Are we excited yet?

Will 2022 be the year that cryptocurrencies falter? Or will these parallel currencies, “private money” issued by private tech platforms, continue to fascinate?

Whatever cryptocurrencies are, they are patently not money. Money needs to be a store of value, widely used and accepted, in order to buy and sell stuff. It must have some reasonably stable relationship with the value of everything else in the economy.

Money is like language – the more it is used, the more useful it is. Which is why, if you could only choose one, fluency in English is more useful than fluency in Basque. This is the paradox of money: the more of it around, the more valuable it is, unlike other things where the value rises if it is scarce. Money is the opposite because it is a technology, not a commodity

Sticking with the analogy of that other great technology, language, English is not perfect, but it is the language more people default to, and therein lies its value. A language like Esperanto may have been conceived as the most logical language, most elegant in its grammatical symmetry, but is utterly useless in practical terms because no one else speaks it. Could Bitcoin be the Esperanto of finance?

If you can’t trade widely in a currency, it’s not money. Take the most widely used currency, the dollar. Its value resides in its universal recognition, its worldwide reach, measured most accurately not on the trading floors of Wall Street but in the fact that taxi-drivers in large parts of the world can tell you the dollar’s value on a day by day and in some cases hour by hour basis. That’s real power, real reach.

The dollar is universally practical, interchangeable, and therefore highly valuable. The dollar is “public money” backed by the revenues of the US economy, issued by a US federal institution, welcomed everywhere. Even Islamic State, the most implacable anti-American group imaginable, demands its ransoms in dollars. While happy to recite the Koran, they want paid in greenbacks. The dollar supersedes politics, culture and religion.

The advocates of crypto and its most widely known incarnation, Bitcoin, argue that “private money”, issued by an algorithm and backed by nothing, is purer than “public money” backed by the State because the State is corruptible. This is a matter of opinion. But money is not about opinion. In fact, even though the notion of “private money” is associated with technology and new finance evangelists, it’s not so modern at all and indeed is used widely on this island.

Of the many unusual things in Northern Ireland, one that is rarely commented on but always noticed, are the unusual bank notes issued by Irish banks such as Bank of Ireland and AIB, British banks such as First Trust and Ulster Bank and even a Danish bank, Danske Bank. These are worth the same as sterling, but they are not legal tender anywhere in the UK. The currency only circulates within Northern Ireland. In a bar or shop in England, people will laugh at you for proffering these notes and they are not obliged to take them. They are NI-specific bank notes, convertible at one for one with sterling, issued by private banks in Belfast.

These notes are as close to “private money” as you can get, because unlike Bank of England sterling, which is “public money” issued by a public institution (the Bank of England), the NI currency is issued by private banks. Banks in Northern Ireland are “chartered” by the Bank of England to issue “private money” on its behalf, and the notes are redeemable for “public money” at par.

This idea of private banks issuing private money is quite alien to us. This country and every other sovereign country in the world, use “public money”. In the North they use private money backed by the Bank of England, which gives the northern banks permission to print money. Ultimately, the charter is backed by the UK state. The northern economy proves that private money can exist and can work as the crypto supporters maintain, but the key difference is that the “private money” in the North is backed by the Bank of England, which is backed by the UK state.

What about private money like a crypto, which is backed by nothing? We’ve had these monies issued by banks before. They were termed “wildcat” banks in the US in 1800-1863. Due to a profound absence of coins and the fragile grip exercised by the federal system as the country expanded westwards, Americans innovated in finance. Private banks issued money, claiming it was backed by the State or the money in the bank’s vaults. All too often these “wildcat” monies proved to be ephemeral. Sometimes the banks went bust; the value varied from state to state; and the currencies were wracked by instability, the opposite of what is needed to establish real currency credibility.

Crypto has a “wildcat” feel to it. A recent interesting note by UK-based technology writer Stephen Diehl fleshes out this comparison in more detail.

Some private currencies were more successful than others. In fact, the description of the southern states of the US as “Dixieland” comes from the legacy of one such private currency. The Bank of Louisiana issued a $10 note. Back then, Louisiana was bilingual due to its French-speaking Cajun population. The $10 note was known by its French name, the dix, meaning 10 in French. But the English speakers couldn’t pronounce the silent “x” in the French way, so the “dix” pronounced “deece” in French became dix or dixie in English.

This note was used widely in the Confederacy. In time, the Confederacy became known as Dixieland, home of the Dixie Chicks, the Dixie Democrats, and a whole host of Southern dixie-related monikers. In time, the dix disappeared, replaced by the US dollar.

The history of private money isn’t too sparkling, so why would it be any different now? If anything, the risks are greater. Take the craze for NFTs (non-fungible tokens). These are digital assets that can only be bought with cryptocurrencies, mainly Ethereum. Prices are soaring, but of course they are, because NFTs are among the few things you can buy with crypto.

The currency was created before it could be used, leaving investors with a money that had no everyday use. Then NFTs come along and it’s hardly surprising that prices of NFTs are rising, as the cryptoholders can buy nothing else with their cryptocurrencies. It is a sealed system.

It’s not hard to imagine how all this might end – lots of little people holding lots of valueless assets while the big guys get out. As the denouement could take some time, bubbles can inflate for a long time and the more people involved, the more people there will be to evangelise about the brave new world. This time it’s different, didn’t you hear?

The problem is that history tells us to be careful. When something claims to be money but patently isn’t, is backed by nothing, generates no income, and promises you the sun, moon and stars, it sounds like a quick way to destroy wealth not create it.