The core of the Better Money plan is to implement a system for the Issuance, Distribution, circulation, Redemption and De-Issuance of digital Base Money that is backed by a 100% reserve of physical gold. Like e-gold®, which pioneered this concept nearly twenty years ago, this system mobilizes the value of gold as money for payments via the Internet.
This post will outline basic, mostly technical elements—an intro to the “what”—but mostly steer clear of the “why”. Many other posts will explore the rationale of Better Money.
A private sector Monetary Authority
The Better Money System is organized to serve as a private sector Monetary Authority. Usually when one sees the term “Monetary Authority” it is in reference to a government Monetary Authority such as the United States Federal Reserve, the Bank of England or the Reserve Bank of India. So what do I mean by Monetary Authority?
As a quick aside, throughout this blog I will be following a convention (used in many contracts) of using capital letters to signify defined terms. There is a definitions section. I cannot presume my definitions will be universally embraced as standards; they are simply offered in an effort to afford greater precision in the context of this blog. At this stage though, rather than parse the formal definition of Monetary Authority, which would involve chasing down other definitions embedded in it, let me put it this way.
A Monetary Authority is responsible for the:
- Issuance (and De-Issuance) of the Base Money of a particular brand of money (i.e., a Currency), and,
- Provision of a Settlement Platform for processing/executing account-to-account transfers of that Base Money.
These two functions imply two Roles: Issuer and System Provider. With every government Monetary Authority both roles are vested in a single entity. With the Better Money System the System Provider and Issuer Roles may potentially be performed by different entities. Moreover, while there is always a single System Provider, there could be multiple Issuers (if, for instance, the System has multiple Currencies).
The System Provider in turn, as in every government version, attends to two domains. It provides a Settlement Platform – the mechanism via which the Base Money circulates. It also administers participant access, assuring that only persons meeting specified requirements can own or use Accounts on this Settlement Platform.
In its administrative role, the System Provider is responsible for credentialing and extending whatever system Privileges are necessary to participants designated to perform other specialized roles, including the one or more Issuer(s).
Before moving on I want to be clear on a very critical distinction between this private sector Monetary Authority and a government version. The money (at least some forms of the money) issued by a government Monetary Authority is usually vested with the status of Legal Tender. This term is commonly used in error. If some sort of money is not Legal Tender that doesn’t mean it is illegal…unless of course it is a counterfeit version of the official stuff. The lack of Legal Tender status just means its use is voluntary. Stated differently, if some sort of money isn’t Legal Tender you don’t have to accept it for repayment of a debt or for any other reason if you prefer not to. There is no reason the core Better Money Currency, the Base Money of which is backed by a 100% reserve of gold , should ever be designated anywhere as Legal Tender.
Legal Tender considerations aside, however, there are many laws, regulations and judicial rulings and precedents in the US and most other countries with which the Better Money System must comply if it is to provide service to people subject to those jurisdictions. An important precedent in the United States will require the System Provider—perhaps pending a more logical regulatory rubric—to restrict participation in the system on a jurisdiction-by-jurisdiction basis which, in the US, currently means state by state.
Like Fedwire, but different
The Better Money Settlement Platform adapts and extends concepts implemented in the Fedwire® Funds Service, a critically important payment system operated by the US Federal Reserve but not directly accessible by the public. In this section I will briefly describe both systems, how they are similar, and how different.
Fedwire?
Many people have never heard of Fedwire but if you have ever sent or received a bank wire in the US, odds are you've indirectly interacted with it. To send a bank wire, you provide a wire instruction to your bank. The instruction includes the wire coordinates of the recipient’s bank account. These coordinates identify the recipient’s bank, typically by a unique “routing number”, and the account number of the recipient’s account at that bank. In turn, both the payer’s bank and the recipient’s bank, have their own bank accounts at Federal Reserve Banks (or an account with some other bank that does). The actual settlement (transfer of Base Money), which is from the payer’s bank to the recipient’s bank, occurs by means of accounting entries on the books of the Fed, i.e., via Fedwire.
An account-to-account transfer of Better Money, called a "Spend", is similar but eliminates the middlemen. In a way it is as if you could log onto Fedwire yourself—avoiding the delays, cost and risk of error of the (at least) two bank intermediaries obligatorily involved in a bank wire—and upload a payment instruction. [I will describe in later posts why the Fed is unlikely to ever allow widespread direct access to Fedwire.] As in the Fedwire case, this instruction—called, not surprisingly, a "Spend Instruction"—also specifies the payment coordinates of the recipient, consisting of the unique identifier of their Account.
Of course Better Money is also different in that the Fed deals with USD and the Better Money System does not.
The transfer protocol
Fedwire and the Better Money System both function as Real Time Gross Settlement (RTGS) platforms. RTGS entails a closed system of accounts with which participants can make or receive account-to-account transfers to/from other participants.
Transfers via an RTGS protocol are “push” type payments, meaning the payer provides specific advance authorization of the payment instruction directly to the System Provider and the system authenticates that it is a valid instruction prior to execution. [This is quite different from credit card or ACH transactions, in which the payer authorizes the recipient to "pull" (aka "draw", resulting in a "draft" of) the payment…and the processor takes the recipient’s word for it being authorized by the payer.] The system then settles the transfer immediately (hence the “Real Time” part), simultaneously crediting one account and debiting the other. The term “Gross” is used to distinguish from arrangements that involve netting.
Unit of account
One of the innovations pioneered by the e-gold system in the 90's was the adoption of standard units used for quantifying weight—grams or troy ounces, which are interchangeable by a fixed arithmetic ratio—to specify the units of account for each of the four e-metal® Currencies. (For example, grams of e-gold (AUG) and grams of e-silver (AGG) were distinct units of account). Now obviously quantities of a Currency that exists only in electronic form reflecting accounting entries maintained in a database don't actually weigh anything. These words were used to form names for currency units to emphasize the hard contractual requirement that every (electronic, monetary) gram of e-gold in circulation had to be Backed at all times by at least 1.0 (physical) gram of gold bullion (Fine Content) in Allocated Storage.
This differs of course from the words used by government Monetary Authorities as names for the units of account for their Currencies. Once upon a time words like dollar, pound, yen, dinar, shekel and ruble did refer to bullion coins of particular weights but their continued customary usage has long since lost any such connotation. Units of mass (such as the gram), in contrast, aren't conducive to tricky exploits of redefinition.
Decoupling the numeraire
A more subtle innovation pioneered by e-gold was that a Spend Instruction could specify the amount to be transferred in terms of a different Numeraire than the Native Unit of Account of the Settlement Currency. The terms "Numeraire" and "Settlement Currency" may make it sound complicated but an example makes it easy to understand. Jane might specify:
"Pay [Jill's Account] 10 USD' worth of AUG".
AUG® was the designation for e-gold, sort of like GBP represents British Pound or JPY Japanese yen. The system would then perform a calculation, using a Reference Exchange Rate maintained by the system as a convenience to users, to determine how much actual e-gold to convey. If at that moment 1.000 AUG = $40.00 USD, the amount to actually be transferred would have been 0.25 AUG. So in this example, the Numeraire was USD and the Settlement Currency was AUG.
The Better Money System supports and actively encourages use of conventional national Currency units as the Numeraire for specifying the amount to be conveyed in a Spend Instruction. It also uses AUG as the native unit of account for the gold backed Currency, having bought the trademark.
This simple capability of decoupling the pricing or invoicing Numeraire from the unit of account native to the Settlement Currency has a lot of subtle ramifications which I will explore in later posts.
Finality of settlement
A transfer of money via an RTGS-type system is immediate and final. The recipient has full access to the money received and can spend it right away if desired.
There is a major difference between how Fedwire and the Better Money System assure payment finality.
Fedwire assures finality on the strength of a government guarantee. Were something to go wrong, the US government stands ready to act as a lender of last resort to cover a default that might otherwise lead to failure or reversal of a Fedwire transfer. One reason this guarantee is needed is that with Fedwire a participant is permitted to make a payment that leads to a temporary ("daylight") overdraft. In other words, in certain circumstances the Fedwire system extends credit.
The Better Money System, in contrast, achieves finality of settlement by imposing/enforcing a "Strict Debit Rule". A Spend Instruction is executed only if the paying account has an Available Balance equal to or greater than the amount of the payment. A Spend Instruction that would, if executed, cause an overdraft generates an error message.
There are good reasons for the Federal Reserve to allow daylight overdrafts, or at least there used to be. Until about 2008, it made sense for the Fed to permit such overdrafts in order to aid banks in their strategies to economize on reserves. Since then, reserves and the so-called "money multiplier effect" have played even less of a role in money and banking than previously; banks are holding trillions of USD as "excess reserves".
The advantage of the Strict Debit Rule in the Better Money System is that it eliminates any role for credit in the payment process. This affords protection from the risk of payer default thereby better assuring payment finality.
A closed system
Both Fedwire and the Better Money Settlement Platform are closed systems. They are "closed" in two ways.
Transfers can only be made between system participants. There is no way for a non-participant to receive or own a balance of the type of money that circulates in these closed systems.
They are also closed in the sense that outside money—in fact value of any kind—cannot enter the system just as the money that circulates within the system cannot exit.
With Better Money (and here I am speaking of the Base Money form, the form that circulates by book entry transfer on the Settlement Platform), the only means by which a Person may obtain some is by receiving a Spend from another participant who/that already has some. This raises the question – if the money in these systems can only go around and around, by what means can the overall amount in circulation be increased or decreased?
Issuance and De-Issuance
To explain how the quantity of money circulating in a closed system—such as Better Money or between the Federal Reserve Banks whose liabilities circulate via Fedwire—can be increased or decreased it is useful to talk about balance sheets.
Money that is issued and outstanding (as opposed to forms of money that are physically minted or types of money that are metaphorically "mined") always constitutes a liability of its Issuer, or, in the case of Broad Money such as bank Deposits, its creator. [The obligations of a Mint, in contrast, relate to the specifications they claim to meet; Mint obligations are more like a warranty situation.]
With the Fed, the sum of the account balances of all the financial institutions that hold deposits with Federal Reserve Banks shows up as a liability on the combined balance sheet of the Federal Reserve System http://www.federalreserve.gov/releases/h41/Current/ called "Reserve balances with Federal Reserve Banks".
With e-gold®, the aggregate Monetary Liabilities were reported in real time with a utility called "Examiner", multiple random captures of which, such as http://web.archive.org/web/20060716030459/http://www.e-gold.com/examiner.html are archived at archive.org.
Open Market Operations
The processes of Issuance and De-Issuance both entail an exchange between the Issuer and a special counterparty known as a Primary Dealer. [My definition is here and an introduction to Primary Dealers in the Federal Reserve System is here.] These exchange processes both involve two transfers and the combined transactions are called "Open Market Operations".
In the Issuance type of exchange, the balance sheet of the Issuer is symmetrically expanded. The Issuer receives additional assets from a Primary Dealer via some sort of transfer process external to the system. These new assets are paid for within the system with newly created Base Money, increasing the total amount circulating via the Settlement Platform.
The technical means by which the new money is created in the Better Money System involves the use of a special account which I will call the issuance account for now. The issuance account can be thought of as a purposeful overdraft account, the balance of which, expressed as a positive number, always equals the aggregate balance of all other like-denominated accounts on the Settlement Platform. While the balances contained in all other accounts on the Settlement Platform are accounted as current assets of their respective owners, i.e., money, the balance of the issuance account represents the Issuer’s Monetary Liability.
De-Issuance occurs via Open Market Operations that entail an exchange transaction in the opposite direction, symmetrically shrinking the Issuer’s balance sheet. The Issuer receives money from the Primary Dealer that goes into the issuance account, reducing its overdraft amount and decreasing the Issuer’s Monetary Liability. The Issuer then releases specified assets external to the system to the Primary Dealer.
There is a defining difference between Open Market Operations conducted by a government Monetary Authority (that is organized as a Central Bank) and those that involve the Better Money system.
- A government Central Bank conducts Open Market Operations pursuant to its own discretionary monetary policy. It determines how much Base Money it wants to be in circulation and implements Open Market Operations to achieve that goal.
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With the Better Money system, the Issuer is powerless to exercise any such discretion. Primary Dealers initiate Open Market Operations pursuant to their own business needs arising from their obligation to make an orderly market for exchange. Provided the Primary Dealer is proceeding in conformity with business process rules enforced by the System Provider, the Issuer is then obliged to perform its end of the bargain.
The asset portfolio
All government Monetary Authorities, whether of the Central Bank type or another variant known as a Currency Board, are organized as banks. Like all banks, their assets can be classified into two general categories, reserves and (what I will call) investments.
The investment portion is easier to explain. Investments are remunerative assets, that is, they are intended to produce income, typically in the form of interest. The investments might be direct loans (in which the bank is the creditor) or Securities.
The idea of holding reserves, in contrast, is not to generate income. Reserves are more like money. Banks are arranged more or less in layers, with the Monetary Authority being the deepest or foundational layer.
For a regular commercial bank, its reserves largely consist of assets which constitute Monetary Liabilities of the Fed:
- Deposits it holds at its Federal Reserve Bank (or an intermediary bank), plus,
- vault cash (Federal Reserve Notes, for stocking its ATMs and the occasional teller drawer).
With the Fed itself, its assets classified as reserves consist of:
- gold stock (also called "gold certificates"),
- Special Drawing Rights (SDRs),
- Reserve Position in International Monetary Fund (IMF),and,
- Foreign Currencies.
With Better Money it is much simpler. The Issuer binds itself by a contract called the Issuer’s Declaration of Liability that requires it to always hold a 100% reserve of physical gold against all of its Base Money issued and outstanding. There are no investments in the asset portfolio held against the Monetary Liabilities since all investments entail some degree of risk, which I intend to discuss by and by.
Administering participation
There is a huge difference in requirements for administering participation in a system such as Fedwire vs. the Better Money system. Fedwire restricts participation to a relatively small cohort of (mostly domestic) financial institutions and is not accessible by the general public. In contrast the Better Money system must implement processes for evaluating the eligibility and enabling the matriculation of a vast pool of prospective participants. The processes of applying for participation, verifying identity, performing suitable due diligence, assigning appropriate system permissions and monitoring transaction activity will be detailed in later posts.
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