First, credit money solves liquidity issues in a complex economy by means of a business called banking. Second, being a social institution, money both expresses and contains conflicts between warring parties within the capitalist system. Modern credit money works ultimately because it watches over a capitalist peace.
Bitcoin is the product of a rupturing of that peace with the financial crisis. Bank bailouts were a particular breach. As protestors observed: “Banks got bailed out, we got sold out." We only think about the plumbing when it breaks; when money broke, we saw an efflorescence of ideas around money, including cryptocurrencies.
Being bailout-proof is a big part of the design of cryptocurrencies. If it can just be “printed" and handed out to the bankers who broke the system, something must be fundamentally wrong with modern money. Liberty-loving system designers with such ideas thought they could do better. Their mission: to apply cryptography to money and take power away from state-banker elites. Their inspiration was the currency system immune to such abuse, the gold standard of the 19th century.
There is one problem with this inspiration, however: the gold standard was a credit system just like our modern system. It was also built on promises both political and economic. Indeed, it was precisely because it could not keep its political and economic promises that the gold standard failed.
A credit note is an IOU, a promise to pay something. Money under a gold standard was a promise to pay gold. The key term, note well, is promise: institutions issuing such notes had to make good on this promise and deliver the gold when notes were cashed in.
This system of promises to pay gold worked so well that it appeared to end users that gold was waiting for them in the vaults. Comforted by the security of the promise, they rarely bothered with the cumbersome metal, using notes instead. People incorrectly assumed that their notes represented gold in the vault much like a movie ticket represents a seat in the cinema.
But this is not how the gold standard or indeed any credit system works. Or rather, this is exactly how credit appears when the system is working well. So convinced are we that a credit note is as good as gold that we are collectively offended when the truth is revealed: the wizard turns out to be a fraud.
Despite what goldbugs may say, banking is no more fraud than borrowing is sin. A bank takes in short-term loans of “cash" (deposits) and makes longer-term loans, but the same “cash" is not simply lent back out: that is a different business called money-lending. With banking, the business’ own liabilities (IOUs) are issued when making loans. These newly-minted deposit liabilities are just like other deposits: they can function as “money" because they can be exchanged for “cash" on demand. To meet this demand, banks keep some fraction of “cash" in reserve.
“Cash" can be any outside asset, something other than the bank’s own liability. With the gold standard, this outside asset was gold, a finite commodity. In our system, this outside asset is central bank money, the IOU of the central bank, the state’s bank. Bank money is a promise to pay central bank money, a promise maintained so effectively that we take them to be the same thing. But what is central bank money a promise to pay if not gold?
In a word, GDP (gross domestic product). Modern money is like a government bond with special features: it pays no interest (it is “zero-coupon"), is owned by the bearer, and it never matures, it is perpetual. Modern credit money is a claim on national wealth. Central banks hold government IOUs and governments hold high-quality, virtual IOUs: future taxation claims against every economic entity within a political community. The robustness of these interlocking claims, political and economic, is what gives credit money real value. These are hard-edged social relations, so solid that they act like commodities.
Cryptocurrencies are designed as artificially scarce digital fiat tokens with no intrinsic economic value. They are designed this way because they are meant to do battle with “fiat money" tokens that are also seemingly based on faith and subject to state abuse. Cryptography is meant to create an abuse-free fiat token.
This effort is based on a false premise, not that there was no abuse (there certainly was), but that money is a token created by fiat. There is no such thing as “fiat money"; we should put the term out of circulation.
What can be created in more or less disciplined ways are promises to pay real value. This is what happens in a credit system, even one based on gold: promises are created and destroyed all the time as the economy endogenously solves its liquidity problems. The point about having a commodity as the outside asset rather than another IOU is that it disciplines the system by being finite: depositors can run for gold. The gold standard was a disciplined credit system, far too inflexible as it turned out, for either global capitalism or democracy.
It is easy to see why it failed: ask yourself how much money the economy needs. Limiting money to a finite stock is the most arbitrary form of central planning, deciding in advance and for all time the liquidity needs of a complex, evolving economy. Politically, because government borrowing would also be limited to outside asset reserves, spending programmes would be so limited as to constrain even basic democratic demands.
The “barbarous relic" was therefore abandoned for a more flexible anchoring asset: the national economy itself, accessed via the interlocking institutions of the central bank and the fisc. Contemporary capitalism uses this flexibility to maintain a balance between class interests, a balance taking different forms at different times and places. While this balance held, credit systems built on national economies remained more or less disciplined.
But as this balance tipped towards capital globally, discipline started to give way. The national economy at the top had little to check it given that its liabilities are the outermost asset in the global system: there was no place to run other than dollars. Only a global balance of power could check it, but capital became ascendant just as the globe became unipolar. An undisciplined credit system resulted, predictably leading to a crisis and a fundamental questioning of money.
Those longing for gold or its cryptographic equivalent have identified the culprit by accident. If gold represented discipline, then the lack of gold does in fact indicate indiscipline. Bitcoin is a misdirected but legitimate cry for a more disciplined and democratic economic system.
But bitcoiners are solving the wrong problem. Our problem is not the technocratic one of redesigning a phantom called fiat money. Our problem is political: undisciplined capitalism amplified by unipolar geopolitics leading to an undisciplined global credit system. Returning to gold via bitcoins is simply too austere and inflexible for democratic capitalism. It might actually aggravate indiscipline by undermining the state’s ability to balance out capital in the interests of democracy.
Besides, unless banking itself were banned in a bitcoin world, we would soon get a bitcoin credit system with bitcoins acting as a gold-like, inflexible outside asset atop which credit claims are built. Bitcoin exchanges already functioning as such.
The classical gold standard period ran from 1880 to 1917; the British Empire was at its height while most people in Britain and the rich world could not vote. The gold standard is thus synonymous with Empire and the absence of democracy. The system’s inflexibility reflected its undemocratic political fundamentals. Limiting the money stock to a finite number of bitcoins would only benefit those who benefited under the gold standard, the same people who caused the financial crisis. Ironically, these are the same people bitcoin was designed to discipline.
The efflorescence of cryptocurrencies has reminded us of one important thing, however, that our economic system is designed by us collectively. Our institutions are like social software, we can design them to our own specifications. We can even imagine delinking markets, the state, and money from capitalism itself.
But it appears hard to design our way out of hierarchy. Hierarchy emerges in bitcoin through mining, and mining in turn is answer to the question: how do we maintain a distributed ledger, a ledger without a central agent? The solution is to grant updating rights to users who have done some “proof-of-work". But the ability to do computational work is hardly democratically distributed. There is also the issue of who maintains the code, how forks are decided, and that all design happens “centrally".
Bitcoin has sought in vain to eliminate hierarchy; the point is to tame it. This is true of modern credit systems as well which are inherently hierarchical and therefore susceptible to abuse. Cryptocurrencies are wonderful experiments that prove we cannot design our way out of hierarchy. Just as economic value cannot be created by fiat, complex social institutions cannot have pure technological fixes. In the end, institutions are only metaphorically like software: they are not mere instruction sets but containers of conflict. We can design and build new institutions, but like all good designers, we must have a good sense of our materials.
Anush Kapadia is assistant professor in the department of humanities and social sciences at the Indian Institute of Technology, Bombay.