[118729] in Cypherpunks
TGE: Who needs money, anyway?
daemon@ATHENA.MIT.EDU (Robert Hettinga)
Wed Oct 6 18:40:51 1999
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Date: Wed, 6 Oct 1999 18:05:41 -0400
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From: Robert Hettinga <rah@shipwright.com>
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Date: Wed, 6 Oct 1999 16:29:35 -0400
To: Digital Bearer Settlement List <dbs@philodox.com>
From: Robert Hettinga <rah@shipwright.com>
Subject: TGE: Who needs money, anyway?
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The Geodesic Economy
by Robert Hettinga
"Who needs money anyway?": The New Monetary Economics, Monetary
Separation, and Digital Bearer Settlement
October 1, 1999
One of my best friends in the whole world is Mark Tenney of Mathematical
Finance in Alexandria, Virginia. The best man at my wedding, I met Mark
during my mostly sad attempt to go to the University of Chicago as a
"Student-at-Large", where I snuck in the back door and hung out for
almost a year before they threw me out -- though, to my credit, or lack
there of, it was for impecuniosity, more than anything else. "First thing
you do, you get the money", and all that.
It was fun, though, and I *did* manage to transfer enough credit from
Chicago to finish my undergraduate philosophy degree at Missouri. Up
until the last five years or so, when I discovered the "University of the
Internet", I'd always wished I could afford to go back some day and play
some more, especially in finance and economics.
Anyway, Mark was one of those scary mathematical prodigies who finished
both high-school and college in three years apiece, finished
all-but-a-doctoral-dissertation in Physics at Brandeis in three years,
hedging himself with an Master's, then turned on a dime and did the same
thing in Finance at Chicago, hedging again with an MBA in Finance. All
this before wading into the fray of quantitative fixed-income
analytics-for-hire, swinging that claymore-sized intellect of his with
both hands.
Last year, I told Mark that I had decided to concentrate on digital
bearer transactions full-time, and he asked a bunch of questions like he
always does when I reveal my latest off-the-wall idea. And not saying
much in reply, which he also always does, being one of the most laconic
people I've ever met. That's okay, I suppose. I talk enough for both of
us.
Anyway, a few days later, Mark calls me up, all excited. Well, as excited
as Mark gets, anyway. "You could issue digital bearer certificates backed
up by an S&P 500 portfolio," Mark says with not much affect, followed by
dead air, which is my cue to talk.
"Yup," says I, chattering away, "That's easy. Old hat. We talked about
stuff like that on cypherpunks *years* ago. The only problem is, it's
illegal in the US for various reasons, and proving that you're *only*
issuing to and redeeming from foreign nationals is *really* too
complicated. We don't call it 'digital bearer settlement' for nothing. Of
course, that doesn't keep several smash-the-state cryptoanarchists out
there from daydreaming, in color, about that idea pretty much full time.
Expressions like 'tax-evasion' and 'money-laundering' only make them work
harder, after all. Me, I'm only in it to reduce transaction costs.
Illegal business is chump change compared to putting the entire global
economy onto the net in digital bearer form.
"Steve Schear and I even figured that you could do it with just about
*any* stock, anywhere, from anywhere, as long as it was legal in the
jurisdiction you did it *from*. Sort of an "Unsponsored Network
Depository Receipt", UNDRs, for short..." and then, I proceeded to go
into an entire rant on *that*. In four-part harmony. Arlo Guthrie would
have been proud...
Finally, I run out of gas, like I always do, and Mark says, "If you issue
digital bearer certificates collateralized by the S&P 500, you won't need
cash anymore." More dead air.
"Well," I said, jumping back in, "maybe, maybe not. I mean, the dollar's
pretty much pecunia franca right now, yes? Anyway, you wanna write
something up about it, and we'll zing it out onto some of my mail lists
for comment?"
I figure that if Mark was excited enough, *he* could bash on the
mathematical finance of this idea much better than I ever could, being
mostly innumerate myself, with my undergraduate philosophy degree from a
midwestern state-school, and leftover student-at-large credit from UofC.
I mean, the closest thing I ever got to a genuine financial education was
sneaking out of the University of Chicago Bookstore Graduate School of
Business textbook section with books like Brealy & Meyers' "Corporate
Finance", and Sharpe's "Investments". Needless to say, reading stuff like
that, and hanging around people like Mark at a place like Chicago pretty
much set my "if there's not a market for it, it really doesn't matter"
view of reality into steel-reinforced concrete. It's kind of the core of
my anti-state bias as well, I suppose.
Mark is, of course, a pro at this kind of stuff, having figured ways to
use Green's functions to kill off lots of Monte-Carlo modeling, building
closed-form solutions for various security prices, and so forth. His
asset-liability models sit in the guts of several very large insurance
companies, and there are questions about his asset-value calculation
methods on the US actuarial exam. One of his latest projects is building
the analytical core of start-up e-finance company in an as-yet
undisclosed European country, and his client before that was one of the
largest financial services firms in the world, owning well-known
insurance and mutual fund companies everywhere you would care to name.
So, I didn't hear much from Mark about this idea of his anymore, probably
because most of his "wetware" bandwidth is paid for these days, with real
money, and he doesn't have much time to spare for actual fun -- much less
writing a non-reviewed finance paper that I would just pass around the
net for free. And so that's the last I heard of it for a while.
Then, a few months ago, after I'd started up my new company, IBUC.COM, to
actually issue digital bearer cash and other stuff some day, some newbie
on the cypherpunks list talked about trying to do yet another internet
currency, a smallish rant with a whole bunch of, well, *wrong* stuff in
it. So wrong, in fact, I can't even remember most of it. As is
unfortunately usual in these circumstances, I ended up writing my own
rant in reply. It centered around my own favorite point on the subject,
that unless any "internet currency" was exchangeable into *dollars*, or
some other standard unit of exchange, nobody was going to pay any
attention to it.
There have been several efforts on cypherpunks and elsewhere to think
about synthetic currencies based on attention, or machine cycles, for
instance, and, while using machine cycles to prevent *forgery* is at the
core of most decent micromoney protocols like MicroMint, but you have to
denominate your digital bearer cash in something *financial*, or it will
be of no real use to normal people. Not that most cypherpunks care about
being normal, you understand, but there it is.
Nonetheless, I did toss off some nice words in the direction of the
e-gold <http://www.egold.com> guys, who, at the time, were issuing a kind
of gold-backed "internet currency", albeit in book-entry form. They had
been having some success with it, mostly among the anarcho-survivalist
gold-bug crowd. Meaning that a lot of very bright erst- and
proto-cypherpunks have been playing with e-gold, for reasons of politics,
paranoia, or both. Or at least so I figured at the time, anyway.
Dr. Douglas Jackson, the oncologist-turned-founder of e-gold, is quite a
bit more phlegmatic about these things himself, though certainly never a
fan of fiat currency. He understands, for instance, that storage costs
can make gold-backed account balances actually depreciate over time. But,
in implementing the e-gold payment system, he and several thousand e-gold
users have ended up with quite a bit more experience in non-credit-card
internet payments than anyone else has to date, mostly because they
didn't try to do anything too complicated in the early stages.
More to the point, all of Doug's competition (like First Virtual,
CyberCash, and DigiCash, to name a few) have killed themselves off going
for the main chance. They kept trying to conquer the world, trying to be
some kind of *sole* transactor of business on the web, without
understanding that finance is a business of herds and swarms and that
*nobody* trusts anyone who's the sole *anything*.
Meanwhile, Doug's still doing a tidy, if not land-office, business,
precisely because he's *not* trying to take over the world. In fact, I'd
say that anyone who's interested in internet payment should pay more than
a little attention to e-gold, or, as their evangelist Jim Ray likes to
call it, "The little internet payment system that could."
Anyway, Ian Grigg <mailto:iang@systemics.com>, an expatriate Australian
who I can't really call a cypherpunk -- more of a "moneypunk", maybe,
since he's spent a lot of time lately down in Anguilla building things
for e-gold, among other people -- sees this cypherpunks rant of mine
about internet currency after I forwarded it to dbs, the digital bearer
settlement discussion list that I run. Ian observed there that if
transaction speed was fast enough, the market would probably converge to
a world without cash at all. Shades of Mark Tenney.
Since I respect Ian's opinion, because Ian seems to have read every
"Austrian" economist there ever was, and is a great fan of Scottish free
banking, not to mention because of all his work for e-gold, which now
runs on his "Ricardo" web-market-making system, I thought to myself,
"Okay. Maybe. Someday. In the meantime, I want IBUC to do cash, dollars
preferably, thank you very much, and after that, other *actual*
securities, and, after *that*, we'll see if the dollar really does
evaporate as the world's primary exchange currency." And having said so
to the list in reply, I left the discussion there for the time being.
Which brings me to a little while ago, when I was half-to-three-quarters
of the way through with a nice rant for this column on something else
entirely, and ended up throwing it all in the trash.
That was because of something I got in email from *another* friend of
mine, one of the best internet transaction lawyers in the business, John
Muller <mailto:johnmuller@bobreck.com>, a partner at Bobreck, Fleger and
Harrison, in San Francisco. Among other things, John is Chair of the Web
Site Working Group of the American Bar Association Joint Subcommittee on
Electronic Financial Services <http://www.abanet.org/buslaw/efss/> (say
*that* ten times fast), and Co-chair of the Automated Transactions and
Electronic Agents project of the ABA Cyberspace Law Committee.
What John sent me was the most recent Electronic Financial Services
Update, the back issues of which can be seen at
<http://www.abanet.org/buslaw/efss/whatsnew.html>, and in that update was
"Towards a Moneyless World?"
<http://www.sscl.uwo.ca:80/economics/faculty/nmewien.pdf>, a paper by
Malte Krueger, of the University of Cologne and the University of Western
Ontario, for the International Atlantic Economic Conference, which was
held in Vienna this past March. Apparently, this paper was also presented
in different form to the Second Berlin Conference on Internet Economics a
little while later.
And, there, after converting PDF to PostScript, and then PDF to ASCII
text so I could read it faster, *there* was a pointer to where my friend
Mark Tenney -- and, I bet, Ian Grigg -- got the idea that as transaction
latency and transaction costs go to zero, the value function of currency
converges to that of more "financial" assets: They were quoting, whether
they knew it or not, the so-called "New Monetary Economics" (NME), a
phrase coined by Robert Hall, but conceived, in the early 1980's, by no
less a pair of financial luminaries than Eugene Fama, of the Efficient
Market Hypothesis, and Fischer Black, of the Black-Sholes option
equation. Others, like Krueger, apparently, call this the "BFH system",
in their honor -- or for other reasons, it's hard for me to tell.
Krueger says, of NME/BFH,
In the current system money (cash and deposits) is used as
medium of exchange and unit of account. In the BFH system
there would be no common medium of exchange with a fixed
nominal value in terms of the unit of account. Instead,
assets with variable prices are used. This implies that, in
principle, any asset could serve as a medium of exchange. An
example that is often used to illustrate 'moneyless' payments
are mutual funds shares. The value of mutual funds'
shares varies with the value of the funds' assets and within
certain limits they can be used for making payments. So, the
medium of payment 'mutual fund share' has a value that
is not fixed in terms of the commonly used unit of account.
Eugene Fama (1980) argues that monetary separation is
efficient because the financial system (Fama uses the
term 'banks') serves two functions that are independent of
each other: the accounting function and the portfolio
management function. Banks could fulfill the accounting
function without holding assets or using any medium of
payment. It would be sufficient to have a unit of account.
As an uninvolved third party, banks could just keep records
of transactions. The issue of liabilities and the purchase
of assets is derived from the second function, the portfolio
management function. In this function banks help individuals
to hold their wealth in a form they desire.
What the above means to me is pretty much what Tenney and Grigg said,
that Moore's law creates an increasingly geodesic, ubiquitous, public
internetwork, which, coupled with the financial cryptography of digital
bearer settlement, "surfacts" currency into its constituent parts. Why
keep something which doesn't earn you money, in other words? Why not use
something which is as risk-free as possible but still earns money while
it's in your possession? Furthermore, the longer money's going to be in
your possession, the more incentive you have to invest in something where
short-term volatility isn't a problem. We'll leave discussion of my
opinion on the "accounting" function as an exercise for the reader.
Anyway, Macroeconomists call this division of unit of exchange from unit
of account, monetary separation. And, as a result, we get more and more
different kinds of exchange with decreasing transaction cost. Banks go
back to being "counting houses" instead of fiduciaries, trustees, keeping
track of who owes what to whom, and the returns on money are higher for
the users of that money. The advent of the money-market mutual fund, was,
of course, a step down this road.
As to whether this means the death of currency, Krueger comes down on the
side of network effects -- unfortunately conflating them with
path-dependency; network effects being cool, and path dependency being
balderdash -- and says that the opportunity costs of keeping track of
various different asset classes, and, more importantly, exchanging those
different asset classes with others just to effect any trade whatsoever
in a virtual re-emergence of barter, still costs too darn much, and thus,
the internet gives us monetary integration, and not separation. As
someone said of Mozart, "too many notes".
I'm personally not so sure, Moore's law being what it is. It might be
easy enough with with enough bandwidth and processing power to do all
those exchanges and re-balance one's "portfolio" of money-equivalents,
paying people in whatever asset class they want, and still make more
money than parking money as dollars in a bank somewhere, or, worse,
keeping cash on hand.
However, I also think that it'll be a while, just yet, for that world to
emerge, and, frankly, I want to buy things with *dollars*, and right now.
By way of some even *more* twisted synchronicity, Krueger's paper then
points to my friend Tatsuo Tanaka's paper on the macroeconomic
consequences of internet free banking. Which, oddly enough, I edited and
recommended for publication in the peer-reviewed internet journal First
Monday four or so years ago. I even invited Tanaka to come up and present
the paper at a Digital Commerce Society of Boston luncheon shortly after
the paper came out.
Tanaka says, first of all, that internet free-banking is like the
expatriate-cash Eurodollar market on steroids. Internet free-banking
drives the final nail in the coffin of central bank control of any
nation's currency, because, if a currency is stable enough, and maybe
even if it isn't, sooner or later more of the currency is "issued" on a
fiduciary basis outside a country, collateralized by foreign-held
dollar-denominated accounts, for instance, than is issued by the central
bank itself. And the net makes *where* the money is, heh, immaterial.
Unfortunately, Tanaka also says that competition for underwriting cash to
the net causes the eventual fractional reservation of digital cash
against its denominated currency, and that, sooner or later, crises of
confidence in all those different issues, and their various partial
reserves, force the creation of, you guessed it, monetary union of some
kind. Tanaka liked to wax about the eventual creation of a central bank
of cyberspace, thus setting most cypherpunks' and other free-money
advocates' teeth on edge, mine included, skyward-rolling eyes and all.
But the story gets weirder than that. Recently, Douglas Jackson and his
crew at e-gold have been taking their association with "moneypunks" like
Mr. Grigg (and, um, others :-)), to heart lately. They split themselves
into a trustee-underwriter relationship of several firms, and, in the
process, have created an offshore subsidiary, based in, where else,
Anguilla, to, you guessed it, offer fractionally-reserved, (but
non-blinded) gold-denominated digital bearer certificates, called, oddly
enough, DigiGold.
The idea behind DigiGold is to fractionally reserve gold denominated
transactions, loaning out the reserve's other fraction to offset the cost
of gold storage, which, as we noted above, at a percent or more a year,
is a considerable one if you're trying to create a currency which is
supposed to hold its value. In fact, Ian went so far as to start buying
and selling notes denominated in gold recently, apparently as part of his
work with DigiGold.
"Gold-denominated Burmese opium futures", indeed.
For one final bit of weirdness, I eventually got around to reading
Glassman and Hassett's "Dow 36,000" article in the Atlantic Monthly,
<http://www.theAtlantic.com/atlantic/issues/current/9909dow.htm>, which,
at the core of its analysis, notes that among other things and contrary
to received wisdom, equities held in the long term are much *less* risky
than even long-term government bonds are, and how the market has been
compensating for that for the last few decades or so by driving equity
prices slowly upward to their risk-adjusted "reasonable" price. Like
their title says, they say that the Dow could be at 36,000 and still be
"reasonable", whatever that means. Mercy.
A splendid read nonetheless, whether you agree with them or not, and the
bit about the risk of the equity market certainly makes a compelling
argument for a very, very, interesting result for us, in light of all of
the above.
At the core of all modern financial analysis is the proposition that
government bonds, especially short-term ones, are the safest investment.
They're safe because, for instance, the chance of the US government
defaulting on any given 90-day T-Bill on any given day is virtually
non-existent. T-Bills are literally risk free, and all other investment
is calculated against them for riskiness. The Net Present Value equation,
for instance, says that if the returns of a proposed investment are less
than you would get from a T-Bill, you should forget the investment and
keep your money in T-Bills instead.
And, at every year of bond maturity, the government bond sits at the
lowest point of the risk "well" for that maturity. Or so I thought, until
I saw Glassman and Hassett's description of what all financial theorists
knew already for a fact, that the long-term risk of the overall equity
market is much less than that of even government bonds.
So. Can we back that "zero" equity-market risk down the maturity curve to
the present? Maybe, with a derivative or two. I haven't gone looking for
the answer, and it's press time already. I wouldn't be surprised, though,
and to walk out on a very thin limb, I'm going to assume it to be true.
Certainly the idea of, say an S&P 500-, or maybe a larger-index-based
"cash" starts to make sense, if we can do it. After all, Ian Grigg and
his friends are trying, for all intents and purposes, to do roughly the
same kind of thing with gold. Gold hops around a bunch, and volatility is
probably not a good thing for a currency to have. So any financial
engineering you can do to at least take the volatility down a bit would
be good. And you'd want to do the same thing with equity indices,
because, as a functional perpetuity, a stock can be just as volatile as a
30-year bond might be.
What we get, if we do create a low-volatility equity-based currency, is
really very interesting.
We get what Gene Fama and Fisher Black must have been thinking about back
in early eighties heyday of the "New Monetary Economics": a completely
private form of "riskless" return.
Think about that for a minute. Not only do we have digital bearer
settlement, so we don't need the nation-state to provide force and ensure
the non-repudiation of our transactions, but we don't even need another
kind of force either: the confiscatory force of a nation's tax system,
making for "riskless" government securities, which, in turn, undergird
our very concept of what risk is.
What we get is truly *private* money. That is, someday we can create a
completely synthetic currency based upon a commonly-referenced *equity*
market index.
Look, Ma, no currency board, much less a central bank. No guns. No
sovereign. And we still get money. Amazing.
So now, instead of stepping *back* to a commodity economy to avoid state
control of the monetary supply, using something like gold to anchor value
on the net, we can step *forward* into the information economy, the
geodesic economy: All we need to collateralize our transactions is a
sufficiently representative and publicly known equity index, with the
volatility hedged for short term use using *other* publicly known
derivatives. Presto change-o, a synthetic internet security. And, of
course, this works with bearer held stocks, if we ever get those, as
well.
Finally, anyone who wants to can do this -- well, if their reputation's
good enough. This is finance, after all.
Of course, the sticking point all this fun is the state itself, as I said
to Mark Tenney more than a year ago. Remember all the book-entry taxes
and regulations about bearer ownership of bonds, TEFRA, et. al., here in
the U.S., and then exponentiate that number to get the regulatory
barriers for bearer equity.
It'll certainly be easier, for the time being, to issue cash denominated
in dollars than it would be to try to climb an enormous ziggurat of
regulators and legislators, telling all of them that issuing bearer-form
equity-index-denominated money would be a good thing, even if it
completely removed *their* central banks, much less *their* very
government bonds, from the center of the financial universe. A lead
balloon, indeed. Almost makes you want to believe in path-dependency,
that does.
But don't despair. Remember that if digital bearer transactions really
*do* turn out to be significantly cheaper than book-entry transactions,
something I'm betting my company on, sooner or later an equity
index-based "internet currency" will in fact emerge as the best way to
buy things.
Even more interesting, if we're right, government-extorted revenue will
cease to be the foundation upon which the concept of "riskless" return --
and all of finance itself -- rests.
But that's probably what Fama and Black had in mind, right?
Cheers,
RAH
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Robert A. Hettinga <mailto: rah@ibuc.com>
The Internet Bearer Underwriting Corporation <http://www.ibuc.com/>
44 Farquhar Street, Boston, MA 02131 USA
"... however it may deserve respect for its usefulness and antiquity,
[predicting the end of the world] has not been found agreeable to
experience." -- Edward Gibbon, 'Decline and Fall of the Roman Empire'
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Robert A. Hettinga <mailto: rah@ibuc.com>
The Internet Bearer Underwriting Corporation <http://www.ibuc.com/>
44 Farquhar Street, Boston, MA 02131 USA
"... however it may deserve respect for its usefulness and antiquity,
[predicting the end of the world] has not been found agreeable to
experience." -- Edward Gibbon, 'Decline and Fall of the Roman Empire'
