have an exemplar in history in this idea that it is not created centrally or officially. People have always found a way to meet their own personal needs when it comes to money.”“Bitcoin will not be the money of the future,” predicts Weatherford who believes governments need to give up or lose control of currency before virtual currencies can really take off, “but the money of the future will look more like Bitcoin than the money we have in our pockets and banks today.”