1. Money, Investment, Payment System, Or All of
the Above?
By Stephen M Madigan
Wikipedia defines money by its use as "a medium of exchange, a unit of account, and a store of value."
Currency is but one form of money, and fits in the first category of this definition. Currency is also the
smallest component of what economists define as the "money supply." The money supply includes
different components such as credit, deposit accounts, and the like.
Since virtually all e-currencies are used as units of value in exchange for goods and services, virtually all
of them qualify as money and as currency. I further am of the opinion that Visa(tm) and MasterCard(tm)
dollar units are also currencies, though the companies don't like you to think of it this way (this view
may be controversial to some). In fact, credit card accounts are the most widely used e-currencies in
circulation today. I will go further and state that the distinction between currency and e-currency is, in
fact, virtually zero in today's electronic world.
The more interesting distinction is between government-issued (call them "public") currencies and those
that are issued by private companies (call them "private").
With the introduction and widespread adoption of PayPal, private (e-)currencies suddenly became a hot
topic. PayPal was one of the first private currencies tied neither to a government nor to a credit card
issuer. But, private currencies are certainly nothing new. The original currencies in existence in the
United States were in fact privately issued "Bank Notes" issued by banks in the US. They served a very
important purpose in the early days of this country, since they had value independent of whether the US
continued to exist as an independent country. (Go visit a coin shop and you can see some of these
interesting documents.)
The original US bank notes were generally backed by a precious metal - in fact, they were often gold or
silver certificates that could be exchanged for the precious metal at the bank if you wished. A bank
account was a stash of gold for which you were given certificates. The US government later issued their
own currency, and these were also gold or silver certificates. Those days didn't end until 1972, when the
US "went off the gold standard" which pegged the value of a US dollar to a certain amount of gold. Up
until that time, the US government was required to back up the value of its money with gold held in
depository facilities around the country. Fort Knox is the most well-known of these facilities, but by no
means is it the largest.

2. It is in this context that we must look at the private e-currencies in circulation today.
All currencies are backed by something which establishes its value. The easiest to understand are gold-
backed currencies. The units of value of such a currency is tied to some amount of gold held in reserve
someplace "safe." You can in fact still purchase gold certificates, just not from very many governments.
Usually they are issued by gold-mining related companies who will issue a certificate to represent
ownership of gold held in their vaults ("paper gold"). Make it a bearer certificate, and it's pretty much
gold-backed paper money.
The next easiest to understand is a currency-backed currency (such as PayPal is). For example, some
smaller countries issue their own currencies at a fixed rate in relation to the US Dollars it holds in its own
reserve. These are dollar-backed public currencies. There is no shortage of dollar-backed private
currencies - one of the first was the traveler's check. Merchants accept these pieces of paper because
there is a well-financed, trust-worthy company who will accept that paper in exchange for US Dollars.
Visa, MasterCard, and others also back their currency with US Dollars (and other currencies). Their units
have value because merchants believe that they will (usually) receive a public currency in exchange for
the units stored electronically in their accounts. Yet in reality, merchants value credit card units
significantly less than the currencies that are held in their accounts. The reasons behind this are
chargebacks and fees (as well as hassle factor). However, merchants are not permitted to charge
consumers more due to their agreements with these credit card companies. As a result, even cash
customers pay more for goods and services from these merchants (and why you should always demand
a 2-3% discount when paying cash).
One mystery is why public currencies that are not backed by anything of value have value. These
currencies are often called "fiat" currencies because people take them at face value based on
confidence in the issuing government. But this is only part of the story. In reality, these currencies have
value based on several factors. First, they are the only way to settle debts to the government (in most
countries). Therefore if you owe taxes, you had better have some of these around. The second often
overlooked component of value is the earning power of its population of people and corporations (more
or less the current and future gross domestic product, or GDP, of that country). In fact, I would claim this
is the most important factor when considered in combination with the monetary and other policies of
the government in question.
To understand why, look at the global bond and bill market. The us government borrows billions and
billions of dollars from investors and foreign governments every year. It must do this in order to finance
its budgetary deficits, which of course include debt interest and principal payments. The US government

3. enjoys a very low interest rate on its debt. The reason for this is a high level of confidence in the world
that the US will repay that debt very reliably and predictably. Why does the world have such confidence
in the US government? Because of its ability to collect taxes from its citizenry!
If the US government suddenly repealed all of its taxes, the value of the dollar would plummet as
investors lost confidence in dollar debts owed by the US government. If the US government suddenly
raised taxes by say, 10,000%, the dollar would plummet as well, as the world of investors would realize
that there was no longer any motivation for people to work to make money, and therefore the ability of
the government to raise money through taxation would go down the toilet. If unemployment were to
skyrocket, or corporate profits collapse, or both, the US dollar would similarly lose value.
On the other hand, if the US government drastically cut back on waste and unproductive spending, the
value of the dollar would rise, because investors worldwide would see that the US government was even
more able to pay its debts. (Rising dollar value means lower interest rates paid on bonds issued by the
government, which leads to a lesser need to raise taxes, which leads to a rising dollar.) In short it is your
earning potential and that of your children that sets the value of the dollar. The value of the US dollar is
for all intents and purposes, tax-based.
You won't hear this analysis directly, only indirectly in the media. It's a scary reality that the US
government has complete control over the value of your savings, and the right to effectively steal from
you (take value away without your permission). It's also a pretty negative way of describing things, true
as it is. Instead you will hear about factors that underlie or correlate with the ability of the government
to raise taxes to pay its debts. As an example, "consumer confidence" is a predictor of how much junk
we will buy this year, incurring sales taxes and leading to corporate profits, leading to more tax revenue.
It may seem strange that this is more important than a rise in wages for the common worker. Why?
Several reasons. Higher salaries may reduce corporate profits, and lower the government's tax base.
And, higher wages may not result in higher spending, it depends on how secure consumers feel, or
whether they feel the need to save for retirement or a rainy day. It's all about the taxes in reality.
Contrast this complex situation with the simplicity of an asset-backed currency, and you might wonder
why anyone bothers with tax-based (a.k.a. fiat) currencies for commerce. The simple answer is that
public fiat currencies allow the government a monstrous degree of control over its economy and
ultimately its citizenry. If the government were to suddenly announce that everyone's salary was to be
cut by 50%, or that everyone had to give up half their savings to pay down the national debt, there
would be a revolt (one would hope). Its far easier to simply "print more money" by raising taxes (but not
too much), borrow more from the public markets against the earning power of future generations, etc.
These are all things that ultimately reduce the value per unit of the money we all receive, but so far, no
riots. But I digress....

4. Before putting you to sleep any further, let's jump to the concept of private, asset-backed currencies. It
should be clear at this point that a private currency backed by the US dollar is not much different than a
US dollar. It might be more or less valuable than a US dollar in its purchasing power however.
Consumers (should) love to use credit cards and value their credit lines more than money, because of
the protection they get from fraud, and the flexibility to choose to be stupid and delay payment at
exorbitant rates. Merchants should value a credit card less because of the chance of not getting paid by
a fraudulent consumer, but more because of the increase in sales by accepting a consumer-preferred
means of purchase. Because many traveler check companies will still honor counterfeit or fraudulently
passed checks (in certain circumstances), it was common for many years to find that you could buy more
foreign currency using these than by using cash! E-currencies based on the US dollar have similar
considerations in determining their value - what are the costs, benefits, and risks involved in using these
versus the alternatives? For the consumer and for the merchant?
For legitimate merchants, the primary differentiating concern is this: "When I get paid, what are the
chances of a chargeback? What are the assurances that this currency is not counterfeit?"
For typically unsophisticated consumers, primary differentiating concerns are these: "How broadly is this
currency accepted in case I need to use it for a different purpose? What are the extra features of this
currency? Do I have some degree of protection from merchant fraud? Does it have reward points?"
Concerns common to both include: "What fees do I have to pay to complete a transfer? How much does
it cost to exchange this currency for another that I need? What is the exchange rate for this currency
going to be over time in the future?" And, since the currency is privately issued, "What is the chance
that my currency will suddenly lose some or all of its value because of fraud on the part of the issuer?"
However, there is one much more significant and overriding concern that has emerged, thanks to whom
else, the US government. It is: "what is the likelihood that this currency will suddenly become worthless
because the US Government goes after the issuer?" This is not a new concern, of course. Even a gold-
backed public currency could quickly become worthless if that country suddenly came under attack, or
the government of that country was exposed as corrupt. This is the nightmare scenario for any currency,
especially if the attacker is the US government.
So we know that e-currencies, even those backed by dollars are a currency with different characteristics
than the dollar. Is the act of exchanging public currency for e-currency an investment? The answer
is....not inherently, no. It depends on the intention of the one purchasing the e-currency. In many cases,
purchase of an e-currency is performed for the sole purpose of enabling an exchange with a counter-
party. In this case, the e-currency, regardless of its backing value, is an investment (ignoring whatever

5. rewards result from the exchange). An e-currency by itself is generally NOT an investment if it is backed
by the same currency that the holder would hold anyway. Moving your US dollars from a bank to an e-
currency for no particular reason does not constitute an investment. However, if a holder of an e-
currency doesn't normally hold the dollar for other purposes, it can be a wise investment whose return
is tied to the change in exchange rates. The same is true for currencies backed by gold (unless you
already held the gold). E-currencies do not yield interest or dividends in and of themselves for many
good reasons. It is possible however, to invest using e-currencies. I will cover that topic in a later
installment.
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