The BCS Financial Services Specialist Group compresses over 2,000 years of history and explains how we moved from using gold coins to being on the brink of governments issuing their own central bank digital currencies.

The internet, TCP/IP, electricity, the printing press, the internal combustion engine: these are hugely important technologies. That’s because they are enabling technologies.

An enabling technology is an invention or innovation that can be applied to drive radical change and can, quite literally, change the world. General purpose technology, by comparison, might change just a single industry.

Blockchain is one such enabling technology. Here, we explore blockchain-based currency.

So, currency and money - are they the same thing?

Money and currency might be used interchangeably in everyday conversation, but the two words actually mean different things. To economists, money, in its strictest sense, is three things:

  • A medium of exchange. Buyers can exchange money with sellers when they want to purchase goods or services. Without money, life would be hard and slow. Imagine swapping as a means of getting what you need and relying constantly on the seller having what you want and also, critically, wanting what you’ve got to offer. The time invested in finding the perfect swap is called the transactional cost and money helps to keep this overhead to a minimum.
  • A unit of account. Money is used to measure the value of something in an economy. We measure the value of goods and services in terms of money, just as we measure distances in meters, time in minutes and weight in grammes.
  • A store of value. Money is a repository of purchasing power. Money allows us to store purchasing power at the point income is received and spend it when we need it. Gold, jewels, houses, stocks and bonds are all stores of value but they are hard to use in transactions. Buying a house using gold, jewels and Rembrandts would be incredibly hard. Money, on the other hand, enables transactions to happen with relative ease and speed. This speed is highly desirable. This concept of easy exchangeability is liquidity. Money is the most liquid asset.

Money’s other critical feature is trust. If you were a farmer and took your harvest to market but didn’t want to swap it for something directly - you wanted to store the purchasing power for later - you’d have to take an IOU. Would you trust the IOU to be valid in the future? People break their promises. For money to work, we must all trust that it is valid and valuable. And, we must also trust the body which creates money - a point to which we’ll return.

Currency, on the other hand, is tangible - it is the pound in your pocket. Currency is effectively a physical form of money which is circulated by the public. Currency is convenient, anonymous, but also transient - it can be destroyed, whereas money is permanent.

Looking at the history of money makes the distinction between money and currency clearer. Early societies used commodity money: gold and silver coins. Gold coins fulfilled all of the obligations above and worked well. The problem is that gold coins are hard to transport and if you lose them, you’re in trouble. The same applies if you lose your cryptocurrency credentials!

Paper currencies then evolved as pieces of paper that could be exchanged for goods and could also be taken to a bank in exchange for a promised quantity of gold and silver.

I get it. But I don’t buy into this idea that money is invisible and currency is physical. I’m paid electronically and pay for everything electronically. Money is converted into cash when I use an ATM.

Stick with us - we’ll get there. The Gold Standard was a system whereby a whole country’s supply of currency was similarly linked directly to gold. The Gold Standard eventually unravelled when the great depression struck, banks failed and people began exchanging their paper money for gold. England faced the prospect of running out of gold, so pulled out of the system in 1931, followed by the United States in 1933.

The Gold Standard was replaced by fiat money in 1971, after the US administration severed the direct convertibility of US dollars into gold. Fiat is a term to describe currency that is used because of a government's order, or fiat, that the currency must be accepted as a means of payment.

The Bank of England explains: ‘One advantage of a system that uses fiat money is that the amount of money in circulation can be responsive to changing economic conditions. This can support the smooth functioning of the economy. By contrast, the total amount of money circulating in the economy during the Gold Standard was ultimately limited by the amount of gold that could be mined.’

It's also important not to overlook the advent of the ‘promissory note’ using an agency model, which has been around for centuries and enabled travellers to avoid carrying coins. Names such as Western Union stand out as using this model.

Cheques evolved as a means of instructing your bank to move money from your account to another account. Cheques were a major innovation - without them, oceans of hard currency would have to be shifted around the banking system each day. Cheques are a slow and expensive method for banks to work their transactional magic and with the advent of computers, money moved from physical to digital ledgers.

So, if it’s not linked to gold - how is money actually made?

The Bank of England controls the UK money supply. Its aim is to keep inflation under control and to maintain a steady growth in the economy. Most developed economies have a central bank for largely the same job.

To create money, the Bank of England sells bonds - called gilts - to other countries and big institutional investors. These bonds are effectively IOUs. They’re attractive to investors because they generate regular interest payments (the coupon). Investors can generally rely on getting their money back as countries don’t default - usually. That risk of a government failure to pay up is what dictates the coupon.

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Very broadly, the Bank of England then lends this IOU-backed new money to retail banks whose job it is to circulate it around the economy. With this money and its savers’ money in their vaults, retail banks can then make loans against it. There are very strict rules about how much money - or collateral - banks must hold to remain in business.

The odd thing is, most money in our economy isn’t created by the Bank of England or by the Royal Mint. Rather it is created by the banks themselves.

If you borrow £200 from your bank, it puts the money in your account and new money is created. When it appears in your account, it becomes real. As you pay off your loan, the money disappears. How much money a bank can lend out is related directly to how much they hold in reserve.

The Bank of England explains: ‘Banks create around 80% of money in the economy as electronic deposits in this way. In comparison, banknotes and coins only make up 3%. Finally, most banks have accounts with the Bank of England, allowing them to transfer money back and forth. This is called electronic central bank money.’

So, where does Bitcoin fit into all this?

Digital currencies have been evolving for over a decade now and have certain attributes, especially autonomy. You can control how and with whom you spend your money, with no reference to intermediaries like banks or especially government.

Bitcoin was invented by a person or group of persons in 2008 under the pseudonym Satoshi Nakamoto after publishing the white paper Bitcoin: A Peer-to-Peer Electronic Cash System. Bitcoin transactions are discreet - a purchaser’s identity, much like a cash only transaction is hard to prove or trace (but not impossible).

As Bitcoin is peer-to-peer, anyone on the network can transact freely with any other user, anywhere in the world. Bitcoin is also free from all the fees, charges and controls associated with everyday bricks-and-mortar banks.

Bitcoin owes no allegiance to any government nor central bank. Its supply is limited unlike fiat currency.

Is Bitcoin money or currency?

Bitcoin is notoriously volatile - it isn’t a reliable store of value. As such, it is more of an investment than a form of money. Why would you spend a Bitcoin - or a Pound, if you thought it would be worth more next week?

What does the Bank of England think?

The Bank of England has announced the joint creation of a Central Bank Digital Currency (CBDC) Taskforce to coordinate the exploration of a potential UK CBDC.

A CBDC is a digital currency that is backed by the same attributes that underpin existing fiat currencies, yet has the advantages of a pure digital currency.

In the case of ‘BritCoin’, the CBDC would be a new form of digital (not crypto, i.e., a central BoE database rather than a distributed blockchain ledger) money, issued by the Bank of England and for use by households and businesses. It would co-exist alongside cash and bank deposits. Its advantage might be very fast and disintermediated transactions - buyers could send money to a seller immediately and without reference to the traditional banking system. There would be a need for some degree of anonymity to make it acceptable.

The Bank of England says: ‘If a CBDC were to be introduced, it would be fiat denominated in sterling just like banknotes, so £10 of CBDC would always be worth the same as a £10 note. Any CBDC would be introduced alongside - rather than replacing - cash and bank deposits.’

The Bank of England isn’t alone in eyeing CBDCs. The USA, China, Russia, Canada, Sweden and Singapore are among the many countries exploring this financial technology.

The future of money is undoubtedly digital - but which one?