This series, adapted from Resistance Money, uncovers Bitcoin’s anti-authoritarian roots, contrasts it with other digital money, and shows how it makes good on the dream — not of digital money, but digital cash — by doing away with monetary middlemen.
Authors: Andrew Bailey, Bradley Rettler and Craig Warmke
Cash is peer-to-peer. We can save it and spend it without depending on others. When it comes to money that isn’t cash, we trust individuals and institutions to provide financial services for us. When things go well, these providers take on certain roles and thus make our lives much easier. But they also bring risk. When these risks materialize, these providers make our lives much harder. To gain a better appreciation for digital cash, we’ll focus on three functions or roles within the monetary domain and the risks associated with each: managing, mediating, and making money.
Managers
Few store their life savings in cash under a pillow. Instead, we have others store our savings for us – managers. They usually have expertise, resources, and staff to provide security. Banks serve as managers most often. We entrust them with our funds because we think it’s riskier to hold the funds ourselves.
Yet managers could lose our funds too. When banks hold funds, we trust them to keep funds safe from loss or theft. But banks usually don’t store funds in vaults, physical or otherwise. They lend our money to others for profit. So by enlisting a bank to store our funds, we must also trust them to do so responsibly. If they do it irresponsibly, we might lose some or all of our funds.
Mediators
When using cash, you hand over some dollar bills, and the transaction is complete. No one else needs to know what happened, and no one else needs to cooperate for full settlement to occur. The handover is the settlement. In modern electronic payment systems, the “handover” often involves a complex web of trusted parties. These are the mediators.
With a tap of your Visa card, you can leave the store with Flintstone vitamins in hand. But the transaction isn’t actually complete. Provisional settlement – a conditional and easily revocable state – occurs when Visa initially approves the transaction. But final settlement – unconditional and not easily revocable – typically takes days or weeks. In that time, money will travel through Visa, your bank, and the merchant’s bank. It ultimately settles through master central bank accounts but might first wind through corresponding banks that facilitate inter-bank transfers.
Thanks to mediators, merchants themselves don’t need to extend you credit or know who you are or where you live. But under the hood, mediators involve significant complexity. Your card has the Visa logo. The merchant trusts Visa. Visa trusts your bank. Your bank trusts you. Trust expands our financial powers and provides convenience. Thanks to mediators, we can also transact over great physical distances – good luck doing that with physical cash.
The system works only if mediators deal quickly, honestly, and with few mistakes. But each mediator is a potential point of failure. If they fail, convenience vanishes. You might get stuck in an infinite loop of Muzak and customer service representatives, hoping for someone to put Humpty back together again before dinnertime.
In the web of managers and mediators, some entities play both roles. Banks play both, for example. But whether service providers manage funds, facilitate transactions, or both, they know quite a bit about us. We provide personal information when we sign up for their services. And as we use those services, they collect even more personal information. So we have to trust that they’ll steward this information responsibly – to protect it from prying eyes and to surrender it to authorities only with due cause.
Despite the overlap between mediators and managers, only when a provider serves as a mediator does it also serve as an intermediary between you and your counterparty in a financial transaction. That is, while both managers and mediators are trusted parties in the sense given earlier, mediators are also trusted third parties. To make this more vivid, imagine a cash transaction where you hand a dollar bill to a middleman, who then hands it to the merchant. Middlemen are often unnecessary for cash transactions. They are also risky: middlemen might delay or block the transaction or even take a cut for themselves. But modern electronic transactions require middlemen. When things operate smoothly, our trust and their trustworthiness together yield all manner of convenience.
Makers
Under the watchful eye of the Securities and Exchange Commission, American corporations create shares and sell them on the stock market. Corporations that issue stock are makers. And holding stock requires trust in its maker. A company that issues more units of stock may dilute the share of the company owned by shareholders, even if those shareholders continue to hold the same number of units. So issuing more stock also makes each unit less valuable.
Money has makers too. Even if you’re unfamiliar with corporate finance, you’ve likely used the dollar, euro, or yen. Their makers are banks. How this happens varies across national boundaries and within them. Typically, inside money comes from commercial banks. Your bank account – which is inside the private sector – holds inside money. Your bank, in turn, ultimately has a balance at a bank for banks – the central bank, which is out- side the private sector. Thus, this balance concerns outside money.
Inside money is an IOU for outside money. For example, your personal bank account might show a dollar amount. But those aren’t real dollars. They are IOUs or claims on real dollars, the things represented by physical dollar bills or in balances that commercial banks hold at the central bank. Whereas commercial banks issue inside money through debt, central banks issue outside money through, well, decree. And either way, we trust banks to create money responsibly.
The most influential central bank in the world is the US Federal Reserve. It provides a monetary asset, the US dollar, around which billions of people coordinate their economic behavior. They carry out their mission by pushing and pulling various levers to help ensure that the US dollar maintains a stable price – or, what’s the same, that goods and services enjoy a stable price in dollars.
The Federal Reserve is a trusted party in all three senses of maker, manager, and mediator – it is the monetary trinity. The Fed makes the dollar. The Fed manages the funds of other banks. And the Fed ultimately serves as the central mediator for digital dollar transactions through services like FedWire.
In sum, managers offer convenience and peace of mind. Mediators maintain financial plumbing. And makers enable economic stability and exchange through a common medium. Users of modern money trust these parties to do their jobs well. This is a tradeoff and involves risk. As cypherpunk Nick Szabo says, trusted parties are “security holes.” Managers sometimes fail, leaving their customers with pennies on the dollar. Mediators sometimes block lawful commerce. Makers also make mistakes. They might print too much money and, as inflation soars, put on the brakes too late. Then they might slam the brakes too hard and, as a recession looms, keep the brakes on for too long. Sometimes makers know which levers they’ll pull and, as private citizens, execute a series of, let’s say, well-timed trades in the stock market. This is insider trading, not with company stock, but with what company stocks trade against – a national currency.
As a group, these trusted parties can and sometimes do imperil our financial privacy, our funds, our freedom to use them as we’d like, and their value. Some will judge that the benefits of trusted parties outweigh the risk. They might be right. It might also be true that we would benefit from having options without one or more of these trusted parties so that participating in the economy doesn’t force us into a single set of tradeoffs.
As we’ll see in Part 3, this is what Bitcoin gave to the world: a monetary option that does away with trusted parties.
