On the Nature of Central Banks (as Firms) and the Emergence of Central Banking

8 min readFeb 9


This writing extends my work, Ronald Coase, and Nick Szabo’s in regard to the emergence of central banking, the cause of it, and the value that might be harnessed because it with relation to the advent of CBDC’s and bitcoin. It’s a powerful observation written in an innocent seemingly (but not) undeveloped form.

On the Nature of the The Wealth of Nations

The Wealth of Nations is a book that I find very often misrepresented. I have had many occasions where I call the other person out for not having read the book while citing from it. The full title of the book is important and helpful to note here, “An Inquiry Into the Nature and Causes of the Wealth of Nations”. And its not an opinion piece, its an objective overview.

On the Nature of ‘The Nature of A Firm’

I unfortunately can’t give proper credit due for an article I came across about Coase theorem, named after Ronald Coase. The article explained that Coase’s theorem was not named after exactly what Coase’s insight described but rather a corollary of it.

Whether or not I understand and recollect the writing that inspired me I felt I needed to go back to understand Coase’s insight and this led me to spend some more time with his works “The Nature of the Firm”

As for the Nature of “The Nature of the Firm” its relevant to point out that it seems to me at least that the “nature” part of the title is a reference to the insight being and extension of Smiths TWON:

It can, I think, be assumed that the distinguishing mark of the firm is the supersession of the price mechanism. It is, of course, as Professor Robbins points out, “ related to an outside network of relative prices and costs,”1 but it is important to discover the exact nature of this relationship. This distinction between the allocation of resources in a firm and the allocation in the economic system has been very vividly described by Mr. Maurice Dobb when discussing Adam Smith’s conception of the capitalist : “ It began to be seen that there was something more important than the relations inside each factory or unit captained by an undertaker; there were the relations of the undertaker with the rest of the economic world atside his immediate sphere . . . . the undertaker busies himself with the division of labour inside each firm and he plans and organises consciously,” but “he is related to the much larger economic specialisation, of which he himself is merely one specialised unit. Here, he plays his part as a single cell in a larger organism, mainly unconscious of the wider rale he fills.”

What is a Firm?

A Firm by Coase’s definition is best understood in contrast to market and priced based transactions:

In view of the fact that while economists treat the price mechanism as a co-ordinating instrument, they also admit the co-ordinating function of the “ entrepreneur,” it is surely important to enquire why co-ordination is the work of the price mechanism in one case and of the entrepreneur in another. The purpose of this paper is to bridge what appears to be a gap in economic theory between the assumption (made for some purposes) that resources are allocated by means of the price mechanism and the assumption (made for other purposes) that this allocation is dependent on the entrepreneur-co-ordinator.

A Firm then has a entrepreneur which organizes, otherwise market based transactions, but within the firm with other agent under (employment type) contracts with the firm. For cause it seems that is a reason that a Firm might be more profitable than independently seeking market solutions:

The main reason why it is profitable to establish a firm would seem to be that there is a cost of using the price mechanism. The most obvious cost of “ organising ” production through the price mechanism is that of discovering what the relevant prices are.4 This cost may be reduced but it will not be eliminated by the emergence of specialists who will sell this information. The costs of negotiating and concluding a separate contract for each exchange transaction which takes place on a market must also be taken into account.

On The Role of Contracts in Firm Formation

Coase goes on to describe the relations between Firms and the nature of the types of contracts they might have that would distinguish them as independent market agents:

A factor of production (or the owner thereof) does not have to make a series of contracts with the factors with whom he is co-operating within the firm, as would be necessary, of course, if this co-operation were as a direct result of the working of the price mechanism. For this series of contracts is substituted one. At this stage, it is important to note the character of the contract into which a factor enters that is employed within a firm. The contract is one whereby the factor, for a certain remuneration (which may be fixed or fluctuating), agrees to obey the directions of an entrepreneur within certain Zimits.2 The essence of the contract is that it should only state the limits to the powers of the entrepreneur. Within these limits, he can therefore direct the other factors of production.

The Re-solution of Unionization and Capitalism

Here unionization isn’t a fair word to peg Coase with having referred to but I think it can be helpful to understand the nature of his observation. He wants to show that it can be in capitalistic free market that it might still make sense that an internal hierarchy is born out of a group voluntarily giving up there independent in the market (ie they will become workers under a single boss).

And this is especially based on the cost’s associate with using the price mechanism of the market and the formation of contracts. This means if there are issues with getting honest prices and forming good (perhaps long term!) contracts then it might be in one’s rational self interest in a capitalist market to participate rather in a firm.

This re-solution, which doesn’t choose which type of an economy or society each is best in regard to firms, but rather simply observes how and why the formation of firms can happen naturally, I believe is Coase’s intention. He was excited because he re-solved traditionally conflicting views.

The views still can conflict. They are peoples views. But you can now put the phenomenon of firms and free market agents under the same theory.

On the Special Nature of CBDC’s

CBDC’s are being blindly resisted by libertarians and bitcoiners alike. I think they don’t understand CBDC’s and I think they and many economists wouldn't believe me if I told them what CBDC’s are. CBDC’s are M0 which is easy enough to guess and understand for someone that has read of the concept M0.

But I think still in practice and thought and speech the former faction including noted economists would not believe that you can settle with a CBDC without going through the central bank (otherwise how have we not just opened a chequing account with the FED?).

On the Nature and Role of Clearing Function of Central Banks

People don’t really need to take the time to understand money in order to use it. This is how it arose, naturally, without design or foresight, and so as technology it has evolved beyond the comprehension of the average user of it.

I think many people would be surprised and even economics student to understand that the reason that central banks exist from a clearing and settlement stand point is simply because of the cost to transfer cash and coins.

Its the driving and security cost of transporting the base layer medium that creates the usefulness of central clearing.

On the Cost of Transport and the Effects of a Reduction It In a Market

Here we return to Nick Szabo’s formalization of Smith’s observations as an extension of Metcalfe’s (network theory) law:

Metcalfe’s Law states that a value of a network is proportional to the square of the number of its nodes. In an area where good soils, mines, and forests are randomly distributed, the number of nodes valuable to an industrial economy is proportional to the area encompassed. The number of such nodes that can be economically accessed is an inverse square of the cost per mile of transportation. Combine this with Metcalfe’s Law and we reach a dramatic but solid mathematical conclusion: the potential value of a land transportation network is the inverse fourth power of the cost of that transportation. A reduction in transportation costs in a trade network by a factor of two increases the potential value of that network by a factor of sixteen. While a power of exactly 4.0 will usually be too high, due to redundancies, this does show how the cost of transportation can have a radical nonlinear impact on the value of the trade networks it enables. This formalizes Adam Smith’s observations: the division of labor (and thus value of an economy) increases with the extent of the market, and the extent of the market is heavily influenced by transportation costs (as he extensively discussed in his Wealth of Nations).

On the Nature of the Formation of Central Banks and the Implications of CBDC’s

Central banking in its current form is effectively a new technology. Current bitcoin mainstream theory sees this technology as obsolete. In fact the libertarian bitcoiner dreams so hard of a world without them that they don’t have a real argument as to where they will go and why. The bible for this baseless argument was named “A Bitcoin Standard”.

This is seemingly purposefully confusing since it doesn’t really describe a money or bitcoin standard at all. There’s no economic theory in it whatsoever.

Here I wish to present a theory of the formation of central banks which is based on the value harnessable that grows with the extent of an economy that has evolved to have (multiple) private banks (with there own private currencies).

This value harnesasble then simply arises as the cost (which includes time and security!) of the transport of the money mediums.

A Positive Theory of CBDCs

If Bitcoin is set to asymptotically take control of central bank’s abilities to create differing monetary policy effects then there is left the role and function of clearing and settlement. Because of Szabo’s formulation we are able to see the value of a change from a settlement medium that is physical to one that is digital (and thus can be instant) is immense.

I think this value should be studied and I think that CBDC’s would introduce a proper bridge for nations to adopt bitcoin as the base layer settlement for international contracts and in doing so nations would then themselves benefit from the reduction in transport cost of their current physical currencies.

Without Loss of Generality

This insight would apply generally to any economy that grew to have value captured or capturable by a central clearing authority. This support’s our theory of bitcoin backed banks as a corollary to the world wars increasing the cost to transport gold effectively nullifying the value of it as the base layer settlement medium/standard. Here we are thinking about the world clearing institutions such as the IMF.