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LeoGlossary: Ledger Based Money

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Ledger based money are assets that have characteristics of money and are kept in a ledger. This is a large portion of what makes up the monetary system as we know it.

This difference from those monetary systems that were based upon coinage (or specie) and cash/banknotes. It is established through the use of accounting, specifically double-entry.

Money changed when Luca Pacioli introduced the world to double-entry accounting. Before this, accounting was nothing more than a list of assets. Credit was not possible since there was no way to track who was owned what. The creation of the liability solved this. It is also what enabled the great banks of Europe to emerge.

Today, we can break down money as follows:

  • central bank - banknotes (coins) and reserves
  • commercial bank - digital currency
  • Eurodollar - any asset that is liquid and tradeable

Outside the banknotes and coins, all the monetary units reside on a ledger. The only difference between any of the forms is who is in charge of the ledger.

History

Money over the last 500 year changed a great deal. Advancements in technology helped to usher in new forms over time.

Most think of the Middle Ages as a period of coinage, which is not incorrect. Coins were a dominant form of currency that were used for transactions. However, it was not the only way people conducted business.

Ledger based money was very common. It was here were the idea of Ghost Money emerged. This provided elasticity at times when coinage was in short supply. When problems with the official money supply arose, merchants still had to trade. Hence, they started to create Ghost Money as a solution.

This was nothing more than one trade opening up credit to another. Here we see how money is created. Essentially, the merchants is making a loan to the buyer, which is repaid at a later date. This could be in coinage, barter, or with another good.

The system evolved from merchants offering this, exclusively, to the banks stepping in. Understanding the use of credit is what established Europe as the financial center for hundreds of years. Trade exploded as the money supply became more distributed around the region.

Of course, the introduction of national or central banks only added to this concept. While they were established at a time when physical currency was the norm, technology during the 20th century changed this. As we moved into the electronic age, followed by the digital, communication became more advanced. We could handle things faster and in larger volumes. The idea of bank settlement occurring in cash was discarded. Instead, ledgers were adopted, kept by central banks such as the Fed, monitoring what was in the account of each bank.

21st Century

Cash is a dying animal. At this point, it is generational. The younger members of society were nor reared on this. To them, it is debit and credit cards. Actually, for many, it is payment applications on a smartphone. To them, that is what money is.

The evolution of money over the last 50 years paralleled improvement in our communication systems. It is what allowed for massive growth on a global scale. The Eurodollar System served a major role in the funding of global trade. Short term loans are crucial for financial institutions to operate. Digital communications really made this viable.

Balance sheet capacity become something that was directly linked to our ability to facilitate trade. When banks and entities are constrained, a lack of liquidity takes place.

In this realm, collateral became money.

As Alan Greenspan once remarked, due to the "proliferation of products", it became increasing difficult to even identify was money was.

Cryptocurrency

Many feel that cryptocurrency is the next evolution. This makes sense since it is in alignment the progression thus far.

Cryptocurrency is ledger based money. It resides on a decentralized databases called blockchains. These are ledgers that are on computer nodes all over the world. In fact, it is called distributed ledger technology.

The best example of this is Bitcoin. It was the first to be introduced, created by the anonymous Satoshi Nakamoto. This network utilized mining which involved solving mathematical puzzles in an effort to gain the right to produce a block. The incentive is to garner the block reward, which was paid out in the network's coin (Bitcoin). This is known as the Proof-of-Work (PoW) consensus mechanism.

Since that time, there were other systems which brought different forms of consensus to the table. The most popular is the Proof-of-Stake that was developed. At the moment, the best know blockchain to utilize that is Ethereum, although that originally started as PoW.

Cryptocurrency resembles the Eurodollar System in that it operates outside the control of central banks and governments. Like that system, anyone involved can create money. This provides the opportunity for value capture to exist.

This was enhanced with the introduction of the smart contract. This technology is helping to bring another evolution of money to the forefront. It is leading us into an era whereby finance is also altered. Many feel that decentralized finance (DeFi) is going to be a major part of the future.

Advancing to this degree should come as no surprise. Having decentralized financial systems is just changing who controls what is taking place. The traditional financial system (TradFi) is nothing more than ledgers too. We can see this in how the transactions are handled by brokerage firms.

General:

Posted Using LeoFinance Beta