Degrees of Virtual Value

How many degrees of interaction are we removed from the actual value we transfer with money?

Let’s trace it for traditional finances. The staple of stable value over time is the gold standard. Gold is reasonably hard to get, reasonably hard to fake. It is chemically inert so it’s convenient to hoard in the bottomless vaults or dragon caves. Gold supply growth is predictable and reasonably low. We view gold as level one value equivalent. Gold is suited for its role by the physics engine of our universe.

Gold is very dense value storage. Which makes it poorly suited for microtransactions. Buying groceries or paying for a bus ride with gold would be a nightmare. On the other side of the scale paying for buying luxury estate or budgeting of a large corporation would require some sophisticated logistics to move metric tons of gold from one place to another.

That’s how people invented banknotes. A bank (was) is a trusted institution that has a gold reserve. A various fraction of this gold reserve is represented by paper bills. The bank (presumably) will give the gold to whoever owns the bill.

Very small or very large quantities of gold can be represented with a paper bill. Good for microtransactions and macro transactions. The drawback of the system is paper bill does not have physical protection as gold. The paper bill is easier to forge. Banking system relies on the government system producing rules forbidding forgery of banknotes and enforcing these rules. The banks operating this way today are national banks. The ordinary banks are subsidiaries of national banks and use banknotes issued by national banks. Also, most modern currencies are not tied to gold anymore.

Banknotes are second-level value equivalent. Switching from gold to money is a sacrifice of protection for better transactions.

For several decades we use computers connected to the web to replace other technologies. Migrating banking ledgers from paper to electronic databases accessible online allowed to get even more transaction convenience compared to banknotes. It also allowed to crank up the amount of transactions processed by orders of magnitude. This is the age of electronic payments. Moving value around the world according to the changing values in the databases of the banks.

Electronic payments are third-level value equivalent. Electronic payments rely on government regulation but also on internet infrastructure and encryption technologies.

Now there are financial instruments like stocks, futures, options, default swaps which are essentially bets on what is going to happen with the market in the future. They are one more level removed from the actual value but we are not going to explore this rabbit hole here.

How does this apply to cryptocurrencies?

Cryptocurrencies run on the electronic databases similar to what the banks use with the same encryption standards. However, in the bank case, access to the core database is held by the bank chain of command. In the cryptocurrency case, it is a consensus algorithm. A computer program that processes the changes in the database according to the consensus of multiple network nodes. The interface of the node of a blockchain network would the first level of interaction with digital value.

Note that the first level of value for the cryptocurrency already relies on the internet infrastructure and on the government to provide some legal safe space for the node owners can run their businesses while throwing crypto-anarchist “government sucks!” rants.

This is how it looks to interact with bitcoin at this level:

Digital gold has a user-hostile interface. This is the price for being the only owner of the virtual asset.

Enthusiasts and private companies take effort to make this more user-friendly and create a various mobile wallet or web wallet interfaces. Like Trust Wallet.

This wallet is an application that turns cryptic commands from the previous picture into button pushes. In return you… trust the developers of this wallet that it contains no backdoors that would threaten your digital gold vault.

Wallet GUI (graphical user interface) is the second level digital value equivalent.

Then there are applications that use cryptocurrencies as a part of their infrastructure. For example exchanges. They provide you with an address but don’t give you the direct access to its private key. This works more like a modern bank. The same category is all the applications that use blockchain as a page for irreversible notes. Our company did a project that combines both of these things for public funding of the educational institutions.

The blockchain applications with GUI that don’t provide direct access to the users private key are the third level of digital value equivalent.

To sum it up - cryptocurrencies are removed from the original value source just the same way the traditional financial system is removed from manipulating with gold. On the level of paper wallets and crypto wallets the crypto wallets give us more control over the value asset. However most value transactions are done on the third level anyway.

The biggest difference is in the price of setting your own financial infrastructure. For the crypto world it is orders of magnitude lower compared to setting a traditional bank. Which provides tools to play around with market design and economic institution design at your own leisure. That's what we do on a daily basis at each of three levels at ESKA.