In order to fully appreciate and understand the significance of cryptocurrencies, we have to trace our steps back through to the real history of money. I promise I will keep this brief. Keep in mind that throughout human history these same developments in currency occurred more than once in different parts of the world at multiple times (for example China developed paper money centuries before Renaissance Europe); however, my timelines here are based on the general pattern of the progression of money/value.
- Barter System
- Medium of Exchange
- Coin Currency
- Bank Notes/IOU
- Cash/Bretton Woods Agreement
- Fiat Currency
I made a simple timeline to share here, and then I have gone into more detail below using generic examples.
In very, very early Homo Sapien societies humans lived in small tribes and communities. This made a barter system simple, easy and convenient to use. Since groups were so small it wasn’t difficult to keep track of who owed who what. Some simple accounting might have been kept, but overall it was an honour-barter system.
As an example, if you helped your neighbour (Kyle) re-build his hut after a tree branch fell and collapsed its roof, Kyle may repay you over the next season with onions, eggs and berries he forages or grows. Meanwhile, you obtained smoked boar meat for your family from Brian the Butcher, and now you will make Brian a new pair of shoes. But a new pair of shoes is worth much less than all of that meat. This means that you still owe Brian the Butcher. You will either have to come up with something else to repay him or repay him later with a favour (perhaps help with his roof one day). This, while tedious, worked well for thousands of years for humanity, especially in small societies.
Medium of Exchange
When groups become somewhat larger, a local common medium of exchange was used, such as cowry shells, seashells, animal teeth, certain pebbles/rocks, etc. This common local medium of exchange relieved people of remembering who you owed and who owed you what. You could simply exchange the local currency of cowry shells. So in our above example, Kyle would have paid you, say, 100 cowry shells (the local currency) for helping you repair the roof of his hut. Now Kyle does not have to forage food for you or owe you at a later date. You would then pay Brian the butcher 50 cowry shells for a bunch of meat for you and your family to eat this week. Now instead of having to owe Brian the Butcher at a later date, you can focus on making and selling shoes for cowry shells to other members of your community. And when Brian the butcher needs a pair of shoes he can pay you 10 cowry shells for them. This works better than the barter system… but…
… let’s say that now you have traverse a mountain range and encountered another village in the woods. Except they use deer teeth as their local currency and there is no Google currency conversion rate. These local currencies work well for small local communities but did not translate well between communities. One society may value certain objects or services in an entirely different fashion than another.
When groups started to interconnect and engage, a more common currency was used such as a precious metal. An authority usually was in charge of creating/minting the currency. The age of minted coins based on precious metals lasted for thousands of years (2000-3000 years). It allowed prolific trade and economic development of Kingdoms and Empires. Imagine the Roman Emperor trying to pay his soldiers in chicken eggs, potatoes and boots? Imagine merchants bribing politicians with cows instead of gold Florins? Coinage made real commerce possible. The first coins originated in Lydia at approximately 600 BCE by the Lydian King (Alyattes).
While coinage was an excellent medium of exchange to facilitate the economy, it was still precious metal, which meant that enough of it weighed quite a bit. It took a while to mint and transport, especially large sums… So in comes the Banknote. Around approximately 1600 CE banks would issue a banknote which was a promissory note to pay the stated sum on demand. So a bank would hold a certain sum of coins/gold and issue notes of different denominative values (i.e. $1 worth of gold, $25 worth of gold etc). These notes were used much like cash. However, back in this time period, it was the actual bank who issued this form of private money and not a government institution. It was not until the end of the 17th century (~1685 CE) in Canada (then a French colony) that the French governor of the region issued IOUs (I owe you) the first government currency. This was done out of necessity due to the difficulty in transporting enough coinage to colonies. In fact, most precious metal was being mined out of North America and being sent to Europe to the Kings and Queens. All of this is based on a gold standard. There is a certain amount of gold in banks/Kingdom treasuries to support the banknotes and IOUs.
Cash/Bretton Woods Agreement
Fast forward a couple hundred years to WW1/WW2 and cash is commonplace. After WW2 something known as the Bretton Woods Agreement is adopted in 1944. Without going into too much detail it basically stipulated that currencies were pegged to the price of gold. This was accomplished by pegging th USD to the gold standard and that the U.S. Dollar (USD) was to be the world’s reserve currency, which other currencies would all be based off of. One stimulus for this was the notion that currency destabilization contributed to the initiation of WW2 (the German Mark was so debased it demoralized the Germans and allowed them to look to Hitler for saving, in financial desperation).
The “Nixon Shock” – In 1971 American President Richard Nixon made a unilateral cancellation of the direct international convertibility of the USD into gold. He de-pegged the USD from gold. However, the USD was kept as the world reserve currency. So all the national currencies were connected to the USD, and the USD had been anchored to gold, but now it was “free floating”. This is the development of Fiat currency (currency that is backed only by the government who issues it). The amount of USD in existence had to be directly proportional to the number of gold bullions the US had. Essentially meaning that in order to increase the money supply of the USD there had to be an increase in gold holdings. With the de-coupling of the USD from the gold standard, the Federal Reserve was able to print US dollars based on monetary policy rather than the gold standard.
Since 1971 the world economy has been functioning on fiat currency. Basically, a country’s money has value for two reasons: (1) the government says it does; and (2) people believe and have faith in the government. What gives people such faith? Well, let’s give credit where credit is due.
If a country is stable it has
- Functioning government,
- Military force,
- Tax income,
- Social services (variable depending on each country),
- Good international relations
This is certainly valuable to citizens and one of the reasons why the fiat system has worked so far.
In 2008 a person(s) by the name of Satoshi Nakamoto, a cypherpunk, released the Bitcoin “Whitepaper” where he explained his electronic, proof of work, cryptographic, peer to peer cash system. Now, more than 10 years later there are thousands of cryptocurrencies (most of which are utter garbage). Bitcoin has skyrocketed from being worth less than $0.01 to well over $3000 USD (at the end of 2018, after spiking up to $20,000 USD and coming down). Bitcoin allows for pseudo anonymous transactions to occur electronically 24/7, without any intermediary. There is no government, bank or private or public institutional oversight on Bitcoin. Yes, various governments are starting to create regulations around bitcoin, but at the fundamental core, there is no direct oversight over bitcoin and it does not need any regulation to function.
Total digression below about a parallel of currency to biology… I had thought of this analogy part way through my writing of this post and decided that it did not belong in the body of the post… so here are my thoughts:
Side note… I have a Bachelor of Science and I can’t help but think of an analogy here. The common currency of our bodies is “ATP” (Adenosine Triphosphate). To keep things simple it is essentially a unit of energy that quite literally powers 99.99% of every single cellular action that results in our thoughts, ability to breath, for our heart to beat, our livers to process our meals, our white blood cells to fight off infection for our skin and hair to grow everyday… etc. All of that ATP is derived from the macronutrient foods we eat for energy (primarily carbs, fats and protein). No matter if you ate white bread, organic brown bread, pizza, McDonald’s, steak, grilled chicken, caviar, salad, rice etc it all ends up converted into ATP, which is then used to perform other functions. Imagine biology trying to function as a barter system? Not possible. No matter how you earn your money, where you work, what investments you sell, how your business operates, it all is exchanged for dollars (like ATP), which you can then take to do whatever you like with (buy food, entertainment, education, pay down debt, pay rent or bills, etc).