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This article was published 24/1/2018 (925 days ago), so information in it may no longer be current.
I just purchased some cryptocurrency, but hush… don’t tell my financial advisor. Money managers over the age of 50 think Bitcoin and see Dracula, then start reaching for the garlic wreath and silver cross. Financial pundits under 30 either shrug and wonder why the fuss, or gush with enthusiasm.
To explain cryptocurrency, let’s start with the ideas of currency and money.
We all think of the coins in our pocket as money. Early version of currency were any commodity that buyers and sellers were willing to accept in payment. Canada’s early currency included trinkets of copper, precious metals and furs. Such "commodity" money also has intrinsic value.
A classic fable about the origins of so-called "commodity money" appeared in 1946, when an economist published an account of the money economy in a prisoner-of-war camp where he had spent part of the Second World War. Because they were uniform, easily transported, divisible and valued, cigarettes emerged as a common currency. Since smokers needed to feed their addiction, the stock of money dwindled until the next Red Cross shipment. This controlled their value. Non-smokers valued cigarettes simply because they could trade them for stuff.
In the artificial world of a PoW camp, where prisoners could not create or invest in businesses or pay taxes to support the camp infrastructure (kindly provided by the Nazis), cigarettes formed the very limited function of money known as a "medium of exchange."
After its conquest of North America in 1760, Britain attempted to impose the pound as the official currency, but this never took. Many currencies, including American and Spanish dollars, "Nova Scotia" money and army payment chits, all circulated until Confederation, when the new government deemed the Canadian dollar as the official currency.
But money is more than currency. While the Bank of Canada (not the government) issues our currency, it does not create money. Banks do.
Imagine I wanted to start a pizza joint. All manner of costs require payment before the first sales.
A first step in my business life is to secure a line of credit from a bank. Using a business plan, my winning personality exuding confidence and, most often, collateral such as equity in my home, the banker agrees to lend funds. This simply means creating a chequing account that allows me to pay bills. This chequing account is new money added to the economy, backed only by the faith of the lender and, hopefully, the new activity of my business.
Just as it governs currency, government strictly controls the creation of new money by managing interest rates and designating the level of savings a bank must retain and not lend.
Cryptocurrencies such as Bitcoin emerged after 2008, partly because the failure in financial regulations triggered widespread disillusion with the banking system. The creation of virtual currency outside government regulation marks an important moment in the continuous evolution of our financial system.
Just as bankers have records of financial transactions by every customer, cryptocurrencies have created records comprising computer programs that record all transactions made by members of the "club" — those who have purchased the cryptocurrency. Known as "blockchains," these programs continuously update the list of transactions (the blocks) that link (chain) all interactions of buyers and sellers. A key idea in the cryptocurrency world is transparency, where all club members can "see" every transaction. Banks do not allow me to monitor the transactions of other customers.
Are cryptocurrencies secure? In a word: no. Multiple breaches have occurred. Many of these new currencies will also swing widely in value. But these are just teething pains for a major innovation in how we pay for goods and services.
In the early stages, a cryptocurrency circulates only among buyers and sellers, usually intent on cashing in on a speculative binge or making clandestine purchases. But as the number and diversity of members in a cryptocurrency club expands, these forms of currency become more widely accepted. The instant Starbucks accepts a cryptocurrency will mark an important step in the evolution of this form of money. More important will be the date when a cryptocurrency extends credit and therefore creates money, becoming a "cryptobank."
Now, why is Bitcoin worth $17,000? Why is a toonie worth a "double-double?" Because people think so, just like non-smokers in the PoW camp might have believed that two cigarettes were worth a small bar of chocolate.
Government will try to regulate cryptocurrencies, just as the new Canadian government regulated currency and banks after Confederation. But a cryptocurrency that can demonstrate stability in value and wide acceptance among buyers and sellers, as well as transparency in transactions, may replace government control with social oversight. That would be an entirely new approach to financial regulation.
We live in a brave new virtual world, where with an app on my phone, my car becomes a cab and my house a hotel. It is a short step to where an app on my phone pays for my coffee, using cryptocurrency based on multiple servers. This is not Apple Pay, which still links to a conventional bank account. Even better, when I have the Wi-Fi node implanted behind my left ear, I will be able to eliminate my phone and a thought in my head will become the coffee in my hand.
Gregory Mason is an associate professor in the department of economics of the University of Manitoba.
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