Sovereign governments everywhere are petrified. An ingenious new invention that allows people to make payments across borders without leaving a trace in the official monetary system is spreading like wildfire. Its workings are so clever that few understand them. It's backed by some of the leading entrepreneurs of the day. The embattled establishment is warning that the state’s right to regulate finance is being undermined.

That may sound a lot like bitcoin in 2014. But, in fact, it's the story of a much earlier episode of monetary innovation: the birth of modern banking in sixteenth century Europe.

For just like Bitcoin's mysterious creator, Satoshi Nakamoto, the bankers of Renaissance Europe invented their own form of money. And their experience, it turns out, can teach us a thing or two about bitcoin. Above all, this can show that bitcoin's boldest promise lies not as a currency, but as a reboot of the way money works which has its origins 500 years in the past.

#### Felix Martin ##### About Felix Martin is an economist and the author of the *Money: The Unauthorised Biography*, published this month by Knopf. Between 1998 and 2008, he worked at the World Bank, mostly on the reconstruction of the former Yugoslavia, and helped establish the European Stability Initiative think tank. Since 2008, he has worked in the fund management industry in London.

The King's Money —————-

In the early middle ages, Europe’s feudal society began to re-monetise. Obligations that had previously been rendered in kind – the tenth of one’s produce paid to the landlord, for example, or the two week’s of one’s labour owed to the king – began to be valued and paid in money instead. Whose money? The king’s, of course. Sovereigns guarded their exclusive right to issue money jealously and forbade from their subjects the minting of metal coinage, the standard payments technology of the day.

Their subjects were not happy with this situation. They enjoyed the explosion of commerce that money brought. But sovereigns had a nasty habit of abusing their monetary monopoly to fund their wars and debauchery. The medieval merchant was constantly at risk of a sudden debasement of the currency designed to transfer his hard-earned wealth to his predatory monarch.

Many were the complaints lodged against this politically unjust and economically inefficient situation – but few were the concessions from the sovereigns. That is, until Europe’s merchants re-discovered a clever technology that enabled them to escape the sovereigns’ greedy clutches: the ancient art of banking. Why bother with our rulers’ myriad, unreliable, national moneys, these clever entrepreneurs asked, when we can have just one and manage it in our own interests?

And so they did. The merchants began to account their debts to one another in their own, private, international monetary unit – the écu du marc. They had no need of coinage to represent their new money – that was yesterday’s game. Instead, they deployed bills of exchange – written records of credit balances. Such was the trust they had in one another that no collateral was required to back this stateless paper currency – just a quarterly conclave at the great fair of Lyons, where outstanding balances could conveniently be cleared. It was an extraordinary achievement – nothing less than the creation of a private money to settle payments on a continent-wide scale. It was not unusual, wrote a contemporary observer, to see "a million pounds paid in a morning, without a single sou changing hands."

>Henceforth, money would be a hybrid beast – issued by private banks, but under license from the sovereign.

But there was the rub. The disappearing sou was a coin of the French king. The impact of the merchant-bankers’ splendid innovation was not just economic, but political. Just as the new private money increased his subjects’ control over their financial affairs, so it diminished the king’s command of his tax base – and so threatened his political authority. The result was a long-running guerrilla war between sovereigns and their subjects over the central questions of the monetary standard: what rule should govern how much money should be created, and who should get to decide?

It was a battle neither side could really win. The merchant-bankers had the killer payments technology – but their private money could not circulate beyond their tight-knit circles. Sovereigns, meanwhile, could make their money circulate all right – but their profligacy ensured that this happened only under duress. It was centuries before a truce was declared with the foundation of the Bank of England in 1694. The bankers would contribute their payments technology and their commercial nous, and in return, the king would allow them to issue his sovereign money, the pound sterling.

Henceforth, money would be a hybrid beast – issued by private banks, but under license from the sovereign – and its creation would be managed according to neither fiscal nor commercial interests alone, but as a compromise hammered out between the two. It was nothing short of a Great Monetary Settlement: a politico-monetary quid pro quo that has remained the basis for all capitalist financial systems ever since.

The Lessons We Can Learn ————————

So what lessons does this Old World precedent hold for money’s latest manifestation? The first is that bitcoin’s real promise does not lie in bitcoins themselves.

Consider, to begin with, the issue the monetary standard. Any money is essentially a system of transferable credit. An extraordinary variety of tokens have been used over the years to represent and operationalize such systems, from gold coins to written entries in account books, but the essence of money – an underlying system of credit accounts and clearing – is always the same.

>An extraordinary variety of tokens have been used over the years to represent and operationalize such systems, but the essence of money – an underlying system of credit accounts and clearing – is always the same.

There are four central questions that any such system must answer. The first two are closely related: how much money should be created, and who should decide? The answers to these two questions set the monetary standard. They determine – insofar as it is under anyone’s control at all – how much a pound, a dollar, or a bitcoin is worth. Then, with the matter of the standard settled, two further practical questions arise. The first is how new money is actually created in order to achieve the chosen standard. The second is how payments are made – how credit balances are transferred between counter-parties to settle of debts incurred in the course of exchange.

Bitcoin’s answer to the first of these questions is a simple one. There is a fixed limit on the number of bitcoins that can ever be issued, written into the bitcoin code. So its answer to the second question is simple too. Nobody decides how many bitcoins will be issue. Since the limit is fixed, there is no discretion involved.

Meanwhile, Bitcoin’s answers to the third and fourth questions are closely connected. The mechanism for issuing bitcoins is that credit balances are "mined" – that is, bitcoins are credited to a user’s account in return for contributing processing power to the task of verifying payments recorded in a digital ledger. That ledger – the blockchain – is in turn bitcoin’s answer to the fourth question, of how payments are made. Bitcoin credit balances are recorded a unique ledger in which the entire history of bitcoin transactions is recorded.

This ledger is not held in one place, however, but distributed across the entire network of computers belonging to bitcoin users. And changes to the ledger resulting from transfers of credit balances form one user to another require computationally costly verification by other users before they are authenticated as complete. The blockchain, therefore, is a special kind of ledger – a distributed, public ledger.

The Limited Appeal of Bitcoin —————————–

For the sovereigns of the early middle ages, the answers to the two questions of how much money should be created, and who should decide were: as much as I need to fight my wars, and it’s my right to decide how much that is. For the merchant-bankers who escaped their grasp, they were: as much as we need to settle trade, and only we can judge that. Both objectives were legitimate enough, but often, they were not aligned. So it was only when a compromise was agreed – a standard that married the two – that a single, hybrid money was able to win widespread acceptance.

The problem with bitcoin’s standard – with its fixed limit on issuance and its abrogation of human discretion – is that it looks fated to have limited appeal. A digital version of the gold standard sounds good in theory to a generation fed up with governments printing money to fund yawning deficits. But history shows that the popularity of "hard money" comes and goes.

In the Europe of the early middle ages, it was the merchants who liked their money hard – so their invoices would hold their value – and sovereigns who wanted it to bend to their needs. Fast forward to the nineteenth-century United States, and the same battle was fought between America’s bankers its farmers. Today, it is the baby-boomers across the developed world whom price stability suits, and their children and grandchildren who stand to benefit from a bit more inflation.

>The fairness and efficiency of a hard money standard waxes and wanes. Capitalist economies never stand still, so neither does the appropriate monetary standard.

In all three cases, the underlying dynamic is the same. An economy’s creditors – those who hold financial claims on other people, when everything’s netted out – lose when the standard monetary unit buys less stuff. Its debtors, by the same token, gain. The trouble is that – as all these cases also show – the distribution of creditors and debtors throughout society changes radically over time. As a result, the fairness and efficiency of a hard money standard waxes and wanes as well. Capitalist economies never stand still, so neither does the appropriate monetary standard.

That is not a statement of opinion. It is a statement of historical fact. Operating on a standard that suits only one part of the population confines money to limited circulation: even the greatest private money in history – the écu du marc – discovered that. To lock a monetary system to a fixed standard, and then throw away the key, is to condemn it to a marginal existence. To achieve widespread use, money must operate on a standard that suits a wide range of interests. So bitcoin’s intrinsic limit may make it very popular – but amongst a limited constituency of users.

What Exactly Is Money For? ————————–

Then there is bitcoin’s answer to the third central monetary question: how new money is actually created.

Sovereign money was (and mostly still is) created against public debt. The sovereign incurred debt by employing officials or buying provisions, and thereby got its liabilities into circulation. The merchant-bankers’ money, on the other hand, was created against commercial debt. They issued bills to finance trade, and those bills then circulated as money. Bitcoins, by contrast, are created on a very different principle. They are issued as a reward for verifying the transaction log.

In a world in which people have lost faith in government’s judgment on public expenditure and in bankers' acumen as arbiters of sound business, there is obviously something unattractive about relying on these qualities to determine how new money is created. In contrast, a system where the process of money creation is open to all and tightly linked to the technical job of sustaining the payments system itself sounds much more sensible. Look a little harder at these three alternatives, however, and there is an awkward question lurking in the background: what exactly is money for?

>It is as if money exists not to serve any ulterior purpose at all, but simply as an end in itself.

We may not like the processes whereby sovereign money or bank money were created – but they did have clear rationales. Sovereign money was a tool to achieve the sovereign’s aims – public action of one sort or another. Likewise, the bankers’ money was a tool to expand trade and thereby consumption. So it made perfect sense that the issuance of new money should be tied to the financing of public or private spending.

Seen in this light, the logic of bitcoin mining is strangely circular. The issuance of new money is tied to the job of maintaining the integrity of the payments system. It is as if money exists not to serve any ulterior purpose at all, but simply as an end in itself. In that case, bitcoin may indeed be the perfect metaphor for our relentlessly transactional culture. But it is less clear that it can serve as the currency of a modern, market economy, in which the creation of money through the extension of bank loans is intentionally linked to the expansion of business investment.

Coinage: The Original Internet of Things —————————————-

Bitcoin, however, is more than just its answers to the first three key questions of money.

At its core is its novel payments technology – the distributed public ledger – which could just as easily be used to process payments denominated in US dollars, or British pounds, or Japanese yen as in bitcoins. So how does bitcoin’s answer to the fourth question any money must answer measure up against the historical alternatives?

The oldest of those is cash: coins and notes that represent credit balances and transfer them from person to person when passed from hand to hand. It is in fact a very ingenious technology when one thinks about it. Settlement is instantaneous. There is the risk of counterfeiting, of course – but no need to refer to any centralized records. And the ledger recording society’s network of credit and debt at any point in time is genuinely virtual: it consists simply in the physical distribution of the information-bearing tokens. Coinage, you see, was the original internet of things.

>It is as if the medieval fair of Champagne or Lyons happens every day – indeed, every ten minutes.

The bank-based payments system pioneered by Europe’s medieval merchants, which accounts for the vast majority of payments today, works differently. It deploys real ledgers – paper-based in the middle ages, digital today – to keep track of clients’ money. When payments are made, credit and debit balances are cleared against one another – within a single ledger if both counter-parties bank there, or across two or more, If not. Unlike cash, settlement is not quite instantaneous. No longer is clearing done only quarterly, and in person, as in the days of the medieval fairs. But it usually take at least a few seconds, even if it is purely electronic. Settlement risk, meanwhile, derives from the possibility of failures in banks’ IT systems – a possibility that exasperated clients will confirm is all too real.

Bitcoin’s payments technology is a kind of mixture of these predecessors. Like the existing, bank-based payments system, every transaction is recorded. But rather than a hierarchy of centralized account books, bitcoin has only one, which is updated (more or less) in real time. It is as if the medieval fair of Champagne or Lyons happens every day – indeed, every ten minutes. But bitcoin’s payments system is also like cash: because bitcoin’s ledger is distributed and public, shared across its users and requiring endorsement not from any authority but from users’ peers in order to authenticate payment. The fairs, as it were, are held spontaneously, rather than at the behest of the bankers' cabaal.

Why Bitcoin May Be Different —————————-

If history is a guide, it is here that bitcoin’s real potential lies: in its hybrid payments technology. As Europe’s medieval merchant-bankers proved, a brilliant new means of recording and verifying money transfers can indeed be a revolutionary event – not just in economic, but in political terms.

The existing, bank-based payments system is expensive and antediluvian – but also profitable and therefore jealously guarded by its powerful owners. Other technologies co-exist – such as cash payment face-to-face, or the developing world staple of hawala for international transfers – but they cannot seriously compete with banks. If Bitcoin’s technology is as cheap, as scalable, and as secure as its advocates claim, it may be different.

That last point, of course, is crucial. One reason that cash, that most archaic of payments technologies, still exists, is because it really is anonymous. Anonymity in transactions can be abused, of course. But it remains a basic civil liberty. Payments systems that use ledgers rarely offer the same assurance. Efficiency and economy are nice to have: but not at the cost of our right to privacy.

>If history is a guide, it is here that bitcoin’s real potential lies: in its hybrid payments technology.

It was thirty-five years ago – long before bitcoin, the internet, or even the Macintosh – that the French philosopher Jean-Francois Lyotard warned that "the computerization of society...could become the 'dream’ instrument for controlling and regulating the market system, extended to include knowledge itself and governed exclusively by the performativity principle." An unreasonably dystopian vision, perhaps, given the enormous increases in prosperity and individual freedom that the web has brought. But it is only now that computerization is transforming money – the most basic institution of all in our market societies. So it is a dystopia we must make all the more certain does not become reality.