Many economists extoll the virtues of the free enterprise system. Yet even some of the staunchest advocates of laissez-faire insist that the market “fails” with respect to money and banking. While the claim that sound money can emerge spontaneously without any deliberate governmental design might not be popular, it is supported both by theory and history. The benefits of sound, market-generated money and banking are often underappreciated but highly significant.

The connection between sound money and banking is especially crucial because despite the ubiquity of central bank monopolies on the provision of basic money, highly regulated private banks still provide the vast majority of money circulating in the economy (mostly in the form of checkable deposits redeemable in basic money). The benefits free markets can provide through these institutions are particularly significant for less developed countries, which suffer disproportionately under poor money and banking systems.


Market money: The invisible hand is not fractured with respect to money

Though a number of classical economists recognized that money arose without any explicit design, the first to spell out the emergence of money step by step was the late 19th  century economist Carl Menger. He famously argued that media of exchange emerged primarily as a means of overcoming the high costs of a barter economy.  Over time, the decentralized actions of private individuals eventually caused the economy to converge toward a commonly accepted medium of exchange, i.e. money.

Later scholars built upon Menger’s ideas to show that the institution of banking also arose spontaneously alongside the emergence of money.  These authors showed that the best historical banking systems were the ones that were left most free to develop without burdensome government interventions and regulations. The key principle that prevented banks in these systems from either over- or under-issuing their own monetary liabilities is the market regulation imposed by competition. So in general, the government need not apply any special regulation to banking so long as it enforces contracts.

The emergence of sound, market-generated money and banking institutions helped finance the early stages of the industrial revolution and set the stage for more rapid economic growth and development. Indeed, Adam Smith outlined how the emergence of trustworthy, bank-issued money contributes to economic growth by converting what would otherwise be idle cash balances into a form of savings that can be intermediated into productive investments.  He even credited Scotland’s relatively free and unregulated banking system for being a primary catalyst for the country’s its rapid economic growth in the 18th and 19th century. Many other scholars have since shown the importance of the link between financial and economic development.

An important implication from this research is that the link between sound money, financial liberalization, and economic development is especially critical for poorer developing countries. The collapse of the international gold standard and of any vestige of support for sound, market-originated money has had pernicious effects for developing countries that – in the wake of the postwar “Keynesian consensus” regarding monetary policy – were often encouraged to establish central banks. All too often, however, these central banks wielded their power for the benefit of their sponsoring government’s coffers, financing large budget deficits and opportunistically trying to manipulate the public’s inflation expectations.

Fortunately, recent technological advances have made it easier for even citizens of the poorest nations to gain access to alternative, private forms of money as well as the private banking system.


Government response threatens Bitcoin and other recent advances

There’s no better illustration of how money can emerge through the actions of private individuals than the rise of Bitcoin.  If polled in, say, 1999, most economists would have said it was impossible for private individuals to create any sort of money in the 21st century. But bitcoin proved that proposition to be false.  Bitcoin is a privately created, irredeemable electronic currency. While it may never become a major form of currency, its acceptance has spread quickly.  Bitcoin is not issued by any government, nor backed by any physical commodity, but many large companies such as Microsoft, Dell, DISH Network, and now accept bitcoins as payment for goods and services.  Still, many governments are issuing rules and regulations that endanger the benefits from these types of advances.

China, India, Jordan, Kazakhstan, Mexico, Russia, and Thailand – to name a few – have all been hostile toward bitcoin.  In 2013 China prohibited financial institutions from “buying, selling, quoting prices in, or insuring products linked to bitcoin.”  The Reserve Bank of India and the Bank of Thailand didn’t go this far, but they issued warnings about the risks of transacting with bitcoins. In the world of finance, these types of warnings have a major impact because regulators possess so much control over financial firms.  For instance, shortly after the Reserve Bank of India issued its warning, the main bitcoin trading platform in India suspended its operations.

The situation in the U.S. has been somewhat mixed. Federal Reserve Chair Janet Yellen, for example, announced in 2014 that the Fed “simply does not have authority to supervise or regulate bitcoin in any way.”  The Treasury Department’s Financial Crimes Enforcement Network (FinCEN)  has – so far – decided to regulate all bitcoin-related service companies as any other money transfer firm. This decision subjects these firms to U.S. anti-money laundering laws, but an even bigger barrier has been the decision by a few states to take a more hostile approach than the federal government.  New York’s BitLicense, for example, caused several prominent bitcoin-related companies to cease operations in New York.

Typically, governments justify the heavy-handed approach in the name of consumer protection and crime enforcement. At least two U.S. Senators have spoken out against cryptocurrencies. U.S. Senator Charles Schumer (D-New York) referred to bitcoin as “an online form of money laundering used to disguise the source of money, and to disguise who’s both selling and buying the drug.”  Senator Joe Manchin (D-West Virginia) suggested – though he did not explicitly call for it – that an outright bitcoin ban could be the way to go, given that the digital currency has “allowed users to participate in illicit activity, while also being highly unstable and disruptive to our economy.”

These sorts of statements ignore that criminals regularly use U.S. dollars, even though nobody could ever confuse the dollar with an unregulated digital currency.  Surely even Senators Schumer and Manchin would stop far short of calling for a ban on U.S. dollars to stop criminal activity.  Unfortunately, the Senators’ hyperbolic view overshadows much calmer official government statements. It seems to be forgotten, for example, that David Cohen, the U.S. Treasury Department’s undersecretary for terrorism and financial intelligence, announced that the U.S. government sees no evidence of widespread use of virtual currencies for evading sanctions or financing terrorism.  And few seem to remember that the German Finance Ministry has recognized bitcoins as a unit of account, allowing its citizens to pay taxes with the virtual currency.

Advocates of stricter regulations also argue that bitcoin is ripe for consumer fraud because the transactions are irreversible. It’s true that bitcoin exchanges cannot be reversed with the type of chargebacks available to credit card users. But many business owners have pointed out that this finality is a feature, not a bug.  It turns out that fraud works both ways: Sometimes consumers purchase goods and then tell their credit card company not to pay the merchant, thus defrauding a business. Overstock CEO Patrick Byrne, for example, has touted bitcoin for exactly this reason, pointing out that bitcoin makes such fraud “pretty much impossible.”

Critics also ignore that markets can actually address these types of problems without overbearing government regulation. And they miss the broader point: No cryptocurrency, or any other private currency, will gain widespread acceptance unless it can overcome problems like these to the satisfaction of both consumers and business owners.  In many places, regulatory, legal, security, and fraud issues seem to be overshadowing what policymakers should be focusing on: fostering competition in money and banking.


M-PESA and the rise of mobile money

A major advance in recent years, particularly in the developing world, is mobile phone-based payment and banking services, popularly known as mobile money. Mobile money began as a way to transfer cellphone minutes. Over time, it evolved into a full-scale payment and money transfer system. Mobile accounts are typically denominated in a given country’s domestic currency, and therefore do not themselves represent entirely new forms of private money.

Nevertheless, they do offer their customers a seamless way to swap their government-issued currency for privately-issued bank deposits, foreign currency denominated deposits, or balances denominated in any digital currency.

Since 2007, 255 “mobile money” services have been deployed, reaching more than 300 million customers in 89 countries—roughly two-thirds of all developing markets.  More than half of these services have taken root in Sub-Saharan Africa, the region of the world with the lowest rate of financial inclusion.  The most successful case study of the mobile money revolution thus far has been M-PESA in Kenya.

M-PESA was launched in April 2007 by Safaricom, Kenya’s largest mobile provider. Today, Kenya is the world leader in mobile money with 26.2 million accounts – more active accounts than adults in its population. The M-PESA system in Kenya now handles more transactions than Western Union does globally.  The total value of M-PESA transactions exceeded $24 billion in 2013, more than half of the country’s GDP.

The most important impact of M-PESA is that it has played a significant role in accelerating the development of Kenya’s financial system. Traditionally, banks had been unable to profitably branch to reach the vast majority of the rural, unbanked population. In 2006, Kenya had only 450 bank branches and 600 ATMs—fewer than two bank branches per 100,000 people.  The rise of M-PESA, however, has ignited a wildfire of innovative apps and new business models that have rapidly accelerated the pace of financial inclusion.

Perhaps the most critical innovation was the model of agent banking. Agent banking allowed Safaricom and its licensed retailers to set up small shops throughout the country. These shops, or “agents,” provided basic banking services such as cash deposit and withdrawal and money transfer services. Within months of M-PESA’s launch, the number of agent branches in Kenya had surpassed the number of banks, ATMs, and alternative money transfer services combined.  As of 2014, Safaricom had enlisted more than 116,000 agents across the country.

Another important innovation, developed by local banks, is mobile savings and credit applications connected to M-PESA. Applications like M-KESHO, M-Shwari, and MOBI-BANK have connected millions of unbanked citizens to the formal banking system, enabling them to set up mobile checking and savings accounts and access relatively cheap credit for the first time. The result has been a rapid increase in financial inclusion. Between 2007 and 2010 alone, the number of bank accounts in Kenya increased from 2.5 million to 8 million.

The percentage of Kenyans with access to formal institutions nearly tripled from less than 25 percent in 2006 to more than 67 percent in 2013.  Another beneficial effect on the Kenyan financial system has been increased financial deepening, defined as the ratio of private bank liabilities to GDP. This ratio rose from roughly 33 percent to 44 percent in the five years following M-PESA’s emergence.  The Economist Intelligence Unit projects the amount of bank credit and deposits in the region will rise by as much as 300-500 percent by 2020.


Competition and an ‘enabling’ regulatory environment

One of the reasons why Kenya served as ground zero for the mobile money revolution was because its regulators had the wisdom to create an “enabling” regulatory environment. This approach allowed mobile providers to issue mobile monies and establish agent networks without being subjected to the same strict regulations as traditional banks.  Additionally, M-PESA has stimulated numerous financial innovations that have promoted monetary competition.

Entrepreneurs have already begun launching apps that allow mobile money users to transact in bitcoin and other digital currencies as well as other national currencies. In Kenya, for instance, Kipochi was launched in 2013 as an M-PESA integrated bitcoin wallet. The next year, BitPesa was launched to facilitate large-scale remittances. If other developing countries follow Kenya’s lead, mobile money services could help spur enormous economic growth.


The lesson from innovations such as Bitcoin and M-PESA is that the invisible hand not only can extend to the provision and regulation of money but, in fact, should. The market is fully capable of converging toward good money when governments keep from meddling in the monetary system and restrict themselves to enforcing contracts and upholding the rule of law. If technological advances are indeed making Hayek’s ideas on competing private currencies more feasible, the frontier we should be focused on might in fact be the developing world.

There, domestic currencies are relatively poor and access to the banking system has been sparse. But technological advances in money and banking have been improving access to the banking system and imposing some discipline on the worst government monetary authorities.  These advances should be fostered, which means that regulators should permit competition not only in the banking and payment system – as countries like Kenya have begun doing to a small degree – but also in the provision of money itself.  If these innovations take hold and continue to help the developing world prosper, the U.S. and other developed countries will also reap the benefits.