December 18, 2004
Mexico flirts with the silver unit - a good base for digital issuance
One sees more and more references to Islamic countries musing on gold as their base for currency; but also silver might shine again. Mexico is delving into her historical consciousness for some semblance of honesty in money.
Whether this ever gets further along than a popular movement is unclear, but certainly the populace seems to like the idea, if an essay by Hugo Salinasthat is circulating the net is any guide (or here or here; the original spanish seems lost!). So much so that the Bank of Mexico allegedly felt the need to defend its own paper unit.
People outside financial cryptography often get bemused by the concentration on precious metals. When outsiders see Issuers using those tired barbaric relics for currencies, they find it too easy to write off the field. What they miss needs some explanation and with Mexico's flirtation, now seems to be as good a time as any to explain.
It's fundamentally a consequnce of open governance. To see that consequence, let's review how open governance works. For those familiar, skip these paragraphs...
The core of issuance is about presenting a contract of value. It could be any value, really, and it is only the imagination of the Issuer that is the limit here. Currencies are one such, first proposed by David Chaum, but also financial instruments such as shares, bonds and options are equally issuable.Virtual issues were obvious from the very first days: loyalty systems, gaming units, gambling chips and the like were readily recognised as issuable, and there have been many proposals in this vein since Chaum first kick started the field with his blinding formula.
Which all leads to a very tricky problem: if it is so easy to issue loyalty points and so easy to issue currency, how does a confused public tell the difference?
Enter, for the first part, the contract. The agreement between the Issuer and the users is called a contract, and in that document it should say what the issue is. Currency, loyalty, casino chips, or options on futures of first sons; it's all written in the agreement.
But, the canny and suspicious public says, those are just words! How do we know that the Issuer will keep his word [1]?
Enter for the second part, the five parties model. In the 5PM as it is abbreviated, reserves can be allocated and stored with one party that is independent of the Issuer. This would be an escrow partner or a trustee. Then, a second party becomes a co-signatory, whos signature is required to release any assets. Thirdly, the Issuer appoints a manager to day to day deals, with a small float, so the Issuer himself is separated from the business aspects. That makes for four parties, all watching each other.
And finally we enroll the public as the fifth party. She is coopted into auditing all the activities of the other parties. So the 4 insider parties publish their activities and also the status of the reserves at any one time, and the user keeps an eye on all those things.
The 5PM reduces the issuance of value to a process and to an accounting mechanism. We have reduced the safety of an issuance to a problem of no more difficulty than counting. We've swept away all that nonsense and cost called Basel II, Sarbanes Oxley and other disasters of governance, and put the user firmly in charge.
All she has to do is count [2].
And this is where precious metals like gold and silver step in. Metal is easy to count. It is either here or it is not. The bars are either in the vault or they are not. Any member of the public can cope with that question.
In contrast, every other base for issuance is more complicated. Are there dollars in your account? Where is the wire that was sent last month? Have my airmiles been credited, and are they really there if I cannot buy the flight I want? Am I a shareholder in full ownership of these shares, and what's this about the shares having been lent out? Can you explain the theft of mutual funds again, but really slowly this time [3]?
The problems with virtual issues like currency, shares, bonds, etc etc, go on and on. Physical metal however is tractable. It stops right here: is there a bar or is there not?
Which means that by far the most efficient thing to issue in a digital world, in the context of governance, is precious metals. It's efficient in the sense that a very small team can create a very powerful governance model and present an honest issue to their user community. Hence, startups look closely at the relic, and see not barbarity, but governability.
So Mexico's move is good news for digital issuance. The more the silver and gold gain respect, the more users there are for a simple, robust digital issue. And the more we have a firm base in precious metals, the more issuers can get into the complicated stuff like dollars, mutual funds and shares, and provide those with the open governance that users expect. Go Mexico!
Images are from Mobile Silver. For more interest in coins, see Austria issues 100,000 Euro coin
[1] In financial cryptography, the Issuer is masculine, and the user is feminine. This cryptographic custom uses a trick of the english language, and may or may not make any sense in other languages.
[2] Just to cap off this quick description of the 5PM: we now have sufficient empirical evidence that it works.
[3] These are all real, today complaints, well beyond the ken of the user. Mutual funds in the US were raided in a complex scam by insiders that stole more value than we care to write down. And for shares, there is a complex scam alleged in courts where the manager of the shares, DTCC, was claimed to have lent out the shares without limit to those shorting the stock, again without limit.
Posted by iang at December 18, 2004 08:25 AM | TrackBack