It is common to hear critics of Bitcoin and other decentralised digital assets state that they are not backed by anything and, as such, are not money. In contrast, fiat money is backed by the government that issues it. The word fiat, broadly speaking, means ‘by decree’ and derives from the Latin word for “Let it be done” (as in ‘fiat lux’, or ‘let there be light’, from the Book of Genesis). As implied, this decree comes from the government issuer and, as any holder of Soviet Russian roubles will tell you, what it is really backed by is faith in that government.  

Arguments against treating Bitcoin or other unbacked digital assets as money will also often cite the ‘functions of money’, which define money as a: 

1. Unit of account  
2. Medium of exchange 
3. Store of value 

The functions of money

Many forget that the original author of this list of functions, William Stanley Jevons, split the first function into two: common measure of value and standard of value. Jevons’ work, Money and the Mechanism of Exchange was written in 1875 and was a continuation of his belief that economics, as a science concerned with quantities, is necessarily mathematical. He contributed to the marginal theory of utility where one explores the change in pleasure or satisfaction by increasing or decreasing one’s consumption of something.  

This mathematical point of view overlooks the point that trust, faith, pleasure and satisfaction are psychological and, as such, are subjective. The marginal utility of the same cold drink would seem higher if it was handed to you when you are on a hot beach compared with the arctic tundra. Likewise, the same drink will likely taste better if served in a frosted glass rather than a plastic cup. In other words, context matters. 

Rocks as money

Money, and trust in it, is similarly psychological and, in some ways, ethnographical as well as mathematical. This was amusingly illustrated 120 years ago in 1903 when William Henry Furness III, an American physician and ethnographer, visited the island of Yap, now part of the Federated States of Micronesia. There he observed an unusual monetary system based on giant limestone circles known as Rai or Fei, the heaviest of which weighed approximately 4,000kg. What made this even more startling was that the stones did not even come from Yap; they mostly came from quarries in Palau, about 300 miles away. 

The Yap islanders maintained their ledger of ownership through oral history. Should the owner of a stone wish to purchase something then a deal was done, and the other party took ownership of the stone. However, at no point did the stone move.  Even more baffling was an incident where a particularly valuable stone was not on Yap as it had fallen overboard during a storm while being transported there. The sailors had all attested to its value and the cause of its loss, which satisfied the Islanders, and it went into ‘circulation’ from where it sat on the ocean floor. The Yap Islanders had the same faith in their stone-based system as people have in any other monetary system.  

Gold (a different type of rock) as money

Milton Friedman, a Nobel Prize winning economist, wrote a paper on Yap as ‘The Island of Stone Money’, highlighting the similarities between the lack of movement of the physical underlying assets – the Rai stones – and the lack of movement of physical gold reserves between France and the United States in 1932, which contributed to the 1933 US Banking Crisis. In that crisis the French sold dollar assets for gold and, not wanting to ship the gold across the Atlantic, asked the Federal Reserve Bank to store the gold on the Bank of France’s account. The Fed’s staff moved the gold to different drawers in the same vault and labelled them as the property of the French Government. Friedman also pointed out that gold is a scarce commodity that is extracted with human labour and is assigned value by people (ironically it also tends to be secured below ground, albeit in bank vaults). In the context of Yap, limestone rocks were equally scarce, as they had to be mined and transported from the only source the Islanders knew of, which was in Palau.  

Digital assets as money

The settlement of trades in Bitcoin and most other digital assets now increasingly works along the same principle. Trades take place between parties and the Bitcoin is reallocated by a custodian, figuratively speaking, in the same vault, meaning all that changes is the allocation. Avoiding moving Bitcoin on-chain, like avoiding moving gold or Rai, makes settlement cheaper, easier and less risky. In the case of Bitcoin and gold, avoiding taking either out of the custodial vaults that secure them reduces the risk that they could be lost or stolen.  

The progression from limestone Rai in Yap to gold in the Federal Reserve, to Bitcoin private keys in a Hardware Security Module operated by a cryptoasset custodian, shows that while the technology has been updated, the faith-based system is the same. Anyone who thinks that owning scare data is a step two far in terms of abstracting this idea, should reflect that a few decades ago most bank accounts were operated by banks on IBM mainframes (many still are) and the Fedwire system, which manages movements of the USD, is an Oracle database. Faith in rocks at the bottom of the sea; faith in gold in a vault; faith in your account on an IBM mainframe; faith in the USD in the Oracle database cluster; faith in your Bitcoin private key in a hardware wallet on a decentralised blockchain.  

When faith dies

Faith in something, like a good reputation, takes time to build and can also be quickly lost. In October 2022, the Governor of the Central Bank of Nigeria, announced that the highest denomination banknotes of 200, 500 and 1,000 naira would be redesigned, and all the old notes had to be exchanged for new ones by the end of January. This led to a great deal of unrest and the removal of the 200 note was cancelled (by government fiat), six days after the Central Bank’s (new) deadline of 10 February 2023. However, reports are that the damage has been done and the 200-naira notes are no longer being commonly accepted, yet they remain legal tender (by government fiat), at least until 10 April 2023.  

Faith is not easily predicted or explained. Sometimes it defies all logic. Can a Bitcoin, which is just a 160-bit random number, really be assigned value, particularly in cases where transacting in it does not even involve moving the number anywhere?! The honest answer is, we shall see. If something does not fit the definition, then perhaps it’s the definition that needs rethinking.