Federated E-Cash as a Bitcoin Scaling Technology
I have been advocating for federated e-cash based on bitcoin for a long time. Interestingly I suggested this quite a lot to somebody who ended up working for Blockstream. The reason why I thought this was necessary requires some context.<p>I thought it was kind of like Free Banking. And just as warning, in US history, Free Banking has a different unrelated meaning. So do not confuse the concept of Free Banking with the historical Free Banking, the &#x27;Free&#x27; referees to different aspects. In US what is referred to is the &#x27;freedom&#x27; to open banks at all. Before that, in the US, each bank required a voucher from the state legislature.<p>What I am talking about is the freedom of issue, sometimes called &#x27;Joint-stock banking&#x27;. Meaning a bank can issue bank notes (IOUs) without any restriction on how to back that IOU. This is relevant because historically quite often the state (and later federal) government would enforce a strict connection between outstanding notes and government debt. This is rather clear why governments would want that. This leads to a number of problems, historically most important that defaulting states would destroy its banking system at the same time. Other problems are that government with low or decreasing debt might not have enough debt to cover outstanding notes leading to a deflationary effect.<p>Broadly how this works is, you have a Gold standard and then you have a set of &#x27;banks&#x27; issue IOU on top of that. These come in form of private bank notes (typical a standard of note amount emerged as well). You can think of a outstanding bank notes, the same way as money the bank has in a checking account. The important difference being that the bank gets the interest, and not the holder of the note. And the profit derived from this is what makes the bank want to do this in the first place.<p>The amount of IOU any individual bank can issue is limited by the consistence demand for clearance from other IOUs accumulated by banks. So I go to Walmart pay with an note. Walmart can check of course if the issuer is acceptable to them and then they hand that over to their bank to put in into their checking account. The bank then will bring those notes to the issuing bank, and demand reserves (ie gold) and transfer it to its own &#x27;vaults&#x27;.<p>Once you have more then 2 bank pretty quickly &#x27;clearing houses&#x27; develop. These would be sort of membership clubs where after each day&#x2F;week&#x2F;month you would do a clearing of everybody against everybody and figure out who has to pay how much and who gets how much. These clearing houses were often separate private institution.<p>The clever part about this is that this serves as a good indicator of who is abusing the system. So if you end up issuing to many notes, the reserve drain will be observed by other banks and they will kick you out of the clearing house as a default risk.<p>The other interesting aspect of this sort of system is that it has an implicit regulation of currency demand and supply. In modern economics sometimes considered as &#x27;velocity&#x27;. So each bank has a minim reserve and how much reserve they have depends on how many notes they need to cover the clearing house demands. If demand to hold currency is high, and therefore less demand on reserves, the bank can safely expand the amount of notes it issues. However in the opposite situation, if people drop their requirements to hold currency, the banks has to pull notes from circulation. Typically in historical system the notes would be backed by a wide range of liquid commercial stocks and government bonds.<p>In a more standard economic way of saying this is that those banking system were adjusting the monetary base (M) in accordance of the monetary velocity (V) and this results in a relatively long run stable MV and therefore a stable PQ (Price level * real expenditures).<p>What this means is that once reserve stop growing, you would expect Price level to drop or rise depending on Productivity. So if the economy is growing and things become cheaper the average price level would drop accordingly (just like price of consumer electronics drops). Attempting to enact such a policy is sometimes called &#x27;Productivity Norm&#x27;. Another way of saying it, it would approximate a stable NGDP. This is not the type of demand deflation that caused the Great Depression. What this means is that workers would not have to fight for adjusted wages every year along with inflation. You get slightly higher wages every year automatically.<p>Historically the most easy way to observe this is currency in circulation depending on harvest. During harvest there was a huge amount of currency outstanding, as everybody was paying workers, making deals and so on. When it turns winter, and there is far less economic activity going on, people much rather have more money at the bank so it can earn interest. Therefore what we should observe is the outstanding base of money being response to that requirement and we can actually see this in historical data from systems that were organized like that.<p>There were also banks that had 100% reserves, meaning the amount of notes they issued was always the same as the amount of gold reserves in their vaults, of course at those banks you would not earn interest, but rather had to pay a fee for the services. This sort of 100% backed system is what seem to be proposed here. Historically these sorts of banks were very unpopular, to the point where they basically didn&#x27;t exist at all unless for some special circumstances.<p>My biggest issue with Bitcoin when people suggest it could be the backbone of a new economy, is that it does not have this feature. Bitcoin is like if you are trading on pure non-floating gold coins. If there is an increase in the amount of demand for Bitcoin, there is no corresponding increase in supply as to keep prices relatively the same. If you want to have a multi-level deep economy with labor, debt and so on, this is not tenable.<p>Of course many Bitcoin people I proposed this to were very much against this. Of course the Bitcoin paper starts out with:<p>&gt; A  purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution.<p>I suggested that you could have different &#x27;banks&#x27; cross signing each other and building a network of trust in the same way the clearing houses used to do. Banks and their costumers would only accept currency from trusted parties.<p>You could run around with your wallet, potentially being filled with a notes from a whole bunch of different &#x27;banks&#x27;. Seems to me this would make tracking very difficult. It would allow lighting fast payments and unlimited amount of transactions between parties.<p>Our discussion often ended with the suggestion that he was not totally convinced but that it would be a great use-case for side-chains. This seems at least partly something like I suggest, just as a 100% reserve only system as I understand it. This might have some uses but for me, doesn&#x27;t fix the underlying issue with Bitcoin when considering it as the reserve currency for a nation state.<p>I would love to see a warrant where the IOU are unlimited and backed by some portfolio of other assets. This would allow bitcoin to truly serve as the backbone of a modern economy. Just like gold combined with IOU based banking became backbone of modern economy.<p>P.S: It highly unlikely that my ramblings from all these years ago influence this project. I don&#x27;t want to suggest that it did. I just found it interesting.<p>P.P.S: The person I used to argue this with also suggest I join Etherium crowdfunding and I refused. So clearly I am the idiot here.