An Oversimplified History of Money
Setting the stage for understanding crypto.
Today we’re talking about money.
Yes I know we’re all itching to get into bitcoin, doge, defi, NFTs, and the next 20x coin. I implore you to keep itching for a bit longer because knowing the fundamentals of money is important. It will set the stage for understanding the roles that cryptos play in our world today.
After all, bitcoin (the first-ever crypto) was created with the purpose of being an alternative currency that is independent of the control of central entities. It was meant to be a new kind of digital money.
We'll dive deeper into bitcoin's functions and technicalities at a future date.
To understand why there seems to be this need for new money we need to understand old money and current money.
Note: In most places, bitcoin is currently considered digital property instead of a currency. Currencies cannot be taxed.
Chapter 1: From no money to old money
Once upon a time, humans had to do everything on their own. They built their own shelters, made their own clothes, and sourced their own food. This was a time when no money existed.
Along the way, the people realized that it's inefficient to have everyone doing every kind of task so they specialized. By specializing, they got economies of scale and became higher-skilled at a single set of tasks. This led to workflow efficiencies and cheaper, higher-quality goods.
The result — an increase in the quality of life for humanity as a whole.
For specialization to work, the people needed an effective way to exchange what they produced with one another. So they began the process of bartering.
⚠️ The Problem: Bartering sucked
Time and effort-intensive
Imagine if I grew bananas and you made farming tools we would have to always agree on how many bananas each tool is worth before a trade can occur. This is hard, troublesome, and downright impractical at scale.
If on the off-chance that we agreed that a tractor was worth 1000 bananas and made the trade, you would have another problem — you would never be able to finish 1000 bananas before they went bad. You'd then need to have someone else take 995 bananas for something else.
The double coincidence of wants
Coincidence of wants: The intersection between what one party desires and what the other party can provide
What if you don't want bananas at all? What if you only needed potatoes? I would have to find someone else who wants bananas and has potatoes to be able to make the trade.
Now imagine these problems multiplied across every person within a society. Barter looks good on paper but is extremely inefficient in practice.
💡 Solution: Commodity money
To make this trading process easier, they needed something everyone agreed had value and could be used to help facilitate this exchange.
Because commodities hold value in their utility, they naturally took on this role. Throughout history, many different commodities have been used as money — cows, alcohol, cowry shells, giant unmovable limestones, and precious metals.
Thus commodities became the very first form of money, born out of the haphazard barter system.
Chapter 2: Old money gets an upgrade
Commodity money worked relatively well. But not all commodity monies were created equal. The best of them had to be:
Durable: You don't want your money rotting/eroding
Scarce: Sudden discovery of a large supply of the commodity would devalue the commodity immediately
Desirable universally: One man's trash is another man's treasure doesn't apply to money
Transportable: Carrying 50 bags of cowry shells across the ocean just to purchase a high-value item is impractical
Divisible: Have you ever tried buying an egg with a gold bar?
As the dust settled on the explosion of different types of commodity money, people eventually gravitated towards precious metals like gold and silver. While they are not the most useful material in the world, they are scarce, durable, and universally desirable.
⚠️ The Problem: Precious metals are difficult to transport and divide
💡 Solution: Representative money
Somewhere along the way people started to deposit their precious metals at a bank, in turn, the banks would issue promissory notes to them.
Promissory notes are pieces of paper with stamps of authentication that serve as a promise to their holders that they could exchange them for actual gold with the banks.
Instead of redeeming their gold at the bank, people began to use these notes to buy and sell goods and services instead. Banks also began to issue different denominations of the notes. These notes became proxies for gold itself.
For this system to work, people had to trust the banks to maintain that these pieces of paper were backed by something with real value.
This move was a pivotal moment for humanity in terms of the way we saw money. In increasing the utility of our money, we sacrificed our ownership and control over it.
This was a trade-off we were willing to make.
Chapter 3: From old money to current money
Eventually, countries began creating their own currencies through their central banks. To retain the value of their currency and for international relative pricing, these currencies were on the gold standard.
In short, the currencies' value was pegged to gold, and you had the right to a fixed amount of gold based on a set amount of currency.
⚠️ The Problem: Gold limits the economy
Here's some simple arithmetic:
Fixed supply of gold + Money supply pegged to gold = Fixed money supply
Fixed money supply = Limited economic growth
Limited economic growth = Bad :-(
+ Limitations in monetary policy (ability to incite inflation & deflation)
If you have no context about how our economy works, watch this extremely useful video by Ray Dalio to get a base understanding.
💡 Solution: Fiat money
To solve the issue, countries decided to drop the gold standard.
And… voila we have fiat. Yes, it's that simple.
Britain did this in 1931 and the United States followed in 1971.
By abandoning the gold standard, we have officially moved away from money having any intrinsic value. And we can increase and decrease the money supply as we wish.
"Money is the value by which goods are exchanged, not the value for which goods are exchanged" — John Law
The trade-off applies here as well. With fiat, we have to trust governments and central banks to maintain fiat’s purchasing power through sound fiscal policy.
The value of fiat
If fiat has no intrinsic value, what is holding up its value?
"Fiat has value because people believe it has value."
While that's true, it's not entirely true. The value of fiat is also held up by two systemic mechanisms:
Central banks and governments promise to take reasonable actions to preserve fiat’s purchasing power on the markets.
There is demand for fiat because it is legal tender.
A currency is legal tender when it is officially accepted as a form of money and used for payment of taxes in a country.
Since everyone needs to pay taxes, everyone in a particular nation needs that country’s fiat
Since businesses also need to pay taxes, businesses tend to accept fiat for payments even if they are not obligated to, leading to more demand for fiat
Ultimately, these factors drive belief in the value of fiat. But the value of fiat also comes from its systemic utility.
Systemic utility drives demand, and demand = value.
Think about this the next time someone says crypto-assets have no intrinsic value.
So... what is money, really?
Today's most widely accepted definition is the one from William Stanley Jevons in 1875. According to Jevons, money has three primary functions:
Medium of exchange: It is an intermediate instrument used to facilitate transactions between parties
Unit of account: It is the unit by which things are priced. The US dollar is a unit of account because the prices of goods and services are denominated in USD.
Store of value: It reliably retains the value you paid for it for future use
As the world changes, our ideas about money change as well. Michael Saylor, CEO of MicroStrategy thinks that money is socio-economic energy. Here's a clip of him speaking about it.
By the way, MicroStrategy has acquired more than 100,000 bitcoins in the last year.
I think that money is an entity that enables and supports the function of our societies. Its definition, properties, and functions have changed according to the needs, priorities, and perspectives of the people across history.
I believe it will keep changing as we write new histories.
The history of money was a lot more complicated than what I covered here. The path to fiat was full of hiccups along the way.
The developments in money occurred in different increments, at different times, in different geographical locations before homogenizing over time. If you’re interested in a fuller version of the history, you can learn more through this series on Youtube.
Money is like any other living organism. Evolve to survive, or die. The largest problems with our money today will be the driving forces for our next money tomorrow.
I know I left the most important questions unanswered. What are the biggest problems with our money today? Are bitcoin or any other cryptos the best solution to them?
We’ll dive deeper into these questions next time.