© Philipp Paech, 2017 – Keywords: Payment, Law, Trust, Gold standard, Coins, Bank notes, Bitcoin, Blockchain,
The present text is the post-produced and slightly extended version of a presentation I gave at the LSE, entitled “Cash: The Future of Money in the Bitcoin Age”, on 28 November 2017. The other presentations were given by Tatiana Cutts, Eva Micheler and Nigel Dodd. The event was chaired by Jo Braithwaite (for audio and video recordings go to http://www.lse.ac.uk/Events/2017/11/20171128t1830vSZT/cash).
The second part of this post, covering book money, electronic money and bitcoins, will be published shortly (follow this blog not to miss it).

Bitcoin is somehow the Elephant in the room when it comes to discussing the ‘future of money’. However, before judging whether it is a good alternative to replace money as we know it it is helpful to think about how money has evolved in the past, why it has evolved and what the legal implications of these changes are.

In this post, I will discuss these points with reference to different money patterns which, in principle, we know well but have probably not thought them through. Specifically, this post will consider the evolution of money from gold nuggets to gold coins, to gold-backed bank notes, to modern bank notes, to commercial book money, to electronic money and, ultimately, to Bitcoin.

For each of these stages of the evolution of money I will consider three issues: market practice, where the value derives from and the legal underpinnings supporting payment.

Gold nuggets

For this post, I would like to start our analysis with payment in gold or other precious metals. For ease of reference I will only refer to gold, however the same principles apply to other means of payment consisting of precious metals, such as silver, platinum or copper.

As a means of payment, gold has historically had two forms: either as simple nuggets or as minted coins with a face value. It is easy to assume that the value of gold-based means of payment derives from an understanding that there is intrinsic value in the material itself. While this is true as an initial assumption, there is an additional twist.

In this first section I will address legal questions underpinning payment in gold nuggets, before turning to minted gold coins in the following section. Exchanging gold nuggets as a form of payment is a relatively archaic concept, very similar to barter. As a means of storing value it was very efficient however – with the only downside being the potential for theft and loss.

The acceptance of gold nuggets as a means of payment required due diligence procedures, at least in most common payment situations where there was an absence of trust between the parties. This ‘due diligence’ would require the payee to be convinced about the weight and pureness of the material and for the parties to agree on the material’s market value. In other words, absent trust, this procedure to make and accept a payment was complex and prone to failure. It is easy to see how this system created opportunity for conflict and dodgy practices. As result, this system entailed not only economic and social cost, but it also impinged on the ease of making payments (given that it required the procedures described before), and hence on liquidity. Lastly, gold was a scarce resource and it could not be proliferated as a means of payment without at the same time influencing its relative scarcity, which in turn affected its market value.

Since the economics are now clear, let’s think about the legal treatment of a payment in gold nuggets. The value is intrinsic to the material, a tangible object. As appropriate due diligence makes trust between the parties superfluous, it was unimportant where the nuggets originated, who their previous owners were and what their history was. Gold is gold, and even its physical form can be modified. The old Romans described this concept, quite to the point, as pecunia non olet – money doesn’t stink (nowadays, we call the concept ‘fungibility’ which is gentler as a term but means the basically same). Also, the producer was irrelevant, in other terms, there was no ‘issuer’. As a consequence, the legal analysis of the transactional environment can be confined to precisely a two-party relation, i.e. that between the payor and the payee.

The only aspect that had to be catered for in legal terms was how to organise the transfer of ownership of the relevant gold nuggets, thereby legally attributing them and their value to the payee. The (probably universal) solution is a transfer of property or ownership, effected by way of delivery of the tangible object itself accompanied by the relevant agreement between the parties.

Gold coins

Turning to minted gold coins that have a face value, the above analysis changes. Here, the payee’s due diligence procedure is not necessary, at least not under standard assumptions. Instead, assurance regarding purity and weight of the coin is generated by way of trust in the authority that minted the coin – the Senate, Queen, Khan or whatever form of rule is hip at the relevant time and place. In minting the coin, the authority guarantees that the coin has the weight and degree of pureness necessary to underpin its face value.

This being the general idea we know that there was still ample room for dodgy practices. The easy case relates to fraudsters grating milligrams of the precious metal off the edges of a coin. More relevant in the present context is that at regular intervals, typically shortly before the relevant ruling system came to an end, the relevant authority itself could undertake the dodgiest behaviour of all – diluting the alloy that the coin is made of. It never takes long before market participants start to doubt the face value of the gold coin and lose trust not only in their means of payment but in their government altogether, which probably accelerated the fall of the relevant regime.

We can deduce from this observation that minted gold coins with a face value are somehow halfway between a means of payment based on the intrinsic value of the material and a means of payment based on trust. The trust-induced part of their value is however less relevant, as it relates exclusively to questions of weight and pureness which the market is able to contest and check itself if needed. The intrinsic value of the material of a minted gold coin remains its fundamental value-determinant.

The legal treatment of gold coins is probably slightly more complicated than that of gold nuggets. At a first level of analysis they are identical. For both, the act of payment is supported in legal terms by the concept of transfer of property from the payor to the payee, i.e. delivering the coin or nugget, accompanied by relevant agreement.

However, the coin’s value is partly induced by the market’s trust in its issuer (see above). A coin will only be used as payment if both parties have trust in the relevant authority (should they do their due diligence themselves, they are treating the coin like a nugget, i.e. with reference only to its pure material value). This trust relationship between market participants and the issuer is foremost of socio-economic nature and is a natural consequence of the fact that market participants are located in a specific territory or within a specific currency zone, such as the Roman Empire.

The payment depends on the existence of this trust. There seems to be something like a factual contract binding together the authority and all its subjects that use a given gold currency. This understanding is inherently included in the agreement of the parties, regarding the payment. In other words, while the factual element of perfecting the payment (delivery of a gold coin) remains the same as with any other physical object, the accompanying agreement is considerably more complex than the agreement that accompanies the transfer of a gold nugget, as it contains important assumptions which the parties agree not to check.

Gold-Standard Bank Notes

The market practice leading to the introduction of bank notes has been described elsewhere. I would like to concentrate here on a couple of crucial elements.

At some point in history, gold and other precious metals as immediate means of payment disappeared and authorities instead issued banknotes that were, in theory, fully covered by gold reserves. This turned out to be a fiction in many jurisdictions very early on; but for the present purpose, we assume that this theory was a reality in practice.

The first question I would like to consider relates again to trust. As the paper of a banknote itself is worthless, the value of the note becomes dependent on the market’s trust that the relevant authority, let’s call it for present purposes the central bank, keeps its promise – that it will actually exchange the note for gold. However, for practical reasons, the market cannot really test that promise. It is usually only tested in times of crisis, and the test typically fails. Hence, as compared to gold coins, in relation to which trust is relevant but not the prevalent trust-inducing element, the case of gold-backed banknotes is different: trust in the authorities is the main value-building element of the banknote. The material value of the – very remote – underlying gold ‘backing’ the banknote makes more of a mental than factual contribution to this value for those making and accepting payments with it. However, the value of the material itself is still paramount in conceptual terms.

The second issue relates, again, to the legal framework supporting the payment. At first glance, the banknote itself, i.e. the tangible object, could be transferred the same way as the gold nuggets or gold coins are transferred. However, the legal analysis is conceptually more complicated and depends on what is actually being transferred when we hand over a banknote. It would be too superficial to connect legal effects only to the placeholder object, i.e. the note itself.

Interestingly, the legal analysis probably depends on whether the claim for delivery of gold against the central bank is ‘realistic’ or just a fiction.

In scenarios where the claim for gold is realistic, a payment from one party to the other, affected by handing over a note, means that that claim against the central bank for the gold backing the banknote is transferred. Remember, by contrast, gold nuggets and gold coins: the ownership of the valuable tangible itself is transferred. How is that claim transferred? Well, legal minds go wild on this question. We can identify two main approaches to a solution. The first approach treats the claim as being assigned to the payee and the transfer of possession of the paper note is just the proof of the relevant agreement between the parties. This solution is legally neat but entails a plethora of problems that would render the whole set up impractical, and would wreck the trust in the system within a very short time. For example, if one of the earlier transfers was legally invalid, as a consequence there is a mismatch between who has the banknote and who is the owner of the claim against the central bank – think of a stolen note.

The other approach to a solution is called ‘negotiability’. Often we speak of a ‘bearer’ note, the idea behind which is built on a highly fictional basic assumption: the claim for gold against the central bank is embodied in the paper (whatever that is supposed to mean) and with the possession of the paper also the claim is automatically transferred. This means, in more practical terms that the value is legally attributed to whoever has the paper, regardless of the history of earlier transactions. It is the modern version of the pecunia non olet principle mentioned earlier.

Either way, the legal analysis is heavily dependent on the question of whether the central bank will honour its promise to deliver gold upon presentation of a banknote. Again, the trust of the market participants in the central bank and its promise is the crucial prerequisite for the practical functioning of the system, and for the application of legal framework that supports the actual market practice.

If the claim for delivery of gold against the central bank is itself just a fiction, there is no real claim against the central bank from the outset. The value of a banknote in such a situation is defined differently and the object of the transfer is different from the earlier scenario. One might be inclined to still apply the legal model just described. Or one might associate the situation with the status of nowadays’ banknotes (see immediately below) which by default are not directly backed by any gold reserve.

Modern Bank Notes

By modern bank notes I mean the typical Dollar, Yuan, Pound or Euro note – none of which mention any obligation of a central bank to exchange it for anything else than maybe a fresh note or notes in other denominations.

The exchange function of money has become inextricably intertwined with its value. Nowadays, the value of money consists exclusively of the possibility to exchange paper bank notes for goods or services. Market participants will, therefore, attribute value to their bank notes to the extent that they trust the monetary, economic and fiscal policy in a given jurisdiction.

The object that parties exchange when something is ‘paid’ for is, as a consequence, not even a claim against the central bank. It consists of the pure trust in the continued acceptance of banknotes as means of payment and the trust in the stability of how it exchanges goods and services. There is probably no way to capture this all-encompassing trust for purposes of a proper legal analysis of what is transferred. The note itself is transferred like a simple tangible object, despite its much wider significance.

Interim Conclusion

Before analysing the electronic forms of money, I would like to draw an interim conclusion on the physical forms of money.

For practical reasons, the world has gradually shifted away from means of payment where value is entirely or partially linked to the existing of some underlying material value, notably gold. The market has moved that way for reasons of efficiency and liquidity – modern bank notes are easier to handle, and their macroeconomic potential can be calibrated more finely than was the case with means of payment linked to gold or other underlying material value.

While the material itself as value-inducing factor has disappeared, trust has been introduced into the equation to a continuously-increasing extent. While the value of gold nuggets was entirely built on the value of the raw material, the value of modern banknotes is exclusively built on trust.

In parallel to this shift, the legal treatment of a payment transaction became increasingly complex. The more important the trust element, the more complex the legal analysis becomes. The law is now unable to provide a consistent legal answer to what is actually transferred when a modern banknote is used for payment. As a consequence, it must limit itself to govern only the transfer of the materially irrelevant paper manifestation of an enormously complex concept built on and consisting of, different elements of trust.

The second part of this post, covering book money, electronic money and bitcoins, will be published shortly (follow this blog not to miss it).

Please leave a comment (below). Inappropriate comments will be removed.

Posted by Philipp Paech

Dr Philipp Paech joined the LSE in 2010 as an Assistant Professor of Financial Law and Financial Regulation. He is the Director of the LSE’s Law and Financial Markets Project and a research fellow at the Institute for Law and Finance in Frankfurt. Before joining the LSE, Philipp spent many years at the heart of international legal and regulatory reform of the financial sector, working from 2007-2010 for the European Commission’s Directorate for financial services in Brussels and from 2002-2006 for UNIDROIT in Rome. Philipp holds a doctorate from the University of Bonn and obtained the Diploma of EU Studies from the University of Toulouse. He is a qualified lawyer admitted to the Bar of Frankfurt.


  1. Karin Wallin-Norman December 2, 2017 at 10:16 am

    Thank you Philipp for this analysis. Particularly this morning I am intrigued by the ‘trust issue’. I’ve never understood really the ‘trust in the central bank’ – because I have never felt it. After all, trust is a feeling! Probably nobody else has felt trust in their Central Bank, or? I mean most people know nothing about the Central Bank apart perhaps from the mere existence of it. But trust? How can you feel trust in something that you don’t know anything about? I cannot yet grasp the full legal implications of this but I wonder: if cryptocurrencies was involved in the monetary, economic, fiscal – and therefore legal – environment of a certain jurisdiction, maybe people would begin to feel trust in them? Maybe regulation is not a threat to Bitcoin but its ultimate savior? Looling forward to your next post!



  2. It is easy to entertain trust in gold but in a Central Bank? I believe the deemed trust is illusory. Take the US dollar. The authorities in the US don’t vouchsafe how much money they print intermittently or continually. Humanity worldwide use the USD in good faith as a universal currency because of the world’s banking trust. The trust is not on the central bank but on the cumulative acceptance of par value.



  3. Dear Karin,
    This is an interesting one: I agree that trust may be personally unfounded and not more than a mere feeling. Instead, trust is often transported through societal channels, like trust in the government (though I don’t even read a newspaper), trust in doctors (though I have no clue about anatomy). We accept this because others do, some of them are informed enough to feel trust that is founded on knowledge.
    Cryptocurrencies carry a bit the same issue (though they claim exactly the opposite): a politically un-influenced, un-tampered set up that frees us from trusting anybody. Still – don’t we actually exchange the object of our trust, towards the computer scientists controlling the technical platform?
    Because this becomes now visible, I agree with you – regulation of blockchain and crypto-currencies will be the saviour because it unites a powerful technology with a workable governance framework.



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