Coins to QQ at Web 2.0

With the back­drop of tumul­tuous finan­cial mar­kets, I did a pre­sen­ta­tion on a his­tory of cur­rency at Web 2 Expo in New York (In the inter­est of full dis­clo­sure, I should prob­a­bly also men­tion that I was on the advi­sory board for the con­fer­ence). None of the fun­da­men­tals I high­light in this will change as a result of the recent events in the US finan­cial mar­kets because most of the new dri­vers I high­light are emerg­ing out­side of the US and will prob­a­bly have their first impact out­side of the US too. With that said, I wanted to con­tinue the dis­cus­sion and expand on it with the read­er­ship of TNL.net and other peo­ple who may not have been able to make it to the pre­sen­ta­tion. I look for­ward to any comments.

So with­out fur­ther ado, here are my pre­pared remarks:

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Good after­noon,

I know many of you are prob­a­bly won­der­ing why a his­tory of cur­rency would be on the pro­gram at a Web 2.0 con­fer­ence. So let me first dis­pel a few con­cerns you may have:

• His­tory can be a use­ful indi­ca­tor of what may hap­pen in the future. Under a his­tor­i­cal lens, Web 2.0 is pretty easy to pre­dict as the nat­ural descen­dent of com­mu­nity orga­niz­ing and low­ered cost of com­mu­ni­ca­tion and mediation.
• Web 2.0 will impact cur­ren­cies and that will prob­a­bly be the biggest thing his­to­ri­ans of the future may remem­ber about Web 2.0

So, in the next few min­utes, I’m going to take you on a trip through roughly 60 cen­turies of his­tory (just the high­lights, I promise) and will show you how each major shift in the evo­lu­tion of cur­rency reflects what we con­sider pil­lars of the Web 2.0.

Hav­ing done so, I will attempt to take you through the next 25 years and project how Web 2.0 may fun­da­men­tally rede­fine how we think of cur­rency, and present some of the chal­lenges and oppor­tu­ni­ties this his­tor­i­cal change may present.

So here we go…

About 4000–5000 BC, the basis of most trad­ing was some­thing called barter. Barter is sim­ple to under­stand, really. At its most basic level, it goes some­thing like this:  “I have fish and you have some chick­ens. How many chick­ens will you trade me for my fish?”

The other guys says he will give me 5 chick­ens for my 10 fish and, if I feel it’s a fair trade, we make the exchange.

So that’s all good but one can’t live off fish and chicken alone. And even­tu­ally, I go back to the guy and he tells me he’s not inter­ested in fish but if I can find a cow to sell him, he’d be will­ing to exchange 50 chick­ens for it. So now, I’m out look­ing for some­one who will give me a cow in exchange of some fish.

That may work for a cou­ple of goods but you can see how inef­fi­cient an approach it is.

Back then, peo­ple started real­iz­ing the same thing and so there was a move to find some way to sim­plify things. Com­mu­ni­ties started gath­er­ing around some goods that they would agree were use­ful as a basis for trade: grain, honey, rice, etc…

And, through these actions, the con­cept of money was born… and with it, the basis for what defines a cur­rency was established:

• It pro­vides a stan­dard mea­sure of value for goods and services
• It serves as a medium of exchange
• It serves as a method of stor­ing value

Let me get into those points in more details before we move on.

A cur­rency pro­vides a stan­dard mea­sure of value for good and ser­vices. If I go back to my exam­ple of chick­ens and fish, I can look at cur­rency as a go-between. By estab­lish­ing that a fish is worth 1 pound of grain and a chicken is worth 5 pounds of grain, I can then extend the model to a cow is worth 100 pounds of grain and a house is worth 1 ton of grain. From this data, I can infer that a house is worth more than a cow, which is worth more than a chicken and so on…

How­ever, none of this can hap­pen if there isn’t an agree­ment amongst every­one that a par­tic­u­lar cur­rency has value. You could call that a cer­tain wis­dom of the crowds and that’s where cur­rency starts over­lap­ping with web 2.0. We’re going to get to more details about that later.

The sec­ond point is that a cur­rency serves as a medium of exchange. Because every­one agrees that grain is a great way to make those com­par­isons, I don’t have to go around and try to make con­ver­sions from one item to another. I trade the item against grain and then can use the grain to “buy” some­thing else. In that sense, I can exchange any good for grain and grain can be exchanged against any other goods.

Once again, this only works if peo­ple agree on it as a medium of exchange. And that, in turn, rep­re­sents a form of meta­data about a trade. Sort of like if peo­ple were to tag an item with the same term. And once again, we get to a posi­tion where it over­laps web 2.0 as the crowd is now work­ing together to estab­lish value and there­fore define markets.

And because cur­rency is meta­data, it can also serve as a way to store value for future use. For exam­ple, if I fish, there’s only so long I can keep my fish before it spoils. By sell­ing it imme­di­ately (ie. Trad­ing it for its cur­rency equiv­a­lent), I can avoid that spoilage and store its value for future use. So, in a sense, cur­rency serves as a stor­age medium.

But the fact that it works as a stor­age medium can be both an advan­tage and a dis­ad­van­tage. As stor­age for value, the cur­rency itself become valu­able. And when some­thing is valu­able, well, some peo­ple try to acquire it through means other than pro­duc­tion. From here, we end up with theft, pil­lage, war, etc… And from all this car­nage, we get to the point where peo­ple try to find ways to pro­tect their cur­rency (and, almost as often, their lives).

In around 3000 BC, in ancient Egypt, some peo­ple come to the insight that, by stor­ing their cur­rency together and agree­ing to share the cost for an army to pro­tect that cur­rency (which, at the time, is grain), they may be pro­tect­ing them­selves from loss. Along the banks of the Nile, gra­naries start to appear and they become a place for stor­ing cur­rency: peo­ple come in with the grain they received as a form of pay­ment for what­ever it is that they sold. And the first accoun­tants appear, keep­ing track of what amount of cur­rency peo­ple have in their accounts.

Every­body is happy and cel­e­brates as they have dis­cov­ered a fan­tas­tic way to store their cur­rency and keep peo­ple from threat­en­ing them. Across Egypt, peo­ple pat each oth­ers on the back until, well, until the first cur­rency crisis.

Around 2200 BC, severe drought made grain more scarce. The result was that dis­burse­ments (tak­ing grain out) started to move at a higher rates than deposits (putting grain in). And some peo­ple found them­selves in a sit­u­a­tion where they had spent all the grain they had and had a hard time pro­duc­ing any­thing they could sell. In this case, the value of the cur­rency (grain) increased because the cur­rency became more scarce.

Even­tu­ally, the prob­lem affected the top of the eco­nomic food chain, aka. The pharaoh and, as a result, local peo­ple started opt­ing out of pharaoh rule and attempt­ing to take con­trol of their own cur­rency. When all was said and done, about 200 to 300 years later, grain was aban­doned as a cur­rency as it was con­sid­ered that a cur­rency that can be eaten is a cur­rency that can have a prob­lem. So met­als, which could be turned into tools, which them­selves could be melted again to turn them back to met­als, started emerg­ing as the dom­i­nant form of currency.

This is impor­tant because it finally moves cur­rency to some­thing that is more abstract. Metal may be a com­mod­ity that, with­out any work, could be con­sid­ered of lit­tle value but, as an abstract con­struct of value, it works. And for the next few cen­turies, that’s the case.

Some inter­est­ing alter­ations in terms of the ways money is stored and car­ried hap­pen dur­ing that era. For exam­ple, in a num­ber of coun­tries like China and Swe­den ini­tially, peo­ple real­ize that metal may not be the most portable of cur­rency for large trans­ac­tion and so places where cur­rency is stored (now called banks, because, ini­tially they were sit­ting on river banks) start issu­ing the equiv­a­lent of paper receipt for stor­age and peo­ple start trad­ing those receipt. Here, we see the emer­gence of two key com­po­nents of a more mod­ern system:

• First, the con­cept of rep­re­sen­ta­tive money, where a piece of paper can be redeemed for a cer­tain amount of metal, there­fore rep­re­sent­ing that metal.
• Sec­ond, the emer­gence of paper as money, cre­at­ing another layer of abstrac­tion in the transactions.

With the move to paper, cur­rency becomes sort of an I.O.U., rep­re­sent­ing a cer­tain value but not pos­sessed of that value in itself. This shift, called the shift to rep­re­sen­ta­tive cur­rency, is impor­tant because it estab­lishes cur­rency as an even more abstract con­cept. The piece of paper you receive is basi­cally a receipt that can be redeemed for some equiv­a­lent amount of metal but it isn’t the metal in itself. So here, we see cur­rency basi­cally becom­ing free-floating meta­data, assert­ing worth with­out nec­es­sar­ily show­ing it.

The prob­lem is that the dis­tance from a bank where the paper note can be redeemed becomes a fac­tor in terms of exchang­ing the banknote.

Enter John Law.

Law is an inter­est­ing char­ac­ter: he’s a Scot­tish econ­o­mist who, at age 23, shoots a man, is tried and found guilty of mur­der. He’s thrown in jail, man­ages to escape and lands in France. While there, he gam­bles a lot and comes upon two major observations:

• Peo­ple have taken to trad­ing the paper bills as if they were coins
• Paper is divorced from the metal it represents

From there, he deducts that who­ever could con­trol the flow of paper bills could start issu­ing more IOUs than they have metal for.

With this, he comes up with the con­cept of a reserve bank, assum­ing that he could have a bank with only 75 of the cash reserve needed to cover the IOUs it had issued. But there’s a prob­lem with that: in order to con­trol the flow of paper bills, he needs sup­port from a gov­ern­ment. And ini­tially, most peo­ple think it’s a crazy idea and won’t go for it. But Law con­vinces some more junior peo­ple that it’s a good idea and, even­tu­ally, one of his patrons hits the jack­pot: Philip D’Orleans rises to power and quickly real­izes that he’s run­ning a coun­try where the gov­ern­ment has a sub­stan­tial deficit. So he puts Law in charge of cre­at­ing a national bank and law sets out to cre­ate the first gov­ern­ment con­trolled reserve bank, issu­ing more paper than it has metal cur­rency for.

It’s a pretty rad­i­cal idea. Law is deal­ing with a soci­ety where every­one agrees that what you see is what you get as far as cur­rency goes but then he lever­ages the agree­ment that paper is a rep­re­sen­ta­tion of what you get and, after hav­ing taken over con­trol of the cur­rency flow, he turns that into what you see is what you get if no one rushes the bank.

Because with his sec­ond insight, John Law cre­ates the con­cept of frac­tional reserve bank­ing, which basi­cally means that the bank, at any given time, only holds a frac­tion of its obligation.

But frac­tional reserves can be a lit­tle scary: they work well as long as peo­ple trust that the bank can repay them. And most of the time that’s not an issue because while a per­son needs to pick up their gold or sil­ver or what­ever other metal the cur­rency is traded against, another per­son prob­a­bly doesn’t need his or hers. So it bal­ances itself out in some sort of com­mon good.

Where the sys­tem can fail is when every­one decides to take their metal out at the same time: remem­ber, the bank doesn’t have enough metal in its safe to cover all the cur­rency it’s dis­trib­uted. That prob­lem is actu­ally an echo cham­ber problem.

A run on a bank, the sit­u­a­tion I’m talk­ing about, gen­er­ally begins with a whis­per: some­body has heard that the bank is hav­ing prob­lem and con­cludes that money you’ve deposited there is no longer safe. That whis­per starts spread­ing and, thanks to an echo cham­ber type of effect, peo­ple worry that their money is no longer safe in this bank. Since they don’t want to lose that money, they run to the bank and with­draw all their money from the bank. Prob­lem is, they are not alone and quickly tens of thou­sands or more peo­ple start doing the same. Because of that mas­sive onslaught, the bank no longer can meet its finan­cial oblig­a­tion and actu­ally does fail.

This hap­pened in the 1920s with the great depres­sion and it’s hap­pen­ing now (that’s why the gov­ern­ment is busy bail­ing out a num­ber of finan­cial institutions.

But let’s return to his­tory. In the 1940s, after World War II, the Bret­ton Woods accord estab­lished some global rules for cur­rency exchange against gold. But most of the recon­struc­tion of Europe ended up being backed by US dol­lars to the point where the US held some­where around 65 per­cent of the global gold reserves. In 1960, an econ­o­mist called Robert Trif­fin fig­ured out a prob­lem with what had hap­pened: there were more dol­lars in the mar­ket­place than there was gold to back it up. In the early 60s, an ounce of gold was worth about four to five dol­lars more in Lon­don than it was in New York.

Due to many polit­i­cal and eco­nomic events through­out the 60s, the pos­si­bil­ity of a run on gold and a run on the dol­lar started increas­ing and on March 17, 1968, the pos­si­bil­ity became real­ity, cre­at­ing a sub­stan­tial money cri­sis. The whole finan­cial sys­tem teetered on the edge of col­lapse dur­ing that era and even­tu­ally, the Bret­ton Woods accord was aban­doned. On August 15, 1971, US pres­i­dent Richard Nixon announced that the US would no longer con­vert dol­lars to gold. In fact, he added the US would not con­vert dol­lars to anything.

That announce­ment is appro­pri­ately called the “Nixon Shock” because with it, Nixon puts an end to the con­cept of a rep­re­sen­ta­tive cur­rency estab­lished by John Law. In its place is now the con­cept of a Fiat cur­rency, a cur­rency that is traded not because it has a guar­an­teed value but because the gov­ern­ment says that this cur­rency MUST be accepted as a form of payment.

And so cur­ren­cies now float, not based on a phys­i­cal value but based on what peo­ple think that value ought to be: today, dol­lars, euros, pounds, and yens have a par­tic­u­lar value not because it is set against actual goods but because peo­ple believe that the gov­ern­ment that backs those cur­ren­cies will con­tinue to do so in the future.

So let’s go back to our fun­da­men­tals of cur­ren­cies: they have to be an agree­ment and that’s where we get to web 2.0 and its impact on currency.

Which gets us to more recent times. Dur­ing web 1.0, a num­ber of com­pa­nies start­ing think­ing that the inter­net, because it was global in nature, needed a global type of cur­rency. So tech­nolo­gies like Dig­i­cash, Cyber­cash, Ecash, Flooz, Beenz, appeared in an attempt to mir­ror cash and cre­ate new currencies.

But they had many prob­lems. First of all, the dif­fer­ent sys­tems were hard to use, often requir­ing soft­ware to be installed on the users’ machine. That lim­ited par­tic­i­pa­tion and, if you remem­ber one of the fun­da­men­tal rules of cur­rency cre­ation is that users gen­er­ally agree on using a com­mon cur­rency.
The sec­ond part was that the sys­tems actu­ally went too far in try­ing to emu­late cash. So, just as you need to go to an ATM to get cash today, most of the sys­tem used the con­cept of a purse that was to be refilled from a dif­fer­ent area. But why go to an ATM to with­draw cash when you’re on the Inter­net? Why not say, “I have money in my account, refill my wal­let if it’s empty. ”

The third, and prob­a­bly most impor­tant part, was that once spent, the cur­ren­cies were trans­ferred back into some real world cur­ren­cies like the dol­lar or pound ster­ling (and no euros because this is all hap­pen­ing before the euro became a con­sumer cur­rency.) That was the biggest mis­take because cur­ren­cies weren’t really traded.

The dot­com bub­ble crashed and, along with it, most of the vir­tual cur­ren­cies that had been intro­duced. It wasn’t a very big deal because peo­ple didn’t hold much money in those currencies.

Mean­while, a par­al­lel devel­op­ment hav­ing absolutely noth­ing to do with cur­rency cre­ation took form across the inter­net: because of its global out­reach, the net was a per­fect place for peo­ple to play games together. At any given time of day or night, there was always some­one inter­ested in a game of chess or backgam­mon or some­thing else. Some games went beyond the basic board games and lever­aged the con­cept of role play­ing games that had been so attrac­tive to so many com­puter geeks.

And over the years, as com­put­ers became more pow­er­ful, the qual­ity of the graph­ics improved. And as the games improved, new point sys­tems were cre­ated for each quest allow­ing to trade work (game-related achieve­ments) for goods (bet­ter weapons, magic potions, hous­ing, etc..)

Those points took var­i­ous forms. So games like World of War­craft or Lord of the Rings online, which are set in a medieval-like type of envi­ron­ment, turned to gold as their achieve­ment point sys­tems. Lin­den Lab, with cre­ated Sec­ond Life, cre­ated the Lin­den Dol­lar, and so on and so forth.

But then… then some­thing really unex­pected by most of the game mak­ers hap­pened: peo­ple started exchang­ing those vir­tual cur­ren­cies for real world ones. Look­ing back now, it seems to make total sense: the chal­lenge, for a lot of those games, is that it takes a lot of time to acquire vir­tual currency.

Here, in the devel­oped world, time tends to be at a pre­mium. Most of us are mul­ti­task­ing con­stantly because we just don’t have enough time to do every­thing that we would like to. But because we spend a lot of time work­ing or doing other things, we don’t have much time to play games. On the other hand, we tend to have more dis­pos­able income than peo­ple in under­de­vel­oped countries.

For exam­ple, in 2005, the aver­age annual salary (and let me make this clear, I’m talk­ing aver­age annual salary) for a Viet­namese worker was 1200 dol­lars. That’s 1200 dol­lars a year. That same year, in the Guang­dong province of China, that num­ber was $2,778.

Some of those peo­ple are in their early 20s and when they get out of work, they go out and spend some of their money to play video games. At some point, a few entre­pre­neurs around south­east Asia real­ized that if they paid ANYTHING to those play­ers, they might be able to get past some of the more bor­ing tasks and resell the accounts to peo­ple with lit­tle free time. A new eco­nomic model was born and all of a sud­den, World of War­craft gold started get­ting traded against US dol­lars and euros.

Stu­dents of cur­rency his­tory could have pre­dicted this. Remem­ber, cur­rency is a social agree­ment on the value of some­thing and here, those vir­tual cur­ren­cies became an agree­ment on a value of time.

While ini­tially the phe­nom­e­non was one of sup­ply aris­ing from south­east Asia to meet North Amer­i­can and Euro­pean demand, it even­tu­ally went around full cir­cle. When China decided to start requir­ing that peo­ple reg­is­ter their work occu­pa­tion as “vir­tual work­ers” for peo­ple deal­ing with that type of trade, over 750,000 peo­ple applied in the first quar­ter. That’s three quar­ters of a mil­lion peo­ple in China alone claim­ing to make the major­ity of their liv­ing from cre­at­ing goods they sell against vir­tual money.

And Asia is where it actu­ally gets very inter­est­ing because fric­tions between the gov­ern­ment and vir­tual cur­ren­cies are becom­ing more common.

Meet Ten­cent. Cute lit­tle pen­guin, right? Well, that lit­tle pen­guin is cur­rently at war with the Chi­nese gov­ern­ment. It started rel­a­tively innocu­ously. Ten­cent pro­vides an IM sys­tem and offered a vir­tual cur­rency, the QQcoin, to be used so one could upgrade their online avatar (an avatar is basi­cally what your online char­ac­ter looks like) and allow for peo­ple to give gifts to other avatars. Not a big prob­lem until a few other web sites started accepted QQcoins as pay­ment for ser­vices, and even­tu­ally for goods. In May 2007, the Chi­nese author­i­ties started issu­ing warn­ings about the QQcoin. By Novem­ber 2007, they were blam­ing it for impact­ing the Yuan, the national currency.

That indus­try, which peo­ple have called the vir­tual world econ­omy, real money trade, or RMT, cur­rently rep­re­sents any­where between 2 and 4 bil­lion US dol­lars of trans­ac­tion flow a year. That’s up from inex­is­tent less than 5 years ago.

So let’s keep that num­ber in our minds and move to the next set of influ­ences Web 2.0 is hav­ing on cur­rency. As you know, Web 2.0 in increas­ingly about giv­ing power to the user and increas­ing peer to peer relationships.

I talked ear­lier about the vir­tual cur­ren­cies that popped up dur­ing the web 1.0 phase. There was one com­pany which, at that time, came up with the idea of mov­ing cur­rency from one Palm device to another. For those of you in the audi­ence who may not remem­ber that time, Palm devices where the spir­i­tual grand­fa­thers of the iphone or most smart­phones today. Well, the Palm thing didn’t work out for them, so they fig­ured they’d start mov­ing money via email. Oh, and they renamed the com­pany around the name of the prod­uct: Paypal.

I think every­one here knows the rest of the story. Pay­pal has become a leader in mov­ing money on a per­son to per­son basis with some­thing as sim­ple as an email address in terms of iden­ti­fi­ca­tion. That sim­pli­fied trans­ac­tions and many peo­ple around the world are actu­ally using pay­pal today to move money from one cur­rency to another.

And while many may snicker at the idea that mov­ing money from some­thing as ridicu­lous as the Palm, well, it was just a ques­tion of tim­ing and mar­ket­place. Cur­rently, in Kenya, M-PESA is doing the equiv­a­lent of 10 mil­lion US dol­lars in daily per­son to per­son trans­ac­tion on mobile.phones. That 3.6 bil­lion dol­lars a year.

That’s real cur­rency right now but why does it have to be a real one? After all, it’s just vir­tual money as it moves from an elec­tronic device to another.

Mean­while, mar­ket­places like prosper.com and zopa have started allow users to make loans to each other via a web inter­face. It’s called peer-to-peer lend­ing, basi­cally, peo­ple lend­ing money to other peo­ple, or as most of those com­pa­nies claim, they’re Ebay for money.

Accord­ing to the online bank­ing report, it will be a US$9 bil­lion a year busi­ness by 2017.

That’s real cur­rency right now but why does it have to be a real one? After all, it’s just vir­tual money as it moves from an elec­tronic device to another.

So if we take the trends we’ve just explored:

• Vir­tual cur­ren­cies have grown to be traded as if they were real currencies
• Peo­ple are mov­ing money from one per­son to another via the inter­net or mobile devices

We may be able to come up with the con­clu­sion that where this is going, in the long run, is an area where exchanges could be set up either online or on mobile devices to use vir­tual cur­ren­cies are real currencies.

And if we assume that this first step is pos­si­ble, then it’s not too far away from the next step, which is an explo­sion in the num­ber of cur­rency offer­ings we may see in this world.

What we’re see­ing here is the first shot in what I think is the next evo­lu­tion­ary step in the his­tory of cur­rency and it’s an evo­lu­tion that could either be a tran­si­tional phase with­out major dis­rup­tion or a mas­sive change in the way peo­ple are inter­fac­ing with cur­rency: this could be our generation’s Nixon Shock.

The issues around this new world are significant.

The first issue is around who is con­trol­ling those cur­ren­cies. For most of his­tory, cur­rency was under the con­trol of the cur­rency issuer. But in the last cou­ple of cen­turies, there’s been an increas­ing trend towards gov­ern­ment con­trol of currency.

How will gov­ern­ment react when their own cur­rency is chal­lenged? And will their reac­tion mat­ter? After all, the Chi­nese gov­ern­ments actions to date, as far as the QQ is con­cerned haven’t stopped trading.

What will hap­pen in terms of tax col­lec­tions? Will gov­ern­ment have to start accept­ing cur­ren­cies beyond their own as agreed form of pay­ments? And if they accept other forms of cur­rency, will they have to accept other government-run cur­ren­cies as form of payment?

How will crim­i­nal behav­ior be dealt with? Today, crim­i­nal ele­ments can be tracked because when­ever they have to deal with some cur­ren­cies, they have to even­tu­ally deal with banks. And because banks are reg­u­lated, crim­i­nal behav­ior can be inter­cepted. What hap­pens when those money flows move out­side of the finan­cial insti­tu­tion con­trol? Shouldn’t gov­ern­ments think about reg­u­lat­ing those insti­tu­tions as money trans­fer operations ?

What hap­pens when the num­ber of cur­rency explodes? Sure, com­puter sys­tems can do the con­ver­sion with­out prob­lems but how will WE assess the worth of a currency?

And, as cur­rency ini­tially pro­lif­er­ate, there will even­tu­ally be a move towards an agreed upon set of new cur­ren­cies because remem­ber that cur­rency is ulti­mately, about an agree­ment value by all of us. But when some of those cur­ren­cies die, what will hap­pen to the peo­ple hold­ing them? Will the dead cur­ren­cies be con­verted to emer­gent ones? And what hap­pens if the dead cur­ren­cies are ones that were con­trolled by gov­ern­ments? Will they fight for survival?

I unfor­tu­nately don’t have any of the answer to those ques­tions but if there is one thing I know, it is that where ques­tions exist, oppor­tu­ni­ties abound.

And with that said, I would now like to open up the floor for discussion.

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