Many “alternative currencies” today are novelties, born from the ingenuity of individuals tethered to a specific locale. By construction, they do not have a global scope; and, often, there is no desire for one. Take “Berkshares” in the Berkshires region of Massachusetts; it is a relatively new “local currency”, backed by a basket of local goods.  Berkshares is still a function of the dollar: when dollars are exchanged for Berkshares– they are in turn invested in US treasuries – instead of in, say, gold. However awkward, there’s something nice about it, since it elicits pride for the community’s productive efforts along with a feeling of independence. But a medium of exchange such as Berkshares doesn’t even approximate a free banking money regime – in the way that the crypto-currency Bitcoin promises to.  

With the federal funds rate parked at 25 bps –you’ve probably asked yourself why you should hold on to cash.  Last year, like many of you, I sold dollars and went long Bitcoin: 2/3 risk-on neophila, 1/3 genuine optimism with a tempered expectation for profit.  At the time, it took two weeks for clearance and dollar transfer to MtGox –the exchange where trading this cross is the most liquid.  That means the price you see today can end up nowhere near this rate on the day when your funds hit the exchange and become available for trading.

With more efficient market making for the digital currency and full-fledged electronic Bitcoin banks, that kind of barrier to entry will reduce in time. A bold step forward in this direction today would be to couple the digital currency with a protocol known as Open Transactions (OT). The infrastructure would enable agents to enter into banking contracts. It centralizes transactions and makes it easy to trace their lineage –regardless of the medium of exchange used.  In theory, as a user, you could engage in traditional banking with Bitcoin money, such as: market making, origination of derivatives, check issuance, and contract settlement. 

Morally speaking, with a free banking monetary regime, there is a unique (more or less “correct”) level of reserves a bank should hold for each level of nominal spending in the economy. So, if this total level of spending changed (i.e., if aggregate demand changes), banks should respond by adjusting their reserve ratios to meet that demand. Those that don’t are left behind –but no one is too big to fail. One of the most stable banking systems in history, the 19th century Scottish banking system , held gold reserve ratios as low as 1-2%. Banks were signaled to adjust their gold reserve holdings by monitoring levels of total payments through a central payment clearing system. The same idea goes for the digital coupling I’m suggesting.

The value added by using the OT protocol with Bitcoin is due to the transparency of the Bitcoin block chain.  As the user, the onus is on you to decide whether you have confidence entering into contracts with other agents. To assist you in that decision, this infrastructure, operating with a publically accessible digital currency network would provide users with valuable information about banks' reserves, so to speak.  In the long run, it has best chance of lending itself to a fractional reserve Bitcoin where P2P lending is possible. Popular –and, by now, tiresome – deflationary concerns about Bitcoin fall flat against this backdrop.  Free banking theory, where changes in the velocity of money are offset by changes in the private money stock– just got its modern flair with Bitcoin as a commodity base.

(If you have interest in development and validating the protocol, email me or comment: mmreilly- at - gmail.com. There are a few kinds of cryptography operations necessary to understand the public-key aspect—any expertise in cryptography/number theory/hacking would be useful).


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