Utopian Financial Infrastructure

Four Types of Currency

This chapter introduces and describes four types of currency: gold, local, token, and fiat. These types are relevant when answering the question: What type of currency is most suitable for making a payment for a specific kind of trade?

Corresponding to these four types of currency, there are four forms of payment:

  1. Payment using gold currency
  2. Payment using local currency
  3. Payment using token currency
  4. Payment using fiat currency

Since these phrases appear in subsequent chapters, we need to define them. Our intention is to clarify the meanings of these forms of payments and their distinctions.

Both present-day and Utopian societies issue their currencies by "fiat", but there are important differences. Therefore, we need to clarify the meaning of the phrases that include the word "fiat". Here are those phrases: "payment using fiat currency", "pay using fiat currency", "paid using fiat currency", and "paid for using fiat currency".

We will use the term "fiat" for Utopian societies and the term "token" for present-day societies. We'll explain the reasons for this distinction and highlight the key differences between these forms of payment.

The section titled "History of Evolution of Currency" presents a brief summary of how currencies evolved from the barter system to fiat currencies.

The next four sections explore these forms of payment and their associated currency.

History of Evolution of Currency

This section presents a brief, simplified history of the evolution of currencies from the barter system to fiat currencies. The aim is to introduce key terms associated with the concept of "currency" so that readers can look up all the details using the knowledge resources at their disposal.

Before the concept of a currency was formed, humans would simply exchange something for something else. This is called the barter system.

The concept of currency emerged when humans started using a few well recognized commodities as a medium of exchange. Some examples are: cowrie shells, salt, and cocoa beans.

The next stage of evolution was to use metal coins as currency. This stage progressed and culminated in precious metals like gold and silver becoming the metal of choice for minting coins; because they were considered precious and hence good indicators of value. Value is an important consideration for any currency. Gold has several unique and desirable characteristics that it has been regarded as precious for a very long time all over the world. It is considered more valuable than silver and significantly more valuable than other metals such as iron and copper.

Sometime later, only gold was preferred for minting coins. Silver was no longer preferred for minting coins, partly due to its lower value as compared to gold, and hence larger bulk for the same value.

However, gold coins had problems. People would shave gold coins to get some "free gold" while still retaining the gold coin. This led some people to hoard them, resulting in a scarcity of the currency itself.

These problems were solved by introducing paper money and non-precious metal coins instead of gold coins with an explicit understanding that all printed paper money and minted coins of a certain value could be redeemed for a specific amount of gold. That is, the value of gold was fixed in terms of the currency. This system was referred to as the "gold standard". Currencies based on gold standard had predetermined and set equivalences with gold; hence these currencies are referred to as "backed by gold". Essentially, the paper or the coin is a token of some gold held in a government vault. While these tokens have a face value (that is value printed on the face of that paper or coin), the implied value of this token is the same as the value of the gold that it represented.

There was an era in which currencies of different countries were either precious metals or backed by precious metals. People named their currencies in accordance with the local evolution of their language with additional influences from rest of the world. Thus, local currencies all over the world got different names. It is interesting exercise to look up the origins of various currency names like the dollar, euro, pound, frank, rupee, ruble, yuan, yen, dinar, peso, real, etc. Many countries started calling their local currency dollars. Hence there are a plethora of country-name based dollars in the world.

Currencies backed by gold standard implied that societies could not print or mint money over and above the value of the gold they possessed. This limited them in various ways. For example, societies could not print money to overcome an economic crisis. These limitations were deemed important.

In 1970s the gold standard was abandoned in favor of issuing currencies by "fiat". The term "fiat" means "by decree" or "by declaration". The value of the currency is no longer backed by gold. It is backed by "trust" in the issuing society and its government. The trust is that they will sensibly manage the quantity of money that they issue by fiat for the goal of ensuring economic stability.

Essentially, the fiat currencies gave societies the ability to create more of their own currency without any restrictions. Having no restrictions can be a double-edged sword. Some societies misused it and faced hyperinflation within their society, and led to devaluation of their currencies relative to others. Societies who managed their fiat currency better than others gain higher trust in their currencies.

Utopian societies also issue their currency by fiat. However, they use their monetary sovereignty and authority fully as compared to present-day societies. This can be seen when Utopian societies have systematic reasons to create and destroy their own currency. There are benefits for both the creative and destructive aspects of the power to issue the currency.

Payment Using Gold Currency

We have extensively discussed gold as a currency in the "Foreign Trade In Precious Commodities" chapter. This form of payment is termed "payment using gold currency".

Here are the key points from that chapter:

  • Gold is the currency used for foreign trade in precious commodities.
  • One gold dollar is 0.01 gram of gold in all Utopian societies.
  • The gold dollar is a concept, and its equivalent can be bought and sold in the local market as units of the gold ETF.
  • Precious commodities are priced in gold dollars.
  • Precious commodities are paid for using gold currency, implemented using the gold ETF.
  • Since precious commodities are priced in gold, when a buyer and a seller agree on the price of a quantity of a precious commodity, they consider the price to be a fair value for the precious commodity.
  • In foreign trade of precious commodities, when precious commodities are paid for using gold currency, that trade does not cause a gain or loss of precious commodities for either of the trading societies.

This form of payment is easy to understand. Visualizing such payments using physical gold enhances understanding by conveying the idea of giving something precious (that is, gold) in exchange for something equally precious (that is, the purchased precious commodity).

In the past, gold was used as currency. In present-day societies, gold is not used as a currency. Therefore, the concept of "payment using gold currency" applies exclusively to Utopian societies.

Payment Using Local Currency

There is no physical currency in a Utopian society. All money in a Utopian society exists as a digital record. Therefore, within a Utopian society, payments must occur digitally.

The term "digital payment" seems appropriate for this type of transaction. Moreover, this term helps distinguish it from present-day "cash payments" or "payments by cheque". We will continue using this term for a few more paragraphs while explaining why it should be discarded.

Within a Utopian society, "digital payment" involves the payer, the recipient, and their respective accounts. The payer's account is decreased by the amount paid, and the recipient's account is increased by the same amount. This entire process occurs within a single conceptual database as a single transaction. This database is fully controlled by the society's UFI.

Payments between Utopian societies cannot be processed as outlined above. Here is the reason: the payer and the recipient are in different societies. Therefore, their accounts are in different conceptual databases, each under the full control of their respective UFIs. In this case, the single transaction has to update data in different conceptual databases. Transactions are implemented by software, and any software runs under some authority. Because the accounts are in different databases, the software implementing the transaction does not have the authority to update both databases.

Since Utopian societies lack physical currency, any money payment between Utopian societies must also happen digitally. Referring to any payment as a "digital payment" does not clarify whether it is a local payment or a payment across society boundaries. Therefore, when referring to a payment between entities within the same society, we refer to it as "payment using local currency".

The term "payment using local currency" is meaningful within a Utopian society. It cannot be used in the context of a payment across Utopian societies, because the recipient's society will not accept the "local currency" of the payer's society.

When the term "payment using local currency" is applied to present-day societies, its meaning is exactly the same as it is for Utopian societies. All payments in present-day societies are in local currency (whether it is physical cash, or cheque, or a digital payment).

Payment Using Token Currency

The word "fiat" means a decree; a declaration.

When present-day societies print paper money or mint coins, they put a number (say 100) on it and decree (or declare) that the printed paper or minted coin is worth 100 local dollars. With a decree, they create a "token" of the local currency.

Present-day societies can also create money digitally. With fiat (a decree or a declaration), central banks of present-day societies add some value to their own accounts that represents the amounts of local currency that the central bank holds. Central banks use this account to make payments. Using these funds, central banks can buy assets thereby injecting money into the economy.

We will call all three forms - paper, coins, and digital records - token money.

When a payment is made locally in present-day society, conceptually these tokens are transferred from the payer to the payee, and in this case, we will refer to the payment as a "payment using local currency".

We will reserve the phrase "payment using token currency" when the payer and payee are in different present-day societies.

In present-day societies, let's outline the steps of an international money transfer when a payer wants to send funds in the recipient's currency but only has their own local currency.

  1. The payer goes to a local currency exchange organization, and exchanges the required amount from local currency to the recipient's currency. Some exchange rate applies, but for this discussion, it is not important.
  2. The payer puts the foreign currency (obtained from the currency exchange organization) into an envelope and mails it to the recipient.
  3. The recipient receives the envelope and the money inside. In the recipient's society, this money is the local currency.

The above-mentioned steps are merely conceptual; this is not exactly what happens. We simplified the illustration for easier visualization.

Let us consider the implications:

  1. The payer's society does not lose any of its local currency.
  2. The payer's society has fewer of the recipient's society's currency units.
  3. The recipient's society gains some of its local currency.
  4. Money was neither created nor destroyed in this international money transfer.

Let us call the currency of the payer's society P-dollars, and the currency of the recipient's society R-dollars. Further, we will use the term P-society instead of payer's society, and the term R-society instead of recipient's society.

The currency exchange organization was necessary in enabling this international money transfer. The currency exchange rate is based on the demand and supply of the constituent currencies. A sensible and reasonable currency exchange rate can only be established after a sufficient amount of R-dollars reach the P-society.

How did the currency exchange organization get those R-dollars? At some initial time in the past, the P-society did not have any R-dollars. Somehow, the first few R-dollars were transported from the R-society into the P-society. Only then, some currency exchange organization can have R-dollars.

How can the first few R-dollars legitimately reach the P-society? They can reach the P-society only as a payment for something.

At some initial point in time, someone from P-society spent some effort in giving something of value to someone in R-society, and obtained the R-dollars as compensation. We will call this person from P-society the "initiator". Imagine that the initiator from P-society got paid using physical currency of R-society by their customer. The point here is that the R-dollars were "earned" by the initiator by spending some effort.

In the initial days, there were multiple such initiators in the P-society. All these initiators have no use for the R-dollars in P-society, but they know that R-dollars are valuable in R-society. A few organizations in the P-society recognize the value of R-dollars.

So, the initiators find the organizations that value the R-dollars, and exchange the R-dollars that they possess for some reasonable amount of P-dollars.

Currency exchange organizations may have originated from these initial exchanges of P-dollars for R-dollars.

We described two scenarios above:

  1. An initiator from P-society earns R-dollars from a customer in R-society.
  2. A payer in P-society exchanges P-dollars for R-dollars and sends them to a recipient in R-society.

The transactions in both scenarios were accomplished by transferring the physical currency of R-society. That is, token dollars were physically transferred across society boundaries. We used physical R-dollars for illustrative purposes; but these transactions could be conducted digitally and they would be essentially the same; they would still be considered token dollars.

In present-day, we use this token currency (in physical or digital form) to conduct the one-way international money transfer and payments associated with foreign trade. In this context, when we make a payment, that payment is termed as "payment using token currency".

Utopian societies have no physical money; money is a digital record. So transfer of physical tokens of currency is not possible between Utopian societies.

Moreover, Utopian societies do not value possessing other societies' currency even in digital form. This is by design. So, Utopian societies make no provision to record such a possession. So, transfer of even a digital token is not possible between Utopian societies.

Hence, "payment using token currency" is not possible across Utopian societies' boundaries.

Payments between Utopian societies are possible, they are termed as "payment using fiat currency", and discussed next.

Payment Using Fiat Currency

The chapter "Money Transfer: Part 1" outlined a mechanism for payment across society boundaries. When we use the phrase "payment using fiat currency", we are referring to that mechanism of making a payment. This mechanism for payment applies only to Utopian societies. There is nothing equivalent to this in present-day societies.

Making a payment using fiat currency means transferring money across Utopian society boundaries using the one-way money transfer mechanism, which uses the currency exchange rate.

Let us look at it from the perspective of "fiat currency".

In order to make international money transfer happen, some software is required. That software implements the conceptual transaction and makes the payment. Here are the actual steps to accomplish an international payment:

  1. The payer's UFI decreases the payer's account by the to-be-paid amount.
  2. The recipient's UFI increases the recipient's account with an amount that is equivalent to the amount that the payer pays. The equivalent amount is computed using the currency exchange rate.

This conceptual transaction is made possible through the joint efforts of the two Utopian societies. The joint effort is possible because the two societies use the same underlying software. This, in turn, is made possible by their agreements and cooperation in the matter. Each UFI's software, by design, is limited to modifying its own database, but it can communicate with the other UFI's software, and coordinate with it, to complete the conceptual transaction.

Here are the implications of the international payment:

  1. In the payer's society, the total money decreases; it gets destroyed.
  2. In the recipient's society, the total money increases; it gets created.

That is, some amount of local money is destroyed in one society, and an equivalent amount of local money is created in the other society. This demonstrates how the two societies exercise their monetary sovereignty in accomplishing the international money transfer.

The word "fiat" in "payment using fiat currency" indicates that some currency was created and some currency was destroyed in the process.

The phrase "payment using local currency" does not imply the creation or destruction of currency. It is merely a transfer of the money units from one account to another.

This is the full meaning of the term "payment using fiat currency". The payer is said to have "paid using fiat currency".

Superficially, payments using fiat currency may appear very similar to payments using token currency.

Here is the key difference: when paying using fiat currency, some amount of payer's currency is destroyed and an equivalent amount of payee's currency is created. When paying using token currency, no currency is created, and no currency is destroyed.

While present-day societies and Utopian societies both issue their currencies by "fiat", we have chosen to use the term "payment using fiat currency" exclusively for Utopian societies for the following reasons: Utopian societies use the full force of their monetary sovereignty to create and destroy their own currencies in a cross-border payment. Present-day societies do not employ this sovereignty for the cross-border payment. That is, only Utopian societies use their full monetary sovereignty, that is their ability to create and destroy their own currency by fiat; present-day societies don't.