Bitcoin at 10 – Money in a World of Tokens

On this very day ten years ago – January 3, 2009 –, the Bitcoin network went live. Bitcoin’s first block, the Genesis Block, includes a short message as a reminder that the world was, at the time, finding itself in the midst of the biggest financial crisis since the 1920s. The message refers to the headline of the British newspaper “The Times” of that day:

“Chancellor on Brink of Second Bailout for Banks”

And, in fact, at about the same time as the Bitcoin whitepaper was published (October 31, 2008), the failure of Lehman Brothers as an issuer and underwriter of mortgage-backed securities initiated the largest insolvency proceedings in U.S. history and, subsequently, led to a major economic and political crisis of global dimensions.

Bitcoin’s inventor Satoshi Nakamoto is said to have picked that newspaper headline not only to create an immutable time reference for the genesis of the network but also to make a political statement (his own writings support the claim). As announced a few months prior to this event in the whitepaper, Bitcoin was intended to become a peer-to-peer electronic cash system, thereby eliminating the intermediating middleman – probably the prime source of fragility in today’s financial industry.

Cryptocurrency as money

Now, given the stated goal, the question is essentially whether Bitcoin and its numerous variants have since become what is commonly considered to be sound money. A recent analysis of Bitcoin as money can be found at Alt-M. In his short essay, the economist Larry White summarizes the state of the cryptocurrency as follows:

“Bitcoin should not be regarded as the last word in private money, but should be appreciated as a remarkable technological breakthrough. […] The inbuilt volatility of its purchasing power makes it unlikely to displace the incumbent fiat currencies barring an inflationary explosion.”

It is perhaps unsurprisingly, then, that people have begun to look into building stable coins based on blockchain technology. While there are already various – technically and legally – different types of stable coins, they often make a reference to a fiat currency, such as the US dollar or Swiss franc. In other words, they replicate their strengths and weaknesses: While most fiat currencies are exceptionally well-suited as transaction media, many of them are highly ineffective when it comes to storing value over time.

This is a real issue for poor people with very few or no options to diversify their savings.

Money and politics

The control over money is a powerful tool. That is why money and politics tend to go hand in hand. For slightly more than one hundred years, money has come into existence as fiat, i.e., unbacked currency created by an authority – typically the central bank of a country. Fiat currency might be managed diligently in the interest of the “greater good” (whatever that is supposed to mean). However, the past has been anything but a good track record of sound monetary policy. Therefore, it must have been inevitable for F.A. Hayek to refer to the history of money as an “all too monotonous and depressing […] story [of inflation]” (1976, p. 33-34).

Tokenization may be the answer!

Were it not for the efficiency of money as a medium of exchange, our economic system would revert to a simple barter and gift economy. However, modern monetary systems have become purely instrumental, entirely reduced to a means of creating money out of thin air. We can then ask ourselves: Why not rather link money to economic output than political influence, to real wealth instead of decreed purchasing power?

The implementation of this idea may be facilitated by tokenization:

Bitcoin and Ethereum involve native tokens. Such tokens are digital assets without any connection to real-world assets. Now, by means of tokenization, you can basically link tokens tradeable on the blockchain to any asset, in particular shares and bonds; such tokens that leverage the Bitcoin or Ethereum network as underlying platform are called asset-backed tokens.

Tradeability, however, is only the first step. The true nature of a good being money, as the economist Fritz Machlup put it, lies in its moneyness. “Moneyness” can best be defined as something, inter alia, durableportable, fungible, and scarce. Furthermore, where a market exists, liquid trading of such good becomes viable.

Also, moneyness is a spectrum – some goods are better suited than others to be widely used as a medium of exchange. In other words, while some goods exhibit high degrees of moneyness – historically, this has been the case for precious metals such as gold and silver –, others only have modest levels of moneyness – services and bicycles are in a rather difficult position to gain widespread acceptance as a means of payment.

Tokenization of wealth

“But why use money to make transactions when computers offer the possibility to exchange goods and services for wealth?”

In his book “The End of Alchemy”, published in 2016, Mervyn King describes the transformation of the world of finance, the banking system, and money. The former Governor of the Bank of England, including during the period of the financial crisis, seems to envisage wealth being used as some sort of transaction medium.

What did he possibly mean by that?

As Swiss companies have recently begun to tokenize their stocks and bonds using blockchain technology, we will likely see in the future the emergence of freely tradeable and thus highly liquid stocks and bonds outside of traditional organized markets, such as a regulated stock exchange. To be fair: in most instances, such private offerings will unlikely succeed as a new means of payment, and, in many cases, this is not their intention anyway.

However, tokenization as a means to facilitate trade of shares and bonds on the blockchain, allows for a very simple solution that may eventually lead to a private means of payment.

How?

A company – let us call it “Private Money Ltd.” – that seeks to reflect the value creation in a given economy (e.g., the Swiss Gross Domestic Product, GDP) can purchase assets of the said economy, such as stocks, commodities, real estate, and company loans. By selecting good “proxy assets” for the underlying economy, Private Money Ltd. may effectively emulate the total economic output produced within a given country’s borders on its balance sheet. Now, holding shares of Private Money Ltd. would allow people to participate in the total wealth creation of a country as if they were purchasing each asset of the company’s balance sheet directly.

The company’s value would ideally grow or contract at the same speed as the economy’s GDP, thereby more or less keeping share price and production growth (or contraction) in balance. Keeping money stock and production growth (or slow-down) in balance is essentially the policy objective of central banks. However, a private company tokenizing its shares would be less prone to special public and private interests, yet still be accountable to their shareholders.

As mentioned above, since such shares would be tokenized, they would become easily accessible to everyone interested. The use of blockchain technology would allow for peer-to-peer exchange (P2P) as if the shares were regular banknotes and coins issued by a nation state. Given sufficient demand for the shares of Private Money Ltd., people could eventually start using them as a private means of exchange.

New forms of money on the horizon

Such a development may seem contrary to Bitcoin’s claim to be a P2P electronic cash system. Indeed, tokenization necessitates a certain degree of centralization. However, cryptocurrencies have, compared to a tokenized balance sheet, one great disadvantage, as they are not backed by anything other than computing power and people’s confidence in its hard coded safeguards. In other words, people typically have only poor expectations as regards Bitcoin’s “fair value”, resulting in a highly volatile price and purchasing power, respectively. A well-diversified asset portfolio is likely superior in terms of stabilizing market expectations in the long run.

Having said that, Bitcoin eventually evolving into money and asset-backed tokens being used as such need not be mutually exclusive.

No tokenization without Bitcoin!

In any case, there would be no tokenization without Bitcoin and Ethereum, no asset-backed tokens without their native predecessors. It is only thanks to Bitcoin’s ingenious monetary network design and Ethereum’s progress in developing sophisticated smart contract-systems that we are now able to talk about the likely emergence of new forms of money.

This is not the only reason (see, e.g., social scalability; censorship resistance and free speech; access to finance for the unbanked), but it is an important one for us to celebrate Bitcoin’s “genesis block” today.

 

Photo source: https://www.reddit.com/r/Bitcoin/comments/7ns2u7/nakamoto_remembers_the_times_03jan2009_chancellor/

Switzerland’s Financial Market (De-)Regulation in the Age of FinTech

Financial market regulation has become a hot topic: With the advent of “FinTech”, startups building their novel business models flock to jurisdictions that offer them the best regulatory environment. Switzerland’s reputation as a crypto-friendly jurisdiction has awarded the country the title „Crypto Nation“[1]. On the other hand, while not being as welcoming to crypto businesses as the alpine country, the U.S. is still the leading place where entrepreneurial minds find the largest pool of venture capital for the pursuit of their innovative ideas. Other jurisdictions, then again, such as the European Union, have, because of their sluggish political situation, remained in regulatory sleep mode when it comes to FinTech.

The End of “Swiss Banking”

For the last ten years, Switzerland’s banking industry has found itself in the most profound transformations – probably in all its history. The change started with the global financial institution UBS nearly closing its doors at Zurich’s luxurious Bahnhofstrasse due to suffering massive depreciations on their subprime assets in 2007-08; the bank’s failure to anticipate the subprime mortgage price decline resulted in an unprecedented bailout amounting to approximately 66 billion Swiss francs. After that, in 2013, the oldest Swiss bank, dating back to 1741, Bank Wegelin & Co., was forced to discontinue its activities as a result of criminal tax proceedings in the U.S. In addition to individual bank insolvencies and the harsh tax dispute between the U.S. Department of Justice and the Swiss government, the overall conditions for providing banking services were reshaped at fundamental levels: The G20 leaders, and with them FATF and OECD, have pressured the Swiss government to implement the automatic exchange of information between tax authorities by putting the alpine country on various “black lists”, thus effectively bringing an end to the era of bank secrecy (at least for foreigners). They were taking advantage of the momentum brought about by the Financial Crisis:

“Major failures of regulation and supervision, plus reckless and irresponsible risk taking by banks and other financial institutions, created dangerous financial fragilities that contributed significantly to the current crisis. […] Our commitment to fight non-cooperative jurisdictions […] has produced impressive results. We are committed to maintain the momentum in dealing with tax havens, money laundering, proceeds of corruption, terrorist financing, and prudential standards.”[2]

As a result, Switzerland is, for the first time in history, going to exchange information on around two million financial accounts with more than 90 countries this year. No wonder that the global Financial Crisis of 2007-08 has been declared the unofficial end to what had proudly been referred to as “Swiss Banking” for more than 80 years. Today, while still being the two leading places for wealth management services,[3] Zurich and Geneva have lost part of their previous appeal as financial centers. It would, for this reason, not be surprising if the local banking industry has sought to reinvent itself. This has not really been the case though. In fact, until this very day, the big players were hardly keen to innovate and take the future into their own hands. Three crucial reasons for this can be found within the banks themselves: Their IT systems were typically structured at the end of the last century (where their systems are more recent, banks invested dozens of millions just to keep up with the latest mainstream technology). The second reason is concerned with “legacy bank customers”, such as long-standing U.S. and French clients owing taxes to the Internal Revenue Service and the Ministre des Finances et des Comptes publics, corrupt politicians robbing their South American citizens, or Russian oligarchs laundering dirty money through Western European banks. Finally, the regulatory burden has continually been raised in the aftermath of the Financial Crisis. This inexorable rise has most clearly been the case with regard to anti-money laundering regulations. In other words, exploring new shores and thereby taking unpredictable risks are not among the viable options of a typical Swiss bank any longer.

Digitalizing Finance

The neologism “FinTech” has become a buzzword, only being surpassed by the excessive use of the terms “blockchain” and “crypto-something”. Apparently, FinTech is a much broader concept than the other two comprising areas as diverse as, for example, risk management in banks, crowd-based platforms for raising capital, portfolio strategy tools built on machine learning algorithms as well as cryptocurrency trading engines. In fact, FinTech is yet another term to describe what has been happening for years: The banking industry, with its anachronistic paperwork and computer mainframes from the 70s, has long been overdue for a makeover. While incremental improvements have certainly been undertaken continuously, incompatible legacy systems have become so onerous for banks that today’s most delicate bank projects are the ones involving the restructuring of existing IT systems.

By contrast, technological progress outside of the banking system has been taking place without showing any signs of a slowdown. Almost ten years ago, for example, Bitcoin’s genesis block was “mined”. The Bitcoin cryptocurrency network has been up and running since then amounting to a market capitalization of more than 300 billion U.S. dollar at the peak in December 2017. While Bitcoin’s success may have been unexpected for most of us, its fundamentals are fairly simple: The cryptocurrency wisely combines the long tested technology of cryptographic proofs with the concept of a decentralized computer network. Today, despite its scalability problems, Bitcoin and other cryptocurrencies have shown the world that cross-border payment transactions can happen as easily as sending an email, and that secure asset custody no longer depends on traditional institutions but can be done in the palm of your hand. Undoubtedly, the shift from an Internet as a “mere” channel of communication to an Internet of value has been initiated with the emergence of blockchain technology.

The 2014-Bitcoin Report

The development of blockchain businesses in Switzerland really gained traction in June 2014 when the people around the mastermind Vitalik Buterin were looking for a place to set up a foundation to further the development of their cryptocurrency and smart contract protocol called “Ethereum”. They needed to rely on a legal structure to carry out what later became a rather dubious way of raising capital, the so-called “initial coin offering” (ICO). They found a small town in Central Switzerland, Zug, which is now the domicile for more than 2’000 FinTech companies and thus known as “Crypto Valley”. Since then, this new part of the Swiss financial industry has grown enormously, attracting more and more entrepreneurs, venture capitalists, IT pundits, attorneys, tax professionals, accountants, and, of course, the regulator.

The Swiss regulator first got interested in the topic as members of the parliament asked the Federal Council to publish a report on the legal implications of being involved with Bitcoin. The Federal Council’s report of 2014[4] clarified that cryptocurrency can be embedded into the existing legal framework. The report also classified Bitcoins as a lawful asset, stating that there are no provisions prohibiting private parties to voluntarily use the cryptocurrency.

The 2014-report being a big relief for the still emergent crypto-industry allowed it to grow further (and probably also faster). What followed was an extensive public debate of the question whether coin holders may have property rights with regard to digital assets since Swiss property law technically restricts ownership to physical objects. In fact, blockchains perfectly replicate the economic theory of property rights: Blockchain-based assets are excludable and rival; public-key cryptography allows for the clear allocation of digital assets to their “owners”. In other words, unlike data stored in one of Facebook’s data centers, the data underlying a Bitcoin transaction cannot be copied and transferred to third parties while the original coin holder retains possession of the data at the same time. Another hot topic under Swiss law is concerned with the transfer of tokenized assets, such as a stock or a legal claim. The main problem here arises from the statutory requirement that the transfer of legal rights (“assignment”) must be carried out in written form. It is highly likely that the legislator will amend certain parts of the Code of Obligations to take into account new ways of transferring ownership of digital assets, such as signing a transaction with the private key that is stored in a smartphone “wallet”.

The first wave of FinTech “deregulation” took place in 2017, particularly covering crowdfunding platforms that bring together borrowers and lenders. In addition, the Swiss regulator introduced a sandbox regime for companies allowing them to accept public deposits as high as 1 million Swiss francs without any regulation or supervision. A new banking license “light” currently under way aims to reduce the amount of banking regulation for FinTech companies seeking to obtain a regular banking license. These companies will be permitted to accept public deposits of up to 100 million Swiss francs, essentially enabling them to offer the whole range of crypto-services, such as storage, brokerage, and trading.

The Rise of the “Crypto Valley”

The good thing about Switzerland’s regulatory environment is that it is fairly decentralized. While this is not true for financial market regulation and supervision, which is spearheaded by the Swiss Financial Market Supervisory Authority (FINMA), it accurately describes fiscal and tax matters. In short, Swiss cantons as well as municipalities compete against each other for individuals and corporations. The Canton of Zug is the perfect embodiment of this crucial policy: It has exercised a pull on international companies looking for competitive tax environments for more than two decades. In other words, Switzerland’s political system of federalism has perfectly suited the underlying paradigm of blockchain technology.

Since the Canton of Zug was the first choice for most foreign blockchain companies moving to Switzerland, the City of Zug started accepting Bitcoin and other cryptocurrencies as a payment for their government services. This obviously made the headline of major publications around the world. It was then simple but smart marketing to rebrand the area, which had previously been known for its commodity industry, as “Crypto Valley”.

While in particular the U.S. Securities and Exchange Commission has put most blockchain-issued tokens into the “securities” bucket,[5] thus effectively bringing them under its jurisdiction, FINMA advocated a more industry-friendly approach by dividing crypto-assets into three groups in February 2018:[6]

Payment tokens, such as Bitcoin or Ethereum, do not convey any legal rights to their holders. They are solely used as a means of exchange. Such tokens are typically not subject to prudential supervision but still fall within the scope of anti-money laundering regulation.

Utility tokens are basically contractual rights to certain services, similar to digital keys enabling access to a specific piece of software.

Asset tokens comprise all tokens representing rights that have traditionally been traded on financial markets, such as stocks, bonds, and derivative contracts, as well as any other claim to “something” that does not qualify as a utility token.

While FINMA’s division intro three token classes allows for more pronounced regulation and supervision, it is also more complicated than the U.S. approach. Anyhow, the current main problem of blockchain companies is not how FINMA but banks treat them when applying for a corporate bank account. However, in September 2018, the Swiss Bankers Association standardized the opening process by publishing non-binding guidelines for their member banks.[7]

The Emergence of Swiss Banking 2.0?

Being fully aware that Switzerland lost its fight for the protection of financial privacy, it is the Swiss legislator’s stated goal to encourage the development of blockchain technology, in particular with regard to asset tokenization. In the meantime, former high-level bankers have joined start-ups that seek to obtain an approval from FINMA as “crypto-banks”. Unlike the Principality of Liechtenstein with its separate “Blockchain Act”, Switzerland will not go for a completely new set of regulations but rather “deregulate” existing laws by taking into account the ways of doing business in the age of FinTech.

This article will appear in a forthcoming issue of the Cayman Financial Review.

 

[1] See Financial Times, Switzerland embraces cryptocurrency culture, January 25, 2018, https://www.ft.com/content/c2098ef6-ff84-11e7-9650-9c0ad2d7c5b5.

[2] G20 Leaders Statement: The Pittsburgh Summit, September 24-25, 2009, notes 10 and 15, http://www.g20.utoronto.ca/2009/2009communique0925.html.

[3] See Deloitte, The Deloitte International Wealth Management Centre Ranking 2018, https://www2.deloitte.com/ch/en/pages/financial-services/articles/the-deloitte-wealth-management-centre-ranking-2018.html.

[4] The Federal Council’s report (only in German) can be downloaded here: https://www.news.admin.ch/NSBSubscriber/message/attachments/35361.pdf.

[5] See U.S. Securities and Exchange Commission, Public Statement on Potentially Unlawful Online Platforms for Trading Digital Assets, March 7, 2018, https://www.sec.gov/news/public-statement/enforcement-tm-statement-potentially-unlawful-online-platforms-trading.

[6] See Swiss Financial Market Supervisory Authority, FINMA publishes ICO guidelines, February 16, 2018, https://www.finma.ch/en/news/2018/02/20180216-mm-ico-wegleitung/.

[7] See Swiss Bankers Association, Opening corporate accounts for blockchain companies – Swiss Bankers Association publishes guidelines for its members, September 21, 2018, https://www.swissbanking.org/en/media/positions-and-press-releases/opening-corporate-accounts-for-blockchain-companies-guidelines.

Negative interest rates and the redistribution of…

The background

Negative interest rates are currently a hot topic. Mainstream economists consider them necessary since

    • overall public debt levels are at historic highs (as a result, monetary policy has continuously adopted the goals of fiscal policy),
    • the stability of the financial system is fragile due to high-risk assets in the balance sheets of banks (over- and mal-investments), and
    • the «monetary guardians» at the central banks (who does watch them btw?!) are the only people that have enough leverage to «inflate» away the ubiquitous problems!

The rationale behind such a monetary policy goes as follows: Negative interest rates pressure people to spend money, aiming at cranking up the economy. Doing so, central banks discourage savings and thus long-term investments. However, as long as there is cash money, people have means for avoiding the consequences of such a policy by withdrawing all funds deposited at the bank (the «zero lower bound» problem).

Redistributive effects

Without entering into the details here, this short article seeks to explain the most common redistributive effects attributed to policies introducing low or even negative interest rates:

Redistribution from poor to rich

Low and negative interest rates disproportionately affect poor people because they are not able to diversify in assets that are less prone to inflation; in other words, poor people are more subject to the effects of financial repression than the rich.

Redistribution from the manufacturing sector to the banking system

The «Cantillon Effect» implies that people «closer to the money» disproportionately benefit from cheap money. By being able to buy assets (estate, stocks etc.) earlier than others, they can buy in at low prices. Employees in banks and corporations as well as politicians are favored by the Cantillon Effect.

Redistribution from the private sector to the public sector

Governments can refinance their debts at artificially low prices. Many investors, such as pension funds, are legally obliged to hold government bonds; their legitimate earnings are de facto confiscated.

Redistribution from small and mid-size companies to big corporations

Big corporations disproportionately benefit from lower refinancing costs on financial markets (instead of bank borrowing); also, they are economically incentivized to engage in «empire-building», mainly through mergers and acquisitions.

Redistribution from young people to old people

As a consequence of the redistributive effects mentioned above, younger people earn less (in real terms) and can save less than previous generations (assets are more expensive in both relative and absolute figures).

Redistribution from the periphery to the center

Since banks, big corporations, and politics are usually located in specific urban areas, people move there, which eventually causes wages and rents to increase even more.

In sum, even if the redistributive effects are smaller than expected, monetary policies of such kinds are highly antisocial. The worst part is, however, that the negative consequences do not materialize immediately but only after some time. Tragically, they often go unnoticed by the people most concerned.

Bitcoin’s Value Is Purely Subjective

While one Bitcoin token is currently approaching 5’000 US$, many people wonder why Bitcoin has «value» in the first place.

The first question that arises: Might those people actually mean «price» instead of «value»? Well, the concepts of price and value are entirely different. They cannot be the same logically. A person only sells, or buys, a good if the price that she can realize is higher, or lower, than her personal valuation of that specific good. Therefore, any identity of price and value would bring the economy to a halt.

Secondly and more importantly, the phrasing of the initial question is misled. Value is not something intrinsic that is part of an object. This becomes obvious when taking a closer look at Bitcoin. A Bitcoin token consists of nothing but digital data that are stored in an electronic wallet as well as in the distributed network. (That set of digital data confers on its holder the power of control over Bitcoin tokens.)

«Value is not something intrinsic that is part of an object.»

Think of bananas: They are beyond doubt highly nutritious. Most people enjoy eating them. However, imagine that humans couldn’t digest bananas. While bananas would still be the same physically, we wouldn’t crave them at all though. There is nothing intrinsic about the value of bananas. Yes, they make sense in our case but they may as well not!

Since value is not an «ontological» property of an object, value must be subjective (look up Austrian Economics). Value thus lies in the eye of the beholder. This has major implications: When I value an object dearly, this doesn’t mean that others do as well (or to the same extent). They may even assign a negative value to that object; hence they hate it. Therefore, interpersonal utility comparisons, widely spread in politics and academia nowadays, are literally of no value. This, in turn, means that the positive effects of policies must be limited. Politics, however, is a different topic I don’t want to delve into here.

So, we have to ask ourselves what those «properties» are that make Bitcoin tokens valuable to its users. This question cannot be answered conclusively (for the reasons mentioned above). At least let’s try a conceptual approach:

Libertarians probably use the network because they prefer «stateless» cryptocurrencies to legal tender and bank-issued money. They don’t like money that can be created at will and out of thin air.

Techies and academics may engage in it because the underlying distributed ledger technology has become a new interesting research area. It allows for «trustless systems», be it payment systems or «decentralized autonomous organizations» (DAOs).

Criminals may value the Bitcoin network’s capabilities to disguise their transactions. They presumably like that they are not forced to go through the banking system anymore.

Most people (e.g., venture capitalists) probably hold Bitcoins because they can either take part in «initial coin offerings» (ICOs) or they speculate for a rise in prices. This can also be described as Bitcoin’s «bubble economy».

Importantly, at the end of the day, the different categories of stakeholders in the Bitcoin network get something in return for their money and time invested in the venture. Obviously, the whole thing is not risk-free. In their eyes and minds, however, Bitcoins are sufficiently valuable to go with the risks associated with the cryptocurrency. To them, there exists a myriad of different reasons as laid out above though.

«In their eyes and minds, however, Bitcoins are valuable, for different reasons though.»

Some people argue that Bitcoin derives its «value» from the electricity put to work within the mining procedure. This, however, sounds like a slightly adapted version of the mistaken «labor theory of value» in classical and Marxist economics. Certainly, electricity is a prerequisite for the decentralized proof of work-approach, which eventually makes the Bitcoin network secure («electricity-turned-trust»). However, the amount of electricity, while undoubtedly contributing to a positive subjective valuation of users, is not the value of the network itself. In fact, current electricity costs are nowhere near the «value», or price, of a Bitcoin token. For the same reason neither does Bitcoin’s value stem from its «trustless» database (the «blockchain») nor from the algorithmic scarcity (∼21 million), which is embedded in the Bitcoin protocol. These features of the Bitcoin network are «only» reasons why people use the network.

Take gold as an example: Its useful properties (relatively scarce, malleable, durable etc.) have contributed to its use as money for thousands of years. However, people had to discover gold to be more beneficial than earlier kinds of media of exchange in the first place. «Discovering» value is a purely mental, or psychological, process. Once enough people had made this astonishing discovery, network effects unfolded and made gold even more attractive as a means of payment. Demand and supply rose… market prices went up, too.

«Discovering value is a purely mental, or psychological, process.»

So, next time when someone asks you whether it is the artificial scarcity, the electricity injected into the network, the «network effects», or even the pseudonymity of transactions, you know that these useful network features only act as potential reasons why people may assign some value to Bitcoin. However, those reasons are not the value of Bitcoin. Never! Valuation is always the subjective result of our mind.

Soaring market prices follow from there…

The War Against Cash in Europe

There are good reasons why the debate on cash is heating up right now.

While European governments and central banks have stepped up capital controls in the last few years, cash has become the major hurdle for conventional monetary policy. Therefore, many economists, as well as a number of high-ranking government officials, have presented and reiterated their arguments in favor of the abolition of cash virtually at every opportunity.

Although most European citizens do not approve further restrictions on cash, the outcome of the political debate is open.

The use of cash in Europe

The political reasoning for a ‘European’ war on cash is based on an ideological mindset that is identical to what is heard across the Atlantic. What is different, however, is the popularity of the use of cash, which also differs from country to country within Europe.

Unlike the Scandinavians, who have largely moved to a cashless society, other countries still prefer to keep their notes and coins. Recent surveys show that over 70% of the German population opposes further restrictions on cash. Switzerland’s National Bank has announced that it will not follow other countries’ example of phasing out what is the world’s highest denominated bill (in terms of exchange rate value), the 1,000 Swiss franc note.

People’s attitude towards cash appears to be influenced by the cultural context of a nation. Germans, for example, have faced at least four monetary reforms in the last 100 years. The great hyperinflation in the 1920s must have left marks in the Germans’ consciousness.

Unlike the German currencies, the Swiss franc has never experienced monetary instability of comparable scale. It is rather the general suspicion toward government power that has led the Swiss to take a conservative stance towards cash.

Today, and especially after 9/11, restrictions on cash have increased exponentially.

Denmark and Sweden are at the complete opposite. These countries have officially passed legislation in order to discontinue cash step-by-step. The largest Scandinavian banks have recently stopped allowing cash withdrawals in most branches. Moreover, the financial industry has actively encouraged regulation limiting cash use in daily transactions in the name of fighting crooks and protecting the environment. Finally, Danish law leaves the decision whether to accept cash or not to the providers of goods and services; as of this year, clothing stores, restaurants, and gas stations are allowed to turn away customers who cannot pay electronically. It is literally a Scandinavian war against cash that has taken place in the last decade.

Internationally, initiatives against cash reflect the current interconnectedness of financial markets.

The emergence of a globalized financial system led to the regulation of cross-border payment transactions and capital flows. The original intent was to make it harder for criminals to channel in money that originated from crime. Regulation of cash deposits and withdrawals at banks was initiated as early as in the 1970s in the USA and in the 1980s and 1990s in Europe.

Today, and especially after 9/11, restrictions on cash have increased exponentially.

Most legislation is supposed to prevent money laundering and terrorist financing. However plausible these reasons are, they have also been blatantly misused in the war on cash. Since the European Union is competent in the field of anti-money laundering regulation, there has been great effort to harmonize national laws. The EU finance ministers have recently called the EU commission “to explore the need for appropriate restrictions on cash payments exceeding certain thresholds” throughout the Union, and, to the same effect, the European Central bank has announced its willingness to “examine the consequences of phasing out” the 500 euro banknote.

Despite this political agenda and its questionable implementation, many countries of the Eurozone have already put in place strict measures: The French government tightened restrictions on cash payments and intensified monitoring of high-value withdrawals after the latest Paris terrorist attacks; the upper payment limit was lowered to 1,000 euros. Italy recently went back to its former limit of 3,000 euros. Payments exceeding these amounts must be executed through a licensed bank.

While extending the scope of the anti-money laundering statute to non-financial intermediaries, even Switzerland now regulates transactions over 100,000 Swiss francs. Yet, it is unlikely that the political intention is to stop discriminating cash users at some point but rather to incrementally reduce the allowed transaction limits, and eventually, to discontinue the use of cash entirely.

The government’s need for cashless finance and its fallacy

Following the meltdown of the financial system in 2008, governments collaborated with the financial industry by bailing out large banks in an unprecedented way. As a consequence, public debt levels have surged. At the same time, interest rates are at the lowest possible, approaching zero.

We have reached a point in the fiat money system where even unorthodox monetary measures, such as ‘quantitative easing’ or ‘helicopter drops’, have missed their official goal of stimulating the economy. Newly printed money has barely been going into real capital production, but it has rather been inflating asset prices; instead of investing in new products and services, many businesses have recapitalized on better terms, performed buybacks or paid out dividends to their shareholders.

This is a good thing for banks because they are relieved from servicing “toxic assets;” however, such a monetary policy is not able to boost the economy in a sustainable manner. This is where cash comes in: Cash has become a real drawback according to mainstream economic theory. It limits the central bank’s ability to reduce short-term (nominal) interest rates below zero.

According to the concept of “zero lower bound”, if interest rates drop into negative, bank account holders are encouraged to withdraw their savings and keep them as cash. Given that cash does not pay any interest, it is still better to hoard cash under the mattress than to leave it in the bank where it is charged negative interest or a fee. If falling rates exceed the costs of holding cash at home or in a safe deposit box, people will withdraw en masse.

It is obvious that banning cash would not build up confidence in the current system, but rather destroy the last bit of it, as recent data on growing cash circulation in the Eurozone, Switzerland and the UK indicate. The problem about this is that the viability of certain fiat currencies genuinely depends on substantial cash restrictions.

If cash were abolished, any fiscal or monetary policy would be enforceable in the short run.

A little bit of tapering might be bearable for the US dollar, if interest rates return to pre-crisis levels. However, it will not be the case for the Eurozone and would provoke the exit of a member country. It is therefore essential to certain European countries (and to the EU itself) to increase the degree of financial repression in order to refinance their debts and deficits at the expense of the public.

If cash were abolished, any fiscal or monetary policy would be enforceable in the short run: Increasing negative interest would force bank account holders to spend their money or to invest it in riskier assets, such as bonds or stocks. Despite the disastrous effects on the economy, such as malinvestment, outright confiscation of wealth would hit account holders even harder: In a system where all money is electronic, bail-ins, capital levies, or seizures could be imposed on bank customers without them having the slightest chance to avoid those controls. It is obvious, though, that such a policy would pervert the original purpose of money, which is above all to securely store value.

Proponents of anti-cash policies too often forget the non-coercive character of money. Describing its emergence, the great Austrian economist Carl Menger points to the fact that “[c]ertain commodities came to be money quite naturally, as the result of economic relationships that were independent of the power of the state” (Principles of Economics, 1871, Auburn [2007], 262). In other words, banning physical cash would simply lead to the emergence of alternative means of payment that would outcompete official tender. A lot of people would start using near-money substitutes, such as gold or silver, or whatever commodity facilitates the exchange of goods and services instead. Ignoring this fact shows us how little mainstream economists know about the origin of money and how much they overestimate the validity of their policy advice.

Cash from the perspective of the individual person

Actually, there are good reasons to oppose fiat currencies. They are inherently flawed due to a lack of competition. However, when it comes to the physical manifestation of fiat money, i.e. cash, there is a need to differentiate. In the existing context, cash truly means freedom, at least in the sense of less state control or more options to choose from.

Let us have a look at recent examples in Europe: Greeks have experienced far-reaching restrictions on cash withdrawals at the peak of the debt crisis, bank customers’ deposits in Cyprus were bailed in up to 50 percent in March 2013, and Italian and Portuguese bondholders have been forced to acquire stocks of insolvent banks for the last two years. These are all too familiar stories in Europe today; financial repression seems to be the political panacea to overcome the consequences of preceding government failure.

The abolition of cash would represent the logical next step in a series of detrimental government interventions. Yet, it would never justify such an extensive infringement of personal liberties.
When it comes to creeping state control, it is no surprise that certain European countries, such as France, are at the forefront. An electronic world would be far easier to both tax and control. Such a narrow view on the issue of tax evasion, however, completely ignores the root causes for tax evasion in the first place. Furthermore, the abolition of cash might reduce the black market economy at first, however it would just be a question of time until black markets would thrive even more.

Cash does not only mean privacy towards state agencies, but also towards data gathering companies. In other words, the end of cash is also the end of privacy. A cashless society would give governments and businesses access to information and power over citizens in an unprecedented manner.

Considering the ubiquity of money in our society, no sphere of life would be left untouched. Physical cash offers a fallback option for the time governments become prohibitive or electronic systems break down; cash literally offers insurance to its owner and thereby protects him or her from the loss of freedom and property. Cash is said to be inefficient and primitive; however, anti-money laundering regulation has artificially increased costs for merchants who prefer cash. In a market economy it is not up to the banks (or the government) to decide on the means of payment, but to the consumer. And let us not forget: Cash is especially valuable to the billions of people who are unbanked or underbanked worldwide.

Cash is no end in itself, but rather the indispensable means to exercise basic rights.

Finally, cash embodies the value of unconditionality. Cash is basically not dependent on a third-person or a private contract. It is not contingent on the solvency of banks or the effectiveness of the financial system. Unlike bank money, cash transactions are immediately cleared and settled. The same is true for bitcoin, which is why the cryptocurrency is called electronic cash. There is one but significant reservation to the principle of unconditionality: Cash remains dependent on the solvency of its issuer, the government.

The idea of an outright ban may seem far-fetched to some of us; however, the longer the interest rates stay low or negative, and the longer the economy does not get off the ground, the sooner unthinkable proposals could be argued as being without any alternative.

Cash is no end in itself, but rather the indispensable means to exercise basic rights. Even if it were possible that hardly anything changed in a cashless society, the abolition of cash would de facto prejudice human behavior.

Cash is not about illicit activities, but enabling a lifestyle that does not harm others. Fyodor Dostoyevsky wrote in 19th century-Russia that “money is coined freedom;” today, we would probably correct him: Cash is coined freedom.

Published in the Cayman Financial Review