Special thanks to Sam Hart and Ethan Buchman for feedback and review.

This article discusses the medium of money through the lens of the trust context in which it operates. Historically, value exchange within a community, where trust among individuals is inherent, often relied on credit money based on accounting records and reputation. Whereas, outside the community, particularly in import-export trade with strangers, trust is lower and people commonly turn to commodity money, such as gold or silver, valued for its intrinsic worth and material weight. In the presence of an authority, where trust is intermediated, various materials from marked coins to paper banknotes have been used as money, as long as they are enforced for payments and tax collection. Modern nation-states employ fiat money, which is based on the public's trust in the state's ability to manage and repay its debt. Bitcoin and other decentralized crypto assets, fundamentally rooted in cryptography, represent virtual resources within the network, with intrinsic durability derived from the laws of physics. Consequently, cryptocurrencies function as commodity money similar to gold and are suitable for use in low-trust environments without the presence of an authority. Beyond functioning as commodity money, cryptocurrencies are programmable and offer communal databases of verifiable records without the need for intermediaries, and allow new forms of coordination and economic models. While states and banks around the world are trying to adapt to these developments, current implementations of credit mechanisms in crypto largely mimic traditional banking models. The potential of peer-to-peer credit systems facilitated by crypto protocols, remains largely unexplored and ripe for innovation.

Money Inside

Within a community, where trust is inherent among individuals, exchanges often rely on credit money. For example, I give you grains, you give me a token marked with a grain symbol. This token represents your debt, which I hold onto until you return my grains. Alternatively, you can deposit your grain in a secure storage facility and receive a grain token, while I do the same with my wine. Then, in the marketplace, we simply exchange these tokens, which can be redeemed for the actual goods in storage, settling our debt. This is how money worked 5000 years ago in Sumerian towns, as they began trading their agricultural surplus and used clay tokens first for counting, then for accounting, and eventually for administration.[1] These tokens were made of clay, often stored in clay envelopes for safekeeping. The contents of the envelope were marked as recordings on clay tablets for additional security. This practice was, in fact, an early form of double-entry bookkeeping.[2]

Credit money, based on trust between local community members or a network of traders, has been widely used for centuries in various forms such as certificates of debt, vouchers, notes, cheques, bills of exchange, and mutual credit across regions from Asia to Mesopotamia to Europe.[3] Whereas, outside of the community, when trading with strangers, a different form of money was necessary.

Money Outside

When we move outside of our immediate communities, engaging in import-export trade with strangers, trust levels are lower. In this case, people often turn to commodity money, materials with intrinsic value that can be weighed to ensure their worth without requiring trust in the counter-party. Initially, a specific amount of barley, measured in a unit known as a shekel, similar to pounds or kilograms, was used in exchange for a given amount of grain. Gradually, barley was replaced with materials like silver and gold, which were more durable, easier to carry and verify, and harder to forge due to their scarcity in nature. [4] [5]

Eventually, to avoid the repetitive task of weighing these materials, Anatolian traders began stamping a mark on the metal to certify its weight. Around 620 BC, the Lydian kings standardized the purity and circulation of coinage.[7] During this same period, rulers in China and India also began to adopt coinage. The practice of authorities sealing coins and inscribing numbers combined the process of accounting from high-trust environments with the use of materials with intrinsic value reliant upon weighing of species for low-trust verification. This innovation represents the midpoint on the trust spectrum, a point of intermediated trust by the government.

Money in the Presence of Authority

As towns grew into cities and states, authorities were established and people used various materials for money, including marked coins, paper notes, and silk, as long as they were permitted for payments and tax collection. In the presence of authority, trust between the sides of an exchange was intermediated. For example, the Sumerians used clay tokens as proof of goods stored in temple warehouses under royal control.[8] Similarly, from the 7th to the 12th century, Chinese rulers mandated paper banknotes, which originated from merchant receipts of deposited commodities in warehouses.[9]

Among the various media for recording monetary value, metal coins had the greatest legitimacy in fulfilling the functions of money, due to intrinsic value derived from rarity, durability, and ease of verification.[10] The advent of coinage facilitated efficient money circulation, from paying mercenary soldiers and slaves, to retail trade, to tax collection. This cyclic flow of coins became a vehicle for expanding the authority of empires, including the Lydians, Greeks, Persians, Romans and others.[11] For centuries, states around the world accumulated silver and gold reserves through trade, mining, and conquest, and minted coins based on these reserves.

States needing to stimulate the economy and stabilize the money markets would resort to debasement, reducing the amount of precious metal in each coin to mint a greater quantity. Over two hundred years, the silver content in the Roman Denarius was reduced from 90% to 5%, leading to hyperinflation and contributing to the demise of the Western Roman Empire.[12] Silver and gold coins were the lifeblood of medieval Europe’s economy, such that the availability of metals often caused periods of economic expansion or contraction.[13]

In the 7th century, to facilitate larger transfers of metal coins, the Chinese began using paper money. By the 10th century, during the Song dynasty, promises to pay were introduced to address a shortage of metal coins. Kublai Khan, the ruler of the Mongol Yuan dynasty in the 13th century, banned coinage altogether, mandating the exclusive use of paper money across a vast territory. This represented the first widely recognized paper fiat money not backed by a commodity reserve, a concept later introduced to Europe by Marco Polo.[15]

The relative dominance of credit or commodity money fluctuated over the centuries, particularly during periods with less stringent authority, or in places on the fringes of power. [16] Similar to Chinese merchants from the 7th century onwards, Indian and Muslim traders used hawala, cheques, and promissory notes for long-distance payments. [17] This mechanism of payments for import-export, involving trusted agents who periodically settle accounts among themselves, emerged as a safer alternative to transporting large sums of gold bullion and coins over insecure routes.

In the 14th to 15th centuries, before an influx of metals from the Americas, European merchants relied on promissory notes as receipts of gold or silver deposits. This practice was based on trust established over time through trade. Likewise, for import-export transactions, the use of bills of exchange was common, facilitated by a network of exchange bankers and trade fairs for clearing obligations. Bills of exchange served not only as a means of payment but also a form of credit.[18]

Over time, bills of exchange and cheques evolved to become negotiable instruments, allowing these obligations to themselves be used as payment via endorsement. This innovation enabled the creation of additional credit money among a chain of parties who trusted each other, thereby providing liquidity and expanding trade. While merchant banks and deposit banks efficiently facilitated such short-term credit, long-term credit relationships emerged in the early 14th century as rulers, such as Edward III, financed their wars by borrowing from private lenders, including Florentine bankers.[19]

In the 15th and 16th centuries in Europe, monarchs continued to borrow from private bankers to finance their military expenditures. By the 17th century, banknotes representing private deposits, like those issued by goldsmith bankers of London, began circulating as money.[21] These bankers issued more notes than they had in reserves, effectively using credit to expand the money supply. With the establishment of the Bank of England in 1694, for financing England's war with France, banknotes transitioned into government-backed money.

This ability for governments to issue debt, secure funds from lenders, and monetize their debts was pivotal to the formation of states. The establishment of new state institutions enabled governments to credibly commit to upholding property rights and preventing confiscation.[22] Notably, by limiting the monarchy with a representative parliament that included creditors, the United Kingdom was able to gain increased access to private credit.[23] As a result, states began to accumulate debt as treasury bonds and settle through periodic repayment. Governments increasingly spent more than the tax revenues they took in and covered deficits through borrowing.

In times of war, particularly during the early 20th century, states were compelled to borrow more money often lent by foreign countries. Military spending could drive countries to exceed their ability to borrow, forcing them to depeg their currencies from gold reserves, and weakening their currency as a result. After World War II, European countries were very aware of the role exchange rates had played in escalating conflict, particularly the repayment of foreign debt. Meanwhile, the U.S. held two-thirds of the world’s gold reserves, which set the stage for the Bretton Woods agreement in 1944.

Bretton Woods sought to stabilize foreign exchange rates by tying them indirectly to gold. Under this system, only the U.S dollar was backed by a fixed rate of gold, while other currencies would target an exchange rate to U.S. dollars by managing their dollar reserves. This made dollars as good as gold, while enshrining the U.S. dollar as the world’s primary reserve currency.

However, using a country’s national currency as international money presents a challenge known as Triffin’s dilemma: as the world economy expands and demand for that currency increases, the issuing country must run a deficit to supply it. This undermines the credibility of the currency as a sound means of exchange, leading to a situation where the gold reserves backing those dollars soon becomes insufficient.[25] In fact, this system was viable primarily because banks outside of the U.S. invented the eurodollar system, which refers to U.S. dollars deposited in banks outside the United States, often used for international transactions.[26] Indeed, within just two decades following the Bretton Woods agreement, the U.S.'s gold reserves experienced a significant decline. The depletion disrupted the established system of international trade, which was heavily reliant on gold exchange standards to balance trade flows. Ultimately, Richard Nixon would end the Bretton Woods system in 1971, delinking the dollar from gold, and converting to a fiat money system.[27] As a result, all national currencies that had been targeting an exchange rate with dollars were no longer pegged to gold.

The eurodollar market facilitated the continuous growth of dollar circulation globally, significantly expanding the international liquidity of the dollar and making it a dominant currency for global trade and finance. This status was further solidified by the petrodollar system. In the mid-1970s, an embargo by OPEC’s Arab nations led to increased oil prices, contributing to economic downturn and increased inflation in the U.S. This situation resulted in a deal—initially secret—with Saudi Arabia whereby in return for military aid, the Saudi government agreed to sell their oil exclusively in dollars and invest in the U.S. Treasury bonds, thereby financing America’s spending.[28] This arrangement would eventually play a significant role in the two Iraq wars, reinforcing the doctrine that oil should be traded in U.S. dollars. Through U.S. economic and military influence, most oil-producing nations were ultimately compelled to sell their oil in dollars, establishing the petrodollar system and reaffirming the dollar's status as the global reserve currency.[29]

As a result, most modern nation-states today hold dollar reserves, while their own fiat currencies are established as legal tender through government regulation. Domestically, these fiat systems rely on the state's ability to effectively manage its economy and service its debt. International trade continued to rely on floating exchange rates and joint intervention primarily by economically powerful countries to keep the rates stable.[30] In the decades following the introduction of the eurodollar and the petrodollar system, despite increased deregulation, globalization, and the growing complexity of financial networks, states and banks have consolidated their control over both the “money inside” and “money outside.”

Digital Commodities

At the heart of digital commodities like Bitcoin lies cryptography, which is fundamentally a relationship between thermodynamics and information theory. Much like brute-forcing a password involves attempting numerous combinations, consuming time and energy to access a piece of information, cryptographic primitives rely on strong randomness to ensure the security and integrity of transactions on the blockchain. Bitcoin’s decentralized network enables making payments over a communication channel without the need for a trusted intermediary.[31][32] It represents a new form of commodity money, drawing parallels to gold through its reliance on proof of work for value creation.[33] Its introduction has not only redefined "money outside" by providing a low-trust, globally accessible currency, but also catalyzed an unprecedented wave of monetary experimentation.

Ethereum's launch in 2015 significantly expanded the landscape of digital commodities and made it easier to develop and use programmable money through its smart contract system. This has enabled a reimagining of financial instruments and the emergence of decentralized finance (DeFi), extending the utility of blockchain technology beyond mere currency to encompass a wide range of applications, from governance to art.

However, challenges such as scalability and high transaction costs during peak periods pose barriers to mass adoption of blockchains. The development of “Layer 2” solutions for Ethereum and a new generation of blockchains like Cosmos, Polkadot, and Avalanche aims to address these issues, promising a more scalable and efficient "internet of blockchains."[35]

The trajectory of digital commodities suggests a future where financial transactions are more inclusive, transparent, and decentralized. With these advancements in blockchain technology, “money outside” has once again become free from centralized control. However, states and their creditors worldwide are keen to adapt to these changes and establish their own positions.

States vs Digital Commodities

In response to the rise of blockchain-based digital commodities, states initially established regulations for taxation and the prevention of illicit uses. More recently they have largely focused on two main areas: classifying crypto tokens for consumer protection, control, and further taxation, and developing their own digital fiat currencies.

The classification of crypto tokens as securities or commodities remains unclear in the U.S., despite proposals aiming to define digital asset market structures based on decentralization.[37] Projects with centralized control are suggested to fall under security laws, whereas sufficiently decentralized ones may be considered commodities. In contrast, the European Union's Markets in Crypto-Assets (MiCA) framework, effective by the end of 2024, mandates token issuers to register as legal entities and follow their whitepapers closely, with exemptions for 'tokens without issuers' like Bitcoin.[38] This evolving regulatory landscape underscores the shift towards digital fiat currencies, marking a significant transformation in traditional finance and banking systems.

How might states develop a digital fiat currency? While Central Bank Digital Currencies (CBDC) offer efficiency benefits, those without robust encryption, guaranteed privacy, and anonymity raise serious concerns. A state-controlled wallet system for CBDCs, similar to China’s digital renminbi,[39] could result in full governmental control over private assets and lead to mass economic surveillance. A more viable option might be to adopt the stablecoins mechanism, where licensed entities issue digital fiat currency tokens backed by government bonds or fiat currencies held in their reserves.[40] Europe’s MiCA framework also addresses stablecoins, categorizing them as “asset-referenced tokens.” However, it's crucial for stablecoins to incorporate a strictly privacy-preserving mechanism to prevent widespread economic monitoring. Countries opting for the stablecoin model for their fiat currencies could significantly expand the global market for their debt.[41] Additionally, to diversify and manage risk, national reserves can hold sufficiently decentralized crypto tokens alongside other assets.

Just as the U.S. held a monopoly over gold reserves by the end of World War II, modern states might now contemplate acquiring significant holdings of bitcoins or other crypto tokens. However, the consensus mechanisms of blockchain networks possess inherent self-defense capabilities. These mechanisms ensure participation in the consensus of an open blockchain network while preventing the operation of multiple identities by the same entity (Sybil attack) through an admission method called proof-of-work. In Bitcoin, this method requires the participants to use tremendous computation power. Clearly, an economic cost is required to secure a distributed computing network, and new blockchains use the alternative proof-of-stake mechanism for validator admission, which is simply locking capital deposit to become a participant. This deposit must be costly enough, so that malicious actions or being offline are sufficiently disincentivized. Any attempt to own the majority of a crypto asset would compromise the security of the underlying decentralized blockchain network, thereby causing its value to depreciate even before such monopolization could be fully realized.

This inherent resistance to monopolization in decentralized crypto networks underscores the robustness of “money outside” against centralized control. However, centralizing tendencies persist through mining or validation pools. Nevertheless, the journey towards truly liberating “money inside” requires moving beyond blockchain-based replicas of traditional banking and credit mechanisms.

Reimagining “Money Inside”

Credit money on blockchains, as demonstrated in protocols like MakerDAO, AAVE, and Compound, is currently employed by users who deposit and lock their assets into a pool and borrow other assets, often stablecoins with interest, against their collateral. More automated and generalized central bank-like mechanisms, such as Rico and Reflexer, provide stablecoin credit based on crypto commodity reserves like Bitcoin or Ethereum. [42] [43] Furthermore, under-collateralized lend-borrow protocols such as Centrifuge, Goldfinch, and Maple offer a kind of banking platform for intermediary actors to be underwriters. These intermediaries manage the funding of lending pools and facilitate a know-your-customer process, along with credit scoring for borrowers.[44] These approaches mirror the business loan practices in traditional fractional reserve banking systems, where banks extend loans by creating new deposits with interest, lending to borrowers who provide assets as collateral for the loan. Beyond merely emulating traditional banking models that provide intermediated trust for credit, there exists a potential for direct peer-to-peer or mutual credit systems facilitated by crypto protocols. Particularly, the concept of deferring payment for actual transactions based on trust within communities or trader networks, remains largely unexplored and ripe for innovation.

Credit money based on trust between the members of a community has been criticized for its inability to scale. Traditionally, this challenge stems from the difficulty of having a consistent unit of account across various communities, each with their own forms of credit money, and the limited transferability of peer credit between different communities.[45] However, blockchains greatly simplify the creation of credit systems like bills of exchange and promissory notes and can enable them to reach much greater scale.

The Cycles Protocol is developing a novel approach to crypto credit.[46] It aims to integrate the functions of clearing houses, akin to the role central banks fulfill for commercial banks, with existing networks of trade obligations through bills.[47] Given that companies must share their confidential bill information to allow a solver to identify cycles of liabilities and settle them, this process will be facilitated through a privacy-preserving blockchain mechanism.[48] This system could enable participants to benefit from credit clearing mechanisms in their trades at a global scale.

Another approach to crypto credit could involve using on-chain promissory notes for payments involving non-fungible tokens (NFTs), where the involved parties trust each other. In such a mechanism, the recording of debt repayments to peers would inform a relative reputation score. Similar to negotiable bills of exchange, transitive notes could facilitate the extension of credit and wealth across different communities. The primary challenge is not necessarily the lack of traditional identity verification, rather underdeveloped webs of trust, immature reputation records, and liquidity within social networks. Circles UBI is an early pioneer of social graph-based credit money, yet it needed ways to increase liquidity for actual participation.[49] Ancient credit money facilitated exchanges among individuals in the same town or those who had developed trust relationships through frequent trading. Similarly, for peer-to-peer crypto credit to function effectively within communities, internet-scale webs of trust has to emerge on blockchain networks.

The magic of instantly transferable digital commodities may have created blind spots for the crypto community. Crypto assets aiming to be the dominant store of value miss the essence of money, which is to facilitate exchange through trust-based credit. People have accepted notes as payment from those they trusted for centuries in Asia, Mesopotamia, and Medieval Europe. Why not leverage latent trust in our community to enhance liquidity and local economic stability using peer crypto credit protocols?

Conclusion

The medium of money encompasses more than the combination of its traditionally well-known functions as a unit of account, medium of exchange, and store of value. It constitutes societal relations across different trust contexts, whether inside or outside communities, and in the presence or absence of authorities. Crypto monies, leveraging blockchain technology, offer capabilities beyond mere monetary transactions or digital commodities. They serve as a communal and global record for verifiable data, managed not by any single company or state, but by a network of independent entities. In doing so, blockchains present innovative solutions to scaling social trust systems and enhancing the accountability of vital social institutions.

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