What Is A (Crypto) Currency Anyway?

By the end of the WWII, the German economy was wrecked, Germany was split into four zones under the military rule of the Americans, British, French, and Russians. Hitler’s Reichsmark was still in circulation, but had been rendered almost worthless by massive inflation in the latter stages of the war. Because Reichsmark notes bore the swastika, the Western administration withdrew them from circulation, replacing them with Allied Occupation Marks, printed in the US.

Getting this temporary new currency to circulate was not easy — so difficult in fact that a barter economy soon evolved with cigarettes as the currency. This unusual situation happened almost naturally. In Germany smokers’ ration cards had been issued from 1940 onwards, limiting smokers to a mere 40 cigarettes per month. Since most smokers have a more substantial appetite than that, a black-market for cigarettes soon flourished. When the war ended cigarettes were the most effective currency because they were already circulating, the supply was limited, and they were regularly burned — damping down inflation.

In June 1948, the Deutsche Mark was launched, with an airdrop of 40 DM to every resident of West Germany. At last there was a reliable currency in circulation and it forced the black market into swift retreat.

While cigarettes could never be a sustainable currency, it worked surprisingly well for a few years among a population of over 30 million.

What makes a currency viable?

By definition a currency is a medium of exchange — it must be exchangeable for goods. Until the dawn of the digital world, this severely limited what could serve as a currency. It couldn’t be something that decayed easily, or could be forged easily, or was too large or too heavy and, above and beyond those practical details, people who used it needed to have faith in it.

These conditions reduce the possibilities of what can serve as a currency considerably. Historically, until the invention of printing, there are few examples of money that was not coins of one kind or another, made from iron, bronze, silver or gold. The invention of the coin is lost in history as also, surprisingly is the invention of the account. There is evidence from 30,000 years ago of the use of tally sticks, as a primitive form of accounting.

You can think in terms of “exchange money” (coins for buying things) and “account money,” which is a store of value managed by some organization you trust. In ancient Egypt, Babylon, India and China, temples and palaces often included commodity warehouses that issued “certificates of deposit” as a claim on goods stored there.

Also, there is the idea of legal tender. A currency is legal tender if, by law, you cannot refuse it as payment. Such currency is, of course, only legal within a given jurisdiction.

Finally, a currency needs to have a relatively stable value so that it can act as a store of value and a metric of value. Currencies that fluctuate in value fail because they are not reliable either as a store or a metric of value.

To summarise, ideally a currency has the following characteristics:

It can be exchanged for goods or services, as the medium of exchange.
It can be used as a currency of account (if an appropriate mechanism exists).
It is proof against fraud.
It is highly portable.
It is legal tender.
It is a store and metric of value.

De Facto Currency

In the 16th century the circulation of gold and silver coinage constituted a near-global currency. It was in use across the Eurasian landmass from Scandinavia to Korea.

It was viable because the coins were valuable of themselves. There was minimal coin value inflation, the coins could be tested for fraud, and they didn’t need government validation. The coins were portable (within reason) and on the trading routes, secure banks existed where large holdings could be deposited. Consequently, merchants had faith in such coinage, and it was used extensively — and for many years, even after paper currency was introduced

At various points in history, currencies have emerged and survived without need for government imposition. And it looks like it may be happening again. Cryptocurrencies may evolve into de facto currencies, and there may be nothing governments can do to prevent it, short of martial law.

Let’s consider it point by point:

Are cryptocurrencies an effective medium of exchange?

Demonstrably so. A number of them: Ether, Litecoin, Bitcoin Cash, Monero, and others, are used as money, by a growing band of consumers and retailers (mostly eRetailers). Their value can be readily known 24/7 by reference to crypto markets. In fact, they have a distinct advantage in this as the cost of exchange is very low. Faith in these currencies as a medium of exchange is established.

Can they also be a currency of account?

In reality that is their strength. The crypto wallet and its contents are one. As such, a crypto wallet is a bank account, a debit card and currency all rolled into one. They are a currency of account that requires no trusted third party to manage the account.

Are cryptocurrencies proof against fraud?

The record cries “YES,” and so does the mathematics that spawned them. As far as anyone knows, they are impossible to forge. As with any other currency, it can be stolen. But crypto is by no means as easy to steal as bank notes, which belong to whoever holds them.

Is cryptocurrency portable?

Yes — highly portable, more so that gold or silver. They are as portable as, say, a mobile phone or a banknote. if not more so.

Is cryptocurrency legal tender?

Not in the sense that people are obliged to accept it in payment. However, because of the existence of various fast exchange capabilities and crypto debit cards, it is as good as legal tender as you can easily exchange it for legal tender.

Can cryptocurrencies be used as a store and metric of value?

This is where, at the moment, many cryptocurrencies fail. Their value (as expressed in local currency) fluctuates far too wildly. They will not become practical currencies until such fluctuations tamp down.

At Algebraix we have thought long and hard about this problem. We looked at it this way: Most of the popular cryptocurrencies are alternatives to fiat currencies — they provide payment mechanisms. Our currency, ALX, is a utility token. As such it is more like air miles or other such loyalty tokens, which derive their value from the commercial ecosystem in which they circulate. So our currency may be different. Time will tell.

In two later blog posts, I’ll pursue this topic further and discuss:

Stocks v Coins, What’s the Difference?
What is a Utility Token, and Why Should I Care?