How to create money
Paper money eventually returns to its intrinsic value: zero.
Most economies in the world are built on the model of taxation. They build something of interest and charge you to use it. The price they charge you is usually a market determined rate somewhat in excess of the costs they incurred to build it, and to maintain it. If you’re very successful, you dominate a niche, you provide an invaluable and irreplaceable service, this payment becomes as a tax.
We even say highly successful companies like Stripe is like a toll on your internet commerce. It takes a cut of all transactions, and uses it to fund your service. Much like a tax.
But in economics, there’s an alternate method for governments to make money. That is seigniorage. Seigniorage is the profit made by a government by issuing currency. It’s usually not the primary source of their revenue, but its far from insignificant. For example, if making a £1 coin costs £0.1, then issuing it (assuming no debasement), just made the government £0.9 richer.
This method doesn’t really work in the private markets very much.
(Technically there is a third alternative of sale of goods and services in the market, but normally that’s something that happens inside the economy rather than outside it).
A barter system where you’d exchange bushels of wheat for cloth is an example of a system where you, in effect, have implicit seigniorage equivalent to the traded amount. But since it’s each individual creating their own “currency”, it doesn’t really get used as surplus.
A slightly better system existed when towns and cities and some counties created their own currencies. Each place could actually raise (some) money by printing its currency cheaply instead of taxing people.
There are issues with it of course. Inflation is the most important one, where creating new currency far in excess of the productive capacity of the economy results in inflationary pressures. My favourite example, Genghis Khan, is an example here, as I wrote in the tale of two monetary systems.
This still happens to some extent. Brixton, for instance, started its own currency to keep more money flowing within its local ecosystem. But they still remain curios for the most part.
Today, after fighting the hordes of would be currency counterfeiters, seigniorage has decreased for much of the economy, no matter what the MMT adherents would say. And fraud isn’t exactly unprecedented. For instance.
In 2007, Angel Cruz, founder of The United Cities Corporation (TUC), announced he was establishing an alternative "asset based" currency named "United States Private Dollars". Cruz claimed United States Private Dollars were "backed by the total net worth of the assets of its members" and had printed six billion dollars' worth of the private currency. The backing assets were claimed to be valued at 357 billion dollars. The currency featured the slogan "In Jehovah We Trust". … In 2008, Cruz was indicted by a Federal grand jury in Florida on one count of conspiracy to defraud the United States and six counts of bank fraud while attempting to get United Cities bank drafts cashed. An associate was convicted on related charges and sentenced to prison for eight years. Angel Cruz was finally captured in 2020.
But I digress, one of the reasons this feels difficult to do in the private world is because, like with the barter system, seigniorage doesn’t translate well into exchange of goods for other goods. It only works when you work directly with money. It’s the prize you get for literally creating liquidity.
But wait, private markets do make money for their customers, users and stakeholders. Not make money, like profit, but make money, like loyalty points. As the old rhyme goes.
Money is a matter of functions four, a medium, a measure, a standard, a store.
When I fly British Airways and earn their (terrible) points, this is a way for them to create money, just one that can be used within the tiny, tiny, confines of the (terrible) British Airways flights. When I buy Starbucks and use the stash of points I have with them (or forget the password), that too is them creating money.
They don’t get seigniorage from this however, because the money they’ve created is not fungible with anything else in the economy. British Airways can’t just print a whole bunch of their (terrible) airline points and go take over United. They bear the costs of printing that money (giving discounts to users is a cost), but they don’t get the direct benefits. They’re just hoping the indirect benefits of having people like me fly an extra flight or three will make up for them giving me the points.
(So far they have, only because redeeming BA points seems to require booking a flight only from London to Stockholm in the middle of winter six months in advance at noon on a Wednesday.)
This means the only way to make seigniorage as your revenue model is by first creating demand for your currency. And you do that by creating a huge amount of value for the economy you’ve built up where that currency can be spent.
But why should your money have any value? If I create a currency called $LOOP tomorrow, there is no reason to believe the total value of all currency I’ve issued is $1, let alone $1 Billion or $1 Trillion.
You could back it by equity of a company whose revenues you’re trying to raise via seigniorage, though then the company better create something of actual value. Though in a case like that it’s often easier to monetise what you’ve created by using taxation as the method rather than the much harder seigniorage.
You could back it by purchasing assets of various nature and then using that to backstop the value. This is sort of the way gold-backed currency worked, though without the actual economy part.
But this is almost the perfect definition of a zero seigniorage environment, where you need to spend the same amount as the currency to create the currency, and you can only monetise above and beyond that by adding more functionality. USDC from Circle is a great example here; creating the USDC isn’t what gets them the revenues, it’s the services Circle provides in excess of it, including charging interest.
So what’s left?
You could first try and bootstrap an economy, and then use that to back the currency. This is the equivalent of the fiat economy, where the purchasing power of USD depends on the strength of the US economy.
If done by a company that’s also the very definition of a private currency. And not only that, to add insult to injury, this is reasonably common.
Today, there are over four thousand privately issued currencies in more than 35 countries. These include commercial trade exchanges that use barter credits as units of exchange, private gold and silver exchanges, local paper money, computerized systems of credits and debits, and digital currencies in circulation, such as digital gold currency.
This also sounds hard! Because you do need to create an economy where your currency works. And you have to do this without having the currency to build the economy with! A conundrum.
Okay. So one analogy that’s helpful is from rocket science. Bear with me. If you wanted to reach escape velocity to reach, say, Titan (as we well should), it’s not as simple as setting your sights on Titan and pressing the accelerator.
When a rocket needs to increase velocity or change its trajectory they use what they have around them. The method is gravity assist, **using the gravity of large celestial bodies to slingshot yourselves in the right direction. Voyager spacecraft, both 1 and 2, used it. Voyager 2 famously used it to visit the gas giants, all four of them, in the 80s. Cassini used it to reach Saturn. Messenger used it at Venus.
The comparison being that not using what we have around us seems a major waste if you want to do something. You can use existing centres of gravity to help you reach (or in this case create) a new centre.
So what’s the economic equivalent? Using existing networks of mini-economies as a bootstrapping method. Use existing products and solutions, with its own customers and users and employees, as the way to deliver a service and kickstart an economy.
Most companies that deliver a product (or service) to its customers need to try pretty hard to ensure they stay with them. The way they do it is by creating loyalty programs, just like British Airways above. The problem there, if you remember it, was that once you got BA points you couldn’t really do much with it beyond try and redeem it with BA website, which almost never works.
There have been attempts at creating an exchange to, well, exchange the points with each other, but they have been pretty wildly unsuccessful. Mostly because the incentives for the companies and the users are not aligned - users want to use the points to get value, companies would prefer (largely) to have them be deadweight loss.
The company wants to ensure the users are rewarded and they don’t bear undue cost in doing so. But the user has the added burden of maintaining multiple “mini-economies” inside their heads. One or two is okay, but are you really going to keep a separate “currency tab” for each company you use?
So. If you want to actually create a currency, as many a crypto project tried to do, you need to solve this chicken and egg problem. Currencies don’t exist purely as ledgers for transactions, they’re interlinked networks of belief that have value within an economy because they’re pointers to items of value as commonly understood. This is true whether we’re talking about bottle caps in Cameroon or the 100 trillion dollar notes in Zimbabwe. Or in the ye olden days of the US, when it used to be a bit more fun.
In the United States, the Free Banking Era lasted between 1837 and 1866, when almost anyone could issue paper money. States, municipalities, private banks, railroad and construction companies, stores, restaurants, churches and individuals printed an estimated 8,000 different types of money by 1860.
So instead of exchanging those points with each other, trying to create an exchange price for the (terrible) BA points vs Starbucks Rewards, what you really need is a pricing mechanism. An easily convertible third party currency in the middle that allows ease of use and exchange on all sides. It could just be the dollar, but then the companies wouldn’t want to do that because they lose the benefits of retention from people being inside the walled garden.
The whole idea after all is to turn small walled gardens that you need to leap out of regularly into large gated communities you can live within.
This is the only way a currency can skip from becoming a pure private currency to become something akin to a complementary currency, as something that’s not exactly legal tender but at least complements the national currencies.
And this also cannot be USD or GBP or any existing currency, almost by definition, because of the balance sheet effect. If the currency has to be “bought” or “invested” before it can be used to underwrite a certain portion of economic activity (represented by the points for instance), we quickly get back to the point of there not being any opportunities for seigniorage in the economy.
But instead if it’s the functional equivalent to a currency on its own, that adds tremendous value and benefit. It means you can distribute it (gaining advantage of seigniorage internally), with the initial scale and network coming together from the customers who can afford to not care too much about the exact exchange, since it’s not really money yet, and therefore allow easier exchange and bootstrapping.
If you do want to launch a currency and use seignorage as your revenue, you need to slingshot around existing services. In the beginning it’s like a free perk for the company, a free perk for their customer, and free distribution into something that has existing value for you, the currency issuer. At least until the economy self-starts as a gated community.
It’s one way to solve the classic network bootstrapping problem. Everyone wants to give away perks to grow, but unless there is a critical mass there is no economy here yet. And here, the difficult is that the initial adoption has to be powered through, which is exactly why the quasi-money loyalty points turning into full money is a great way to go about it.
Creating an economy is hard, but it is the ultimate end state of encouraging value creation. It’s an exhilarating ride, in many ways the ultimate one. We’ve always had the question of why cities were so much harder to build, and why longevity of certain companies seemed to come along with stasis.
This is the one answer. And it’s an inconvenient answer. You can try back it with something of value if you like, whether that’s gold backed currency or collateralised stablecoins, but ultimately you need to create an economy to back it with.
Because it turns out the way to build an economy isn’t just to launch some money, it’s to actually create an economy. Otherwise you fall prey to Voltaire’s misplaced pessimism about the value of money. That way lies lunacy.
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Really enjoyed this perspective. Creating an economy sounds intimidating, but it's not impossible. I like the analogy of airline points. It makes the challenge of starting an economy feel like an issue of scaling valuable user aligned services rather than just scale alone.
Now I'll be thinking about how I can start my own mini economy for the rest of the day.