Money, Currency Systems, and Monetary Assets — Part I: The Past
Introduction
“It’s a kind of game, and it’s a game where […] we have points and if you have points, there is this one move where you can reduce your points by a number and increase someone else’s point by the same number. And […] it’s one kind of a fair game. […] It is the closest thing you have to a universal motivator […] Money is definitely a kind of power.”
- Vitalik Buterin answering the question, “What is money?”
A core aspect of cryptocurrencies is its attempt to move beyond (or at the very least, provide a viable alternative to) the current predominant fiat currency systems, which by its very nature, is centralized. Buterin, the creator of the second most successful cryptocurrency in the world — Ethereum — is perhaps as well-placed as anyone to define money. While mainstream applications and public understanding of cryptos are firmly at the nascent stage — no doubt complicated by the wild speculation surrounding its value — the enthusiasm among investors and gradual adoption by businesses globally are undeniable indicators as to its future.
Before understanding the multifaceted problems which xBTC solves, a close look at money and its alternatives is needed. In this post, we do this by: firstly, discussing what is money and its various functions; secondly, tracing the history of money and more specifically, how currency collapse has preceded the collapse of governments; and thirdly, highlighting the need to beyond both the centralized fiat systems. This is the first post of a two-part series, where Part II will look into the solutions offered through decentralized finance (and in particular through bitcoin) to the issues highlighted in this post, while also detailing the lingering problems with these solutions.
What Is Money — A Functional Understanding
“Money is anything that people are willing to use in order to represent systematically the value of other things for the purpose of exchanging goods or services”
- Yuvan Noah Harari, in Sapiens
Historically, the functional definition of money as elucidated by William Jevons in late 19th century has carried much currency. This definition is so prevalent that it is still relied upon by economic textbooks in the modern age. These functions are: a medium of exchange, a common measure of value, and a store of value. Initially, the function of being a standard of deferred payment was also considered to be a stand-alone function, but it is now largely seen to be subsumed within the other categories.
As a mean of exchange, it is used as a mechanism for facilitating the exchange of goods and services. This utility of money solves the various inefficiencies of the barter system, such as the inability to consistently ensure “double coincidence of wants” — the situation where both of the transacting parties possess the exact item the other party wants, and in the correct quantities. Economists of the Austrian school argue that this function is actually the primary function of money, with the other functions (measure and store of value) depending on the degree of acceptability of money.
As a measure or unit of value, money serves as the metric by which the market value of goods, services, and other transactions are formulated. This function of money fulfills the necessary prerequisite for the creation of commercial agreements that involve debt. The third function of money is its ability to serve as a store of value — referring to its durability that would allow it to be saved, and retrieved, and thereby being able to, with certainty, function as a medium of exchange. Stemming from these features is its function of being able to serve as a standard of deferred payments, which means its ability to discharge debts accrued in the future — the basis of our modern credit systems.
In the following section, the reader is taken through a brief history of money, its different comparative iterations, the operation of centralized state machinery on fiat currencies — and its consequent impacts. This will set the stage for revealing what the future of money holds in store, and critically analyzing the best options that are available presently in the cryptos sphere.
History of Money — Tracing its Iterations, Developments, and its Impacts
You would be hard pressed to find any entity which has been so universally considered to be the central motivating factor behind human actions as money, whether correctly or not. Hence, it is only natural that the history of money is one of numerous interesting developments, all of which cannot be in any single study. Here, the focus will be on two very important facets observed in the history of money — firstly, of its varied iterations, and the shortcomings of such iterations; and secondly, of the deleterious impact that centralization has had on monetary systems, particularly through debasement of money. These features will highlight a disturbing yet important feature surrounding fiat money — namely, how currency collapse has preceded government collapse through history, and the need to provide an alternative to such a totalitarian, insecure and inefficient “solution” to the age-old problems (means of exchange, unit of measure, store of value) that money seeks to address.
The first usage of money, as replacing the antiquated barter-like systems of 100,000 years ago, is widely considered to have emerged about 3,000 years ago, from the “cradle of civilization” — Mesopotamia, or modern-day Iraq; this was a rudimentary form of money, known as commodity money, meaning it derives its value from the underlying commodity with which it is made. These gradually became complemented with representative money, a derivative form of currency, which may or may not have had underlying value — meaning currencies such as gold or silver with respect to the former, and paper in relation to the latter.
While metal currencies ticked important functions of what constitutes money, especially with its durability and divisibility, these suffered from various obstacles; for e.g., their supply was not predictable (unlike paper money) as it suffered from both positive and negative supply shocks. This in turn meant that its elasticity was very restricted, and thereby it was incapable of meeting changing demands for money. Paper money, despite its supply being theoretically non-scarce, did not suffer from these obstacles, and gradually became the predominant medium of exchange — although this is not to say that it replaced metal currencies entirely.
An important case study in the supply shocks characterizing metal coinage, was the epoch-making episode of the Roman Empire debasing its currency, by reducing the silver content of its currency from its purest 100% to 90% initially; then, to 50% over the next 150 years, and finally to 5% over the next 50 years. This resulted in the government being able to mint more coins — and the officials believed this would allow them to spend more owing to the minting of more silver coins with the same face value. However, this was matched with an annual inflation of around 1,000%.
The negative impact of such runaway inflation was only understood with time. For e.g., soldiers demanded higher pay as a result of the devaluing of their erstwhile salary, the rising costs were transferred to the general public who had to ever-increasing amount of taxation; this was on top of the fact that the runaway inflation had already put them in a deeply jeopardized financial predicament in their day-to-day lives. This had decimated their trade, and Rome being an empire that was built upon trade, the debasement of their currency triggered a domino effect that had caused the eventual decline of the massive empire. The decline of the Roman Empire is a classic case of how currency collapse precedes the collapse of the government.
There was a clear need to move beyond reliance upon metal coinage, and as addressed before, this came in the form paper currency. Banknotes were first issued in Europe in 1661, and the gold standard — referring to a monetary system where the paper notes are convertible into a predetermined quantity of gold, replaced usage of gold coins in Europe by the 19th century. The 20th century marked mainstream adoption of the gold standard across most countries in the world. Post World War II and the creation of the “modern” and global financial systems through the Bretton Woods Conference, the fiat currencies of most countries became tied to the U.S. dollar — which was in turn fixed to gold. When the U.S. de-tethered their currency from gold in 1971, many countries cut links with their currencies from the U.S. dollar, and soon most of the world’s currencies became “self-contained” in the sense that they were not backed by anything except that government’s fiat of legal tender.
Origins And Pitfalls Of Fiat Currency
Fiat money is a form of money which derives its value not from any underlying or intrinsic value, or its ability to be converted to a valuable commodity, but rather it derives its value from possessing legitimacy through a government order (fiat) declaring/ordering it to be legal tender. Being legal tender means that it is recognized as a satisfactory payment of any monetary debt in the particular jurisdiction in which the government that legitimized the currency operates. These, however, were a far cry from serving as an effective or durable alternative to metal currency.
It is first prudent to note that there was not an automatic, immediate or “natural” jump from the barter system to the fiat currency system. Far from a great leap from the former to the latter, the fact is that fiat currencies always arose out of previously convertible currencies (firstly, commodity money, and then to representative paper money); and this was achieved through deliberate state interventions on these currencies that made them inconvertible.
This form of currency suffers from several problems, going beyond its mere physical limitations (can be damaged, destroyed, counterfeited), to important structural and social issues stemming from its deeply centralized, opaque and entrenched nature. A key case-study of the same has been provided in the previous section through the example of the collapse of the mighty Roman Empire, following the hyperinflation that originated from the debasement of the silver coins.
Subsequent years were checkered with numerous more examples where currency collapse foretold the collapse of government orders, both in the early middle ages (China in the 7th century, also due to hyperinflation through debasement of currency), through to the 20th century (Germany, post WWI). In 2004, Zimbabwe’s currency was hit with an inflation of 624%, and then rose even up to 11,00% during numerous years after that, which made their currency entirely worthless and in utter disarray. There are similar examples post the 1990s in countries such as Mexico, Thailand, Russia; even widely considered to be successful fiat currencies such as the USD and the UK Sterling have been susceptible to similar instances in numerous moments in their histories. The centralized nature of currency that fiat currencies represent, inherently contain serious inefficiencies and downright catastrophic tendencies that cut through geographic identities, and that are intrinsically tied to the inordinate control over the supply of money by a centralized entity.
Conclusion
In this post, we have understood what is money from a functional perspective, and have traced the development of money throughout its various iterations. The growth of money, from its earliest form as a commodity money, to its modern and widely accepted form of fiat currency, has been fraught with stifling inefficiencies at best, to catastrophic collapse at its worst. The need to move on from a centralized entity exercising inordinate control over the entire supply of money is self-evident. In the next part of this article, we shall consider the benefits that cryptocurrencies present, particularly as a new paradigm for decentralized finance. We will also consider why its adoption in mainstream applications have been hampered, and the solutions proposed to these issues in the form of stablecoins. In summation, we conclude that the incumbent monetary order needs a solution that is: decentralized, volatile resistant, and inflation resistant; such a solution will entail the ideal monetary asset in the post-fiat world.
