Although we use money every day, few of us really understand it. Most define it by its most obvious manifestation – government-issued paper certificates or coins that specify units of currency, such as dollars or euros. But that superficial definition does not capture changing forms of money, such as electronically evidenced – or “digital” – currencies, which are confounding many members of the media, policymakers, and regulators. The resulting uncertainty can lead to laws that are sub-optimal.
In a new article, I argue that money should also be viewed functionally – as a “right” that serves one or more of the generally accepted functions of money. The article focuses on two of money’s most generally accepted functions: to serve as a medium of exchange to facilitate the sale of goods and services and as a store of value. To perform these functions, money must have two characteristics: It must be transferable, ideally with low transaction costs; and it must represent something valuable.
This functional perspective can enable readers to understand, more intuitively, the changing nature of money and can also help to de-mystify digital currencies. For example, the current differences between tangible and digital currencies relate principally to transferability; electronic transfer can be quicker and less costly than physical transfer. In contrast, the current differences in the forms of digital money relate principally to value. Value is influenced by who – government or the private sector – issues the money (the difference, for example, between central bank-issued digital currencies, or “CBDC,” and privately issued digital currencies) and, in the case of private issuers, by whether or not the money is backed by assets having intrinsic value (the difference, for example, between asset-backed “stablecoins” such as Tether, and unbacked digital “currencies” such as Bitcoin, whose market price fluctuates widely).
A functional perspective also can inform lawmaking. The traditional purpose of financial regulation is to correct market failures in order to increase economic efficiency. Although that regulation primarily is designed to correct externalities, I propose that the characteristics of transferability and value, which enable money to perform its functions, also should inform monetary regulation.
To facilitate transferability, for example, regulators should examine how to adapt the electronic networks that enable the transfer of wholesale digital payments to the low-cost transferability of retail digital currency payments. They also should consider how to try to lower the high environmental and energy-wasting costs of transferring cryptocurrency-based digital currencies, especially those involving blockchain. To facilitate value, regulators should examine, for example, how to protect stablecoin redemption rights. My article explains in detail how such regulation could help to assure that stablecoin issuers maintain sufficient assets to perform their redemption obligation at all times; could protect any assets held for that purpose from claims of the issuer’s creditors; and could protect the issuer from business and operational risks that could impair its financial condition.
Utilizing regulation to protect money’s transferability and value would expand the proper scope of financial regulation beyond its traditional negative role, protecting against harm, to also include the positive role of helping to promote beneficial business innovations. Although limited, there are precedents for a positive role of financial regulation. For example, because a neutral, open Internet would benefit both consumers and businesses, a U.S. Federal Communications Commission chairman has advocated “establishing rules of the road that incentivize competition, empower entrepreneurs, and grow the economic pie to the benefit of all.” The United Kingdom’s Financial Conduct Authority has originated the idea of a “regulatory sandbox,” creating “a ‘safe space’ in which businesses can test innovative products, services, business models and delivery mechanisms without immediately incurring all the normal regulatory consequences of engaging in the activity in question.” Other examples of using regulation to promote financial innovation include creating governmental offices or hubs to advance innovations in financial technology (FinTech) by bringing together regulators and industry representatives and conducting FinTech research.
To set a common grounding for readers, I try to clarify at the outset what rights should be viewed as money. Taking a pragmatic approach, money should include all rights, in whatever form, that widely serve to function as money in the relevant jurisdiction. This formulation helps to differentiate the unbounded innovation of monetary rights from monetary innovations that are becoming widely used. For example, the fact that some use Bitcoin or other generic-cryptocurrency rights to function as money does not mean that the law should help to correct market failures that can impede that use. The law should not be facilitating all forms of financial innovation; some may be misguided. Widespread usage suggests that the innovation is surviving in the marketplace of ideas and is perceived as beneficial.
I also address the common misconception that money is not legitimate unless it is designated as so-called legal tender. Many jurisdictions, including the United States, do not limit the medium of legal payment and allow any commercially reasonable and widely accepted medium to be used for payment. Furthermore, the very concept of legal tender is technically vague. For example, although legal tender is sometimes recognized as money for the payment of public and private debts, a person offered legal tender is not always obligated to accept it.
This post comes to us from Steven L. Schwarcz, the Stanley A. Star Distinguished Professor of Law & Business at Duke University School of Law. It is based on his recent article, “Money: A Functional Analysis,” available here.