Image: BBC via YouTube
First we shape our tools, and thereafter our tools shape us. Money is one of those tools, and one that is in the process of being reshaped by tokenisation. This process was precipitated by the creation of bitcoin, and has now spread to other forms of tokenised money on blockchains, and to other assets of value. With many different types of value represented on blockchains, and with efficient exchange between them, the way that money and value integrate with our lives will change. The implications of this could be profound.
1875 and the Functions of Money
Please indulge me while I revisit the functions of money. At this point, everyone who has heard someone talk about bitcoin has probably heard of the three functions of money. All together now: it's a unit of account, a means of exchange and a store of value. Far fewer people know where these functions came from. They are from a book written by English economist William Stanley Jevons in 1875. The book is called "Money and the Mechanism of Exchange", and it's pretty wide ranging, dealing not only with the functions of money, but even with things like what coins should be made of. This was back when everything was up for debate.
But Jevons actually described four functions of money. He talks in the book about a medium of exchange (enabling us to transact easily without barter), and a common measure of value ("unit of account"). These two are consistent with the currently widespread version. Then he describes a standard of value, and a store of value. Jevons describes the standard of value as a retention or durability of value over time (gold not eggs), and the store of value definition he restricts to physical storage and portability – a practical consideration. We have collapsed these two – durability and portability – into one function that we call store of value.
To understand something at a fundamental level, it helps to get back to basics like this. Jevons’ book works with these fundamentals, because that's all he had back then; these things were new concepts. If you ignore the style of his prose, some of what he wrote could have been written yesterday (emphasis mine):
“It is in the highest degree important that the reader should discriminate carefully and constantly between the four functions which money fulfils, at least in modern societies. We are so accustomed to use the one same substance in all the four different ways, that they tend to become confused together in thought. We come to regard as almost necessary that union of functions which is, at most, a matter of convenience, and may not always be desirable."
This brings into question the criticism of bitcoin because it doesn't work as a unit of account; maybe it’s fine if it’s just a store of value. We so are used to thinking of money as comprising all four functions that we can’t see how they could be divided. Jevons prompts us to look at this more closely, and from there, the question is how tokenisation of money changes things.
21st Century Tokenisation of Money and Assets
About 150 years after Jevons, our current forms of money represent the credit of various regulated entities: central banks, commercial banks, and e-money issuers. Applying the technology of Bitcoin to these enables us to tokenise them, creating blockchain based digital assets: Central Bank Digital Currency (CBDC), commercial bank deposit tokens, and fiat backed stablecoins. These types of tokenised money come in a variety of currencies: dollars, euros, pounds, rands and naira. These will all exist as assets on blockchains in the not too distant future: nearly all the world's central banks have experimented with CBDC, large banks have built their own tokenised money, and there is $170 billion in stablecoins out there.
One of the things that is driving this process is that other assets are also being tokenised - so called "Real World Assets" (RWAs). At the moment these are more financial world than real world: equities, funds, bonds, and other liquid assets. If you want to transact in these RWAs - and why else would you tokenise them - then you need tokenised money to settle those transactions. We are about to see an explosion in RWAs for two reasons. Firstly, regulators are much more likely to view blockchains as just the next technology when applied to RWAs, than they are with the ‘closer to home’ impact of tokenised money. It is therefore easier to get traction with regulators on RWA projects. Secondly, the efficiency gains are much higher in trade settlement cycles than they are in payments, so the business case for incumbents is simpler.
The Babel Fish of Money
To recap: Jevons gave us the separable functions of money. Tokenisation gives us a new form of money, on blockchains. Tokenising other assets brings them onto blockchains as well, and thus gives them the same characteristics of other digital assets, like tokenised money.
As people, and as legal persons, we have begun to transact with assets on blockchains using digital wallets. The wallet is just a way of storing the passwords that give you control over your assets. An analogy helps: I open up my banking app with a thumbprint, I connect to my bank and I send money; I open up my wallet with a thumbprint, I connect to the blockchain and I send digital assets.
In the near future, we will have representations of all types of value on the same system, so transacting between them will be fast and cheap. If I want to transfer value to you, that is to pay for something, then I could potentially transfer a stablecoin or a fraction of an Apple share to pay for it. But you might want to be paid in Treasury bills, or even US dollars. We need a mechanism for swapping from one to the other: I pay in Apple shares, you receive dollars. With a liquid market and the ability to transact, this is obviously simple. In fact, it is being done already, by many companies. Digital bank Revolut is an example: I have a virtual card linked to my Bitcoin balance, and I can use that to pay for a beer. What happens in the background is that Revolut sells my bitcoin and transfers local currency to the pub via card networks, but the concept is the same.
In the Hitchhiker's Guide to the Galaxy, Douglas Adams introduced an ingenious technology-cum-plot device called a Babel Fish. This gets round the communication problems of galactic travel: you just pop a Babel Fish into your ear. It takes in sound waves from outside, and converts them to the language that your brain understands. Blockchains are a Babel fish for money. Put in Apple shares, get out bitcoin; put in airtime, get out airmiles.
Revisiting the Functions of Money
Now we go back to the functions of money, and what happens to them when tokenised money and value lives on blockchains. I exchange my labour for money because I can then use the money to buy food and beer. My labour and the beer are both priced in the same currency (unit of account), I am paid in money into my bank account (store of value), and when I buy something I use that same currency (medium of exchange). The blockchain Babel Fish changes this.
The medium of exchange disappears first: I pay the pub with bitcoin and they receive rands - there is no common medium. Then the unit of account goes: I can think in whatever currency works for me. We have all done this the old fashioned way on holiday: you look at the price of something and you convert it in your head to your home currency. Online with a browser plugin, or even with VR glasses in a physical store, we can convert prices automatically.
The Store of Value is the Thing
All that remains is the store of value. The tokenisation of money and assets on blockchains gives us each the freedom to choose what store of value we want to use. Now go back to Jevons again, and remember that he initially had two aspects of the store of value: durability over time, and utility / portability. The durability aspect speaks to saving or investing, while utility feels like it is about making payments. They overlap, but let’s look at them separately for now.
The durability store of value over time is the easier one to address first. At the moment, I store value in several different forms: I have a house, I have some local currency credit in a bank account, I have an offshore pension in a second currency, I have some bitcoin. These are all different stores of value, and I have made these choices over time. The original philosophy behind bitcoin was that it gave us freedom from ‘The System’ of banking and governments. This is a little too radical for most people, but turning money and other assets into digital assets brings a degree of choice that was not previously available. An example illustrates this.
In Argentina, locals are understandably reluctant to store their wealth in pesos. While other currencies decay in value over long periods, the timeframe of the peso’s decline is much shorter and thus more noticeable: inflation is close to 300%. There is substantial evidence that Argentines are choosing to convert their salaries to dollar denominated stablecoins, and are using those to make transactions, via crypto-linked cards like those provided by Lemon. The combination of tokenised dollars, digital wallets and fintech innovation has provided a better alternative to the local currency. This is dollarisation by crypto. Stablecoins and the simple user experience created by the likes of Lemon lower the barrier to alternatives to the local currency, wherever you happen to live.
New Basis of Competition
The potential for increased competition, or choice, in currency brings us to the second aspect of the store of value function of money: portability or utility. If you could have any form of the dollar: cash, bank balance, Federal Reserve credit, stablecoin – which would you choose? How would you choose between dollar stablecoins and a euro CBDC? I have made a case above for the importance of the durability store of value, but at the margins, the utility aspect comes into play. I have written about this before, in 2020, and the developments since then make it even more relevant.
An obvious result of crypto-dollarisation, and freedom of choice in store of value, is that countries with weaker currencies will find it harder to persuade their citizens to use the currency. Regulations and laws will probably say that all prices must be displayed, and all taxes must be paid, in the local currency. This is a kind of ‘forced utility’. Beyond that it will become increasingly easy, and increasingly common, for people to choose to live in bitcoin or dollars or Apple shares. Governments will be exposed to more competition, but will also have more tools at their disposal.
The main thing governments and regulators must do is obvious: increase the competitive advantage of your money. This can be interpreted in lots of ways, the traditional one being to strengthen the economy. This ought to be table stakes. The tools of digital assets provide more opportunity, though: make the CBDC programmable in useful ways, create a local regulatory environment that supports innovation around digital assets, make it easy for innovators to work with your currency. All these will increase the utility of your form of money, and thus protect against the risks outlined above.
Exposing currencies to more market forces will have results that are hard to predict. The US dollar is already used for pricing global goods like oil and bitcoin; maybe we will all transact for these goods in future using dollars. There is a reason that nearly 100% of stablecoins are dollar denominated, after all. Perhaps a dystopian view plays out as a flight to bitcoin as a store of value. These are all scenarios to be explored.
A Changing Relationship with Money
Remember Jevons' comment about wrongly assuming that the functions of money must all exist in the same thing. Money on blockchains abstracts everything but the need for money to act as a store of value. Over time, this will change the way that we think about money altogether. This will happen gradually, as innovators build things that solve previously intractable problems. Just as Argentinians are now able to insulate themselves against the declining peso.
Individual choice in store of value is a good thing. It evens out some aspects of the lottery that is the nationality you happen to be born into. The choices we will be making as users of money will become clearer, which will elevate it in our consciousness. Whereas the type of money was previously a default, soon there will be a much wider range of choices. Just as you choose between cash and various cards when you open your leather wallet, so you will when you open your digital wallet. The digital choice will include versions of cash and credit, across a range of instruments and options. Progressive payments teams are already thinking about what this means for them, but so are other financial services providers, including organisations like retailers and mobile network operators. At the moment, the choice at the till is based on convenience, loyalty, cost, and timing of the payment. The number of companies offering us the means to pay will grow, and the tools available to them to influence that choice will proliferate.
Governments and incumbent financial players need to see this as the opportunity it is. Innovation in finance has been happening since the invention of money. There are massive opportunities here to address old problems with these new tools, and I hope that the response is exploration, not restriction.
Commentaires