Sunday, January 3, 2016

What makes money special, the lawyer's edition (with a guest appearance by bitcoin)

Juan Galt recently introduced me to one of bitcoin's biggest problems. Bitcoin is not money, at least not according to the law.

Economists like to say that money is unique because it is a medium of exchange, store of value, and unit of account. Lawyers and judges have a different story to tell about money's uniqueness. Unlike goods, money can't be 'followed.' When a good is exchanged, its entire history goes with it. This history may be checkered. Say that a car has been stolen at some point in its past and then sold, and the police discover this fact. The current owner—though having purchased the car innocently—is required to return it to its rightful owner. The law 'follows' goods.

With money things are different. Each time a monetary instrument is transferred, its history is wiped clean. As long as the recipient accepts the money in good faith, the original owner of stolen dollars cannot make a claim for those dollars.

This peculiar legal treatment of money, dubbed money's liability limitation by Steve Randy Waldman, ensures fungibility. When all members of a population can be perfectly substituted for each other, than we say that they are fungible. If each monetary unit's unique history becomes a datum that merchants must take into account before selling a good, then fungibility no longer prevails. One unit may be worth more than another because its history is more pristine.

Fungibility is important because it promotes the smooth functioning of a monetary system. If merchants have to analyze each piece of money they are offered to ascertain its legitimacy, long lineups will develop. Exchange grinds to a halt.

So why not extend the status enjoyed by current forms of money to bitcoin? What follows is a quick tour through the history of how jurists have rationalized the legal treatment of other forms of money, including coins, banknotes, and bills of exchange. This should provide us with enough grist to analyze bitcoin's current legal status.


Let's start with coins. The basic principle of nemo dat quod non habet governs property; no one can give away that which they do not have. According to early common law jurists, coins were exempt from nemo dat because they couldn't be followed. The inability to follow coins arose from the fact that they were homogeneous. In the words of the jurists of the day, 'money has no earmark.' Whereas one pig could be differentiated from another thanks to the practice of earmarking—cutting out a distinct piece from a pig's ear—coins could not be earmarked, and therefore could not be differentiated.

Thus there was no way for a victim to lay claim to lost or stolen coins. With no way to prove that the coins in the accused's pockets had not already been there, mixed coins could not be sufficiently distinguished to establish title. James Fox, for instance, cites a 1614 case in which a gambler, Warde, "thrusts" his coins into the stack of another gambler, Aeyre, perhaps hoping to get a tell from of his opponent. Aeyre refuses to give the coins back. The judge upholds Aeyre's rights to the entire stash since money has no earmark, and therefore nemo dat does not apply. Once mixed, who ever possesses the pile of coins has the best title.

Interestingly, the only way to preserve ownership of coins in the medieval era was to keep them in a bag. Since they could now be identified by the distinctiveness of their container, like any other good they were subject to nemo dat. Had Aeyre's coins been bagged, he could have easily mixed them with Warde's without losing title to them.

The fact that coins had no earmark meant that each piece's distinct past was irrelevant. While this was awkward for poor Aeyre, society was made better off by this decision. Coins became much more fungible than they otherwise would have been, and this would have dramatically promoted their use in trade, greasing the wheels of commerce in general.


Let's move on to paper credit, namely bills of exchange and banknotes. While bills of exchange developed in the 12th or 13th century, the first notes would not have appeared in England until the 17th century. Though English common law was useful for land disputes, it had not yet developed the expertise to deal with commercial disputes. Indeed, common lawyers' expertise with commercial matters was so limited that Josiah Child, an English trader, complained that he could only make his lawyers understand "one half of our case, we being amongst them as in a Foreign Country."

Rather than resorting to common law, problems arising from the usage of negotiable instruments like bills were governed by lex mercatoria, or merchant's law, a private form of commercial law or custom that had been developed by European merchants over the preceding centuries. Market courts, operated by the merchants themselves, guaranteed a decision the day after a complaint, a necessity given the mobile nature of commercial life.

According to Lowry, the close-knitted nature of the merchant class began to unravel by the end of the seventeenth century, making merchant law less enforceable. As commercial cases were increasingly brought to common law courts, jurists had to decide how to treat these new financial innovations.

Lex mercatoria had always accepted the principle that, as in the case of coins, bills of exchange could not be followed. Since those who accepted bills of exchange didn't have worry about whether they had been stolen or not, this would have made trade in bills of exchange extremely fluid. However, the stance taken by lex mercatoria was an anathema to common law logic. Unlike coins, which couldn't be followed due to their lack of earmark, both bills of exchange and banknotes did have earmarks. Whereas coins were issued in uniform denominations, bills of exchange were usually made out in non-standard ones, say $101.50, making for easy identification. Bills were also signed by a unique debtor and a range of consignees. As for banknotes, these had serial numbers on them. Without the homogeneity of coins, there seemed to be no way to save the these relatively new financial instruments from the harsh strictures of common law nemo dat. Goods they were to be, not money.

It was Lord Mansfield, an English jurist, who took on the task of incorporating lex mercatoria into English common law (Adam Back notes a similar case in Scotland). Take Miller v Race, Mansfield's definitive ruling on banknotes in 1758. The note in question had been issued by the Bank of England "to William Finney or bearer on demand" and subsequently mailed to a third party by Finney. Along the way it was stolen and used to buy room and board at an inn, the innkeeper Miller innocently accepting the note. Finney, upon learning of the robbery, asked Race, an employee at the Bank of England, to stop payment of the note, upon which Miller the innkeeper sued Race. If the bill was treated as a regular good, then Finney would have prevailed. However, Mansfield ruled that despite the note having been stolen, Miller had the best title and was allowed to keep it.

In justifying his ruling, Mansfield dismissed as "quaint" the old earmark principle for not following money. Instead, he appealed to the common mercantile practice of the day. Banknotes, wrote Mansfield, are:
not goods, nor securities, nor documents for debts, nor are so esteemed; but are treated as money, as cash, in the ordinary course and transactions of business, by the general consent of mankind, which gives them the credit and currency of money to all intents and purposes. The are as much money as guineas themselves are, or any other current coins that is used in common payment as money or cash. 
The true reason that money cannot be followed, said Mansfield, is upon "the currency of it; it can not be recovered after it has passed in currency." Thus had Finney sued the robber before he had spent the stolen note, he would have succeeded in claiming title since the note had not yet passed into currency. But once Miller accepted it, the note was "in currency" and thus out of nemo dat's reach. In subsequent rulings, Mansfield extended this same protection to bills of exchange, cheques, bonds, and exchequer bills. Any contrary decision would "incommode" trade and commerce, wrote Mansfield. Thus the customs of merchants were transcribed into common law.


So both lex mercatoria and the common law tradition that superseded it accepted the principle that in order to protect commerce, highly liquid instruments should not be subject to nemo dat.  Given this precedent, why not extend this same broad amnesty to modern monetary innovations like bitcoin, Fedcoin, or other digital bearer tokens?

One reason could be that bitcoin hasn't proven itself yet. Whereas bills of exchange and banknotes had been widely accepted for decades, even centuries prior to Mansfield's ruling, bitcoin is less than a decade old. It fails the my-grandmother-uses-it-test or, in Mansfield's words, lacks the "general consent of mankind." People seem more intent on hoarding the stuff than trading it around in the "ordinary course of business." Unfortunately there is a chicken-and-egg dynamic at play here; how can bitcoin gain enough consent to be granted amnesty by the law if it needs amnesty to gain consent in the first place?

Lacking common law amnesty from nemo dat, an alternative would be to modify bitcoin so that it is completely anonymous. Although it is true that the real world identity of a bitcoin owner remains unknown, the blockchain itself is a publicly-distributed ledger that reveals the history of every single bitcoin. Removing the ability to see the ledger's history would restore true anonymity. In the same way that coins were originally exempt from nemo dat because they were physically impossible to follow, modern law would not be able to trace any given bitcoin because there would be no means to do so. Anonymity in turn guarantees fungibility, without which mass market adoption might never happen. My understanding is that extensions such as Zerocoin or Zerocash would be able to achieve this sort of true anonymity.

The third route is to roll with the punches and accept non-fungibility. If merchants must search each bitcoin's past, they will innovate solutions to cope. One innovation would be to set up a system for grading bitcoin so as to save on transaction time. Tokens that pass a test of authenticity would be accepted at par whereas low grade bitcoin, that which has a soiled history, would pass at a large discount to pure bitcoin. I believe that a few bitcoin grading services have emerged, including Mint Exchange, which sells freshly-mined bitcoin (which are unburdened by a history) at a premium to regular bitcoin.


Let's explore the third route a bit more. There is precedent for non-fungible monetary systems. During the so-called Wildcat banking era in the early to mid 1800s, U.S. privately-issued banknotes of the same denomination (say $1) were often  accepted at varying discounts to par. A $10 note from a the Bank of Talahassee might only be worth 98% that of a $10 note from the Bank of Fargo.

While banking regulations prevented note-issuing banks from establishing branches beyond state borders, nothing kept their notes from circulating outside of their home state. However, for notes to be settled in gold, they had to be returned to the issuing bank. Given the large distances involved and lack of transportation infrastructure, this could be an expensive process. To recoup this cost a merchant would typically accept local notes at par while applying discounts to non-local notes. The discount acted as a fee that covered the merchant's transportation costs. And since each bank's brand of notes involved different transportation costs, there were a bewildering number of discounts.

To solve the non-fungibility problem, a new profession emerged, that of a banknote analyst. In addition to providing merchants with information on how to spot counterfeit bank notes, an analyst would publish a weekly banknote reporter that advertised the market price of each banknote that circulated in a particular city, say Philadelphia. Gary Gorton provides a visual feel for what one looks like. Philadelphian merchants who subscribed would, upon being proffered a particular note by a customer, consult their reporter and apply the proper discount. I've explained in more depth how this process worked here and here.

While a Wildcat-era sorting mechanism for bitcoins would help merchants cope with the fungibility problem, any sort of grading process would also impose an extra set of costs on the bitcoin system, making it less competitive with banknotes and deposits. The lack of uniformity of U.S. banknotes was recognized to be enough of a problem that the 1864 National Banking Acts required all banks to accept notes at par (it would have been better to allow banks to establish branches across state lines, of course. See George Selgin here).

Uniformity would certainly be the most efficient solution for bitcoin, but lacking a central authority that can enforce par acceptance, bitcoin may have to endure a period of non-fungibility before the law deems the cryptocurrency popular enough to earn amnesty from nemo dat. That's a low bar to set, but if bitcoin is as good as its proponents say, it should be a bar that can be limbo-ed.


S. Todd Lowry: "Lord Mansfield and the Law Merchant: Law and Economics in the Eighteenth Century" (1973) [link]
Benjamin Geva: "The Payment Order of Antiquity and the Middle Ages" (2011)
Kenneth Reid: "Banknotes and their Vindication in Eighteenth-Century Scotland" (2013) [link]
David Fox: "Banks v Whetston" in Landmark Cases in Property Law (2015)
Tim Swanson: Unable to dynamically match supply with demand (2015)
Nick Szabo: From Contracts to Money (2006)


  1. Last year, Japanese court ruled that Bitcoin is not subject to ownership, because it is intangible. A lawyer's analysis can be read here: A Singaporean lawyer made the same conclusion with respect to Singaporean law here: . My talks with Stephan Kinsella, a patent lawyer who specialises in theory of property rights, appear to show that he also agrees. Konrad Graf published a monograph about the topic last year here: . I have not read Graf's book yet but since we (Kinsella, Graf, me) tend to agree with each other in respect to legal theory, I think he also makes the same argument, just more thoroughly.

    Also last year, the ECJ made a ruling that from VAT perspective, Bitcoin is to be treated as money, and services around it to be treated as financial services (also no VAT).

    I suspect that other countries will make the same ruling (with respect to ownership) for the same reasons, unless there are specific laws enacted. This would mean that the nemo dat quod non habet is irrelevant.

    1. "I suspect that other countries will make the same ruling (with respect to ownership) for the same reasons."

      No, Australia has said that bitcoin isn't money wrt to tax.

      ...and they cite Mansfield's 1758 decision.

      The big question however is what U.S. law says about bitcoin. What have the courts and or tax authorities said up till now?

    2. Tax is a different thing than ownership and there are different tax laws too. Most EU countries (at least those that I analysed) treat bitcoin-related income tax as barter, while at the same time from VAT perspective they have to treat it as money (some already did prior to the ECJ ruling). Japan also treats bitcoin-related income as barter from tax perspective yet at the same time the court rejected the idea that bitcoin is subject to ownership.

      Australia rejected the VAT exemption for bitcoin sales, but companies are lobbying for a change and senator Sam Dastyri is trying to push a law in this direction. UK's HMRC originally also originally did not exempt bitcoin sales from VAT, but after successful lobbying they changed their opinion. Similarly, some countries objected to the idea of VAT-exemption in front of ECJ, but the court nevertheless decided to make bitcoin sales VAT exempt. The Advocate General literally said that the German VAT laws are incorrect with respect to bitcoin.

    3. In the ATO ruling it literally says:

      "78. In this context, the term 'instrument' in the phrase 'negotiable instrument' refers to a formal legal document[37]. Bitcoin, however, is intangible and therefore is not an instrument, and therefore cannot be a negotiable instrument."

      Again: ***Bitcoin, however, is intangible and therefore is not an instrument***

      So for the same reason, Australian court should come to the conclusion that Bitcoin is not ownable either.

    4. No, you're interpreting that wrong. It is not a negotiable instrument, and therefore as per item 51 is not considered to be money.

      But what about the U.S.?

    5. You misunderstand me. The VAT laws and other laws. The VAT ruling only affects VAT issues. But the same reasoning will probably be used in other rulings regarding other laws too, and that should lead to the conclusion that Bitcoin is not subject to ownership. Similarly as words are not subject to ownership, unless there are specific laws that grant monopolies in this area, such as trademark law or copyright. But bitcoins are neither trademarked nor original works so these laws have no effect either.

      I don't know of cases like this in the US. I suspect that people tried to sue others for "theft" but their lawyers told them that the courts wouldn't recognise it (for the same reasons I explained).

      Even in cases that are related to Bitcoin and public, there is no sign of "theft" in the documents. The two agents that "stole" money from Silk Road were sentenced for money laundering and obstruction of justice (and one of them also extortion), not for theft.

    6. I'm not accusing you of being wrong on VAT rulings being relevant to non-VAT disputes. Agreed. I'm saying that your reading of the specific Australian decision is wrong. Australia does not qualify bitcoin as money as it is not a negotiable instrument (among other things). And if Australia says bitcoin is not money, how can it qualify for exemption from nemo dat?

      I could be wrong, but there seems to be no landmark case on this subject. That would certainly make interpretation easier. A legitimate owner of bitcoin A needs to have those stolen and spent at a legitimate merchant B, and then A needs to sue B. Then we'd have clarity.

    7. Again, just look at Japan. The reason why I suspect bitcoin will be exempt from nemo dat is that it's not ownable, not that it is (or is not) money. But the same final cause underlies both arguments: the intangibility of Bitcoin. ATO argues that Bitcoin is not money (or a particular form of thereof) because it's intangible, and the Tokyo court argued that Bitcoin is not owneable becuase it's intangible.

      Yes, a landmark case in the US would be beneficial. But since ther has been so much fraud and still no landmark case, I suspect that the lawyers think the courts won't recognise the claim so they recommended their clients not to bring the case to court.

    8. I see that the US CFTC has defined bitcoin as a commodity, not as money:

      I don't understand the ownability argument. Stocks are intangible, so are derivatives and bonds. Are you telling me I don't own these things?

    9. Regulators like CFTC tend towards more inclusive definitions, because it increases their power. The question about ownability is different because it does not affect regulatory power.

      Stocks, derivatives and bonds are contractual rights/obligations, while Bitcoin isn't (I explain this in my paper "The Origin, Classification and Utility of Bitcoin"). Technically though you may not own stocks either (DTCC does instead and you have a contract with DTCC).

    10. Interesting...

      So my three original possibilities for bitcoin were:
      1. Exemption from nemo dat thanks to the extension of currency status to bitcoin
      2. Some sort of upgrade to pure anonymity, say something like zerocoin, zerocash, or monero, so that bitcoin lacks any history whatsoever, and therefore will be fungible
      3. Coping with fungibility, like the free banking era.

      and this may be possible too...

      4. The law treats bitcoin as an intangible that cannot be owned, and therefore it can't be stolen, thus solving the fungibility problem.

    11. Well point 4 does not solve the fungibility problem completely, since income tax classification as property still can have a negative effect on fungibility. This also depends on the country, because in some countries classification as property means that profit/loss is not subject to income tax, unlike US. But with respect to liability limitation I believe it does solve the fungibility issue.

    12. Good point. Option 1 is the ideal one; it seems to solve both issues.

  2. For this to even be realistic, you would need to have RFID tracking on every $100 bill and ATM machines would have to scan incoming deposits by Serial Number. Never gonna happen. Oops.. /s #BankTellerRobots


    1. It's not totally absurd. In a 1740ish case, the owner of a note actually took down the serial numbers of his notes and advertised those numbers when the notes were stolen.

      If banknotes had not been exempt from nemo dat, it could be the obligation of a merchant or bank to double check a list of stolen notes before accepting them.

  3. Have you considered Monero (see as an alternative cryptocurrency which solves the fungibility problem? Unlike Bitcoin (BTC), Monero (XMR) is redesigned from the ground to be private, untraceable digital cash, and is actually fungible (all coins are mixed and balances are private by default, with the option of a view-only key for auditing/compliance needs). Monero is still early in development (much like where Bitcoin was back in 2010) but it holds much potential to someday overtake Bitcoin as true digital cash. The three pillars of Monero are privacy, decentralization, and scalability (see

    1. Yep, something like that would do the trick too.

  4. The compromise position would be the one that is used to firm up the certainty of real estate titles. Real estate, like bitcoin, is based upon a chain of title made available to the public. But, in real estate, unlike bitcoin, there is a statute of limitations on disputing the validity of a chain of title called the doctrine of adverse possession.

    For example, in Colorado, if you have a chain of title that is seven or more years long and accompanied by payment of property taxes for that time period, then it doesn't matter if there is a defect in your chain of title earlier on. A similar rule could provide, for example, that a chain of bitcoin title that is at least two years old and contains three or more transactions in that time period, would automatically be valid.

    There are similar compromise options like the holder in due course doctrine and transferor warranties applicable to negotiable instruments that could also be used.

    1. Interesting. Wouldn't this still create fungibility problems? If a bitcoin is less than two years old, then it would still be possible to dispute its validity. Young bitcoin might trade at a discount to older bitcoin, which having reached the 2-year mark would be unencumbered by its past.

  5. Just a note on the legal history of the fungibility of bills of exchange. Mansfield's decisions were only a first step in the process. Because the validity of bill was closely tied to its origination in a commercial transaction (i.e. its status as a "real bill"), it was an 1830s decision -- creating a presumption that all bills are valid -- that really made it possible for bills to be fungible. (See Rogers, Early History of the Law of Bills and Notes (2004).)

    This was actually a key distinction between the Anglo-American and the continental financial systems in the 19th century: both bills and notes could circulate as currency in Britain and the U.S., whereas notes had a significant advantage on the continent.

    Sorry that this comment does not have much to do with bitcoin.

    -- csissoko

    1. That's ok, your comment is a good one. I didn't know about those details. Browsing quickly, it seems that Rogers has a totally different view than Geva and Lowry. Rather than the law of bills emerging from lex mercatoria and being incorporated into common law, the law of bills emerged from common law itself. Well that muddies the waters a bit...

  6. "Fungibility is important because it promotes the smooth functioning of a monetary system. If merchants have to analyze each piece of money they are offered to ascertain its legitimacy, long lineups will develop. Exchange grinds to a halt."

    To some extent isn't this what AML rules do? To those to whom they apply, they have to verify the legitimacy of the person and their money.