Online Currencies: Why Electronic Dollars Outnumber Real Ones

A while back, I wrote about a pending academic research project I was embarking upon with Jeremiah Newhall, a good friend of the site. Below you will find a draft version of a section of our paper which discusses why Bitcoin may run afoul of current counterfeiting laws. Part of the reason I am posting this is to solicit feedback, so please feel free to submit your thoughts in the comments section below.

That virtual dollars outnumber real ones is not a product of the Internet but of the banking system, and in fact a currency’s tendency to self-propagate predates the Internet by centuries. Before the magic of ledgers, a dollar (or a British pound, or a Roman aureus), though infinitely reusable, existed in one place at one time. But the banking system changed that; through the magic of ledgers, a dollar deposited in a bank account (as opposed to a dollar deposited in a safe deposit box) is both in the account—it says so right there in the ledger—and not in the account, having been lent out by the bank at interest. The borrower spends the same dollar that the depositor sees in his ledger statement; it is not two dollars but one dollar in two places. The process repeats ad infinitum: The borrower spends the dollar, and the vendor deposits it in a second bank account, where it exists at the same time that it exists in the first depositor’s account, and simultaneously is lent out to a second borrower, who spends it again.

The limitation of this system was the need to cover deposits: To spend the money, the borrower needed to withdraw physical coins, and thus the bank needed to obtain physical money to pay out deposits. The first paper money, commercial paper, originated as a workaround for this problem, and consisted of a sort of swap of ledger balances. The earliest forms of paper money were actually promises to pay “real” money, i.e. coins, kept in an account of the issuer of the paper (today, commercial paper survives as checks and loan obligations). But in transactions for more than a few dollars, rather than actually redeem these slips for coins, the amounts would be credited to the bearer’s account and deducted from the obligor’s account. That convention permitted the depositor to spend the same dollar (by crediting it to the account of another) that the bank had contemporaneously lent to a borrower as physical money. Suddenly, a dollar could be everywhere at once.

The practice continues today—make a large withdrawal, and your bank will issue a cashier’s check, rather than give you cash. The Internet has merely streamlined the process, and the vast majority of transactions are credited electronically to computerized ledgers of deposit accounts. Buying an airline ticket, for example: Your employer pays you via direct deposit, meaning it orders the bank to debit its account and credit yours; you buy airline tickets by ordering your credit card-issuer to debit your card account and credit the airline’s bank account; you then pay your credit card bill with your salary by ordering your depositary bank to debit your checking account and credit the card-issuer’s account. At no point does physical money or Legal Tender change hands, yet everyone has been paid.

That’s a limitation of Bitcoin as a monetary system: it resists banking and credit. The idea of Bitcoin is that the file containing the data confirming your Bitcoin’s existence is stored physically on your hard drive. But the reason electronic dollars work so well is because they are pure abstraction, consisting of merely an adding and deducting from ledgers. When economists talk about “the money supply,” they mean the willingness to extend credit, to allow a dollar to be in two places at once. Bitcoin is designed to be in only one place at a time. That may be an innovation, or it may be a regression. It may also be why Bitcoin constitutes counterfeiting under U.S. law.

If Bitcoin were a purely abstract currency, like electronic dollars, existing only as an amount added and subtracted in ledgers, then it could not run afoul of counterfeiting laws. If you forge an entry in a ledger, or hack a computer to increase the amount of money in your bank account, you “print” money in the same sense as the Federal Reserve, creating money from nothing. But you would not have “printed” money in the sense of the Mint, which makes bills and coins. When you withdrew the cash you fraudulently created from an ATM, they would not be counterfeit dollars that you stuffed in your wallet; they would be real dollars obtained by fraud. If creating dollars—so long as they remain an abstraction—is not counterfeiting, it is hard to see how creating Bitcoin could be counterfeiting dollars, provided Bitcoin is purely an abstract concept.

But Bitcoin has a physical element; the data downloaded onto hard drives. The physicality of Bitcoin is the linchpin of its trustworthiness as a medium of exchange: because each set of bytes in a Bitcoin can be verified as unique, they cannot be duplicated. This physical element of Bitcoin may bring it within the realm of counterfeiting laws.

Jeremiah Newhall is a graduate of The George Washington University Law School and currently serves as a law clerk in Chicago. He can be reached via the miracle of email. Joshua Sturtevant is also a GW Law grad, and currently serves as an in-house legal fellow at a renewable energy financing and development firm.