This is a chapter from the book Token Economy (Third Edition) by Shermin Voshmgir. Paper & audio formats are available on Amazon and other bookstores. Copyright information an the end of the page.
This chapter touches on the history and most important aspects of money and credit and explains how both topics are intertwined social constructs that are deeply rooted in the value system of our economic networks—the communities, nation-states, or digital tribes we are a part of. With the emergence of blockchain networks, money and other tokenized assets, including tokenized credit and lending services, have become a native feature of the Internet. A good understanding of what constitutes money and credit is, therefore, a prerequisite for being able to assess and co-create this emerging token economy.
Money and credit are deeply interconnected constructs within our economic systems. They serve as the foundation for financial transactions and have evolved over time to meet the needs of growing economies and changing technologies. While money serves as a medium of exchange, unit of account, and store of value, credit represents the promise of future payment and a premium on top.
Historically, the concept of money and credit has shifted from simple and more distributed mutual credit systems or commodity-backed systems, where the value of a currency was tied to physical goods like gold or silver. As economies grew more complex, money and credit needed to evolve to support larger and more intricate systems of trade, giving rise to centralized institutions that managed the issuance of money and credit. Today, fiat currencies are the dominant form of money. They are government-issued and no longer backed by physical commodities. More sophisticated and versatile financial products have also emerged over time, which are managed by an array of private or state-owned banks.
In the context of Web3 and blockchain networks, the role of money and credit is undergoing another transformational process. Tokens, representing both money and credit, can now be integrated directly into the infrastructure layer of the Internet, bypassing traditional financial intermediaries. This shift is particularly significant because it allows for a more fluid, open, and collectively managed system where value can be transferred and verified across borders without relying on centralized authorities.
Separation of Money and State
While it has become widely accepted that it is the responsibility of the state to have a monopoly over the issuance and management of a currency used within the boundaries of a nation-state, this was not always the case. The idea of a state monopoly over the issuance of money is a product of historical social and economic developments, combined with practical necessities and the social consensus around money. The narrative around what constitutes money has been predominantly driven by those in power over local and global financial systems, who actively or passively sought to protect their own interests.
In fact, economic scholars differ in their views on the topic. Those who do not accept the monopoly of the state to issue and govern money are often considered “heterodox.” Heterodoxy is a Greek word that refers to opinions or doctrines that are not in line with an official or “orthodox” position. Both terms are traditionally used in religious contexts. From a mainstream economics point of view, heterodox economics refers to basically every school of economics that is not in line with “Neoclassical economic theory.” “Austrian economics,” “Political economy,” Ecological economics,” “Behavioral economics, Keynesian economics,” “Feminist economics” or “Marxian economics” are all considered heterodox, even though they have little in common with each other.
Carl Friedrich von Hayek—one of the more renowned economists of the 20th century—is an example of an economic scholar who disagreed with the monopoly of the state over money creation. While Hayek is considered to belong to the “Austrian School,” his views on many topics—such as monetary policy—differ from those of other Austrian economists. Hayek promoted a special form of a free-banking system of competing private fiat currencies without the need for a central bank that holds a monopoly over the issuance of money. He suggested that private financial institutions take over the functions of central banks, such as the important function of acting as the “lender of last resort,” but he did not rule out that central banks would remain and fulfill certain monetary policy functions, at least in the short term. Hayek was not the first economist to promote such ideas, but he is often cited by the crypto community for his ideas around the separation of state and money.
The idea of separating state and money was also omnipresent in the communities working on financial cryptography that led to the emergence of Bitcoin. In the context of cryptocurrencies, this idea was probably first articulated in 2015 by Erik Voorhees, the founder of one of the earliest token exchanges. He made an analogy between the freedom to choose one’s money and the freedom to choose one’s religion. Voorhees stated that money and financial freedom are fundamental aspects of our lives and that the type of monetary system we live in affects how one’s life unfolds, claiming that it is therefore just as—if not more—important than freedom of religion. He argued that the choices one makes about money dictate the ramifications of one's life and that “to have an institution like money so controlled by a central entity—by a monopoly—is absurd; it is immoral.” For many centuries, the concept of separation of church and state was inconceivable, and it was considered heresy when philosophers such as John Locke proposed it in the 17th century. The separation of money and state might be the next step in the separation of state powers.
Another thing worth mentioning in this context is that the monopoly or exclusive responsibility for money is not part of most constitutions worldwide—if any at all. There is no legal provision at a constitutional level that the state should have that power. The current practice is based on an informal social consensus, which often resulted from banking practices that evolved over centuries and adapted to geopolitical and global economic agreements. In some countries, these practices have become institutionalized through primary legislation, more specifically by central banking laws, but not in all countries and, for the most part, not at a constitutional level.
History of Money & Types of Currencies
The history of money is as old as human civilization itself, evolving from rudimentary forms of debt and exchange-based systems into complex systems designed to support trade and economic expansion. It is widely believed that early societies began with barter, a direct exchange of goods and services. However, barter poses significant limitations, notably the "coincidence of wants" problem. This refers to the improbability that two parties—each of which has different goods or services to offer—can agree on a deal unless each party wants the specific goods or services the other party offers at the same time.
A universal asset of value as a medium of exchange mitigates this problem. Shells, precious metals, or livestock were the first universal assets used. Over time, more neutral artificial mediums of exchange developed, which were referred to as “money.” Money has proven to be an efficient technology for intermediating the exchange of goods and services, providing a tool for comparing the values of dissimilar objects.
While there is merit in having a universally accepted medium of exchange, heterodox economists do not necessarily agree that pure barter economies or gift economies ever existed. One of those skeptics was anthropological economist David Graeber. In his controversial book Debt: The First 5000 Years, he argues that the concept of debt or credit-based accounting in the form of social debt probably predates money-based or barter-based transactions. While he acknowledges that money- and barter-based economic transactions also existed, Graeber argues that they were limited to low-trust situations, typically involving a set of people who did not know each other and therefore did not consider each other creditworthy. Graeber concludes that a "military–coinage–slave complex" replaced the social debt concept when city-based civilizations started to pay mercenary armies with money they created to loot other cities and enslave their citizens to work elsewhere for free. Mainstream monetary theory also connects money to debt. It is assumed that money needs certain properties to serve as an adequate medium of exchange, store of value, and unit of account in which debt can be denominated.
In modern economies, the dominant type of money or currency is “fiat money.” Before modern-day fiat currencies, other forms of money and more or less formalized mutual credit systems were in widespread use:
Social credit: As mentioned above, David Graeber suggested that economic interactions originated around fuzzy social currencies based on mutual expectations and indebtedness among individual members of a trusted group of people. Members of the group were entangled through a web of social bonds via marriage-based family ties, gifts, and mutual support. These mutual social credit systems were more or less formalized in their method of accounting.
Commodity money: A significant evolution in the history of money was commodity money. Here, items with intrinsic value—such as gold, silver, livestock, or grain—were used as a medium of exchange. The intrinsic value of these goods allowed for more standardized trade because their worth was generally accepted, first locally and later globally. Gold and silver, being durable, portable, and divisible, became the primary forms of commodity money, setting a precedent for what society considered valuable.
Representative money: With growing societal and commercial complexity, representative money emerged. It did not have intrinsic value but represented a claim on a commodity stored elsewhere, typically precious metals. Governments and institutions issued banknotes or certificates that could be redeemed for a specific amount of gold or silver. This system persisted well into the 19th and early 20th centuries under the so-called “gold standard,” where the value of a currency was directly tied to the amount of gold held in reserve. Representative money offered more flexibility than commodity money because it reduced the need for dividing and physically transporting valuable goods such as gold for trade.
Fiat money: Most national currencies today are fiat currencies. They are managed by central banks, which control their supply to regulate inflation and economic growth. The tokens representing fiat money (coins and banknotes) have no intrinsic value or direct ties to physical commodities. Instead, these currencies derive their value from government decree. Trust in their value is based on the strength of economic systems, government stability, and fiscal policies tied to the issuance of money and credit.
Digital fiat money or bank money: In modern economies, the majority of money in circulation is no longer in physical form but exists as digital entries in a bank’s ledger. It is represented by one’s balance in checking and savings accounts and is easily transferable through various electronic payment systems. Bank money represents the bulk of everyday transactions. At the time of writing this book, physical cash accounts for only a small fraction of the total money supply in most developed economies (less than 5 to 10 percent in most countries).
Complementary currencies, mutual credit & local exchange trade systems are usually not considered legal tender within a nation-state. They are not issued by a central bank or other national governmental institution. Their purpose has been to advance specific political, social, or environmental goals. Historically, many alternative currencies have emerged, such as the WIR Bank in Switzerland, the Bristol Pound in the UK, and the Ithaca Hours in the US, and have been considered to complement national currencies. The study of these systems could fill an entire book on its own. These alternative forms of money and credit mostly serve a regional purpose (regional currency), community purpose (community currency), or institutional purpose (private currencies issued by a business, NGO, or possibly an individual). Their use is based on a voluntary agreement between the parties exchanging that particular currency. The issuing institutions of complementary currencies can vary greatly. Local currencies, for example, have been advocated to strengthen regional economic activity—favoring locally produced and locally available goods and services. Their emergence has often benefited economically depressed regions, as these currencies cannot be spent elsewhere, ensuring that money is kept in local circulation to benefit the local economy. Critics of local currencies argue that while they can have some short-term impact, they create unnatural long-term economic barriers to monetary policymaking on a nation-state level and are not sustainable in the long run. Another type of alternative currency is based on the concept of mutual credit, which can be either issued as time-based credits or by using price as a measure of value. The Local Exchange Trading System (LETS) is an example of such a system that provides a directory of offers and needs for goods and services performed by others in exchange for one’s own goods and services. Members may earn credit by providing eldercare for one person and spend it later on childcare or tutoring services with another member of the same network. It resolves the coincidence of wants problem by creating a mutual credit network. Each participant receives a line of interest-free credit, and the IOUs of each participant are then logged in a ledger visible to all members. If one member defaults on their debt, the loss of value or units is absorbed equally by all others. Loyalty points, typically issued by companies such as airlines or supermarket chains to create economic feedback loops of loyal customers, have become an important form of alternative currency. They have gained significant importance in a business context, encouraging customers to continue purchasing goods and services from the same company or federation of companies.
Cryptocurrencies (Web3 tokens): In the wake of the global financial crisis of 2007 to 2009, the Bitcoin whitepaper introduced a new form of internet-native money that resolved the double-spending problem over the internet. But Bitcoin was only the beginning. An array of digital currencies, tokenized fiat currencies, tokenized commodities, and other tokenized asset classes have been issued ever since on blockchain networks, creating new economic dynamics that challenge our current concepts of money, finance, and value creation–which is the overall subject discussed in the use cases chapters of this book.
Central bank digital currencies (CBDCs): In addition to public and permissionless cryptocurrency systems such as Bitcoin, Ethereum, or stable tokens, the idea of creating a central bank currency that operates on a blockchain network has also emerged. The idea is to combine the technological properties of blockchain networks with the stability of fiat currencies, offering a government-backed alternative to collectively managed cryptocurrencies.
Properties of Money
For any system of money to be functional within an economy, it must possess certain key properties. These properties are critical in determining how effectively money can serve as a medium of exchange, store of value, and unit of account:
Fungibility refers to the fact that units of money are equal. Every token of that currency must be treated equally, even if it has been used for illegal purposes by previous owners. This is to protect the rights of innocent recipients of those tokens, who might not have known of the illegal activities. In blockchain networks, the fungibility of currency tokens is challenged if a token can be censored or blacklisted based on the behavior of previous token holders. Only privacy-preserving blockchain networks can provide fungibility comparable to analog money systems. Tokens that represent assets with unique properties, such as paintings or real estate objects, are non-fungible by design. However, if an NFT is fractionalized, these fractional tokens of the unique asset would represent fungible fractional shares of that asset.
Liquidity in the context of money refers to the fact that the technological substrate that represents the type of money (whether physical or digital) must be generally accepted and easily tradable at low transaction costs. Cash, for example, is very liquid in smaller amounts, but large amounts of cash are generally harder to exchange for other assets. In blockchain networks, where tokens have to pay transaction fees to the network nodes, liquidity depends on the transaction volume and on whether there is a flat or a percentage-based fee for network transactions. Blockchain networks can only provide greater liquidity if the cost related to each token transaction is low enough to make microtransactions feasible, which—depending on the type of blockchain, its network capacity, and transaction costs—may or may not be the case.
Divisibility and portability refer to the fact that money must be easily transportable. This was not always the case. Take commodity money such as a barrel of oil. While it is theoretically divisible and durable, a barrel is not easily portable. A bar of gold is equally durable and easier to transfer, but divisibility comes at a high cost, given the process of melting and minting it into smaller units. This is why alternative forms of money, such as representative money or fiat money, were eventually introduced: they provided easier divisibility. Blockchain networks allow for even higher levels of divisibility and portability at much lower costs. They allow for almost limitless fractional representations of any virtual currency, fiat currency, commodity, and other asset. Tokens are also more portable, potentially creating more liquid markets for previously illiquid real-world assets that can now be tokenized.
Anti-counterfeiting mechanisms are vital for maintaining trust in a monetary system. These mechanisms ensure that money cannot be easily duplicated, forged, or tampered with. Physical currencies often use watermarks, holograms, and other security features to deter counterfeiting. In blockchain networks, the consensus mechanism uses cryptographic verification to ensure that tokens cannot be duplicated or double-spent.
Durability refers to the ability of money to withstand wear and tear over time while retaining its value. For example, gold coins and other metals have historically been durable forms of money, withstanding repeated use. Fiat currencies have improved durability, but paper notes still degrade over time and must be replaced. Cryptocurrencies and other Web3 tokens are not subject to physical decay. However, the durability of a decentralized currency depends on the security and longevity of the underlying blockchain network. Durability can be compromised as a result of security issues in the underlying blockchain network, as well as potential security issues in the applications interfacing with the respective token, or if users abandon a network to such a degree that it becomes inoperable in practice.
Stability is critical for money to serve as a reliable store of value and unit of account. Stability refers to the resistance of a currency’s value to significant fluctuations over time. A stable currency ensures that people can rely on its purchasing power for future transactions and planning. Fiat currencies, through central bank policies, aim to maintain stability by controlling inflation and managing economic factors. Cryptocurrencies, on the other hand, often face volatility, which limits their current ability to function as stable currencies. Stable tokens have been introduced to address this challenge within decentralized networks, offering a more stable form of cryptocurrency.
Recognizability refers to the fact that users must be able to easily identify and verify the value and authenticity of money. In traditional systems, this was achieved through standardized coinage and printed banknotes. Today, digital currencies achieve recognizability through the interfaces of financial applications, where the value of tokens or assets is displayed clearly to the user. This ease of identification is vital for ensuring trust and efficiency in financial transactions.
Fractional-Reserve Banking: Money as Debt
When gold and silver served as money, the supply of money was determined and limited by the actual supply of the precious metals and the costs and limits of physically minting coins. As a result, the monetary supply of commodity money was determined by the availability and prices of gold and silver. This is why European rulers invested so much money in the discovery and colonization of the Americas and other continents—they were hoping to find gold and silver to mint more coins. This led to periodic gold rushes. For example when Columbus returned from the Americas with gold and silver–or later–when gold was discovered in California. In both instances new gold and silver were minted, primarily by Europeans, at the expense of indigenous populations. While it spurred the European economy for a while, it eventually led to a supply shock of gold coins. The value of gold declined, devaluing European currencies, which in turn led to inflation. When European economies started to grow too fast—such as during the era of industrialization—the rate of mining could not keep up with economic growth to sufficiently back the currencies, leading to deflation. As a result of this—and many other factors—a fiat-based monetary system was eventually introduced by U.S. President Richard Nixon in the 1970s when he backed away from the gold standard. Money was no longer tied to the value of gold. Instead, it was replaced by fractional-reserve banking. Fractional-reserve banking predates Nixon’s decision by centuries, but his move away from the gold standard accelerated its evolution, allowing banks and central banks to operate with fewer constraints on money creation. Other governments started to back away from gold and adopt this system as well.
Fractional-reserve banking is a system of money and banking that allows private banks to create new money through the issuance of loans, thereby expanding the total money supply beyond the physical money supply issued by the central bank. In this setup, commercial banks hold only a fraction of customer deposits as bank reserves while lending out the rest of the money to private individuals or institutions. Inflation and deflation are controlled by expanding and contracting the money supply through the issuance of credit and adjusting interest rates. Each time a commercial bank gives out a loan, the global money supply of a currency grows beyond the amount of the underlying money (base money) that was created by the central bank. This means that new money, in the form of credit (or debt), is created whenever a bank issues a new loan. When the media writes about the central bank "printing money," they often refer to the fact that a central bank increases the money supply by allowing private banks to issue more credit to individuals and companies and lower interest rates accordingly, making taking out a loan more attractive. Except for a certain amount of paper money issued by the central bank, money is never actually “printed.” As a result, two types of money exist: “central bank money” and “commercial bank money.” Central bank money includes physical currency issued by a country's central bank, while commercial bank money refers only to the credit created by private banks when they issue loans. Bank money exists only as an entry in a bank's ledger.
Bank run: In normal economic times, fractional-reserve banking works quite well. In extraordinary times, however, depositors might simultaneously want to withdraw their money if they lose trust in one bank in particular or the financial system as a whole. Historically, this has happened when depositors lost faith in the ability of one or several financial institutions to pay out their deposited money. Runs on private banks were the cause of the financial crisis between World War I and World War II. As a result, reserve requirements and other default mechanisms offered by central banks were adopted.
Reserve requirements: Central banks or similar governing authorities determine the mandatory minimum reserve requirement of depositor money that banks must maintain either as cash in their own bank or as the private bank’s balance in the central bank’s balance sheet. Minimum reserves are usually calculated to meet average expected withdrawal volumes of depositors. If more customers than usual want to withdraw their money at the same time, the bank will not have enough reserves to pay back its depositors.
Deposit guarantees were designed to protect consumers in times of a bank run. In the EU, the deposit guarantee is 100,000 Euro per person per institution. Deposit guarantees are usually regulated by central banks but paid for by the credit institutions themselves. In the event of the insolvency of a bank, investors are—in theory—entitled to their deposit guarantee. Whether or not the bank and/or the central bank as the lender of last resort can actually cover the deposit guarantee is another question.
Money multiplier refers to the ratio of the total money supply of a currency to its base money. Private banks are only authorized to issue credit up to a specified multiple of the money reserves the bank holds, and this multiple is determined by central banks and similar financial authorities.
Liquidity & solvency crisis: Before a private bank defaults, it can either have a liquidity crisis or a full-fledged solvency crisis. A liquidity crisis is a serious but only short-term problem—where a financial institution has enough assets, but it just can’t turn them into cash fast enough to meet the demand for withdrawals. This liquidity problem can be bridged by calling in short-term loans. A solvency crisis is much more serious, as it means that a bank or similar financial institution simply doesn’t have the assets to pay back short-term loans. The central bank as a lender of last resort or other government institutions can still choose to bail out the financial institution if they believe it is too big to fail, meaning that the collateral damage of default would be too great. This type of bailout, however, is ultimately paid for by taxpayers and is highly controversial.
Central banks & other monetary policy authorities were created to regulate bank credit creation inherent to fractional-reserve banking. They define important monetary policy parameters such as minimum reserve requirements, interest rates, or deposit guarantees to maintain the stability of the banking system. These institutions have varying degrees of autonomy from the governments that originally created them. Their main role was to ensure that private banks remain solvent and have enough funds to meet the demand for withdrawals. Over time, the role of central banks has grown, and they have started working hand in hand with governments to influence macroeconomic parameters such as interest rates, inflation rates, unemployment, and the international balance of payments of their country. This is one of the reasons why, in more urgent economic situations, governmental institutions tend to quick-fix economic problems by adjusting the money supply instead of deploying longer-term and potentially more sustainable fiscal and monetary policies.
Quantitative easing refers to the practice of central banks buying financial assets (such as government bonds or mortgage-backed securities) from commercial banks and other financial institutions. In return, they credit these institutions with newly created electronic money. This way, they effectively create central bank money (base money) out of thin air to purchase assets, with the goal of stimulating lending, spending, and investment when standard monetary policy instruments have become ineffective. Just as with commercial money creation, debt serves as the foundation for money creation in the process of quantitative easing. In this case, however, central banks bypass commercial loan issuance and directly inject liquidity into the financial system by buying government or corporate debt instruments. Quantitative easing was first deployed by the US Federal Reserve and eventually by other monetary policy authorities and central banks worldwide to cope with the collateral damage of the global financial crisis (2007–2009). While it can help an economy out of a recession, the long-term application of this tool carries the risk of creating higher inflation. Prior to 2009, quantitative easing was a rather unconventional monetary policy tool, but after the global financial crisis, it has become somewhat of a standard practice.
While fractional-reserve banking allows for economic expansion through credit creation, it also introduces a reliance on monetary policy mechanisms to manage inflation, regulate interest rates, and maintain financial stability. The relationship between money creation, inflation, and exchange rates is complex, and mismanagement of any one of these factors can lead to economic instability.
Redefining the Concept of Money & Value Creation
While Bitcoin (BTC) was originally designed with the purpose of creating P2P money without banks, it has proven to be a gateway to a new type of economic value creation. Bitcoin tokens can be considered legal tender of the Bitcoin network and its participating stakeholders. Within the Bitcoin network, BTC is the only accepted form of payment (equivalent to legal tender in nation-states). All economic transactions within the network are paid for in BTC, such as transaction fees to the miners. They cannot be paid with fiat money like USD or EUR or other crypto tokens. The price of BTC is expected to reflect growth and resilience factors of the payment network, such as usability, stability, manipulation resistance, and ecosystem growth—similar to how the value of fiat currencies should reflect the resilience of economic activities of a country. The monetary policy parameters are encoded in the Bitcoin protocol and automatically enforced by all nodes in the network. The same is true for other blockchain protocols and their native protocol currencies, though monetary and fiscal policy rules differ from network to network.
“Protocol tokens” such as Bitcoin tokens (BTC) or Ethereum tokens (ETH) have certain properties of money—however, they seem to have more similarities to commodity money or representative money than to fiat money. The production process is distributed (similar to real-life commodities), and the price is determined by supply and demand for network activities and network tokens and thus subject to fluctuation (similar to market mechanisms on commodity markets). Protocol tokens also have certain similarities to fiat currencies because they steer an economic network and are the legal tender of the respective network, but without the fractional reserve mechanism. The blockchain protocol has functions of an automated central bank, where the token creation rules and supply policy are encoded. While a blockchain protocol is a point of centralization, it can only be changed by a majority consensus of all network actors in the form of a software upgrade. As opposed to fiat currencies, policy setting and policy enforcement are distributed between all network nodes. How much control a user has in the system depends on the token creation rules defined in the protocol and differs from blockchain network to blockchain network. Most protocol tokens of blockchain networks have no stability mechanisms built into their protocols.
“Asset tokens” are usually created on the application level of a blockchain protocol and simply represent real or virtual assets such as commodities, stock, real estate, or art. Depending on the exact token represented, they can resemble commodity money or representative money but have no similarities to fiat currencies. Asset tokens can be issued by either a centralized or decentralized institution. Their price is determined by supply and demand for the underlying physical or digital asset they represent.
At the time of writing, many tokens do not fulfill some important properties of money—such as stability, fungibility, as well as practical liquidity through the backdoor of scalability and usability issues.
Stability: Most protocol tokens, like Bitcoin, lack built-in stability mechanisms, which undermines their utility as everyday money. This instability poses challenges for economic planning since prices, wages, and investments cannot be reliably calculated if the token's value fluctuates wildly. Stable tokens have been designed to account for a more adaptive monetary policy than that provided by Bitcoin and similar network tokens.
Privacy: Most tokens today have no built-in privacy by design. Even though Bitcoin addresses are pseudonymous, simple chain analysis of the ledger can link the data flow from a particular address with other data points outside the blockchain and identify who is behind a Bitcoin address. While this requires time, effort, and access to other data points, it can be done. Potential traceability destroys the fungibility of a token and therefore makes it unsuitable as a reliable medium of exchange. Privacy tokens can potentially offer more fungible characteristics, though regulatory challenges may restrict their use.
Scalability: The ability to handle a large volume of transactions per second is essential for a currency to function at scale. The scalability issues of early blockchain networks created network congestion and high transaction fees that stood in the way of mass adoption of tokenization. Scalability solutions mitigate such limitations that hinder the mass adoption of Web3 tokens as a medium of exchange.
Usability: At the time of writing, the technical barriers associated with setting up wallets and managing private keys make them less accessible to the average user. Usability challenges prevent Web3 tokens from being adopted on a large scale, as they require significant technological literacy and present risks such as loss of funds due to lost private keys.