Stablecoins are non-fungible, bank deposits are fungible

On Twitter/X, I recently suggested that the network effects of the stablecoin market are massive. Tether, which has four times more wallets than all other stablecoins, is locked-in as the stablecoin lingua franca, just like English has been locked-in as the global language of business. 

In case you've missed the trend, stablecoins are fiat money (primarily U.S. dollars) that are issued on a new type of database called a blockchain. The total value of stablecoins in circulation has grown from $0 to over $200 billion in a decade, with Tether dominating at $138 billion.

When I said at the outset that the stablecoin market is governed by network effects, what I meant is that a positive feedback loop exists whereby the value that a network (i.e. languages or stablecoins) provides to users increases as more users join the network. Once a given stablecoin has entered into this virtuous loop, other issuers cannot join in, and will have troubles competing. It's a winner take all market that Tether and its stablecoin USDt (and perhaps smaller competitor USDC, issued by Circle) have already won.

Larry White, a monetary economist who I've mentioned a few times on my blog, asked me why I think network effects are present in the stablecoin market. We don’t see network effects with other U.S. dollar payment media like checkable deposits, Larry points out (and I agree), so it's not clear why we should see this with stablecoins.

Here's my logic.

Stablecoins aren't fungible, bank deposits are

The key is that while U.S. dollar stablecoins—Tether's USDt, Circle's USDC, PayPal USD, etc—are pegged to the dollar, and thus seem to be alike, they are not actually completely alike. That is, they are not fungible with each other. 

Fungibility is one of my favorite words, and I write about it quite often on this blog. It means that members of a population are interchangeable, or perfectly replaceable with each other. All grams of pure raw gold are interchangeable. Not all grams of pizza are alike—pizza is non-fungible.

U.S. dollar bank deposits (say Well Fargo dollars and Chase dollars) are fungible with each other. Rather than being independent, they are fused together as homogeneous and singular U.S. dollars. A Chase dollar is just as good as a Wells Fargo dollar for the purposes of making payments.

That's not the case with stablecoins, which are like pizza. Or better yet, in the same way that Chinese yuan and UAE dirham are pegged to the dollar but remain independent currencies, each U.S. dollar stablecoin is pegged to the dollar but functions as its own distinct non-fungible currency. For the purposes of making payments, one stablecoin is not as good as another one, just like how dirham balances aren't perfect replacements for yuan.

The reason behind this difference is that U.S. banks cooperate with each other by accepting competitor's money at par on behalf of their customers. For instance, I can take a Wells Fargo check to my Chase branch and Chase will accept it 1:1 even though it represents a competing bank's dollar. Or I can send an ACH payment directly from Wells Fargo to Chase, and Chase will accept that Wells Fargo dollar at par and convert it into a Chase dollar for me. 

The effect of this reciprocal acceptance is that all U.S. banking dollars are tightly knit together, or interchangeable. A fungible standard has been created.

I can't perform these same actions with stablecoins. I can't send 100 USDC to Tether to be converted into 100 USDt, nor send 100 USDt to Circle, which issues USDC, to be converted into 100 USDC. Stablecoins issuers are loners. They've chosen to avoid banding together to weave a unified U.S dollar stablecoin standard.

This lack of standardization explains some weird things in the stablecoin market, like why there are so many markets to trade USDt for USDC (see below). Notice that the clearing price in these stablecoin-to-stablecoin markets is never an even $1, but always some inconvenient price like 0.991 or 1.018.

Some of the multiple markets for trading USDt for USDC, all at varying prices Source: Coingecko

 

There is no equivalent trading market for Chase-to-Wells Fargo balances or TD-to-Bank of America dollars. These banks' dollars are perfectly compatible and don't require such markets.

The advantages of a single dollar standard

Harmonization is useful. Anyone can walk into a McDonald's and purchase a Big Mac for $5.69 with whatever brand of bank dollar they want. Money held at small banks is just as useful as money at massive ones: the Bank of Little Rock may only have five branches, but its dollars are accepted at McDonald's all across the world, on par with those of Chase, America's largest bank.

McDonald doesn't accept stablecoins, but if it did, it would have to offer multiple prices for a Big Mac: i.e. 5.73 USDt and 5.68 USDC. Each stablecoin serving as its own particular unit of account is inconvenient, both for McDonald's and its customers. PayPal USD probably wouldn't even be accepted at McDonald's: it's too small.

The lack of standardized stablecoin market becomes even more awkward in asset markets. If you want to buy $1 million bitcoins on, say, Binance, there's a whole array of different U.S. dollar stablecoin markets available, including bitcoin-to-USDt, bitcoin-to-USDC, and bitcoin-to-FDUSD. (FDUSD refers to First Digital USD, a medium sized stablecoin.)

The table above shows the prices of bitcoin and ether on Binance, the world's largest crypto exchanges. Notice that liquidity in both Binance's bitcoin and ether trading market is compartmentalized into different stablecoins rather than being fused into a single homogeneous US dollar-to-bitcoin market. Source: Coingecko

You can forget about easily buying bitcoins with PayPal USD stablecoins. No crypto exchange offers that trading pair; PayPal USD is too small to be worth the hassle.

This has the effect of fragmenting the liquidity of the stablecoin market into different buckets. Instead of stablecoins-in-general having a certain level of marketability, each individual stablecoin has its own distinct liquidity profile in asset markets.

In contrast, the liquidity that a Wells Fargo dollar, a Bank of Little Rock, or a Chase dollar provides to their owner in the context of asset markets has been unified into a collective whole. If you want to buy shares of Blackrock's iShares Bitcoin ETF, there isn't a separate market for Wells Fargo-to-bitcoin or Chase-to-bitcoin. As for Bank of Little Rock dollars, they are just as fit for bitcoin purchases as its much largest competitors.

A winner-takes-all market

Now we can understand why network effects dominate the stablecoin market.

If you want to start using stablecoins to trade crypto or buy stuff, you will always be arm-twisted by market logic into choosing the largest most liquid stablecoin. And your decision to go with the largest one makes that stablecoin a little more liquid, thus solidifying its pole position.

Selecting a smaller stablecoin like PayPal USD makes little sense. McDonald's will never accept it, and there are many crypto assets that you won't be able to buy with it. Even when certain PayPal USD trading pairs are available, the bid-ask spreads will be wide, imposing much larger costs on you than if you simply went with a larger stablecoin. Thus network effects, working in reverse, repel uptake of PayPal USD.

The unsafe stablecoin is the largest

Tether remains the largest stablecoin, despite being one of the most unsafe stablecoins. (USDC does not get top marks for safety, either.) Network effects explain this.

Stablecoin rating agency Bluechip awards Tether a D rating, noting that it is "less transparent and has inferior reserves... USDT is not a safe stablecoin". Under normal conditions (i.e. those not characterized by network effects) the safest stablecoins would have long-since displaced Tether from its leading spot. But in stablecoin markets, the safest stablecoins—Gemini USD, PayPal USD, and USDP, all rated A or A- by Bluechip—remain insignificant players. The virtuous circle in which Tether is locked dominates all other factors.

These are the best-ranked fiat stablecoins according to Bluechip. But they are also tiny, with market capitalization below $1 billion. There appears to be no point trying to be a safe stablecoin, since the network effects arising from liquidity completely dominate any safety concerns that users might have.

Eyeing Tether's profits, new competitors are entering the stablecoin market. But this is a game they probably shouldn't bother playing. PayPal arrived last year with PayPal USD, but to date it remains mostly irrelevant, despite huge growth in the overall stablecoin market over the same period. Ripple and Revolut are also slated to bring out their own products. They're also destined to mediocrity, because they're too late to make the jump into the virtuous loop that Tether and (to a lesser extent) Circle occupy. 

(There is one caveat. Should one of the two leaders eventually be shutdown for money laundering offenses or sanctions evasion, one of these also-rans could be vaulted into their spot.)

Might the stablecoin sector eventually migrate over to the unified fungible standard that characterizes banking deposits? 

No, that's probably not going to happen. For a fusion to occur, Tether and runner-up Circle, which issues USDC, would have to start accepting their competitors' stablecoins at par. But they won't go down this path, since that would kill off the network effect that gives them their unrivaled dominance over the rest of the pack. No, it's in the interests of the leaders for chaotic non-fungibility to continue. 

Alas, this lack of standardization may limit the stablecoin sector's broader potential to serve as a cohesive global payment alternative to the better-organized banking standard. Sometimes a bit of cooperation trumps competition.

Renovatio monetae

This silver pfennig from the Archbishopric of Magdeburg (1152-1192) was subject to a policy of renovatio monetae. Twice a year whoever held it had to bring it in to be changed for new coins at a rate of four old coins to three new coins. That suggests an annualized tax rate on coinage of 44%. Image source: British Museum

This is another post in a series that explores how European monarchs harnessed the minting of coins to earn revenues for their coffers. 

A king or queen generally resorted to two different strategies for profiting from the mints. The first was to mint long-lived coinage. The second involved issuing short-lived coinage subject to a policy of renovatio monetae, which is the topic of this post. These aren't mutually exclusive buckets. It's possible for elements of both policies to be blended together.

Almost everything I've written about medieval coinage on this blog has been about the long-lived sort, because that was the dominant pattern in Europe. Under a long-lived coinage system, once a coin had been minted it remained in permanent legal circulation. For example, England's long-lived coinage policy meant that an English penny produced in 1600 would have been just as valid a hundred years later, in 1700, as a penny produced in 1699.

The monarch earned a one-time fee from the original minting of the coin. More specifically, a citizen who brought raw silver to the royal mint left with that same amount of silver now transformed into coin form, less a small part going to the crown. This profit was known as seigniorage. In England, the seigniorage rate on silver typically hovered around 5%, my source for this number being The Debasement Puzzle by economists Rolnick, Velde, and Weber. Once a particular coin was produced, however, the king or queen no longer earned revenue from it.

As society grew and more coins were needed, raw silver was constantly brought to the royal mints by the public in order to be coined, the monarch earning a steady stream of income. This was known as free coinage, since everyone had the right to access the royal mints.

Short-lived coinage subject to a policy of renovatio monetae was an entirely different manner. Under this model, coins didn't circulate permanently. When a king or queen announced what was known as a renovatio monetae, or a renewal of the coinage, all existing coins had to be brought back to the mint to be recoined into new coins. The monarch collected a fee upon each renovatio monetae. 

To help reinforce the monarch's ability to collect a profit, only the most recent coin was allowed to be used within the monarch's domain. Older local coins and coins from other realms were illegal. To distinguish the new version from the outgoing version, the new type was stamped with a different pattern. The penalties for not obeying the rules of renovatio could be harsh. According to Philip Grierson, a numismatist, anyone caught using expired coinage could face imprisonment, a fine, or have their face branded with the old pattern of coin.

Source: Svensson

The period of time between one renovatio monetae and the next varied widely. In England, the monarch initially adopted an interval of nine years, beginning in 973 AD with Edgar. Later on, this was shortened to just three years. In many parts of Germany and Poland, renovatio monetae occurred yearly, as recounted by economist Roger Svensson in his wide-ranging book on the topic. In the Archbishopric of Magdeburg it was carried out twice a year, coinciding with important market days in the spring and autumn. The Teutonic order in Prussia used a much slower ten-year cycle, according to Svensson. 

The date for the switch was often chosen to occur just prior to annual tax payment day or, as in the case of Magdeburg, ahead of a regularly occurring market or festival (see figure above). Requiring that all tax payments or market transactions be conducted with new coins reinforced the necessity of  bringing in old coinage to be melted down into new coinage, thus guaranteeing a boost to the monarch's revenues.

The coinage that prevailed in Poland and Germany from the 12th century almost seems to have been designed with a short lifespan in mind, since it is leaf-thin and fragile. Coins minted in this style are known as bracteates, one of which can be seen below. Svensson speculates that the bracteate format was better suited for the purposes of renovatio monetae than standard coins since the costs of periodically reforming silver into thin and pliable coin would have been lower than heavier coins. 

Leaf-thin bracteates from Frankenhausen. Source: Svensson

 

How much profit did the monarch collect from renovatio monetae? 

For many years the Teutonic order in Prussia used a conversion rate of seven old coins to six new ones, says Svensson. Combined with the fact that renovatio only occurred every ten years, the effective tax rate was relatively light. According to Christine Desan, a law professor, English royal profits amounted to 25% of the metal minted (she cites Spufford), but recall that this tax was levied only every three years so that works out to a yearly tax of around 8%. (Some people may notice the similarity of renovatio monetae to ideas promulgated by Silvio Gesell, who came up with the idea of stamped scrip—money that depreciates.)

In some cases, though, the conversion rate bordered on exploitative. Svensson says that a common exchange rate in Germany was four old bracteates for three new ones. Given two renovatio per year in places like Magdeburg, that works out to a yearly tax rate on coinage of 44%! If a citizen of Magdeburg started the year with 16 bracteates in their stash, and they complied with both renovatio, by year-end target would only have nine bracteates.

This may have created a very weird effect whereby coins became "cheaper and cheaper" over the course of the year in anticipation of the inevitable withdrawal day, according to historian Sture Bolin. Since everyone would have known ahead of time that there was to be a 4:3 conversion on a fixed date, and no one wanted to be stuck holding coins and bearing the conversion tax, sellers would only accept coins at a discount to compensate them for conversion. That discount varied with time. As the final day approached, it would have got progressively wider.

In modern times we don't have to deal with the hassles of renovatio monetae. The coins and banknotes we use are long-lasting: a nickel from 1956 is just as valid as one from 2022. Or consider that while the $1 note is no longer printed in Canada, anyone can still bring them to a bank to be deposited for free. If a policy of renovatio monetae were to be announced by the Bank of Canada in 2025, and Canadians were required to bring our coins and banknotes in each year to be exchanged for new ones, there would probably be a revolt against the inconvenience of it, especially if the fee was high.

This combination of exploitation and inconvenience may explain why the English abandoned renovatio monetae in the middle of the 12th century in favor of permanent coinage. "The renovatio monetae witnessed to the extent of royal control and suggests that coining was routinely coercive," writes Desan. "This new system reduced the burdens placed on people required so frequently to remint their money at a cost."   

However, if renovatio monetae was inconvenient (and frequently exploitative), it also had a key benefit. As silver coins passed from hand to hand, they suffered from natural wear and tear. On top of that, bad actors regularly clipped off their edges, keeping the silver shavings for themselves. By renewing the coinage every year or two, the monarch ensured that the coinage was kept in relatively good condition.

Alas, the same can't be said for long-lived coinage systems, which were particularly prone to the wear and tear problem. After a decade or two of circulating, a typical coin would have lost a significant amount of its original silver content, at which point it would no longer be equal in weight to new coins. This meant that the realm's coins were no longer fungible, or interchangeable, with each other. The familiar problem of Gresham's law would now begin to plague the monetary system, whereby the "bad" coins, which meant the old underweight coins, drove out the "good" coins, the new full-weighted ones. With only shabby coins being used in trade, the money supply was more prone to counterfeiting and clipping, leading to an even shabbier coin supply, and more counterfeiting and clipping. 

Mind you, there were ways to defend against the inevitable downward spiral of long-lived coinage. By adopting a policy of defensive debasements, which I've written about before, the fungibility of coins could be restored.

Nor were long-lived coinage systems spared from being exploitative in nature. The method of abuse was different than that used to exploit short-lived coinage, involving a policy of repetitive debasements in the silver content of coinage.

As an example of this, I wrote a post last year exploring how Henry VIII financed his wars in France using debasement of his long-lived coinage. Do read it, but in short the trick was to increase the number of people visiting the royal mints to convert raw silver into new coins. This would in turn boost the monarch's profits. After all, he or she earned a 5% cut from each new coin produced.  The rush to the mint was linked to the fact that, post-debasement, the public could now get more silver pennies from the mint than before for a given quantity of silver, which in turn allowed them to buy more goods and services than they would have otherwise been able to purchase.

After a series of such debasements, Henry VIII was much richer, but the coinage was debauched. Going into 1542, for instance, the English penny contained 92.5% silver. Nine years later its purity stood at just 25% silver, the majority being base metal such as copper. 

To sum up, short-lived coinage issued under a policy of renovatio monetae was one of several ways to administer the monetary system. It had some advantages over other methods, but was also easily abused. This abuse was linked to the fact that coinage was simultaneously a crucial tool for day-to-day commerce, both as a medium of exchange and a unit of account, and also a way for the monarch to fund itself. Maximizing its latter role by relying on frequent and onerous renovatio may have done severe damage to money's capacity to perform the former role. 

This tension was not necessarily resolved with the move towards long-lived coinage, as Henry VIII demonstrates. And while we may think we have left these these medieval issues behind in the 21st century, I don't think that we can ever fully escape the tensions embodied in money's dual roles as crucial tool of commerce and source of government funding.

Why my favorite coinage is Byzantine coinage

What do I like about Byzantine coinage?

Most people probably admire the Byzantine solidus, a gold coin that maintained its weight and purity for over 600 years, which is quite remarkable for a coin. The solidus was exported all over the world, including to Europe, which lacked gold coinage at the time, making it the U.S. dollar of its day.

That's neat, but it's not the solidus that impresses me. It's Byzantium's small change that I like.

The availability of small change is vital to day-to-day commercial life. Alas, the minting of low-value coins has often been neglected by the state. Small change isn't sexy. And it has often been unprofitable to produce. But that didn't stop the Byzantines. After a monetary reform carried out by Emperor Anastatius in 498 AD, Byzantium began to issue a number of well-marked and differently-sized bronze coins of low value. Anastatius, who had been an administrator in the department of finance prior to becoming an Emperor, appears to have had a fine eye for monetary details.

Let's start with the follis, worth 40 nummi. (The nummus was the Byzantine unit of account.)

The follis in the above video was minted in 540 AD by Justinian I, some forty years after Anastatius's monetary reform. At 23 grams, it contains an almost comically-large amount of material. For comparison's sake, that's the same heft as four modern quarters. Allocating so much base metal to a single coin illustrates the Byzantine's dogged commitment to producing a usable set of low denomination coins for the population.

The decision to go with the hulking follis was better than the small change strategy that the English would pursue hundreds of years later. English monarchs either neglected small change altogether, forcing the public to hack up silver pennies into smaller chunks by hand. Or, if they did produce low value coins, did so in the form of silver halfpennies and farthings, the smallest English denominations. Which was not a good idea. Silver has a much higher value-to-weight ratio than bronze, so the half-penny and farthing ended up being absurdly tiny, as illustrated in the video below from the Suffolk Detectorist.  

"Weighing only three troy grains each, these were 'lost almost as fast as they were coined,'" writes monetary economist George Selgin of the farthing. And because the two coins were so small, almost no information could be conveyed on their face. No, as far as small change goes, the Byzantine's bronze coins were the way to go.

Anastatius had another theoretical option available to him, one which wouldn't have tied up so much raw material. He could have made a token coin. With a token coin (say like James II's tin halfpennies, which came almost a thousand years later, and which I wrote about here), the value of the coin doesn't rely on the metal in it, but on the ability of the issuer to repurchase it at the stipulated weight. By issuing the follis as a token, the Byzantines could have been able to make it smaller, say half the size, yet still rate it at 40 nummi, thus saving large amounts of bronze for alternative uses.

But the Byzantines appear to have been committed metallists, abiding by the principle that the value of money comes from the value of the metal in it. And so they bequeathed the world the monster-sized follis.

In additions to the follis, Anastatius introduced lower denomination bronze coins, including the half-follis (20 nummi), quarter-follis (10 nummi), and pentanummium (five nummi). They are illustrated below. Later emperors would add a three-quarter follis, or 30 nummi coin, to the mix. At times, a tiny 1 nummus coin was issued too.

Follis (40 nummi), half-follis (20 nummi), quarter-follis (10 nummi), and pentanummium (five nummi). Source: Cointalk

The decision to produce a full array of base coins illustrates Anastatius's sensibility to the transactional needs of the common person, for whom the gold solidus would have been far too valuable to be relevant to their economic lives, almost like a $1,000 bill. Oddly, Anastatius chose not to mint any silver coins. But as the English farthing example illustrates, silver was too valuable to be useful for the lower end of day-to-day commercial life, better destined to act like a modern $50 bill than a humble $1 or $5 bill.

Another neat feature of Byzantine coinage is how Anastatius and his successors used each coin's surface area to convey useful information rather than to aggrandize god & state. The obverse of each coin bore the obligatory image of the Emperor, but the reverse side provides loads of monetary data: the denomination, the date of the Emperor's reign in which the coin was minted, the name of the mint, the number of the workshop of the mint. Compare this to Roman coinage, for instance, which often bore expressive portraits on either side of the coin, but next to no data.

If you're interested in getting a longer description of how to read Byzantine coins, check out Augustus Coins.  

I'm new to Byzantine coinage, but I'm impressed by how much information they managed to pack into such a small area. Here's a great introduction on how to read Byzantine coins: https://t.co/46sVeROIKx

The example below shows how to read a follis issued during Justin II's reign: pic.twitter.com/OSsH930c2g

— John Paul Koning (@jp_koning) March 14, 2022

A particularly unique feature of Anastatius's monetary reform was his decision to inscribe the unit of account directly onto his coins. As you can see, the follis has a big "M" on its reverse side, which is Greek for 40. The half follis has a "K", which means 20, and the quarter follis an "I", which is 10. Finally, the pentanummium displays an "Є", equal to 5. All of these numbers indicate the value of the coin in terms of the Byzantine unit of account, the nummus.

Nowadays, we take this format for granted. The coins in your pocket all include the coin's value on their face, just like Anastatius's coins did. But what you need to realize is that the coinage of most civilizations, both before and after the Byzantines, rarely displayed how many pounds or shekels or dinars that coin was worth. Take a look at Rome's Imperial era coinage. There's plenty of religious symbolism to be found on the sestertius, as, and dupondius. The monarch's face appears, as do dates and names. But there's not a single digit to indicate how many units of account the coin is worth. The same goes for most medieval European coinage. (A lone exception is Roman coinage from the Republican period beginning around 211 BC).

Anastatius's decision to stamp the denomination directly on the coin represents a big improvement in usability. No need for transactors to seek an external source to determine how many nummi a follis was worth. It was right there for everyone to see.

Some of you may be wondering: why did so many civilizations avoid numbering their coins? 

Ernst Weber, an economist, has put forward one possibility. A lack of "value marks" may suggest that coins were intended to circulate at "market determined exchange rates" according to their metal content. Coins might have had varying amounts of metal due to inadequate manufacturing technology, people preferring to weigh them prior to payment so as to assess their market value. In this context of non-fungibility, striking a universal unit of account on each coin would be a nuissance, or at least a waste of time.

According to Weber's theory, Anastatius may have had so much confidence in the ability of his mints to produce durable and homogeneous bronze coins that he dared to affix the nummi unit-of-account onto them.

Another reason for not numbering coins may be that a blank slate gave authorities a degree of flexibility to set monetary policy. If a coin isn't indelibly etched with a value, a monarch can alter a coin's purchasing power, or rating, by mere proclamation. This was known as a crying up or a crying down of a coin's value. For instance, an English king might wake up one day and declare a certain type of already-circulating coin that had been worth £0.10 the day before to be worth £0.09 today, thus decreasing its purchasing power. This sort of abrupt change in value would be awkward to implement if said coin already had £0.10 struck on its face.

A ruler might have good monetary policy reasons for wanting this flexibility. But this same malleability could be abused, too, in order to profit some at the expense of others. Anastatius decided to forfeit this flexibility by freezing his coin's value in time. The Byzantine public no longer had to deal with the uncertainty of coins being suddenly revalued.

Unfortunately, the full array of Byzantium small change introduced by Anastatius would only survive for two or three centuries. As time passed, weights would be reduced and workmanship would become "increasingly slovenly," according to numismatist Philip Grierson. The quarter follis and pentanummia would be discontinued by Constantine V (741–775). The half-follis ceased under Leo IV (775–780).

As for the follis, it would stick around for a few more centuries, but around 850 AD, Theophilus would drop the emblematic M in favor of the unhelpful inscription "Emperor Theofilos, may you conquer," writes Grierson. Thus ended the great period of Byzantine low-value coinage. But during the brief period of time after Anastatius, Byzantine produced one of the best examples we have of good small change, presaging the coins we carry in our pockets today.

Weak nations with strong currencies

Two unlikely currencies were among the world's strongest currencies in 2022: the Yemeni rial and the Afghan afghani. Yemen is currently in the middle of a civil war and Afghanistan is a failed state, so neither is your typical candidate for a buoyant currency.

Both countries share a peculiarity, however: unlike most nations, neither can increase the supply of their paper currency. That may explain their odd bout of strength against the dollar.

Let's start with Afghanistan.

It's worth reading this blog post I wrote back in 2021, but if you don't have time the gist is that Afghanistan's central bank – Da Afghanistan Bank (DAB) – is effectively cut off from the global banknote printing market thanks to sanctions. Cash is the dominant form of money in Afghanistan. With the supply of afghani notes fixed and the demand for them rising over time along with population growth, my guess at the time was that the afghani's purchasing power could be fairly stable. "In a chaotic economy, the afghani—or at least some version of the afghani—may be one of the country's more reliable elements."

And that seems to be what is happening. According to Bloomberg, the afghani gained 5.6% against the U.S. dollar in 2022, one of the strongest performances of any currency in the world.

The stock of afghani notes is not entirely fixed. Late in 2022 the DAB was permitted to accept one batch of new banknotes, according to Reuters.

However, the new notes didn't add to the stock of notes circulating in Afghanistan. Rather, they were used to replace existing notes, which are often "torn in shreds or held together with cellotape." The LA Times had a good article on the shabby state of the Afghan money supply, including pictures like this one:

"Afghanistan’s money is crumbling to pieces, just like its economy" [source] copyright LA Times

As for Yemen, diligent readers may recall from my two previous blog posts (here and here) that a civil war has split the Yemeni rial into two different currencies. The Houthi rebels in the North control one branch of the central bank, the Sana branch, and have adopted rial banknotes printed before 2016 as the region's official currency. The Saudi-backed government in the South runs the other branch and has claimed all notes printed after 2016.

The two rials are not longer fungible, their price having diverged over time as the chart below from ReliefWeb illustrates. The rebel's old rials, the ones printed before 2016 (in blue) have held their value against the U.S. dollar, and even risen a bit in 2022. But the value of the Saudi backed regime's rials (in orange) has plunged:

The U.S. dollar exchange rate of the rebel-controlled Yemeni rial and the official rial [Source: ReliefWeb]

The reason? The rebel North is isolated from the rest of the world and can't contract with printers for new notes. Not only that, but the stock of pre-2016 notes is by definition locked in time. A note printed in 2023 can't masquerade as a pre-2016 note, at least not easily so. The official regime even printed up a batch of fakes last year and tried to sneak them over the border in order to undermine the rebel economy, a story I recounted here. But the rebels spotted the difference and refused to accept them.

So like Afghanistan, if you start with a weak economy and a fixed note supply, then add population growth, you end up a strong currency.

Unlike the rebels, the official regime in south Yemen has access to the global banknote printing market, and has ordered new notes and spent them into circulation. Which explains why the official regime's Yemeni rial has steadily declined in value.

How cryptocurrency exchanges peg stablecoin prices

An example of a stablecoin peg from the now defunct FTX US [source]

This post is for anyone who is curious how cryptocurrency exchanges and stablecoins work behind the curtains. It's common knowledge that stablecoin issuers like Tether, Paxos, and Circle run pegs. What isn't commonly known is that crypto exchanges like Binance (and the now-failed FTX) also run their own versions of stablecoin pegs.

Stablecoin issuers like Tether anchor, or peg, the value of their tokens to $1 in fiat dollars, and use their dollar reserves to enforce that peg. Another way to think of the process of pegging is to take two heterogeneous things and use economic resources to make them homogeneous, or fungible, with each other in terms of price.

Exchanges such as Binance peg stablecoins in two ways:

1) Pegging multiple stablecoins to each other

Most crypto exchanges do not peg stablecoins to other stablecoins. They let the price of stablecoins float, or fluctuate, against each other. That is, if you deposit 1 unit of USD Coin and 1 unit of Binance USD to an exchange, you don't get credited with $2. You get credited for a single unit of each heterogeneous stablecoin. The exchange rate between these two coins fluctuates on the exchange according to supply and demand.

FTX was the first exchange to move from floating to pegging stablecoins. Binance followed FTX when it adopted its own pegging mechanism this fall. Basically, Binance promises to treat heterogeneous stablecoins in a homogeneous manner, by allowing customers to deposit any amount of approved stablecoins at the exact same price; $1. Customers can also withdraw whatever stablecoin they wish from Binance at $1, in any amount.

The approved basket for both Binance and FTX includes USDP, USD Coin, Binance USD, TrueUSD, but not Tether.*

By promising to process all stablecoin transactions at a uniform rate, the former-FTX and Binance shifted from the traditionally passive let 'em float practice of dealing in stablecoins to setting, or administering, stablecoin prices.

Pegging a basket of stablecoins is more complicated than letting them float. It requires having sufficient reserves of each stablecoin in order to defend the fixed price. If Binance users all want to suddenly withdraw a certain brand of stablecoin, but Binance runs out of reserves of that type, then it'll have to temporarily suspend its peg, at least until it can acquire more of the in-demand stablecoin.

It appears that this was exactly what happened to Binance earlier this week. When customers wanted to withdraw large amounts of USD Coin, Binance ran out and had to temporarily suspend USD Coin withdrawals. "In the meantime, feel free to withdraw any other stable coin, BUSD, USDT, etc." wrote the exchange's owner, Changpeng Zhao. 

These are 1:1 conversions, no margin or leverage involved. We will also try to establish more fluid swap channels in the future. In the meantime, feel free to withdraw any other stable coin, BUSD, USDT, etc. 🙏2/2

— CZ 🔶 Binance (@cz_binance) December 13, 2022

Later, Binance sent a massive chunk of its own Binance USD hoard to the issuer, Paxos Trust, for redemption into fiat US dollars, before turning those dollars back into USD Coin (by going through Circle, USD Coin's issuer). Binance's coffers refilled, it could thus reestablish its peg.

Let's move onto the second type of peg that exchanges set.

2) Pegging the same stablecoin on different chains to each other

Stablecoins of the same brand exist on different blockchains. Tether, for instance, exists on both the Tron and Ethereum blockchains, as well as a host of other chains. The same goes for USD Coin.

Exchanges always peg a given stablecoin across its multiple instances.

What I mean by that is exchanges allows customers to deposit any amount of Tether (on Tron) or Tether (on Ethereum), and the exchange will treat those heterogeneous deposits as a single homogeneous Tether unit. And when customers want to withdraw, they can withdraw any amount of Tethers—Tron or Ethereum—from that pot at the same fixed price.

But Tether-TRX and Tether-ERC are not homogeneous tokens. They are very different beasts, with different characteristics, use cases, and demographics. Exchanges could in principal treat each instance of Tether separately, letting them float against each other. So in a given minute a single Tether-on-Tron token might be worth 1.001 Tether-on-Ethereum token, and the next 0.998 according to supply and demand.  

Exchanges don't do this. They peg the two instances of Tether. Customers take this for granted, but it's thanks to these exchanges' pegs that a customer can deposit 1 million Ethereum-based Tether onto an exchange and three seconds later withdraw 1 million Tron-based Tether, all at a convenient fixed price rather than a floating one.

To maintain these intra-stablecoins pegs, exchanges must have sufficient reserves of all blockchain flavors of Tether. (And all flavors of USD Coin and Binance USD, too.) Sometimes you'll see an exchange accumulating too much of one type of Tether while running out of the other type, and it'll engage in a swap with in order to rebalance its reserves.

This is likely what happened to Binance this week, when it swapped a massive 3 billion Tether-on-Tron into 3 billion Tether-on-Ethereum. Too many customers we're withdrawing Ethereum-based Tether, and so it had to rebalance its reserves:

In few minutes Tether will coordinate with Binance to perform a chain swap, converting from Tron to Ethereum ERC20, for 3B USDt. The #tether total supply will not change during this process.

Learn more about chain swaps ⬇️https://t.co/abfgnELSvi

— Tether (@Tether_to) December 13, 2022

In the next section, I'm going to sketch out the bigger picture.

Crypto exchanges as stablecoin watchdogs

I generally think it's a good idea for exchanges to treat stablecoins homogeneously, both in the first way (pegging stablecoins to other stablecoins) and the second way (pegging a stablecoins across its multiple instance). Doing so makes things easier for customers. Could you imagine, for instance, if exchanges didn't peg the different flavors of Tether, USDC, and BUSD? You'd end up with dozens of different stablecoin exchange rates:

But creating a stablecoin standard isn't costless. Exchanges need to devote resources to constant management of their reserves. If they make a mistake, as the case with Binance this week, they end up looking bad.

Pegging stablecoin to other stablecoins opens exchanges up to credit risk, too. If a given stablecoin suddenly collapses, exchanges that let stablecoins float needn't worry about a thing. They can continue accepting deposits of the failed coin at its market price. 

Not so exchanges that administer stablecoin prices. Traders will rapidly send the now worthless stablecoin to any exchange that is still pegging it at $1. To prevent the danger of becoming a sop for failed stablecoins, exchanges like Binance have to constantly surveil the stablecoins in their basket for credit risk.

In the grand scheme of things, this is probably a good thing. It deputizes exchanges as stablecoin watchdogs. Since exchanges have significant resources and insider knowledge, they are probably better at analyzing stablecoins for credit risk than outsiders like myself. Binance's basket of fungible stablecoins becomes a signal to the market of what stablecoins are safe.

We already saw an example of this stablecoin watchdog role in action not too long ago. A stablecoin called HUSD began to wobble in August:

HUSD was once one of the safest stablecoins. Now it's off its peg. If HUSD doesn't return to $1, it'd be the first fully-reserved centralized stablecoin to fail. pic.twitter.com/9WmROQR6lD

— John Paul Koning (@jp_koning) August 18, 2022

After regaining its peg, HUSD outright failed in October, collapsing from $1 to a few pennies. 

The collapse seemed to come out of the blue. No so. FTX, the first exchange to peg stablecoins, had quietly removed HUSD from its stablecoin basket in early August, tipping anyone who was observing that something was up. 

However, if there are ecosystem-wide benefits to exchange stablecoin pegs, there are also drawbacks. Exchanges that treat stablecoins homogeneously (and thus take on credit risk) may do a poor job of it, and thus the fallout from a major stablecoin failure could spread to exchanges, an isolated failure becoming a systemic one. The benefit of the traditional practice of letting stablecoins float is that it renders the crypto exchange system more immune to the systemic risk stemming from the failure of a stablecoin.

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*Why is Tether not included in these stablecoin baskets? One theory is that exchanges like Binance and FTX are acting as watchdogs and don't want to include Tether because of its unique credit risk. That's possible, but I think it's more likely that they don't want to include Tether because managing Tether reserves is too costly. This cost arises from the fact that Tether charges a 0.1% fee on all withdrawals and redemptions of Tether tokens. Other stablecoins provide this service for free. As long as this fee exists, it's just not worth it for exchanges to include Tether in their basket.

The puzzle of electrum coins

From the Israel Museum in Jerusalem’s 2013 exhibition White Gold

 [Originally published at Bullionstar.]

For several years Brits have been hearing rumours that their 1p and 2p coins were on the cusp of being discontinued. Not so. Last month the UK Treasury announced its commitment to both coins. The 1 and 2p coins will continue to be produced for ‘years to come.’

Few bits of monetary technology have enjoyed as long an existence as the coin. The earliest coins were produced around 640 BC, some 2600 years ago, by the Lydians, who had built an empire in the western half of what is now Turkey.

To most of us, the usefulness of coins is self-evident. Sure, small coins like the 1p are a bit of a nuisance. They tend to accumulate in our pockets or piggy banks, never used. But compared to barter, or exchanging bits of unrefined metal, coins are a much better alternative.

One would assume that’s why the Lydians created coins in the first place: convenience. But the true story is much more puzzling than that. To this day we don’t entirely know why the Lydians began to turn precious metals into circular discs.

The traditional origin story for coins

The classic story for the adoption of coinage involves the efficiency gains that society enjoys when trade can be conducted by tale rather than by weight. Tale is a sum or a tally. All modern payments are done by tale. A payor counts up the right amount of coins (or notes), then passes the stack to the payee who – if they wish – can glance at the inscription on each coin’s face to ensure that it is legitimate. Circulation by tale is a convenient way of doing business.

But we take it for granted. Before coins appeared on the scene 2000 years ago, numismatists believe that people typically transacted with silver ingots and bars, otherwise known as hacksilber. These pieces could be cut up into smaller amounts in order to cover a range of different transaction sizes.

Because the bits of hacksilber were irregularly shaped, or non-fungible, they couldn’t by counted. Rather, they had to be weighed first, and only then could the transaction proceed. Weighing different bits of silver is a laborious process. A scale must be produced along with a set of weights that both the buyer and seller can trust.

Counting is much easier than weighing. If the stamp on the coin is reliable, buyers and sellers can trust to issuer to have already pre-weighed and standardized the metal for them. And so coinage would have dramatically reduced lineups and waiting time in busy markets all across the ancient world. What a fantastic invention.

Perfectly standardized

At first glance, Lydian coins have all the hallmarks of this classical origin story.

To begin with, they are quite beautiful. Each coin was typically stamped on the obverse side with a design in the form of an animal, human, or myth. On the reverse, or back-side of the coin, a square or rectangular design appears (see image at top). Did these designs constitute some sort of official guarantee of the coin’s weight and fineness? Or did they symbolize something else?

The coins generally lacked any sort of writing on them. Numismatists are thus unsure who actually issued the coins. Was it the city, the king, a merchant or some other rich individual?

One fact that all numismatists agree on is that the Lydians were assiduous to a fault about ensuring standardized weights for their coins. The biggest denomination, the stater, weighed 14.1 – 14.3 grams. Half staters contained half as much metal, followed by third staters (or trites), 1/6, 1/12, 1/24, 1/48, and 1/96th staters, the last of which contain just 0.15 grams of metal.

Smoothed distribution of Lydian coin weights around each denomination. Source: On the Origin of Specie, (2012)

Francois Velde, an economist at the Federal Reserve who dabbles in numismatics, has catalogued thousands of Lydian coins owned by private collectors and museums around the world. Using this data, one can see the remarkable precision of Lydian coinage (see chart above). The weight of the largest coins – staters and trites – tend to be tightly clumped near the standard weight.

Interestingly, the smallest denominations – the 1/96th staters – are much more loosely distributed around the standard weight (see the dark blue line). Velde (2012) attributes some of the lower accuracy of smaller denominations to the fact that they would have circulated more, and thus deteriorated faster.

The inconvenience of electrum

By carefully calibrating the weights of each denomination and stamping them with a seal, surely Lydia qualifies as the first society to make the technological leap to circulation by tale. But it’s here that the story begins to fall apart.

One of the curious facts of early Lydian coins is that they were made from a material called electrum. Electrum is a naturally occurring alloy of silver and gold, often found in streams and rivers. The problem with natural electrum is that the mix between gold and silver is variable. The silver content can be anywhere from 10% to 30%, according to numismatist Robert Wallace (1987).

Given this variability, Lydians must have had difficulties valuing electrum. A given electrum coin wasn’t fungible, or interchangeable, with its cousins. A coin with more gold in it would have a slightly different colour than one with less gold, as the chart below implies. And since gold was probably worth around 10 times more than silver in ancient times, electrum coins with more gold in them would have had a much higher intrinsic value than those with less. But how much more? According to Wallace, this lack of certainty would have caused “endless doubts and disputes over particular coins."

Approximate colours of Ag–Au–Cu alloys [Wikipidia]

What a contradiction Lydian coins are! The Lydians had evidently gone to extreme lengths to perfectly calibrate coin weights, and thus potentially exchange coins by tale, only to undo all the benefits of standardization by making coins with an arbitrary gold-silver mixture. Now buyers and sellers would have to settle on some laborious means of determining a given coin’s mixture, say like using a touchstone, before they could consummate a trade.

The Lydians could have avoided this problem at the outset by issuing coins using silver rather than electrum. Silver, after all, was already traded in ingot form. With silver coins, at least there would be no confusion about intrinsic value. But the Lydians chose not to go this route.

Which leads us to what may be the most popular theory for electrum coins, what I will call the “token" theory.

Electrum coins as tokens

It is Robert Wallace who can be credited with creating what is probably the most widely-accepted theory for electrum coins. Wallace (1987) began by imagining himself in the shoes of an owner of an electrum hoard around 640 BC. This individual had the following problem. His stash of metal was not uniform, and so fellow Lydians didn’t really trust its quality. How could our electrum owner get his suspicious counterparts to accept his metal for its full value?

The easiest solution available to our Lydian would be to refine his electrum into its silver and gold constituents, then sell each separately. But Wallace tells us that the technology for “parting" gold and silver – cementation – would not be available for almost a hundred years, circa 550 BC. So our electrum owner was stuck with his mongrel metal.

According to Wallace, our Lydian stumbled on the solution: turn his raw electrum into stamped coins. Why would a potential buyer trust electrum in coin form but not bar form? The answer is that the owner of electrum didn’t create just any regular coin. Rather than issuing discs that were valued for their (uncertain) metal content, our Lydian electrum owner designed them as tokens.

Electrum coin from Ephesus, 625-600 BC with a stag grazing [source]

A stamped piece of metal can be valuable either because of the material of which it is made or the symbol that is stamped on its face. A token is of the latter sort. By contrast, a piece of hacksilber is the former. It gets its value from the silver itself.

How did a mere stamp create value? Wallace hypothesizes that the issuer’s stamp indicated a promise to “accept back or redeem his coins" at a fixed rate. A skeptical buyer would therefore have no problem receiving an electrum token in trade. After all, the stamp guaranteed that the issuer would buy it back at that very same rate.

Fungibility regained

By setting his redemption price for tokens high enough, the issuer ensured that the market value of his coins would always exceed their intrinsic electrum value. This would have had the beneficial effect of making all his electrum coins fungible. After all, since both a silver-rich electrum token and a gold-rich one could both be redeemed at the issuer for the same fixed price, neither coin was any better than the other.

Electrum could now circulate freely rather than being handicapped by non-uniformity. The decision to turn electrum into coinage had converted “stocks of what was otherwise a doubtful and uncertain substance into negotiable currency large and fixed value," says Wallace. In the process, our electrum owner had become a much wealthier man than might otherwise have been the case.

So what about circulation by tale?

Despite the fact that the weight of electrum coins was so precisely calibrated, numismatists believe that Lydians exchanged the coins by weight rather than by tale, much as they had with hacksilber. The main bit of evidence for this is that electrum coins were never clipped.

Clipping is when someone scrapes or snips a bit of metal off of a coin before passing it on. The clipper keeps the shavings for themselves. Coins that circulate by tale are easily attacked by clippers. Since sellers will accept coins with little more than a glance to the stamp on the coin’s face, a buyer who scrapes off a bit of metal before handing the coin can easily get away with it.

A lack of clipping is consistent with the practice of weighing coins and only accepting those that are up to snuff. If a coin was even a bit too light, then the seller would not take it. And so no one would bother clipping them in the first place.

But if electrum coins circulated by weight and not tale, this hardly seem like a technological improvement over hacksilber. Lydian trade was still as slow and awkward as before.

However, the necessity of weighing electrum coins may have served a purpose. It may have been a security feature designed to protect the issuer’s wealth. Imagine that our issuer of electrum tokens has spent some staters into circulation. Prior to being returned to him for redemption, these staters had all been clipped. Since he has less electrum than what he started out with,  our issuer’s wealth has deteriorated.

To protect himself from this sort of theft, Wallace (1989) suggests that the issuer wouldn’t redeem just any of his tokens. As a security measure, he would only take back those that were still of their original weight. Since no merchant would want to be stuck holding a coin that could not be redeemed, they would always weigh each coin that was offered to them in order to avoid accepting light ones.

They only circulated domestically

Wallace’s theory explains another odd feature of electrum coins. Given the distribution of electrum coin hoards, numismatists believe that they didn’t circulate outside of their area of production. This is unusual for ancient coinage. Roman coins have been found as far afield as Sumatra, while Sassanian coins (minted in modern day Iran) have been unearthed in England.

But if circulation of electrum coins was premised on the guarantee that their issuer would redeem them, then that explains why they wouldn’t have circulated very far. People in a distant city would not recognize or trust the redemption promise of an unknown issuer, and so they wouldn’t accept them in trade.

Electrum diluted with silver

Another oddity of electrum coins is that they often contain far more silver than the natural electrum out of which they were manufactured. Electrum found in naturally-occurring deposits usually contains no less than 70% gold, but the coins themselves often contain just 45-55% gold. For some reason, Lydians coin issuers chose to introduce a bit of pure silver into the electrum mix before coining it.

In the chart below, for instance, the vertical column that represents the 1/6 stater denomination contains around 14 different coins. The majority of these coins contain less than 65% gold.  Only two contain more than 80% gold.

Most electrum coins contained less than 70% gold. Source: Velde

Why would the Lydians have chosen to dilute electrum with silver? The intrinsic value of natural electrum was quite high. Given that gold was worth around ten times the value of silver, numismatists estimate that the most commonly available coin, the trite, was worth several sheep, or ten day’s wages (de Callatay, 2013). Converting into modern terms, the trite would be worth the equivalent of a $500 bill. This hardly seems a very convenient denomination. The smallest coin, the 1/96th stater, was worth about a day’s wages, and thus not useful as small change (Velde, 2012).

Wallace (1987) suggest that by mixing some silver into the natural electrum, the intrinsic value of the coin would have been reduced. The price at which the issuer promised to redeem the coin could now be lowered. This reduction would have permitted electrum coins to participate in a wider range of transactions, thus increasing their usefulness.

Still more questions

New data and theories about electrum coins have improved our knowledge. Unfortunately, it seems that we remain “confused but on a higher level!" remarks historian Francois de Callatay (2013). While Wallace’s theory is elegant, it leads to only to more questions.

Velde asks some of the more glaring ones. If electrum coins were redeemable, what did the issuer promise to redeem their coins with? Gold? Silver? Perhaps they be used to discharge taxes? If gold and silver were to be used to redeem electrum coins, why not use these materials as the basis of coinage instead?

And what did the issuer keep in reserve to “back" his guarantee, wonders Velde. If each coin had to be 100% backed by gold, then our issuer would have had to incur the costs of storing and vaulting the yellow metal. This would have meant that issuing coins wasn’t very profitable. One wonders why our electrum owner would have bothered producing them in the first place.

Electrum coins, what happened to them?

Whereas the Brits still seem to be quite fond of their 1p and 2p coins, the Lydians quickly discontinued their electrum coinage. About a hundred years after electrum coins were first issued, they disappear from the numismatic record.

Around 550 BC, King Croesus decided to issue individual silver and gold coins. This switch from electrum to pure gold and silver coincides with the discovery of the process of cementation, the ability to separate gold from silver. Presumably decomposing electrum into its constituent parts in order to create a uniform currency was deemed superior to issuing electrum discs.

Except for a few smaller city-states that continued to issue electrum coins for another century or two, never again would a mixed silver-gold coin be issued. All that remains is a mystery for modern numismatists to puzzle over.

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Sources:

de Callatay, Francois. White Gold: An Enigmatic Start to Greek Coinage. 2013. [link]
Velde, Francois. On the Origin of Specie. 2012. [link]
Velde, Francois. A Quantitative Approach to the Beginnings of Coinage. [link]
Wallace, Robert. The Origin of Electrum Coinage. 1987. [link]
Wallace, Robert. On the Production and Exchange of Early Anatolian Electrum Coinage. 1989. [link]

Yemen's bifurcated monetary system

Over the last five years Yemen has stumbled into a unique monetary situation. I initially wrote about Yemen's odd currency status two years ago. Here is a quick update.

In brief, Yemen has split into two warring sides: the Houthi rebels in the North and the Saudi-backed government in the South. This split has also torn the nation's central bank into two branches – the Aden branch and the Sana branch.

Likewise, it has separated Yemen's stock of Yemeni rial banknotes into two different types of banknotes. The Houthi rebels in the North (who run the Sana branch of the central bank) have adopted rial banknotes printed before 2016. The officially-recognized Aden regime in the South controls all notes printed after 2016. (Read the original blog post for the full story.)

We take it for granted that banknotes of different vintages, or years, are equal to each other. Put differently, cash is fungible. But not in Yemen. The value of the North's pre-2016 notes and the South's post-2016 notes began to diverge in 2019. Below is a chart published by the Cash Consortium of Yemen (which I've modified for clarity) showing how far that divergence has proceeded. The value of rebel's old notes relative to the U.S. dollar has stayed stable at around 600 rials to US$1 (see red line). But the value of the official Aden government's post-2016 notes has inflated. A new rial is now worth less than half a pre-2016 note (green line).

The reason for this growing gap is that the rebel North can't increase the supply of pre-2016 notes. The supply of old notes is locked. The supply of new notes, however, is not fixed. The South has been printing up new paper money and spending it into circulation.

It would be as if the northern & southern U.S. states had a civil war, the North adopting pre-2016 Federal Reserve notes and the South post-2016 notes. The South keeps printing new notes to finance itself, but the North is stuck with a fixed stock of notes. So the U.S. dollar bifurcates.

A currency war of sorts developed last summer in Yemen. It began with the Aden government printing up new notes of the same size, shape, and appearance as the rebel's pre-2016 notes and then spending them. You can see why the Aden government would want to adopt this strategy. If it could spend the replica notes at the same purchasing power as old notes, which are more valuable, the Aden government would extract twice as much goods & services than it otherwise could. If Aden's replicas succeeded in filtering into the Northern economy, we'd expect the old notes—so stable till now—to finally succumb to price inflation. The price gap between old notes and new notes would collapse.

But this didn't happen. The Northern rebels reacted by banning Aden's replicas on the basis of serial number, according to the Sanaa Center. Notes with a serial number starting with the letter (أ) would be accepted, the rebels said, but those starting with the letter (د) would not be, presumably because د notes are all replicas. (According to the Sanaa Center, the government reacted by printing up serial numbers starting with أ.)

The exchange rates illustrated in the chart above suggest that the North's efforts to filter out the replicas was successful. The Northern rial notes are still worth just as much as before, around 600 rials to the U.S. dollar. Meanwhile, Aden's notes have inflated dramatically, from around 950 rials to 1290 rials per US$1.

My hunch is that some of the rebel's success may be due to the relative quality of the North's banknotes. Given years of active use, Northern rial notes must be relatively filthy right now. Crisp new notes from the South would immediately stand out. After Aden's new notes have circulated for a few years, it may become easier for them to pass as the rebel's old notes. Only then will the price gap start to shrink.

The afghani could split into two (and other possibilities for Afghanistan's currency)

The new Governor of the DAB, Abdul Qahir Idrees, is introduced to staff.  [Source][Source]

Last week I made the case that the Afghanistan's currency, the Afghan afghani, might hyperinflate. In this post I'm going to take a different tack. In a chaotic economy, the afghani—or at least some version of the afghani—may be one of the country's more reliable elements. I'm going to look to several exotic currency scenarios including that of the 1990s Iraqi dinar, which split into an unstable Saddam dinar and a stable Swiss dinar, as a possible template for what might happen in Afghanistan.

My blog post from last week was about the assets owned by Da Afghanistan Bank (DAB), Afghanistan's central bank. The Taliban, which just took over control of the country, discovered to its chagrin that most of the DAB's US$9.5 billion in assets are held overseas and controlled by the U.S. and institutions like the IMF. And now those assets have been frozen.

Here is the former central banker, Ajmal Ahmady:

This thread is to clarify the location of DAB (Central Bank of Afghanistan) international reserves

I am writing this because I have been told Taliban are asking DAB staff about location of assets

If this is true - it is clear they urgently need to add an economist on their team

— Ajmal Ahmady (@aahmady) August 18, 2021

With a wedge being driven between the afghani banknotes that are circulating in Afghanistan and the New York-domiciled assets backing those notes, I went on to suggest in my post that the notes—now rudderless—could only fall in value.

What follows is my counter-argument, to myself.

Yes, the Taliban-controlled DAB has been cut off from its New York assets. But Taliban officials are about to learn (if they haven't already) that they have also been severed from the global banknote printing market. This means that the Taliban-controlled DAB can't issue any new banknotes. Cash is the dominant form of money in Afghanistan. With the supply of afghanis now fixed, and the demand for them rising over time along with population growth, Econ 101 tells us that the afghani's purchasing power should strengthen, or at least not fall by very much.

Like many other smaller countries, Afghanistan doesn't print its own notes. The DAB signed a contract in 2020 with the Polish Security Printing Works, Poland's state-owned money printer, to provide it with new cash. The first batch of new Polish-made afghani notes arrived earlier this year, with more due to arrive through 2022. 

The Taliban's takeover makes it unlikely that subsequent batches will be delivered, at least not without U.S. approval. Thus the stock of afghani banknotes is locked with no timetable for unlocking it.

Nor can the Taliban-controlled DAB print up its own series of afghani banknotes. Banknote printing is a complex affair due to anti-counterfeiting features, exotic substrates on which notes are printed, and designer security inks. I doubt the Taliban can acquire high quality presses, materials, or the requisite expertise to operate them.

Might a rogue foreign printer produce notes for the Taliban?

This is where things get interesting. We can look to other countries like Yemen, Libya or Iraq for ideas about what might happen if this happens (more on these countries at bottom).

Say that a shortage of notes pushes the Taliban to try and secure new ones. The Taliban-controlled DAB might contact an ally such as Pakistan to get some new notes printed up in secret. The rogue Pakistani printer will probably do a better printing job than the Taliban would on its own, but it still won't be able to make perfect replicas of the Polish series (or prior series). And the Taliban may not want replicas anyways. It may ask for an entirely new note design to commemorate its coming to power. Once the Taliban has received the Pakistani-printed notes, it will proceed to put these not-quite-replicas into circulation.

Now the ball is in the U.S.'s court.

If the U.S. decides to publicly disapprove of the rogue notes, then people in Afghanistan will refuse to treat old notes and new notes as being fungible, or equal to each other. The old approved notes will be seen as being tied to the billions of assets held in rich New York, the new unapproved being linked to a destitute Taliban. So the unapproved notes will trade at a discount to approved notes. At that point Afghanistan will have two afghanis: a strong Yankee one and a bad Taliban one. (This would be a situation similar to the bad Saddam dinars circulating in 1990s Iraq. More on that later.)

The Taliban may react by trying to restore fungibility. Afghan citizens would be required to treat the two unequal banknotes as equals. That is, local stores and banks would be forced to accept both the new and old notes at par on pain of execution.

But these measures would only partly work. People would adapt by limiting all their official compliant purchases to be made using the weaker unapproved banknotes. They would hoard the good approved ones, perhaps for use on the black market (where they will fetch their true value) or for export to regions of Afghanistan that are not controlled by the Taliban, and where the Taliban's one-for-one afghani rule has no effect. (Much like how stable Swiss dinars circulated in Kurdish-controlled Northern Iraq).

So a strategy of rogue printing could very well mean the emergence of a strong and a weak afghan. (Some of you will recognize this as Gresham's law in operation). That sounds like sci-fi, but as I've been hinting at throughout this post, this sort of strange currency divorce isn't all that new. I wrote about Iraq's experience here. 

The short version is that prior to the 1991 Gulf War, Iraqi dinar notes had been printed by a private printer, De La Rue. De La Rue's printing plates were manufactured in Switzerland. Cut off from De La Rue after the war, Iraq's leader Saddam Hussein had a new series printed up locally. These were known as the Saddam dinar and circulated at a discount to the Swiss dinar.

Iraq isn't the only example of currency separation. I've written about Libya's near split in 2016. More recently, I described the Yemeni rial breaking into two.

Yemen remains home to one of the world's oddest monetary situations. The entire Yemeni monetary system has split on the basis of the age of its banknotes, with pre-2016 notes being worth much more than newer notes.

See chart below. Old rial notes are in blue, new in orange.

1/2 pic.twitter.com/om1cYI9CM0

— John Paul Koning (@jp_koning) August 3, 2021

The possibility of a dramatic rupture of the afghani might be enough to get the Taliban to swear off the rogue printing option altogether. It may seek to work with the U.S. (i.e. submit to certain U.S. demands) in order to get access to both its Polish-printed notes and New York assets.

As for the U.S., it may agree to work with the Taliban-run DAB for humanitarian reasons, subject to certain conditions (i.e. limits on how banknotes can be issued). This compromise between enemies might lead to a surprising amount of stability for the Afghan afghani.

I've now written two blog posts about the Afghan afghani, both of them describing wildly different scenarios. What's evident is that the situation is a volatile one. It could proceed along any of vast number of arcs.