Cryptocurrency, Money, and Adam Smith

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John Burrow for AdamSmithWorks

January 13, 2020
Anyone opening a current business journal or newspaper or watching any business news is immediately confronted with news or updates on Bitcoin, Litecoin, or Ethereum. This comes as no surprise, as the recent rise in the value of cryptocurrencies made some people extremely wealthy overnight. However, with this growth in popularity and value, the very idea of what cryptocurrency is, what its drawbacks and benefits are, and where it might be headed becomes important as people invest or speculate with it and on it. In fact, answering these questions brings to head a discussion on the very definition of what constitutes currency and money.

Surprisingly to some, the discussion of what is and is not currency is a very old one. Despite the technology involved in cryptocurrency, there are common traits among metallic coins, bags of corn, paper currency, and Bitcoin. Not only do currencies share certain traits no matter the time or place, they also share similar benefits and limitations. Looking back to those who defined currency, such as Adam Smith, may not only provide a better understanding of what currency and cryptocurrency are, but may also help investors, economists, and academics understand their limitations and benefits. Smith and other economists, like Carl Menger, describe money as something socially determined and rooted in the value of a commonly accepted and valued commodity. Upon close inspection, this singular truth tells us what cryptocurrency is and helps shape its future. Namely, Smith and others tell us that cryptocurrency remains simply a currency, as it has yet to become a true form of money accepted and commodified by society.

Recent publications such as Paul Vigna and Michael J. Casey’s The Age of Cryptocurrency: How Bitcoin and Blockchain are Challenging the Global Economic Order focus heavily on the possibilities and promises of cryptocurrency and blockchain technology. In particular, The Age of Cryptocurrency makes note of the limitations of traditional currency and modern banking, arguing the drawback of traditional monetary systems lies in the trust given to people and institutions. It argues that placing trust in a neutral, third-party system like a blockchain algorithm strengthens rather than weakens exchanges and adds value to those exchanges through increased security and the ability to undermine fiscal institutions (7-10). They describe blockchain and cryptocurrencies as a way to eliminate middle-men such as bankers, and thus reduce the issues of trust towards naturally biased agents in monetary exchange (5-7). In fact, the authors posit that cryptocurrency and blockchain can decentralize currency and thus take power away from these “middle-men,” forcing trust in technology and computers and allowing individuals to take power back (5-7). Currency is only as strong as the level of trust and security of verification between computers and thus between those who are exchanging.

Vigna and Case also offer a brief history of currency to explain how and why centralized banking and monetary institutions exist today and to help their case for cryptocurrency. However, Vigna and Case argue that since money’s value is a construct built by society’s acceptance, the banks and the monetary institutions (even government itself) regulated money and forced people to use it in order to take advantage of society’s use of money.(23-8) In an odd way, the authors here suggest that government and all institutions of government were formed for the sole purpose of feeding off of a society’s exchanges of money for the sake of gaining power. They point to times in history, such as Europe’s “Dark Ages” and the American and French Revolutions, to show how governments, institutions, and civilizations have created and cultivated monetary policy and markets to take advantage of society by creating money and standardizing it(28-31). They do highlight that the value of money is derived from its ability to be socially accepted in an exchange (24-45). But, this “sociability” is not anything new. Adam Smith in An Inquiry into the Nature and Causes of the Wealth of Nations and Carl Menger in On the Origins of Money discuss this idea at length, pointing to the origin of money as a socially accepted medium of exchange (Menger 11). Cryptocurrency, at least according to the authors of The Age of Cryptocurrency, can change the rules by taking away the government's source of power (the creation and regulation of money) by placing it into the calculating logic of computers.

The Age of Cryptocurrency and its understanding of the history of money finds several challenges in well known economic literature and historical accounts. Menger’s Origin of Money remains chief among them, as he noted that governments did not create money even though they can standardize what is exchanged (Menger 38). As Menger argues quite effectively, the origin of money comes from society’s willingness to accept certain commodities with a high level of salability which is spontaneous within a society (38).

While Menger’s On the Origin of Money stands as a prime example of a challenge to Vigna and Casey’s history of money , so too does Adam Smith and his Wealth of Nations. It is true that Smith’s work remains most notable for its arguments for open trade and its criticism of government regulation of trade, but the same critiques are also directed at monetary policy and currency. He noted that any government regulation on money generally affects the circulation of money (particularly paper money and notes) and argued that free competition amongst bankers, lenders, and dealers would promote circulation, cause more “liberal” dealings with customers, and make the fiscal system healthier (322-9). Metallic money, at least according to Smith, finds its value in an “agreeable” standard which contains a certain quantity of gold and silver (63). In other words, currency is rooted in something a society deems valuable. Menger’s ideas echo this sentiment fairly well in that there is a sociability aspect to currency that determines value and prices and helps frame exchanges.

With regard to the history of money, Smith made it clear that metals “originally in all countries… [formed] a legal tender of payment” (57). However, he continued to note that metal coins were instituted as currency not by governments but by society because they were “considered as the [only] standard or measure of value” (44-60) Smith remarked that even corn and other commodities stood as something valued and thus able to be exchanged (44-60). Unlike the history given by authors of The Age of Cryptocurrency, society, not the government, originated and helped define currency and monetary value. As such, currency and money, at least according to Smith, is rooted in and reflects the value of a commodity because of its social acceptance in exchanges. Smith noted that despite the growing use of paper money (an innovation of his time), its value was still determined by its representation of gold and silver in a bank’s vault. In other words, the commodity that society deemed worthy (gold and silver) gave value to the paper currency.

Advocates of cryptocurrency often note how its decentralization and non-tangible qualities mean that it does not have the drawbacks, limitations, and issues of trust of paper and metallic currency. As stated above, Vigna and Casey tout this repeatedly in their work, and they attempt to make a case against the argument for metallic currency. However, Adam Smith noted the benefits of metallic and centralized money for reasons of durability, sociability, value, and convenience. Without a doubt, Smith fully supported coinage and metallic money. Society accepted precious metals with high value due to durability, convenience, and ease of division. For Smith, the durability of metallic currency was not just a physical property but an economic one as well. He noted that “the durableness of metals is the foundation of …[the] steadiness of price.”(227-8) Because metals are durable they were valued by society and convenient for exchange (much more so than bags or barrels of raw produce) (227-8). Because of this, and because society valued them in relation to the bulk items they represented, metallic coins kept prices and values of the various commodities they represented somewhat steady.

This durability factor and its economic impact does not find a place in works like The Age of Cryptocurrency. While the authors note that this “metalist” argument does find its place in classical economic literature like Wealth of Nations, they argue that it was only done so as to appease or benefit monetary institutions and governments seeking more power. As such, the decentralization of currency remains a necessary and beneficial part of the future of economies using the blockchain technologies that control and issue cryptocurrency.

Decentralization remains the key factor for those who proclaim the gospel of cryptocurrency and blockchain. Unsurprisingly, history provides cases where multiple currencies existed without a centralizing force or entity. For example, one only has to look at Scotland’s “free banking” system during the 17th and 18th centuries where competing issuers and banks cooperated in a free market that played a role in Scotland’s economic growth during that time. Unsurprisingly, the events that led to Scottish free banking were not lost on Adam Smith. In fact, as a Scotsman, he witnessed the growth and development of these banking institutions and the changes in Scotland’s economy. As authors like Lawrence H. White note, debates concerning the fate of free banking as opposed to centralized banking involved issues of currency, supply, and lack of authority governing and standardizing currency and supply (64-7).

While there are cases of decentralized currencies working well, other cases in history show the limits of multiple currencies, paper money, and a lack of centralized authority and standardization involving currency. The early U.S. states and regions of states produced several different types of currency and notes that proved problematic not just for the government but also for individuals and companies doing trade in the 1780s. Most notably, the Articles of Confederation proved inadequate to deal with challenges raised by the multiplicity and non-regulated currencies in the U.S. and the need for revenue for a centralized government.

Adam Smith also wrote at length regarding the issues of multiple currencies and paper money. While he notes that Scotland’s case shows growth despite its reliance on multiple large banks and many smaller ones all producing different notes, he offers an explanation of the role of banks and the value they have. Particularly, he argued that banks provide the ease and assurance of circulation of money which remains essential in all commercial societies (286-99). Banks and bankers factored heavily in Smith’s understanding of economics and in his ideal economy. Unlike the authors of The Age of Cryptocurrency, Smith, though an advocate of a centralized banking system, does note the benefits of the multiplicity of banks. Lawrence H. White argues that Smith’s point that banks should be centralized is the result of his witnessing the collapse of several prominent Scottish banks (63-6). However, whether or not Smith’s argument hinged upon his unique situation having witnessed these collapses, his ideal economy involved bankers, governments, and institutions all of whom influence and regulate money and currency.

As noted, Smith favored metallic currency for its convenience, durability, and intrinsic value. However, he and others of his time saw the rise of paper currency as something potentially dangerous and full of limitations. For instance, Smith argued that paper money cannot go beyond the borders of a nation since it could not be redeemed other than by a bank found within a single country (293-5). Metallic money did not have this issue as there remained value within the coin itself. Paper money, at least according to Smith, could only be worth what it could afford in gold or silver. However, he also mentions that money in general is only what money can be exchanged for (294-7). Undoubtedly, Smith took notice of the convenience of paper money; however, its worth always came back to gold and silver. Why? Simply put, it is because of gold and silver’s salability. Gold and silver remained the socially-accepted value standard of exchange. Paper money also had the issue of being over-circulated and printed. Smith highlighted that if this were to happen, runs upon the banks would take place (300-1). Coupling paper money’s geographic and banking limitations and its tendency to become over-produced with the problem of multiple banks issuing different denominations and types of notes and bills, meant that using paper money as a socially accepted commodity of exchange remained hazardous despite its benefits.

Cryptocurrency and blockchain, according to Casey and Vigna, seek to enable currency and eventually money, to be decentralized, rooted in mathematical algorithms, and to come in various types based on different computing technologies. Similarly to the diversity of currencies in Scotland in the early 18th century and the young American Republic of the 1780s, there now exist dozens of different types of cryptocurrencies, each rooted and working within different computer algorithms and each having different values. It would seem, at least on the surface, that unlike those instances of the 18th century, there is no root commodity or bulk item that lends value to that cryptocurrency. However, the very fact that the value of cryptocurrency is reported, calculated, and even exchanged into dollars, pounds, euros, etc. indicates that in fact there is a socially accepted medium: cash and money within the banking system. Cryptocurrency’s value rests partially on the very same system that cryptocurrency’s advocates tout as biased, untrustworthy, and ineffective, and that they seek to displace. Despite all of its promises to be a decentralized currency, it rests on the foundation of a centralized, institutionalized, and socially accepted foundation of money and value. In essence, cryptocurrency currently resides as simply a currency and not a socially valued money or a valued commodity. Its value remains tethered to the worthiness of a centralized, institutionalized, and commodified form of money, a facet of currency and money that Smith and Menger described many years before.

So, what is the future of cryptocurrency? Part of answering the question rests on how future societies will use it, but also what value they will find in cryptocurrency. Adam Smith and Carl Menger argued that societies create and determine what money is and that it is rooted in a socially accepted and valued commodity. Until society figures out cryptocurrency’s intrinsic worth, it will remain nothing more than a variation of currency rooted in the value of the cash it can be exchanged for. But, the past is worth looking into to help grapple with current questions on the use, benefits, and limitations of cryptocurrency and blockchain technology. Adam Smith and others can indeed provide partial answers and a better understanding of our monetary system, the nature of cryptocurrency, and the future of both.

1. Casey, Michael J. and Paul Vigna. The Age of Cryptocurrency: How Bitcoin and Blockchain are Challenging the Global Economic Order. London: Picador, 2016.
2. Menger, Carl. On the Origins of Money, Ed. Douglas E. French. Auburn, AL: Ludwig von Mises Institute, 2009.
3. Smith, Adam. An Inquiry into the Nature and Causes of the Wealth of Nations, Vol. 1, R.H. Campbell, A.S. Skinner, eds. Indianapolis, IN: Liberty Fund, Inc., 1981.
4. White, Lawrence H. Free Banking in Britain, 2nd Ed. London: Institute of Economic Affairs, 1996.