The end of El Salvador's bitcoin payments experiment

Back in 2021, El Salvador became the first country in the world to require its citizens to use bitcoin for payments. Last month, four years later, it notched another record: it became the first country to rescind bitcoin's status as required tender. This backtracking was the result of the IMF's threat to pull billions of dollars in assistance if El Salvador didn't put an end to bitcoin's special status.

What have we learnt from El Salvador's four-year bitcoin experiment? I would suggest that it definitively proved that bitcoin is not destined to be money. As far as making payments goes, bitcoin will always be an unpopular option, even when the government gives it a helping hand. And don't blame the IMF for this; bitcoin sputtered-out long before the IMF pressured El Salvador to drop it, as I'll show.

The original motivation behind El Salvador's Bitcoin Law was to harness bitcoin as a means for reaching the unbanked, those without bank accounts, who in El Salvador make up the majority. Cash is still by far the dominant payments choice in El Salvador, but it was believed that an electronic form of cash might complement that. Another goal was to make remittances cheaper by sponsoring a new bitcoin remittance route—few countries are as dependent on remittances from family living overseas as El Salvador. 

President Nayib Bukele made the announcement at a major bitcoin event and El Salvador’s Congress ratified the Bitcoin Law a few days later. Bitcoiners literally cried for joy. For longtime Bitcoin watchers like me, it seemed like an awful idea. But at least it was going to be a fantastic natural experiment.

Satoshi Nakamoto, bitcoin's founder, saw bitcoin as electronic cash, but his dream generally hasn't come to fruition. In practice, 99% of bitcoin adoption is about gambling on its volatile price, with payments being a niche 1% edge case. Bitcoin disciples who continue to believe in Satoshi's electronic cash dream often blame what they see as government meddling for the failure of bitcoin to gain widespread usage as a payments medium. For instance, they say that capital gains taxes on bitcoin makes it a hassle to pay with the orange coin, since it leads to a ton of paper work anytime one buys something with bitcoin. Or they criticize legal tender laws that privilege fiat currency. 

But here was a government that was going to champion the stuff, nullifying all of the headwinds against bitcoin in one stroke! The government meddling hypothesis would be put to test.

The Salvadoran government used a combination of sticks and carrots to kick-start adoption. First, let's list the carrots. The capital gains tax on bitcoin was set to zero to remove the hassle of buying stuff with bitcoin. The government also built a bitcoin payments app, Chivo, for all El Salvadoreans to use. (Chivo also supports U.S. dollar payments.) Anyone who downloaded Chivo and transacted with bitcoin would receive a $30 bitcoin bonus—that's a lot of money in El Salvador. Gas stations offered $0.20 off of a gallon of gas for customers who paid with the app. People could also use Chivo to pay their taxes with bitcoin.

The biggest carrot was zero-transaction fees. Any payment conducted with Chivo was free, as was converting bitcoins held in the Chivo app into U.S. dollars and withdrawing cash at Chivo ATMs. These Chivo ATMs were rolled out across El Salvador and in the U.S., too, to encourage the nascent U.S.-to-El Salvador bitcoin remittance route. Bitcoin ATMs are usually incredibly pricey to use, but in El Salvador the government would eat all the transaction fees. What a fantastic deal.

As for the stick, Bukele introduced a forced-tender rule. Beginning in 2021, businesses were required to accept the orange coin or be punished. This was costly for them to comply with. They would have to update point of sale software, signage, train employees, and set up new processes for handling bitcoins post-sale.

By all rights, this combination of sticks and carrots should have led to a flourishing of bitcoin payments. But it didn't.

The evidence of failure

The first incrimination of the experiment is Figure 1, below. In the Bitcoin Law's initial months, remittances carried out by cryptocurrency wallets exploded, accounting for an impressive 4.5% of all incoming remittances to El Salvador. Not bad! People were actually using the Chivo app to send bitcoins to relatives back home. 

Figure 1: Data from El Salvador's central bank shows that cryptocurrency remittances from wallets like Chivo have steadily shrunk over time from 4.5% of all remittances to 0.87% of all remittances in 2024.

But instead of continuing to gain market share, crypto-linked remittances steadily deteriorated over the next four years to 0.87% of the total by December 2024—hardly a sign of success.

The data for this chart comes from the Banco Central De Reserva (BCR), El Salvador's central bank. The BCR is coy on how precisely it collects this data, but it is almost certainly dominated by Chivo-related transactions. (My note at the bottom explores the data more.)

The second indictment of El Salvador's bitcoin effort comes from survey data compiled by economists Alvarez, Argente, and Van Patten in their 2022 paper, Are Cryptocurrencies Currencies? Bitcoin as Legal Tender in El Salvador. The authors carried out a survey of 1,800 Salvadoran households to get insights into their use of the Chivo Wallet. This wasn't a lazy online survey, but an in-person survey.

The survey found that just over half of Salvadoran adults had downloaded Chivo, which is impressive (see Figure 2, below). Most hardly used it, though. While over 20% of the population continued to interact with Chivo after spending their $30 bitcoin bonus—which isn't a bad adoption rate for an app—the majority of Chivo usage was only occasional, the median Chivo user reporting no bitcoin payments sent or received in any given month, and just one payment per month in U.S. dollars. Payments tools like apps and cards are supposed to be used a few times each week; not once every two or three months.

Figure 2: While awareness of Chivo was high, most Salvadorans did not use Chivo's bitcoin functionality after receiving their $30 bitcoin bonus. Source: Are Cryptocurrencies Currencies? Bitcoin as Legal Tender in El Salvador [link]

The dominance of the app's dollar functionality over its bitcoin functionality also stands out. Chivo was supposed to be a bitcoin payments app, after all, not another version of PayPal of Venmo. For instance, the survey found that of all households who had downloaded Chivo, only 3% had ever received a bitcoin remittance via Chivo, while 8% had received a U.S. dollar remittance via the app (see Figure 3 below). If Chivo was primarily being used for fiat payments, and not bitcoin, then why go through with the whole effort of changing the law for bitcoin's sake?

Figure 3: When Salvadorans did use Chivo for remittances, they preferred it for U.S. dollar remittances over bitcoin-based ones. Source: Are Cryptocurrencies Currencies? Bitcoin as Legal Tender in El Salvador [link]

Moreover, those few citizens who did continue to use Chivo regularly were not the unbanked majority that the Bitcoin Law had originally targeted. The survey found that they were most likely to be from the already-banked minority, young, educated, and male.

By mid-2022, downloads of Chivo had pretty much dried up. Using blockchain tracing, the economists found that $245,000 per day worth of bitcoins were flowing into the Chivo app, which sounds like a lot, but in the payments business, that's peanuts.

It's also worth considering how businesses treated bitcoin after the passing of the Bitcoin Law. Despite the requirement that all businesses  accept bitcoin, just one-in-five actually did so. The survey found that acceptance was driven by large businesses—i.e. McDonald's, Starbucks, Pizza Hut and Walmart—presumably because they couldn't easily evade the consequences of ignoring the law. Bitcoin was not popular with these businesses; the survey found that of those that received bitcoin from their customers, 88% quickly converted them into dollars.

This is problematic. For bitcoin to become money, a circular economy must be kickstarted as the bitcoins spent by consumers are re-spent by businesses on inventory and salaries, which gets re-spent by consumers, and on and on. This wasn't happening.

With just 20% of the population using the app, and mostly for an occasional U.S. dollar transaction, the entire bitcoin experiment can hardly be seen as a wild success. Businesses were not keeping the bitcoins they received, and consumers who were using the app regularly were not the unbanked originally targeted by the Bitcoin Law.

The third and last bit of evidence of the experiment's failure comes from an annual survey from José Simeón Cañas Central American University (UCA) entitled La población salvadoreña evalúa la situación del país. In 2021, the survey began asking Salvadorans whether they had ever used bitcoin to buy or pay for something. This question is more open-ended than the one asked by the three economists, who focused more narrowly on bitcoin transactions conducted via Chivo. 

Figure 4: According to a survey from the UCA, while over 25% of survey participants reported using bitcoin (and not just Chivo) for payments in 2021, only 8.1% used bitcoin for payments just three years later in 2024.

In the first year of the Bitcoin Law, 25.7% of respondents said they used bitcoin for payments. That's a fantastic result, although the $30 Chivo bonus no doubt drove that large number. But over the next three years, bitcoin's usage for payments crumbled, with only 8.1% of Salvadorans reporting that they'd paid with bitcoin by 2024. This is the same downward pattern that we saw in the CBR's remittance data. That's not adoption. That's giving up on bitcoin.

The UCA survey found that the 8.1% who reported using bitcoin for payments in 2024 were not using it for day-to-day payments. Of this group of bitcoin payors, 55% used bitcoin just 1-3 times in 2024. Only 8% made bitcoin payments on a weekly or bi-weekly basis. (See Figure 5 below). I really want to highlight this last data point: in 2024, just 1 in 200 Salvadorans paid for something each week or second week with bitcoin.

Figure 5: In a 2024 survey by UCA, 8.1% of Salvadorans reported using bitcoin for payments that year. This group was then asked how often they used it, with the responses visualized in the above chart. Most used bitcoin just once in 2024, with 55% using it one to three times. 8% used it 20 or more times, which would suggest that almost no one is using bitcoin for day-to-day payments, despite that being the goal of El Salvador's 2021 Bitcoin Law.

Summing up these three pieces of evidence, despite a potent combination of subsidies and coercion, the adoption of bitcoin for payments hasn't occurred. Bitcoin usage in El Salvador is, if anything, regressing. Now that required acceptance of bitcoin is being rescinded, I suspect that it's only a matter of time before all the large businesses that introduced bitcoin payments, like McDonald's and Walmart, drop that option. With the government no longer coercing them to accept bitcoin payments, there's no commercial incentive to continue down that path.

It was IMF pressure on Nayib Bukele that finally got him to give up his bitcoin experiment. But the IMF was doing Bukele a favor, really, because the whole thing was already a failure, as I've explained with the charts above. Cancelling it outright would have been embarrassing to Bukele, but now he can deflect attention from himself and blame the IMF.

Why the failure, and what have we learned?

There is a very big hurdle that has prevented El Salvador's one-two punch of subsidies and coercion from working: bitcoin is intrinsically ill-suited to perform as money. 

The stuff is innately volatile, and so risk-shy individuals don't dare hold it or use it for payments. Risk-seekers can tolerate that volatility, but they expect to be rewarded by a dramatic price rise, and so they refuse to use their bitcoins for payments because they could miss out on the jump. The net result is that no one, neither society's risk-seekers nor its risk-avoiders, ends up paying with bitcoins. Only a tremendous amount of subsidies and coercion will ever overcome their natural preferences, but no sane government would ever try to bring those levels of coercion to bear. (And speeding things up with options like Lightning doesn't change this equation.)

The saddest thing about El Salvador's bitcoin experiment is that all sorts of time and resources have been wasted. El Salvador is not a rich country. The money spent on building and operating Chivo, compliance by businesses, bitcoin signage, and subsidies could have been better deployed on more important things like health and education.  One hopes that other countries learn from this experience and avoid going down the same route that El Salvador did. Brazil, which deployed its wildly popular PIX payment system around the same time as El Salvador launched its Bitcoin Law, provide helpful guidance.

More broadly, I'm hoping that El Salvador's failure finally kills off Satoshi's very misguided dream of bitcoin as electronic cash. I once was a believer in that dream, but for all the reasons I wrote in December, I've long since given up on any chance of bitcoin becoming a widely-circulating currency. But a lot of people continue to sacrifice their careers, time and resources to following Satoshi. Many of these are brilliant people. We want them to be creating valuable things for society. Alas, despite all sorts of evidence that bitcoin payments are a dead end, they continue to hit their heads against the wall, using excuses like government interference. 

Guys, Satoshi's dream is a mirage, a delusion, a hallucination. A government just flexed its muscles for four long years to get bitcoin into circulation, and that still didn't work. The lesson here: bitcoin is a bad payments tool and will never become widely-used electronic cash. It's time to move on.

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*The BCB won't say how it collects this data -- according to the Salvadoran press there are legal limits on how much it can disclose -- but it describes the series as being compiled from administrative records that it receives from "cryptocurrency digital wallets." Reading between the lines, this probably includes Chivo data and any other regulated cryptocurrency service that stores customer crypto and reports to the BCB. (Because Chivo allows both U.S. dollars and bitcoins to be transferred, the BCR's data may be a mix of the two units, muddying the waters.) I think it's safe to assume that the BCR data does not include bitcoin remittances made via non-custodial services, say like Muun wallet or Blue wallet. However, since most of the governments carrot's (i.e. no fees) require the use of Chivo, it's probably a safe assumption that the average Salvadoran uses Chivo for bitcoin transfers, so the BCR data--which almost certainly includes Chivo--is fairly representative of overall usage.

Monetagium

An English penny minted by William the Conqueror, who brought monetagium to England. Source: History in Coins

The way that a modern mafia protection racket works is the mafia starts doing very bad things to regular folks, say you and your business. To stop the damage, you pay them a regular fee. Both sides come out ahead. The mafia earns a tidy stream of income. Your suffering comes to an end.

In feudal Europe, a monetary practice called monetagium worked along the same principles as a mafia protection racket. It began with the feudal lord threatening to do very bad things to the coinage. To prevent these very bad things from happening, the public would pay a fee – monetagium – to the lord. Both sides came out ahead. The lord earned revenue. His vassals avoided a worsening of the coinage.

To better understand the intricacies of monetagium, or monetary blackmail, we need to start off by exploring how the monetary system worked back in the 11th and 12th centuries, in particular the idea of debasement.
 
A feudal lord had a number of ways to earn revenue. These included gabelle, a tax on salt; heriot, a death duty that was paid to the lord upon the death of a tenant; merchet, fee paid on marriage, and the Saladin tithe, a tax paid by all those who did not go on Crusades. Another common revenues source was the prince's monopoly over the coinage. Anyone could bring their personal silver to the royal mints and have it be converted into coins, for a fee. This revenue source was known as seigniorage. The lord of the realm, or seigneur, often outsourced the running of their mints to professional third-parties, or moneyers, who collected the fee and remitted it to the seigneur after subtracting what was needed to pay their own costs and earn a profit.

Seigniorage provided a steady stream of revenue to the lord. But if he really wanted to turbocharge his revenues, a debasement of the coinage could be introduced.

A debasement means a reduction in the silver content of new coins. Post-debasement, a canny merchant could bring a chest full of old silver coins to the mint and get those converted into even more new ones. So for example, if he had 1,000 old coins on hand, and a 20% debasement had been introduced, a merchant would be able to have his 1,000 coins reminted into 1,200 new coins. He might have to pay 50 of those to the lord, leaving 1,150 coins. The extra 150 coins now in his possession provided him with the opportunity to buy more goods & services than before (at least until prices adjusted) and settle more debts.

To take advantage of the opportunity provided by the debasement, a wave of customers would arrive at the mint to convert their silver into new coins, the result being a temporary boost to the seigneur's minting profits. If a single debasement provided a one-time boost to the lord's revenues, a series of such debasements could repetitively turbocharge those revenues. (Henry VIII notoriously used this technique to fund his expensive French wars.)

Patient readers will now begin to understand the idea of monetagium. Debasements may have boosted feudal revenues, but they were generally unpopular with the public, a fact that many writers from that period have commented on. And you can understand why. Debasing the coinage caused inflation, or a rise in the price level, and in no age has inflation ever been popular. Furthermore, the penny was the unit of account, or the means by which people reckoned and computed their financial lives. As the penny was mutated, its ability to serve as a measuring tool was compromised.

By the 11th century, Normandy's dukes had been resorting to regular debasements as a revenue device for some time. But they soon had an epiphany. They realized that they needn't enact an actual debasement to earn a profit. Instead, they could just threaten to enact one, and then extort the public for a ransom to prevent it from going through.

This tax, or extortion payment, was referred to as monetagium. By the late 11th century, monetagium was being levied on Norman citizens every three years in return for the Duke's promise not to reduce the silver content of the coinage. The tax worked out to 12 pennies per household, or hearth, which according to historian Thomas Bisson amounted to the wages of "a day's field work per year." Knights and the clergy were exempt. In scope, monetagium was an "important but unspectacular financial resource," says Bisson, raising a fraction of the much larger land tax on farms.

In other parts of France, including Orléans and Paris, the monetagium was known as the "tallage on bread and wine," writes Bisson. Calculated based on the amount of provisions that subjects had on hand, including measures of winter wheat and spring oats, the bread and wine tax was justified to the population as the king's generous substitute for debasement.

From the perspective of the king or feudal lord, monetagium must have been a superior tax policy to debasing the coinage. Gone was the need to force the population to trudge each few years with their silver coins to the mint for recoinage every three years. And the coinage at least stayed constant, removing the difficulties and uncertainties imposed by inflation on the feudal economy. But while monetagium was less capricious, it was still abusive – in the same way that the mafia's protection payments are abusive. This was especially apparent to the inhabitants of England.

There is evidence that the Normans exported the practice of monetagium to England after William the Conqueror's successful invasion of the island in 1066. The English version of monetagium appears to have operated on slightly different principles than the Norman one, however.

Whereas Normandy had a long history of debasement, England's coinage up till 1066 had remained relatively consistent in weight and purity, a tradition that the English expected the Norman invaders  to uphold, which they did. Unable to credibly use the threat of a debasement to extract monetagium, England's new Norman lords came up with another excuse.

For almost a century prior to the Norman invasion, the English coinage had been regularly renewed each three years. That is, a new version of the penny was regularly issued, the imagery being updated but the silver content staying the same. This was not debasement, but rather akin to the modern practice of periodically issuing new versions of dollar bills. In feudal England, the older versions of the penny were generally allowed to stay in circulation, although from time-to-time the most dated coins would be declared void, says W.J. Andrew, a numismatist. Once they ceased to be legal tender, citizens were required to bring in these discontinued coins to be reminted into new ones, for a fee. The fees earned from demonetization were one of the ways the English kings earned income.

According to Andrew, this English tradition of recurring triennial renewals, or renovatio monetae, gave the Norman kings the missing hook they needed to extract monetagium from the English population. By declaring all coin types to be void each three years (instead of just some of the oldest ones), as was his right, England's new Norman kings could place a costly burden on the population. English-folk would have to regularly haul all their coins to the local mint for costly conversion. To avoid this burden they were proffered an alternative: pay the monetagium every three years instead, and in return the king would let old pennies remain as legal tender.
 
This was not a popular practice with the English. When Henry I came to power in 1100 he would officially end it, proclaiming the following: "The common monetagium... which was collected through the cities and through the counties, which did not exist in Kind Edward's time, this I utterly abolish from now on."

The phenomenon of monetagium also pops up in Denmark in the 13th century in the form of a "plough tax," as recounted by historian Sture Bolin. Like many parts of Europe, Denmark's coinage was subject to renovatio monetae whereby it was routinely recalled and cancelled. The conversion rate was costly; for every three demonetized coins submitted, a Dane might receive only two in return. The policy of renovatio monetae was brought to an end in 1234 by King Valdemar II. In its place, a new tax was levied such that for every plough owned, Danes had to pay one öre in coin. Valdemar justified the plough tax to his Danish subjects as the price they had to pay to enjoy permanent coinage.

Notably, the coins that Valdemar issued in 1234 have the distinction of being the first European coins in the Christian era to have a date stamped on them. In the image below, they are dated MCCXXXIIII, although I must confess that I can't quite make it out. (This source may help you pick out the numerals.)

A penny from Roskilde, Denmark dated 1234 holds the honor of being the earliest Anno Domini dated coin in the history of European coinage Source: Reddit

Bolin suggests that the novelty of coin dating was intended to commemorate both the permanent nature of Danish coinage and the simultaneous introduction of the plough tax, or monetagium.

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So what are we to make of all this today? Modern democracies are not feudal mafioso, yet they often face the similar dilemma of what mix of revenue sources to rely on, one of those sources being monetary debasement. A literal debasement of the coinage is no longer a policy that can be pursued – our currencies are no longer metallic. The modern equivalent would be for a democratic government to lean on the central bank to fund government spending, too much of this resulting in inflation.

In general, democracies have not resorted to modern version of debasement as a revenue source due to the unpopularity of rising prices. Instead, contemporary policymakers tend to rely on income taxes, consumption taxes, and property taxes. I suppose we can think of these obligations as our modern version of monetagium. They are the "better taxes," akin to the Danish plough tax or the Parisian bread and wine tax, that we subject ourselves to instead of the not-so-good taxes that get levied via the monetary system.

Two notions of fungibility

A few centuries ago, lack of fungibility used to be a big weakness of monetary systems. But technological and legal developments eventually solved the problem. Nascent systems like bitcoin are finding that they must wrestle all over again with fungibility issues.

Fungibility exists when one member of a population of items is perfectly interchangeable with another. So for instance, because your grain of wheat can be swapped out with my grain without causing any sort of change to our relative status, we would say that wheat grains are fungible. Fungibility is a desirable property of a monetary system. If all monetary items are interchangeable, then trade can proceed relatively smoothly. If monetary items are not fungible, then sellers cannot accept the monetary item without pausing for a few moments to verify and assay it, and this imposes frictions on trade.   

In this post I argue that there are two ways for something to be fungible. They can be fungible for physical reasons or for legal reasons.

By physical fungibility, I mean that members of a group are objectively indistinguishable from each other. In the previous example, our wheat grains are physically fungible because a cursory inspection shows that they look, feel, and smell exactly the same. Now, a deeper analysis might reveal that the two grains are not in fact perfectly fungible. For instance, it may be the case that your grain of wheat is the hard red winter variety and mine is durum, in which case they are not substitutes, durum being better for making pasta. Or perhaps we each have durum grains, but yours enjoyed an excellent growing season—plenty of sun and sufficient rain—whereas mine isn't so healthy. And so your grains can produce more pasta per than mine. And thus they aren't exact substitutes.

We could even go down to the molecular level and determine that the grains are not perfectly equal and thus not quite interchangeable. But for commercial purposes, there is typically some sufficiently-deep level of analysis at which fungibility between types of wheat grains can be established by an experienced grain inspector and accepted by the market. 

Among commodities, gold and silver achieve a notably high level of physical fungibility. As long as a gram of gold is pure, it is perfectly exchangeable with any other gram of pure gold. Gold's fungibility doesn't necessarily carry over to gold coins, however. Earlier processes used to make coins, in particular hand striking, were not very effective at creating perfectly equal specimens. The edges of coins were often irregular, leaving coins vulnerable to clippers who would safely cut off some gold (or silver) without fear of being detected. Thanks to natural wear and tear, coins that had been in circulation for a few years would contain less precious metals than new coins. Both clipping and natural wear & tear meant that the metal content of coins was not uniform.

New technologies helped increase the physical fungibility of coins. For instance, reeded edges—those little lines on the edge of a coin—prevented people from clipping off bits without detection.  It was now obvious to the eye if someone had attacked the coin. Likewise, shifting from hand-hammered coinage to mechanical screw presses allowed for a more circular final product, one less susceptible to clippers (see comparison below). The invention of restraining collars—which prevented metal disks from shifting around while they were being stamped—also helped. With clipping much reduced, coins that had been in circulation for a while were more likely to be equal in weight to new ones.

These two photos compare hammered coins to milled ones (source)

In addition to physical improvements, an attempt was also made to buttress the fungibility of coins with laws. There are two types of laws that achieve this: legal tender and the so-called "currency rule." Legal tender laws required debtors and creditors to accept all coins deemed legal tender by the authorities at their stipulated face value. So even if two different shillings were not physically fungible--say one was clipped and worn and thus contained far less silver than the second newer one--those participating in trade were obligated to treat them as if they were perfectly interchangeable.

Legally-enforced fungibility was no panacea. In the absence of physical fungibility, the imposition of legal tender laws often had  perverse effects. If two coins were not exact physical substitutes because their metal content differed, but law required them to be treated as interchangeable tender, then the owner would always spend away the lighter one while hoarding the heavier one. Legal tender laws, after all, had artificially granted the "bad" coin the same purchasing power as the "good" coin. Thus the good money is chased out by the bad, which is known as Gresham's law.
 
The second set of rules that courts formulated in order to help fungibility, the currency rule, requires us to shift our attention to banknotes. Like coins, banknotes are not particularly fungible in the physical sense, but for a different reason. Banknotes have historically carried a unique identifier, a serial number—coins haven't. An owner of a banknote can carefully jot down the serial number of each note and, if it is stolen, use that number to help track it down.

In 1748, Hew Crawfurd did exactly this. Before sending two Bank of Scotland £20 notes by the mail, Crawfurd not only recorded their numbers but also signed the back of each one with his name, thus further breaking down their physical fungibility. When they went missing, Crawfurd was able to use this lack of fungibility to his advantage by advertising in the newspapers the numbers of the two stolen notes and the fact that they had been signed by him. One of the notes was eventually identified after it had been deposited at a competing bank, presumably long after the robber had spent it. The bank, however, refused to return the stolen property to Crawfurd.

In the resulting court case, the judge ruled in favor of the bank. Crawfurd would not have his stolen property returned to him. The court reasoned that if the note was returned to Crawfurd, then no merchant would ever risk accepting a banknote unless they knew its full history. This would damage the "currency" of money. After all, requiring merchants to pour through newspaper after newspaper to verify that no one was advertising a particular serial number as lost or stolen would be prohibitively expensive. Banknotes would be rendered useless, depriving the Scottish economy of much of its circulating medium. By allowing merchants to ignore the lack of physical fungibility of banknotes, i.e. the unique marks on each banknote, the court recreated fungibility by legal means. To this day, the currency rule that was first established in Scottish courts in the 18th century continues to apply to banknotes in most legal systems. (Kenneth's Reid's full account of this case is available here).

Bitcoin, a purported monetary system, is interesting because it: 1) lacks physically fungible and 2) is unlikely to ever be granted legally fungibility in the form of legal tender status or via an extension of the currency rule.

Bitcoin's lack of physical fungibility is more similar to that of banknotes than coins. It arises from the fact that all bitcoin transactions are publicly recorded. This means that it is possible to trace the history of a given bitcoin. If the token has been stolen, say in a highly-visible exchange hack, then said token may not be as valuable as a bitcoin that has a clean history. In theory, a forward-thinking actor will only accept a tainted coin at a discount because there is always a risk that the original owner will be able to reclaim his or her stolen property.

There seems little likelihood that the courts will solve bitcoin's lack of physical fungibility by fashioning a form of legal fungibility for it. The state will probably never be friendly enough toward bitcoin to grant it legal tender status. Nor do I think it is advisable that courts extend the currency rule to bitcoin by granting merchants the right to ignore the trail left by a given bitcoin, as they do with banknotes. As I pointed out here, to do so would violates the property rights of the original owner of the stolen objects. Only a select few instruments, those that have already proven themselves to be vital to facilitating society's trade, should be protected in this way.

With no legal route to establish fungibility, the only path remaining for bitcoin's architects is to go back to square one and try to improve the physical equivalency between bitcoins. One way they can do so is by anonymizing the blockchain. If transactions can no longer be traced, than clean and dirty bitcoins all look exactly the same. Full anonymity is easy to implement in new cryptocurrencies. Monero and Zcash, for instance, have gone this route.

In the case of a legacy cryptocurrencies like bitcoin, this functionality would have to be added on to its existing codebase. I have heard rumours that bitcoin developers like Adam Back and Greg Maxwell are working on developing code for anonymizing the bitcoin blockchain. But even if the technology is up to snuff, given the difficulties of achieving sufficient consensus for upgrading bitcoin, it remains to be seen if a fungibility-restoring technology could ever get off the ground.

In my view, the idea that bitcoin developers must try to achieve the same level of fungibility as coins and banknotes is misguided. Proponents of this idea are operating on the assumption that bitcoin is, like coins and banknotes, a payments medium or monetary system. But this is wrong. Whatever its original purpose might have been, bitcoin's first and foremost role is as a new type of gambling machine, a global and decentralized financial game. Like lotteries, casinos, and poker tournaments, and other types of zero-sum games, the main service that bitcoin provides its users is the fun of gambling and the allure of becoming very rich. If they want to benefit their users, Bitcoin developers should be working towards furthering its role as a gambling machine rather than mistakenly pursuing the dream of becoming the next monetary system.

People who play financial games such as lotteries benefit from the unique serial number on lottery tickets. If their tickets are stolen from them, this identifier may allow the original owner to get their ticket back. And that way they can still potentially win the big pot.

The same applies to bitcoin. Most people who hold bitcoins are doing so because they expect its price to hit $1 million. At least if their coins can be traced, a bitcoin owner who has been robbed may still have a chance to win that jackpot (and buy that Lamborghini they've been dreaming about). Removing the very feature that makes bitcoin non-fungible—and thus potentially traceable in the case of theft—would only do harm to the average bitcoin user. Anonymizing the bitcoin blockchain would make about as much sense as removing the serial numbers on lottery tickets.

Bitcoin's lack of fungibility isn't a bug, it's a nice feature.

The evolution of the Federal Reserve's promises as recorded on their banknotes

Since they began to be produced in 1914, Federal Reserve notes have always had a promise or obligation printed on their face. But over time this promise has changed. I thought it would be fun to go through the evolution of the promise as an exercise in understanding how the U.S.'s monetary plumbing has changed.

The original 1914 series of Federal Reserve notes had the above stipulation printed on it. It's tough to read, so I've reproduced it in full below:

"This note is receivable by all national and member banks and Federal Reserve Banks and for all taxes, customs and other public dues. It is redeemable in gold on demand at the Treasury Department of the United States in the city of Washington, District of Columbia or in gold or lawful money at any Federal Reserve Bank."

There were really four promises here. The first was that all banks who were members of the Federal Reserve system would accept notes at their counter, as would the Reserve banks themselves—i.e. the twelve district banks. The second promise was that the government would accept the notes in payment of taxes. This is what I described in last week's post as twintopt, or the MMT/Wicksteed idea of tax receivability. The third promise was to uphold the gold standard, both the Fed and the Treasury being obliged to redeem notes with the yellow metal. And the fourth and final promise was to redeem notes with something called lawful money.

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Let's focus on this last promise, which is the most curious. What does lawful money mean? The Fed gives a brief description in their FAQ, the summary of which is: it's complicated.

Before the Fed's founding in 1913, the U.S. issued a smorgasbord of different government currencies, as the chart below illustrates. The most important of these issues was United States notes, otherwise known as greenbacks. The Treasury was first authorized to issue them when the Civil War broke out, and only in 1994 was it relieved of its its obligation to redeem old United States notes with new ones.

The 1862 act that authorized United States notes declared them to be lawful money and a legal tender, phraseology that implied that to be lawful was distinct from being legal tender. While the act never explicitly defined lawful money, legal tender was already a well-known term—meaning any instrument that by default can be used to discharge a debt. So if James owns Judith $20, legal tender is any instrument that Judith cannot refuse to accept when James wants to discharge his debt.

People often assume that government money and legal tender are synonymous, but in actuality there are many examples of government banknotes that have not been legal tender. Take Scotland, for instance, where neither Scottish banknotes nor Bank of England notes currently have legal tender status. U.S. silver and gold certificates, two forms of circulating paper money that were issued by the Treasury through the 19th and 20th century, were not legal tender—at least not till 1919 in the case of gold, and 1934 for silver. Nor were National bank notes a form of legal tender. These were private banknotes issued by banks chartered under the National Bank Act (see chart above). The Treasury promised to accept National bank notes at par in discharge of most Federal taxes, effectively adopting them as their own IOU, yet refused to grant them legal tender status.

While there is no formal definition of lawful money in the 1862 act, we know that it wasn't necessarily legal tender, and we do know that greenbacks fell into said category. Thus a narrow reading of the lawful money promise on a 1914 Federal Reserve note simply meant that they were convertible into United States notes, which by chance happened to be legal tender.

A much broader definition of lawful money would emerge later. By 1935, Fed Chair Mariner Eccles included not only United States notes—greenbacks—but also silver certificates and National bank notes in the category of lawful money (see pdf). William McChesney Martin, who served as Chair from 1951 to 1970, defined lawful money as "any medium of exchange which frequently circulates from hand to hand as money under sanction of the law." (pdf) By this generous definition, lawful money referred to the entire mongrel collection of government currencies, including legal tender United States notes and non-legal tenders such as silver/gold certificates and National bank notes, and finally legacy notes no longer being printed including Treasury notes of 1890, fractional currency, and old demand notes.

The upshot is that the original promise to redeem Federal Reserve notes with lawful money effectively linked what was then a novel currency to the medley of recognizable government currencies already in use. This promise would have provided the public with much-needed continuity between the familiar and not-so-familiar. After all, the Fed was a new institution that had not yet earned credibility. Tying its obligations closely together with greenbacks and/or every bit of paper then in existence would have helped its cause.

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Having dealt with the idea of lawful money. Let's go on to look at how the promises on Fed notes changed after 1914. I've included the 1928, 1934, and 1963 series:

You can see that the 1928 series no longer included either the first (receivability at banks) or second promises (tax receivability). This was probably for brevity's sake. Even though these promises no longer appeared on Fed notes, they continue to be enshrined in Section 16.1 of the Federal Reserve Act. So when you do your taxes in 2018, the Treasury is obligated to accept notes as payment, just as they were in 1914, even though this isn't indicated on the face of a banknote.

When the 1934 series was printed, the third promise—to redeem in gold on demand—was dropped, both from the face of banknotes and the Federal Reserve Act itself. The U.S. had formally gone off the gold standard that year. Where before any member of the public could have walked into any Treasury office or Federal Reserve district bank and asked to have their banknotes redeemed with gold, neither institution was obligated to uphold this promise anymore. As of 1934, the Treasury would only buy gold from miners and other central banks at a rate of $35 per ounce—but this obligation didn't show up on the face of a Federal Reserve note, nor in the Federal Reserve Act. The promise to purchase gold at $35 was an informal one, with President Roosevelt remarking that the price "may be changed by the Secretary of the Treasury at any time without notice."

In addition to removing the gold redemption promise from the face of a Federal Reserve note, the 1934 series included a new feature: Federal Reserve notes were now legal tender for all debts public and private. It may seem strange to us now, but for the first twenty years of the Fed's existence, Federal Reserve notes could not legally discharge a debt. If James owed Judith $20, Judith could refuse to accept Federal Reserve notes from James, asking for something else instead, say United States notes which were legal tender. Thanks to the 1933 Thomas Amendment (pdf), Judith was now obligated to accept James's Fed notes as payment for the debt. I can only speculate on why Federal Reserve notes weren't originally made legal tender, but one reason is probably due to the memories of the inflation in the 1860s caused by legal tender greenbacks. If something isn't granted legal tender status, it can't do as much damage to the price level.

For almost thirty years nothing changed on the face of Federal Reserve notes until 1963 when the redeemable in lawful money promise was dropped, leaving only the stipulation that a note was legal tender for all debts, public and private.

By 1963, America's mongrel currency was pretty much a thing of the past. Ever since 1934 it had been illegal for gold certificates to circulate publicly. As for National bank notes, they had begun to be retired in 1935. The effort to remove silver certificates in denominations of $5 and above was initiated by John F. Kennedy in 1961. Getting rid of the $1 silver certificate was a bit more tricky. Believe it or not, but at the time there was no such thing as a $1 Federal Reserve note. For decades the nation's entire demand for $1 notes had been met solely by the Treasury's silver certificates. However, in 1963 the Fed finally debuted its first $1 note, upon which the Treasury began to cancel $1 silver certificates.

The Fed didn't start issuing $1 bills till 1963. Before then, all $1 notes were in the form Treasury-issued silver certificates (see top). pic.twitter.com/AZEEwPLKVX

— JP Koning (@jp_koning) August 3, 2017

With most of the government's parallel currencies retired, the promise to redeem Federal Reserve notes in lawful money probably seemed pointless, if not confusing. Thus it no longer shows up on bills, despite being still encoded in section 16 of the Federal Reserve Act. In 2017, you can bring your note to a Federal Reserve for redemption in lawful money, but they will only give you another Fed note in return. The category of lawful money is meaningless.

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Most members of the public don't know how the underlying monetary systems work, but they do see what is printed on its banknotes. To the public, the morphing set of promises on the face of a Federal Reserve note would have been one of the more visible manifestations of a shift from a mish mash of paper currencies issued by two different institutions and pegged to gold... to one single legal tender currency issued by the U.S.'s now-dominant monetary institution, the Fed—the Treasury receding into the background.

It's been over fifty years since the promise on Federal Reserve notes was last changed. What promises will be printed on U.S. money in the future? That's hard to say since we don't even know if paper money will be a part of the future. If the Fed were ever to update its currency by introducing a digital version to circulate along with its paper issue, those in charge of its design would have to think hard about the sorts of promises that will be granted to the bearer of those tokens. Would they be lawful money, tax receivable, and/or legal tender? These are questions that U.S. monetary authorities haven't had to ask themselves in a long time, not since the mongrel currency era when new money was introduced every decade or two.

An example of tax-driven money during the greenback era

Cartoon from 1864 poking fun at politicians and greenbacks (source and explanation)

During the greenback era, the Union government issued irredeemable paper money to help pay for its war against the Confederates. What many people don't realize is that there were actually two different strains of greenbacks—those printed before March 1862 and those printed after. Although these two strains had only slightly different properties, they were not fungible with each other and would go on to have drastically different values in the marketplace. Looking at the respective properties of each type gives some insights a thorny problem: why do colored bits of paper money have value?

One classic explanation for the value of fiat money is so-called 'tax-backing.' If the government stipulates that taxes must be paid using government-issued chits of paper, then that will be sufficient to give those chits a positive value. Back in 1910 economist Philip Wicksteed was one of the first economists to champion this explanation:

The Government, then, levying taxes upon the community, may say: "I shall take from you, in proportion to your resources, as a tribute to public expenses, the value of so much gold. You may pay it to me in actual metallic gold or you may pay it to me in anything which I choose to accept in lieu of the gold. If you do not give it me I shall take it from you, in gold or any other such articles as I can find, and which would serve my purpose, to the value of the gold. But if you can give me a piece of paper, of my own issue, to the face value of the gold that I am entitled to claim of you, I will accept that in payment." Now, as these demands of the Government are recurrent, there will always be a set of persons to whom the Government paper stamped with a unit weight of gold is actually equivalent to that weight of gold itself, because it will secure immunity from requisitions to the exact extent to which the gold would secure it. - The Common Sense of Political Economy, Book II Ch 7

The idea that a tax obligation can be the basis of money, or what Randall Wray has termed twintopt, is at the core of modern monetary theory, or MMT.

Let's see how the tax backing theory holds up during the greenback period. To set the context, South Carolina had seceded from the Union in December 1860, soon followed by ten other states. Hostilities between the Union and newly-formed Confederate states began in April 1861. To help fund the Union side of the war effort, an initial $50 million issue of greenbacks was authorized in July. This was to be the first government paper money emitted since the Second Bank of the United States had been wound up.

The act ruled that these notes were to be redeemable on demand in gold, a promise that was also inscribed on the face of each note (see below). They thus earned the nickname demand notes. This promise meant that, at the outset at least, their price could not deviate from par since any movement above or below their gold value would be arbitraged away. When redemption was rescinded a few months later on December 30, 1861, demand notes began to trade at a 1-2% discount to their face value in gold.

Greenbacks were introduced in 1861. Note the progression from the first issue—ie 'demand notes'—to the second in 1862—'legal tender notes'. pic.twitter.com/ELnSg3QRtB

— JP Koning (@jp_koning) October 10, 2017

The second vintage of greenbacks, known as legal tender notes, was authorized two months later by the Legal Tender Act of February 25, 1862. This act provided for an issue of $150 million, much larger than the first vintage. One novelty is that the second batch of notes was declared legal tender, which meant that a creditor could not refuse to receive them at par in discharge of a debt. The legal tender property was extended to demand notes in March 1862. The second vintage of notes was also irredeemable, putting them on the same basis as the demand notes, which became irredeemable at the end of 1861.

What distinguished legal tender notes from demand notes? As the tweet above shows, the two vintages had visible differences—unlike demand notes, legal tender note did not have the promise to redeem on demand printed on their face. Demand notes also had an extra promise inscribed on them: "receivable in payment of all public dues". What this meant in practice is that the government accepted demand notes in payment for all taxes, including customs dues, whereas legal tender notes were only receivable in a narrow range of internal revenue taxes—and not for customs dues—which at the time made up the majority of Union tax revenues.

Receivability for customs dues was an important point of departure between demand notes and legal tender notes. Duties were priced in gold and could also be discharged with gold coins. So if an importer was on the hook for $x in custom duties, they could certainly scrounge up $x in gold coin to get rid of the obligation, but $x in demand notes would be sufficient to "secure immunity" from the tax. Not so with legal tender notes.

A given importer might only need a small portion of the demand notes in his possession to pay customs duties. Anything above that amount would be worth less than their face value to him, since gold—not demand notes—was necessary to buy goods internationally. However, if that importer could find other importers who were themselves under obligation to pay customs duties, and who would therefore value his remaining stash of demand notes for their tax receivability, then he might sell them his remaining demand notes at a price quite close to the value of gold coins.

So all that was needed to have irredeemable demand notes trade near the value of gold was a permanent market of tax payers who demanded those notes, and a flow of new notes that did not exceed the rate of drainage provided by the tax outlet. After all, if the supply of notes overwhelmed the amount of tax that needed to be paid, then notes would accumulate in importers pockets with no one willing to bid for them. Once everyone's taxes had all been paid up, demand notes would trade at a discount to gold coins. 

Tax receivability was successful in keeping the value of demand notes close to their gold value. The chart below shows the price of both demand notes and legal tender notes relative to gold through 1862-63.  Demand notes never fell to more than a 10¢ discount relative to gold coin. Calomiris blames this discount on the risk that receivability for customs duties would be revoked by the government before notes had been paid in.

Legal tender notes, however, fell to an ever larger discount relative to both gold coin and demand notes, reaching a 40¢ discount by March 1863. While legal tender notes were receivable for domestic taxes, these taxes did not account for a very large share of government revenues. Nor were these taxes priced in gold. Which meant that, unlike demand notes, legal tender notes were not benchmarked to some real good or price index.

So what, if anything, determined the price of legal tender notes? Here I'll introduce another theory for the value of money; the metallist viewpoint. Rather than tax receivability driving a currency's value, a metallist looks to the currency's intrinsic value. When banknotes are fully redeemable, their intrinsic value is determined by the underlying gold on which the note is a claim, the value of which is set in the market for precious metals in technology and the arts.

In the case of legal tender notes, which were no longer redeemable, the realization of intrinsic value had only been delayed to some future point in time when gold convertibility would be re-adopted. This eventual re-mooring date was in turn a function of the Union government's ability to win the war, among other factors. According to this theory, the steady decline in the gold value of legal tender notes in the chart above can be blamed on the realization by the public that the war would last much longer than most originally thought, pushing the re-mooring date ever further into the future.

While the 1861 issue of demand notes had all been bought back and cancelled by the government by mid-1863, greenbacks remained outstanding even after the war had been won. Their discount to gold continued to widen till July 1864 at which point their price steadily rose. See the chart below. The steady return to par probably can't be explained by the tax-backing theory. Improved odds that the government's fiscal situation would allow it to resume gold convertibility—an event that finally occurred in 1879—is a better explanation. There have been a few interesting accounts written about the value of greenbacks over the full 1862-1879 period, including Wesley Clair Mitchell's A History of the Greenbacks in 1903, but also more recent contributions here (Calomiris), here (Smith & Smith) and here (Willard et al).

In sum, the U.S. government was issuing three non-fungible currencies by 1862. Coins and legal tender notes operated under the principles of a metallic money whereas the third, demand notes, seems to have been a purely tax-driven money as described by Wicksteed. So what about a modern dollar note? Is a Federal Reserve note like an 1861 demand note and mostly tax-driven, or like legal-tender notes and operating on a metallic basis?

I'm not entirely sure, but my guess is that it is a messy combination of both. When it comes to money, I'm not a believer in any one theory. Although the odds of a future return to the old 1972 gold redemption rule of 0.024 ounces per dollar is non-existent, the metallic explanation for the dollar's value continues to be relevant. Instead of redeeming currency with fixed amounts of metal as in days of yore, modern central banks repurchase notes with financial assets held in their vault in a manner that is consistent with hitting an inflation target. This is very much like 1800s-style metallism, except with an ever-shrinking CPI basket in the place of a fixed amount of gold.   


Sources:

Wesley Clair Mitchell, A History of the Greenbacks

PS: I recently started a discussion board here. Feel free to bring up topics not covered on my more recent blog posts, suggest posts, or discuss ideas that appear on my Twitter feed. I don't like Twitter for long-form discussion; I'd much rather divert them to the board.

PPS: Nathan Tankus responds here.

The ubiquitous Spanish dollar—a photo essay

"The head of a fool on the neck of an ass."

That's how Londoners described the strange silver coin pictured above, which first appeared in Britain in 1797. Due to worries that Napoleon was about to invade the British Isles, a run had developed on the Bank of England. In response, Parliament allowed the Bank to refuse to redeem its notes with gold coins, but this had only resulted in an inconvenient shortage of coins.

To remedy the shortage, the Bank of England decided to open its vault and put its hoard of silver coins into circulation. Complicating matters was the fact that these coins were not native shillings or pennies, but Spanish dollars, otherwise known as eight real pieces. As such, they had to be re-purposed into local currency. The Bank of England accomplished this task by stamping the head of King George III—the fool—on the neck of Charles IV of Spain—the ass—who occupied the obverse side of that era's version of the Spanish dollar. The Bank then declared that all stamped Spanish dollars were to be worth four shillings and nine pence. People flocked to the Bank of England's window to get their hands on the new coins.  

That the Spanish dollar temporarily became part of England's circulating media of exchange was due to its ubiquity—in its heyday the Spanish dollar, like today's U.S. dollar, was everywhere. After discovering huge amounts of silver in the new world, the Spaniards had set up a mint in Mexico City in 1536 to produce large quantities of silver coins. Mints in Potosi (Bolivia), Lima (Peru), and elsewhere soon followed. It is estimated that some four-fifths of the world's silver produced between 1493 and 1850 came from Spanish America, almost all of it in the form of Spanish dollars! 

Although their design changed over the centuries, by the 1700s the Spanish dollar—easily identified by the two "pillars of Hercules" on the reverse side of the coin—had become known and accepted all over the world. As the map above shows, the two pillars refer to the Rock of Gibraltar in Spain and its counterpart on the Moroccan side of the narrow strait separating Africa from Europe.

In addition to England, the Spanish dollar shows up in the Caribbean islands where it made up a major part of the local coinage. To provide small change, locals cut dollars up into pieces. Below, an 1806 dollar used in Guadeloupe has had its centre carved out of it and stamped with the letter "G". Earmarking of coins was done to prevent exportation and restrict usage within borders. In this way, local currencies were literally piggybacked into existence off of the ubiquitous Spanish dollar.

Source: The Spanish Dollar as Adapted for Currency in Our West Indian Colonies

In the next image, a Trinidadian version of the dollar has been carved up like a pizza. The half piece has been countermarked with a "6", the third with a "4", and the sixth with a "2". These numbers refer to the number of bits or bitts the piece was worth, the bit being a local accounting unit. By marking the letters "TR" on each dollar to indicate Trinidad, the Spanish dollar has been forked to create a second currency.

Spanish dollar marked with TR for Trinidad

All possible methods of cutting up Spanish dollars were used. Here's a 1797 dollar from Saint Lucia that has been cut up lengthwise, like a loaf of bread, with "SLucie" being countermarked on each section.

Saint Lucia Spanish dollar

The Spanish dollar also made a notable appearance on the opposite side of the globe. In 1813, the colony of Australia minted its first currency, the so-called holey dollar. To deal with a shortage of coins, the governor of New South Wales imported thousands of Spanish dollars. A convicted forger was contracted to cut the centre from each one, countermarking each of the resulting pieces with the name of the colony and its nominal value in shillings and pence. As in the case of the Caribbean Islands, this mutilation of the dollar was an attempt to render them useless outside of the colony. The outer ring was rated at five shillings and the centre—the dump—at fifteen pence, or one shilling and three pence. 

Australians solved a coin shortage in 1812 by overstamping Spanish reals—then cutting a second coin from the middle. https://t.co/HcM8FwCtyz pic.twitter.com/JYpzvmcihI

— JP Koning (@jp_koning) August 24, 2017

The Spanish dollar, which would become the Mexican dollar after Mexico won its independence from Spain, was also popular in China. Merchants and professional money exchangers, or shroffs, would test a coin to verify its silver content. According to James Gullberg, they went about this by balancing the coin on their finger and tapping it. If it rang, it was legitimate. The theory goes that once the coin had passed their purity test, a shroff would stamp that coin with his own peculiar chopmark—a Chinese character, an emblem, symbol, or a pseudo character. (I discussed this practice in more depth here). The more chops a Spanish dollar had, the better its quality—even after it had been chopped beyond recognition.

1807 Spanish dollar with chopmarks

Pictured above is a chopped Spanish dollar from 1807. According to Gullberg, Chinese merchants preferred the Carolus IIII dollar, which was issued between 1772-1810. They referred to it as four work, the IIII resembling the Chinese character for going to work. The influence of the Spanish/Mexican dollar continued even into the 19th century: the banknote below, issued in 1912 by the Sino-Belgian Bank, is redeemable in Mexican dollars.

International finance, 1912 edition. A Chinese banknote denominated in Mexican dollars issued by a Belgian bank. pic.twitter.com/wraMOcIepD

— JP Koning (@jp_koning) August 30, 2016

Moving back west, the Spanish/Mexican dollar had a key role to play in the North American economy up to the mid-1800s. In both Canada and the U.S., the unit of account function of money was separated from the medium of exchange function. Early colonists kept prices in pounds, shillings, and pence unit of account, but Spanish dollars and their subdivisions were used to transact business. Because of the long distance from England, there simply weren't enough shillings and pennies to make do.

Even though a local U.S. dollar coin—which was modeled off of the Spanish dollar—had been minted as early as 1794, the Spanish version remained by far the most popular form of coinage in the U.S. The presence of the Spanish dollar was even enshrined in American law, the coins having been declared legal tender in 1793. Many people have even speculated that the famous dollar sign, $, has been bastardized from the symbol for peso.

Source: Evolution of the Dollar Mark (1912)

To illustrate the ubiquity of the Spanish dollar in the U.S., below I've included a 6¼ cent note issued in 1816 by Easton and Wilkesbarre Turnpike Company, which built and operated private toll roads. This odd denomination only makes sense if you consider it in the same context as the Spanish dollar. Unlike U.S. dollars, which were divisible by 100 into cents, the Spanish dollar was divisible into 8 reals. A one-real coin, a fairly common unit around that time, would have been worth 12½ cents, and a ½ real coin worth 6¼ cents. So while the turnpike company's decision to issue a 6¼ cent note might seem odd to us today, it was probably meant as a convenience to its users, who would have been more familiar with Spanish coins than any other type of coin.

A 6¼¢ note (1816). Odd denomination, but logical given that the Spanish half-real was still a popular coin in the US. (8R = $1, so ½R = 6¼¢) pic.twitter.com/7oDAVCTfFc

— JP Koning (@jp_koning) September 18, 2017

As for Canada, below is an 1819 $5 bill from the Bank of Upper Canada. To help customers who couldn't read, the bank conveniently printed an image of five Spanish dollars at the bottom of the note.

This 1819 banknote has five Spanish dollars illustrated along its bottom

For a number of reasons, the Mexican dollar was eventually killed off . The U.S. had originally been on a bimetallic standard, but in 1834 the authorities changed the silver-to-gold ratio to 16:1 from 15:1, in the process slightly overvaluing gold. The discover of the yellow metal in California only further pressured the price of gold down relative to silver, exacerbating the legally-imposed undervaluation of silver. As a result, silver coins began to disappear. After all, anyone who had a stash of silver coins would have found it more profitable to melt them down and export them overseas where they traded at their true economic value. The U.S. had effectively flipped onto a gold standard. To compound matters, Spanish dollars lost legal tender status in 1856, which would have further crimped their demand.

As for Asia, several competing coins were created, including the Japanese yen, a near-replica of the Mexican dollar. The U.S. began to produce special trade dollars that were to be used solely in Asian trade (I wrote about the trade dollar here). Further reducing the demand for Mexican silver was the decision by many nations to follow the major western nations and officially adopt gold standards, including Japan in 1897 and the Philippines in 1904.

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Even though it was eventually eclipsed, there are still modern day echoes of the old Spanish dollar. The pejorative term two bit is still used in the U.S. as a synonym for cheap or insignificant, as in two-bit thief. One bit was ⅛ of a dollar, or 12.5¢, and two-bits 25¢, so a two-bit thief is a 25¢ thief. Amazingly, the practice of pricing in sixteenths continued on the New York Stock Exchange up till 2001. The Toronto Stock Exchange decimalized in 1996.

Up here in Canada, Quebecers use the word piasse for dollar. I had always assumed that they meant piece, but I recently discovered that the wording actually goes back centuries to piastre, the French word for the Spanish peso. Even more interesting is the vernacular usage of trente-sous (or 30 sous) to mean 25-cents, which I only understood after reading this from Frédéric Farid.
 

After the '87 market crash, a business man begs for 25¢ (Source)

The story goes like this. In the 18th and 19th Centuries, an English halfpenny was referred to in the colony of Lower Canada (i.e. Quebec) as a sou. The pound-shilling-pence unit of account (£/s/d) was still in use at the time but Spanish dollars were the most common coin in circulation in both Upper and Lower Canada. Dollars were officially rated by the British authorities at $4 for each £1. A quarter Spanish dollar (a two-real coin or 25 cent piece) would therefore be worth £0.0625.

Since an English pound contained 240 pence, that meant a quarter Spanish dollar was worth 15 English pennies, or 30 half-pennies. And given that Quebecers referred to half-pennies as sous, that gave rise to the ongoing practice of referring to 25 cents as 30 sous. When they use this term today, Quebecers are just referring to the archaic exchange rate between Spanish dollars and pence.

Source: La Maison nationale des Patriotes

This odd system of conversion really hits home when you work through the above scrip note emitted by Distillerie St-Denis, printed in 1837.  It is denominated in three different units. Trente-sous appears twice in French and once as XXX, while in the English paragraph near the bottom the £/s/d equivalent of one shilling and three pence, or fifteen English pennies, appears. Finally, a two-real coin, or quarter dollar—the pillars of Hercules side showing—has been emblazoned smack in the centre.

To end things off, you can also see a ghost of the old Spanish dollar in Venezuela's 12½ centimos coin. This coin is an eight of a bolivar—reckoning in terms of eights and sixteenths is a hallmark of the days of the old pillar coin.

Venezuela's strange 12.5 cent coin. It's a descendant of the famous Spanish dollar, divisible into eighth bits. pic.twitter.com/rVWmVkcdQO

— JP Koning (@jp_koning) May 20, 2016

Given Venezuela's ongoing hyperinflation, the likely destiny of the 12½ centimos coin is to be nothing more than another two-bit dead coin.

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Sources:
George Selgin, Good Money
A. Piatt Andrew, The End of the Mexican Dollar (link)
J.B. Caldecott. The Spanish Dollar as Adapted for Currency in Our West Indian Colonies (link)