Oh yes, Bitcoin and the cryptocurrencies... The future has arrived! The power of the central banks has been broken once and for all and soon we will no longer need state regulation in the financial sector! In any case, this is how or at least something similar the story currently being played out is being told by Bitcoin fans. And at first glance, the development towards cryptocurrencies is really revolutionary! Almost everyone can now issue their own currency and thus enter international competition. From Bitcoin, Ripple, Ethereum and Dogecoin to Potcoin, Trumpcoin and Putincoin. Nothing is too stupid not to be conceivable in some way.
But even if all this seems terribly new:There are also experiences from history. Because there were already phases in which a large number of actors could circulate their own currencies with little or no government supervision. The whole thing was called free banking and was a reality in a number of countries in the 18th and 19th centuries. But one example is particularly famous:Scotland.
Free banking, the bitcoin of modern times?
A big reason cryptocurrencies like bitcoin exist today is the structure of banking. Developers and supporters of cryptocurrencies are bothered by the power of governments and central banks and the influence of banks in general and would like to take payment transactions into their own hands. However, banks are also among the most heavily monitored sectors of the economy. Is it any wonder that some people hope to get something out of circumventing these regulations? A rogue who thinks evil. A few hundred years ago, however, things looked very different. Back then, it was the banks themselves that revolutionized the financial system. And what the blockchain is today already had a dazzling name back then:Free Banking.
>In free banking, banks are treated more or less like other companies and are not subject to any special state regulations. And very important:Banks are allowed to issue currencies independently. You can think of the idea as a libertarian wonderland. In principle, every bank is allowed to do everything. The market then decides which currencies will be accepted and survive accordingly. The rest will perish and those who hold reserves of these failed currencies will have themselves to blame. That sounds pretty radical by today's standards, which also explains why open systems like Bitcoin are still viewed quite critically. Yet such a system has been a reality in the past, well beyond the wet dreams of some US Republicans. In Scotland, for example.
The history of Scotland's decentralized currency system
In fact, the episode of free banking in Scotland lasted quite a while and was by no means a brief blip. For well over a hundred years, from 1716 to 1844 (albeit with interruptions), the banks of Scotland were not subject to separate regulation. During this period there were three large banks that issued their own currencies. In addition to the British Linen Bank, which no longer exists today, these were the still active Bank of Scotland and the Royal Bank of Scotland. These three had the great advantage of being allowed to operate under limited liability with the permission of the Scottish Government. In addition, other banks were also involved in the system and also issued their own currencies. In case of doubt, however, their shareholders were allowed unlimited liability with their own money. It was worth it for many.
Multiple central banks with multiple currencies in one country. Such a system sounds very unstable at first. And in many ways it was. So it was not entirely unusual for the different banks to hoard each other's currencies in order to flood the market with it from time to time and ensure fluctuating rates. On the other hand, all banks adhered to the gold standard, so their money could in principle be exchanged for gold. Of course, this ensured credibility and comparability. Many banks also accept their competitors' money, which makes for even more acceptance. The population definitely accepted that and believed in the value of the major currencies. And the fact that in the more than hundred years of free banking in Scotland hardly any banks went bankrupt was long regarded by researchers as proof that the system actually worked.
But the problem was actually quite different. On the one hand, few bank failures are not necessarily an indicator of the stability of an economic system. On the contrary, bank failures would be a sign that competition is working and that the market is cleaning itself up. As such, the “stability” of Scottish banks in the 18th and 19th centuries is about as encouraging as the “stability” of Bitcoin, Ethereum and all the other cryptocurrencies today. They all still exist. Nevertheless, you will not find someone who has invested all their savings in Dogecoin with conviction. At least I hope so.
It wasn't all that free in Scotland either
But the problems with free banking in Scotland don't stop there. The banks supported their countless currencies on their gold reserves. Of course, the money in circulation was not fully covered by this gold. And that showed up at some point. When the first big run on the banks began in the late 18th century in the course of the French Revolution and the Napoleonic Wars, the Scottish banks simply refused to exchange the money. Of course that was illegal! The whole system was built on this gold standard. But since the government in London was pursuing the same plan, the Scottish banks could easily justify themselves. The whole thing lasted until 1821. So for over twenty years, holders of Scottish currency could not exchange their money for gold. I mean... That was kind of the main idea of the whole system, wasn't it?
Things developed similarly in other countries that had allegedly switched to free banking. Similar economic models existed in parts of the USA, Canada, Sweden, Switzerland and a few other countries. The “freedom” of the banks varied from place to place, but they were never completely free. All were regulated or, as in Scotland, relied on other actors (in the case of the Bank of England). Towards the end of the 19th century, but no later than the beginning of the 20th century, all of these countries finally switched to a central bank of issue. Partly certainly to ensure more stability on the markets. Partly just to make it easier for them to provide their treasury with fresh money. Having your own printing press has its advantages for states.
And how do cryptocurrencies fit into the picture?
With the rise of cryptocurrencies around Bitcoin and Co, these central banks are now facing serious competition again for the first time. And the function of cryptocurrencies is similar to that of free banking in many respects. After all, it is about broadening and decentralizing currencies and ultimately the financial system (democratizing, fans of cryptocurrencies would probably call it). But can something like this work? The historical experience from the free banking phase in Scotland and other countries gives us mixed signals. On the one hand, the system worked somehow. Some experts (admittedly not necessarily the most independent) even see it as a great success story. You think that Scotland has managed to almost catch up with England in terms of its economic power in a hundred years thanks to its free banking.
On the other hand, all free banking systems ended sooner or later. At times they also collapsed because the banks could no longer guarantee the coverage of the currencies and simply stopped exchanging banknotes. Bitcoin and other digital currencies bring even more difficulties. Compared to them, free banking still had the advantage that the banks at the time had a real interest in keeping the money supply constant and the value of their currencies stable. But that doesn't work in an open-source system like cryptocurrencies.
In addition, the framework conditions that led to the death of free banking have hardly changed. Even more than a hundred years ago, states had no interest in granting banks these freedoms, when a central bank is such a convenient source of money. How can we assume that it will be different with Bitcoin and Co? Aye, and in order to get there in the first place, cryptocurrencies would first have to become real currencies. So not just an investment tool for high-risk investors and lunatics... That remains to be seen.
What is to be learned from the matter can still be read in my contribution, in which I offer a few deeper thoughts on what history teaches us. See you next week on the podcast! Until then, take care!