Fat Tailed Thoughts: Digital Monies

Hey friends -

The last two weeks, we covered the definition of money and the rapidly increasing central bank money supply. Almost everything we've discussed is money issued by or otherwise tied to governments. But money is a lot broader than just central bank money like dollars, euros, and yen. This week, money's going digital.

Previous letters here:

In this week's letter:

  • Digital monies - what are they, how do they work, and how has the supply changed over time?

  • A private spaceflight, the environmental impact of concrete, and other cocktail talk

  • Protesting fall with a Strawberry Daiquiri

Total read time: 9 minutes, 59 seconds.

The Fed's Got it Wrong

Let's revisit the Federal Reserve's money supply definition:

the total amount of money—cash, coins, and balances in bank accounts—in circulation.

Last week we said we’d give it a pass for the moment. Not anymore with our newfound understanding of money. It's a miserably incomplete definition that’s restricted to dollars and dollar-linked instruments. The Fed's got it wrong.

We'll even up the ante. Most central banks have a similar definition in place for their respective currencies. They've got it wrong too.

There are a lot of other monies used every day all across the world. Most of these have emerged in the digital world because central bank monies simply don’t exist digitally. This isn't all about cryptocurrency. That's just the most recent innovation in an over 20-year journey. The story starts a lot earlier with video games and mobile money.

The Beginnings of Digital Money

Video games were not the first occurrence of digital money, but they were the first to achieve multi-million person reach.

Video games are a hyper-competitive industry that attracts hundreds of millions of players and generates over $180 billion per year in revenue, more than movies and North American sports combined. Analyzing the video game industry for hints about what the future might bring is almost always a fruitful endeavor.

Rarely has that been more true than with money, and it begins with a game called Maple Story.

Virtual currencies in video games

Maple Story launched in 2003 to the Korean market. It brought with it a novel feature that, if not completely new, had never been launched on the multi-million user scale of Maple Story - a true virtual currency, Mesos. Not only could players earn meso by completing quests in the game, but they could also purchase meso with their Korean won.

As Maple Story grew to over 39 million users by 2006, the virtual universe grew too. The developers built new features so players could launch virtual stores, selling in-game loot they had earned or bought to other players for meso. That feature has since evolved into a centralized auction, the Auction House, where players are charged a 2,000 meso listing fee and a 5% transaction fee.

If you don't spend a lot of time playing video games, this might all sound absurd. You might even be tempted to write it off as "just video games" that has nothing to do with the "real world." Even if I told you that Maple Story has generated over $3 billion in revenue since its launch, you might still not be convinced.

I encourage you to check out the floating mesos-to-dollars exchange rate, $3.55 per million meso at the time of writing. If you wanted, you could start a new career as a Maple Story player. Join the 250,000 active users and spend your day completing in-game quests to earn mesos or spend your time at the Auction House as a trader. No different than traveling abroad, exchange your mesos for central bank currencies when you want to spend your hard-earned money on food and other physical goods.

Maybe it's a crazy idea. Or maybe not. It certainly didn't stop Goldman Sachs from leading a $60 million investment into a Steve Bannon startup. That startup’s business model was simple - facilitate a market where video game players could buy and sell video game currency.

And where better to make a market than in the biggest video game of them all?

World of Warcraft

Hot on the heels of Maple Story, lots of other video games launched in-game currencies including Second Life. Linden Dollars could be spent in-game and exchanged at LindeX for other currencies. Adidas and other launched virtual stores where you could spend your Linden Dollars to buy branded virtual merchandise. But it wasn't Second Life that stole the show, it was World of Warcraft (WoW).

WoW launched in 2004 and rapidly became one of the most popular video games of all time, peaking at over 12 million active paying subscribers in 2010 and surpassing 100 million registered accounts in 2014. Similar to Maple Story, you can earn digital goods and the in-game currency Gold for completing tasks, defeating monsters, and other similar quests.

While formally not allowed by the game's developers, a booming $2+ billion annual market for WoW digital goods emerged. This didn't escape the notice of avid player and former childhood actor Brock Pierce. A few years before the launch of WoW, Pierce founded Internet Gaming Entertainment (IGE) as a digital goods marketplace. It paid freelance video game players for virtual currencies earned in video games and brokered trades to other players.

WoW, with its millions of subscribers, put IGE's business model on steroids. Gold "farms" emerged in China that employed low-wage (and worse) workers to play WoW and earn digital gold. That gold was then sold via IGE for dollars and IGE sold the gold to buyers for even more dollars. IGE was a traditional trading business - buy low, sell high - focused on virtual currency.

Even while it was doing $8.5 million per month in revenue, IGE needed cash faster than it was being generated by the business. The company brought on none other than former Goldman Sachs executive and future Breitbart executive chairman Steve Bannon to help lead the company and raise funding. It was a wildly successful hire - Goldman Sachs led a $60 million investment in 2006. Nonetheless, disaster loomed not far in the distance.

The company behind WoW was fed up with IGE and players farming gold. They cracked down on the practice and closed thousands of accounts, in effect ruining IGE's core business model. By early 2007, the company rebranded as Affinity Media Holdings and sold the virtual exchange business in favor of internet chat rooms and gamer forums.

Virtual currency money supply

The fall of IGE was hardly the end of the story. It was the first of many battles between game developers and players across many video games. That battle continues today at an even greater scale than it did in the early 2000s.

It's difficult to estimate the supply of these virtual currencies. Each video game is its own universe owned and operated by a company under few obligations to report on the size of the economy. The insights we do have available demonstrate that it's big and getting bigger.

BNP Paribas, a French bank, estimates that the market was already worth $14+ billion by 2013. Deutsche Börse, a German stock exchange, estimated that the market size was almost $50 billion in 2015 and launched a failed digital goods exchange to trade to capture a piece of the action. Steam, a video game distribution service that hosts a virtual goods marketplace denominated in Steam Wallet Funds, facilitates over 1 million trades per week.

These estimates only measure cross-currency transactions, from central bank currency to virtual currency or virtual goods. They don't include the amounts earned and spent by players in-game, denominated in the native currency of the games. Those volumes are known only to the game publishers. Inflation rates are likewise at their whim.

But the landscape is starting to shift. New games with new monetary systems are emerging.

We can reframe what happened with WoW in the language we typically use for money to better understand the needs these new games address. WoW is a universe of market participants where the prices for goods and services are denominated in "gold." Market participants are paid gold for providing labor. They can use their hard-earned gold to purchase goods.

The central issuing authority objected to market participants converting their gold to other currencies, so they put in place currency controls. Market participants, especially those with a lot of gold who are therefore wealthy, bore the cost of the currency controls because their wealth was no longer easily used as a medium of exchange for goods outside of the WoW universe.

If WoW were a country, we might expect the market participants to move to a competing country where the currency they can earn is more freely traded. Video games universes are no different, but it took until the innovation of cryptocurrencies for a technical solution to emerge that could support a novel digital monetary policy. It's a topic we'll cover at length next week.

We first need to turn attention to another other-money revolution that was happening in parallel to WoW. While video games were taking off, so too was mobile. With mobile came mobile money.

Mobile Money

Over 20% of the world's population lacks banking services, including over half of Africa. In such countries where individuals don't trust or can't access the banking system and large quantities of cash are a liability, there's room for new money systems.

The story of mobile money starts in Kenya just before the financial crisis in the US. In 2007, Vodafone and Safaricom, a telecommunications company and mobile network operator, respectively, launched M-PESA as the first mobile money network. Today, almost 50 million users make over 15 billion transactions per year on M-PESA. This is just one of many mobile money networks throughout Africa.

So what is mobile money?

Your phone is your bank

Unlike the banking and credit card company based financial networks we're more familiar with, mobile money is built on top of cellular networks. Customers can register for an account via authorized agents, often small mobile stores or even a bakery. Once registered, customers can exchange physical money for electronic money. The electronic money is tied to their phone number and SIM card.

Mobile money customers can use the electronic money as an alternative to cash. They can send the electronic money to family members - just enter the phone number of the recipient and a PIN number to authorize the transaction. They can use it to purchase food or to top-up their airtime minutes and data at any of the millions of merchants also on the network. They can even use the network to connect to traditional banks and deposit money into interest-bearing accounts.

Why does the system work? Initially, it was an attractive way to transfer money over long distances without paying exorbitant fees. Recipients can convert the electronic money into physical cash at over 430,000 agents on the M-PESA network. Increasingly it has become a replacement for cash. Customers can take out loans, overdrafts, and even invest in wealth management funds.

Think about this for a moment. A new money, privately issued by a mobile network operator, that directly competes with government-issued money. That's incredible.

Mobile money at scale

This isn't some small experiment. Over $1.5 billion in remittances - money sent home from family members abroad - flow into M-PESA annually, accounting for over 60% of remittances in Kenya. That's more than 1.5% of Kenya's GDP.

It's not just Kenya. Remittances done via mobile money totaled over $12 billion in 2020. Over $2 billion are transacted every day across mobile money networks throughout Africa, Asia, and Latin America by over 300 million monthly active accounts. These mobile networks are starting to become interoperable - 5% of account-to-account transactions now move across networks and across mobile monies, up from just 2% five years ago.

This transformation is just beginning. The number of registered accounts grew by almost 13% this past year to over 1.2 billion. Transactions volumes are growing even faster, on track for another 50% growth to over $3 billion in daily transaction value by 2022.

In total, $767 billion in mobile money transactions were done in 2020 through 5.2 million agents across 310 money networks in 96 countries. All using a category of privately issued digital money that didn't exist 15 years ago.

If that's not a revolution, I don’t know what is.

The Future of Money

We've now seen what an extraordinary sandbox digital can be for money innovation, but it's by no means the only sandbox. What if we took digital and removed the constraint of a centralized money issuer, like the centralized issuers for video game and mobile monies? That's where the conversation on cryptocurrencies and stablecoins will start. What if we let the existing central bank monies go digital? We'll start to get monies like central bank digital currencies.

Some of the most exciting experiments on what money can be are going on right now on a scale that would have been unthinkable just a few years ago. These experiments are extending the video game and mobile monies innovations, challenging the very foundations of how we think about money today. That's next week's topic - the future of money.

Cocktail Talk

  • GSMA represents over 750 mobile operators worldwide and annually publishes a wonderfully rich State of the Industry Report on Mobile Money. Mobile money isn't just a revolution in money, it is a powerful tool to reduce poverty and crime. I highly recommend checking it out. (GSMA)

  • As a prelude to next week - Verifone, an electronic payments company, announced that they will enable their 600,000 merchants to accept bitcoin and other cryptocurrencies as payment. (Verifone)

  • A good reminder to keep perspective while reading. Nature's editorial makes a well-argued point on concrete's carbon footprint - over 8% of global emissions. But the lead is buried. A single country - China - systemically underreports and nonetheless accounts for over half of the emissions! This type of concentration is consistent with what we've uncovered elsewhere - just 100 companies are responsible for over 50% of all emissions produced since the industrial revolution. (NatureCDP)

  • A belated congratulations to SpaceX and the four private citizens who flew on the first true commercial spaceflight! The crew reached an orbiting altitude of 363 miles, 100 miles past the International Space Station and further than any human has flown in over 20 years, and spent 3 days circling earth before returning back to earth. (Spaceflight Now)

Your Weekly Cocktail

Breaking into the it's-still-summer reserves.

Strawberry Daiquiri

2.0oz Plantation 3 Star White Rum
0.75oz Lime Juice
6+ Frozen Strawberries
Mint spring for garnish

Add all of the ingredients to a blender. Add ~1/4 cup of ice and blend. Add additional ice and blend again until you get the consistency you want. Reminder: you can always add more ice, but you can't take it away. Pour into a tom collins glass, or a coupe, or really whatever you want. It's gonna be awesome.

love strawberry daiquiris. It's one of those drinks I'll happily have in the summer when it's appropriate or in the winter when I wish it was summer. I usually keep it stocked in the freezer for emergency purposes like the middle of the week when I really want one but don't have frozen strawberries. I'd suggest keeping this on hand for when people come over, but I usually drink mine before guests show up. Everything about this drink is right. I'm pretty sure this counts as a smoothie rather than a cocktail.