B&E | The Roots of Crypto Currency

B&E | The Roots of Crypto Currency

By Gautam Vora
Department of FIT Management, Anderson School of Management, 
University of New Mexico, Albuquerque, USA

B&E | The Roots of Crypto Currency

Photo: Jason Benjamin, Creative Commons, some rights reserved

Many forms of money exist. From the tangible forms of money (e.g., commodity to precious metal to base metal to paper) to traditional intangible forms of money (e.g., traveler’s checks to demand deposits to other checkable deposits) to modern intangible forms of money (savings deposits to other time deposits to deposits in money market funds of banks/thrifts and mutual funds). 

Aforementioned forms have the imprimatur of the state or the sovereign, thereby making it economy-wide money. For example, in the US, for January 2015, the currency stock (coins and Federal Reserve notes) is only $1266.3 billion; when other items are added, money stock measure M1 becomes $2927.9 billion. For the same period, money stock measure M2 is $11706.5 billion (http://www.federalreserve.gov/releases/h6/current/#t2tg1link). Thus, the coin and currency is 43.25 percent of M1 and only 10.82 percent of M2. Moreover, most of the money is not “real money”; it is in book-entry form (when we had physical account books) or in entries in a digital database (when accounts are kept on a computer). Thus, this digital money is as “virtual” as it gets. We have many other forms of money whose reach may not be economy-wide:

1) company money: commercial paper, stamps, coupons, points and rewards such as frequent flyer miles;

2) craft money: community currencies (1) (http://www.communitycurrency.org/home);

3) play money: board games (e.g., Monopoly) and computer or online games (e.g., Gods, Gemstone III, Lineage, systems such as Second Life). Some of the online games allow creation of money or other rewards and a player can exchange the real money for play money(2). 

When the games allow creation of money or spawn a currency to meet the demands of players, this currency is digital. Because an online game world is a virtual world, one can call the associated currency a “virtual currency” (3)

The roots of digital currency for the real economy can be found as far back as 1967 when the Rand Corporation published Harrison’s ([1] [2]) two-volume bibliography of articles and reports on the subject of protecting individual privacy and providing data security in computerized record-keeping systems. This was followed by Hunt and Turn’s [3] annotated bibliography for the years 1970-1973 on the same subject. The Harrison bibliography was part of the testimony before The Senate Subcommittee on Administrative Practice and Procedure on the subject of privacy aspects of the cashless and checkless society [4]. Armer emphasized the point made by Oettinger ([5], p. 38] that “Automation affects not the mere mechanics of banking, but the very foundations of banking; not the individual bank, but banking systems and the national and international economies in which they are embedded.” During these times the trends in financial systems were causing economic agents, regulators, and governments some alarm. Lee [6] captures the alarming trend of “checkless, cashless society” quite well in his article. The progress in computing and telecommunications, however, did not take banking system very far. Humes [7] actually discounts the progress made. Nevertheless, Roland [8] lauds the progress made in the industry. Even if we were to ignore Roland’s bold forecasts on the future progress and convergence of numerous technological developments to result in digital watch, computer-aided instruction, impact on employment, smart machines, home-banking, driverless planes and cars, his prescience must be appreciated for he states,

The movement toward [electronic funds transfer] EFT has met a great deal of resistance from the public, which fears that EFT would increase the risk of costly mistakes or theft, reduce privacy, encourage greater government intervention and control or be vulnerable to disaster or sabotage. Progress toward EFT has been hindered by the lack of low-cost, widely available transaction terminals, the high cost of reliable data communications lines, the lack of secure methods of identifying transacting parties, and the lack of adequate back-up systems.

For many purposes, a cashless, checkless society would be highly desirable. Most crimes of gain depend on the use of cash, and organized crime as we know it would probably become impossible if cash were eliminated. If all financial transactions could be monitored by the government, it might be able to intervene more effectively to control inflation and avoid recession. Tax collection could be made automatic and much less painful, both in impact and in the burden of bookkeeping imposed. Sound economic planning by business, government, and individuals might become possible in a way that it now is not. It could permit a more efficient allocation of resources and more accurate investment strategies.

Microcomputer technology and the advent of the [computer] will make the cashless, checkless society feasible and may answer the legitimate objections to EFT.… Trapdoor(4) codes will provide secure communications and positive identification between transacting parties and banks. Low-cost non-volatile memory systems will make possible permanent, non-alterable records of all transactions. Microelectronic technology makes trapdoor coding economically feasible for use in all kinds of communications and transactions, and trapdoor coding can make all kinds communications and transactions secure against eavesdropping and tampering.

Fast-forward to October 1995 when Alan Blinder, Vice Chairman of the Board of Governors of the Federal Reserve System, testified before the US. House Subcommittee on Domestic and International Monetary Policy [9]:

First, the concept of [digital cash or] electronic money is not new. Electronic transfer of bank balances, for example, has been with us for years. Indeed, some of the new proposals simply make available to consumers and smaller businesses capabilities that large corporations and banks have had for many years.

Second, no one knows how the industry will evolve, either in form or in size. Some of us, for example, can still remember predictions made a generation ago that the United States was on the verge of being a cashless, checkless society. Those predictions, of course, did not come true. At least not yet. This last point reminds us that, at present, we do not know which, if any, of the many potential electronic innovations will succeed commercially.

My testimony this morning will concentrate on stored value cards and other types of so called electronic cash, because they seem to raise the most challenging public policy issues. In particular, depending on their design, they could amount to a new financial instrument, an electronic version of privately issued currency. But even the concept of private currency is, of course, not entirely new. Travelers [sic] checks are familiar to everyone. And in the 19th century, the United States had considerable experience, not always happy experience, with privately issued bank notes. But widespread use of private electronic currency would certainly raise a number of policy questions. On behalf of the entire Board, I want to state clearly at the outset that the Federal Reserve has not the slightest desire to inhibit the evolution of this emerging industry by regulation. On the contrary, the Board encourages innovations in payments technologies that benefit consumers and businesses.

Vice Chairman Blinder wondered “whether the Federal Government should issue its own electronic currency” in order to “probably stem seigniorage losses and provide a riskless electronic payment product for consumers. In addition, should the industry turn out to be a natural monopoly, dominated by a single provider, either regulation or government provision might be an appropriate policy response.”

The issues of privacy and risk of distrust of government were not addressed. These issues, however, have continually exercised the public. Szabo [10] proposed “smart contracts”, a mechanism to “combine protocols with user interfaces to formalize and secure relationships over computer networks”. The mechanism was founded on “legal principles, economic theory, and theories of reliable and secure protocols”. Szabo [11] followed his earlier discussion with “digital bearer certificates” conjoining digital cash and distributed (computing and informational) capabilities. All these are building blocks of cryptocurrencies and E programming language(5). Szabo [12] released a well-developed concept of digital currency and mechanism of decentralized (distributed) control for “bit gold” which in general is considered the precursor of bitcoin.

References:

[1] Harrison, A. (1967) The Problem of Privacy in the Computer Age: An Annotated Bibliography, I. Rand Corp, Santa Monica.

[2] Harrison, A. (1969) The Problem of Privacy in the Computer Age: An Annotated Bibliography, II. Rand Corp, Santa Monica.

[3] Hunt, M.K., and Turn, R. (1974) Privacy and Security in Databank Systems: An Annotated Bibliography, 1970-1973. Rand Corp, Santa Monica.

[4] Armer, P. (1968) Privacy Aspects of the Cashless and Checkless Society (Testimony before the Senate Subcommittee on Administrative Practice and Procedure). Rand Corp, Santa Monica, Document Number: P-3822.

[5] Oettinger, A. (1964) Proceedings of the National Automation Conference, American Bankers Association, New York.

[6] Lee, N.F. (1967) Tomorrow’s Checkless, Cashless Society: The Problems, the Solutions, The Benefits. Financial Executive, June. Reprinted in Management Review, 56, 58-62.

[7] Humes, K. (1978) The Checkless/Cashless Society? Don’t Bank on It! Futurist, October 1978, 301-306.

[8] Roland, J.D. (1979) The Microelectronic Revolution. Futurist, April. http://www.pynthan.com/microrev.htm

[9] US House Subcommittee on Domestic and International Monetary Policy (1996) The Future of Money: Part 2 Hearing. Government Printing Office, Washington DC, 11 October 1995. Reprint, Forgotten Books, London, 2013. http://www.forgottenbooks.com/books/The_Future_of_Money_v2_1000869064

[10] Szabo, N. (1997) Formalizing and Securing Relationships on Public Networks. First Monday, 2, 1 September 1997. http://ojphi.org/ojs/index.php/fm/article/view/548/469 http://dx.doi.org/10.5210/fm.v2i9.548
[11] Szabo, N. (1997) Contracts with Bearer. Nick Szabo’s Essays, Papers, and Concise Tutorials. http://szabo.best.vwh.net/ http://szabo.best.vwh.net/bearer_contracts.html

[12] Szabo, N. (2008) Bit Gold. Unenumerated: An Unending Variety of Topics. Forbes.com Blog Network. http://unenumerated.blogspot.com/2005/12/bit-gold.html

Endnotes:
  1. Articles in International Journal of Community Currency Research (http://ijccr.net/about/) are fascinating.
  2. Note that some of organizations hold tournaments for these games and offer real prize money 
  3. The definitional problem of digital currency versus virtual currency versus alternative currency vs complementary currency will never vanish. The development of cryptocurrency has added to the lexicological maelstrom.
  4. “A trapdoor code is a pair of mathematical functions, an encoder and a decoder, each of which is based on a prime factor of a large number Knowing the encoder does not help someone find the decoder, because that would involve finding the prime factors of the large number, and no easy way has been found to do that.”
  5. See, for example, Counterparty platform at http://counterparty.io/ and Smart Contracts at http://www.erights.org/smart-contracts/.
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