A Brief History of Money: Value, Trust and Power Over the Ages - Part 3

In part 2, we discussed how money improved over time to become coins and then reserve-backed paper bills. 

In part 3, we’ll delve into the next, and current, stages: Fiat Money and Cryptocurrency.

To recapitulate, our dimensions of analysis will be:

  1. Where does money’s true value reside?
  2. How does value respond to the passage of time? 
  3. Which kind of trust does it need to function?
  4. Who holds power over the system?

Fiat Money

In 1972, Bretton Woods ended, yet we still use banknotes. What backs them now? Why do they still have value? Simply because people believe they do. Governments/Institutions promise that the banknote will be accepted, people collectively trust them, so everyone accepts them, and validate the promise. Fiat Money is like a self-fulfilling prophecy.

In the past, there were some failed attempts to use this system. In the 3rd century CE, a roman emperor debased the denarius and told people to trust it because he said so. Sadly, in that century there were about 30 emperors, so no one trusted “the emperor”, nor money. Massive inflation ensued. A millennium later, the Yuan Dynasty implemented a paper-based Fiat System, though the dynasty itself collapsed within a century.

This system has a great advantage over the Gold Standard. The standard places a physical limit on how much money can exist (gold is finite, mining takes time), so if people feel that there’s too many notes relative to gold, they’ll get scared, run to the bank, and retire everything. Banks won’t be able to fulfill all withdrawals, and the system will crash. Fiat solves this because ‘trust in institutions’ is neither finite nor created at limited rates. As long as money is proportional to economic growth, printing can proceed. Of course, Fiat isn’t perfect. Trust is its sole line of defense, and it’s not easy to measure. Trust can fade away in months under incompetent institutions, plummeting the value of money in days as people escape to other currencies.

About our Dimensions of Analysis:

  1. Where does value reside? As there is no longer an intrinsic backer, the value of Fiat banknotes is institution-backed extrinsic.
  2. How does value respond to time? Fiat currency is vulnerable to deflation, and profoundly vulnerable to inflation. Usually central banks have a controlled, low-inflation policy. Unfortunately, extreme situations arise, and over the last century many countries, from Weimar Germany to Zimbabwe, have suffered hyperinflation. Fiat loses its value slowly, until it does it suddenly and violently.
  3. Which trust does it require? Total ****systemic trust. There’s no value in the payment instrument to personally validate. You must trust institutions and the social contract that holds them together.
  4. Who holds power? It’s held almost unilaterally by the issuing institution. Either the central bank is autonomous, or answers solely to the government. Within a country, centralization is absolute.

Cryptocurrency: Bitcoin et al

The concept of cryptocurrency has been around since the 90’s, but its recognition soared in early 2009 when Satoshi Nakamoto (alias used by an anonymous person/group) launched the Bitcoin Network. Since then, countless cryptocurrencies have appeared, but Bitcoin is the most prominent by far.

This system works thanks to the Blockchain, a distributed ledger where every single transaction is registered forever. Any Bitcoiner can set up a node with their own copy of the blockchain. Every 10 minutes, a complex algorithm compares all blockchain versions to rule out flawed/fraudulent ones. Then, it consolidates the verified transactions into a block, and adds them to the pre-existing chain of blocks: “Block Chain”. Now, how is Bitcoin created? Someone must put in the processing power for the algorithm. Those who do are called Bitcoin miners. With the correct knowhow anyone can be one. Basically, they “lend” their computer’s processing power to the algorithm, and in return it creates Bitcoin to give them as rewards when they process transactions and consolidate blocks. Additionally, there is a limit: only 21 million Bitcoin will ever be created.

So: First, transactions are registered under digital addresses in the blockchain, so individual identities are private. Second, the system rules out fake/flawed transactions through raw power and consensus, so it’s fraud-proof. Third, money creation is automatic and decentralized, as it is exclusive to an algorithm tied to economic activity, so no human can interfere with supply and break the system. Fourth, as it has a 21-million cap, its inflation proof in the long run. Finally, being digital makes it fractionable, so it’s ideal for microtransactions.

In brief, Bitcoin solves the greatest problem of Fiat, as trusting a single, human-error bound institution is no longer necessary. Also, intermediaries (banks) are no longer necessary, which gives Bitcoin yet more advantages: Transactions, whether local or global, are low-cost, and thanks to a new protocol called lightning network, they take seconds to be completed anywhere, anytime. No more bank holidays or long-distance fees.

About our Dimensions of Analysis:

  1. Where does value reside? In the system. It isn’t institution backed. Its value is purely system-backed extrinsic.
  2. How does value respond to time? Though currently volatile due to being new and used by some as a trading instrument, in the long term it has a deflationary nature. Yes, thanks to its 21-million cap, it’s impervious to inflation. The “Store of Value” property hikes to a new level: stored Bitcoin gains value.
  3. Which trust does it require? Bitcoin transactions are registered on the Blockchain, which is public. This means that the history of a single Bitcoin can be traced back to its creation by anyone. So, you have total capacity of individually validating the value of the instrument that someone gives you, instead of relying on abstract guarantees given by a system. Therefore, trust goes back to the counterparty’s payment instrument.
  4. Who holds power? Everyone. It is decentralized throughout the community of users. Creation and transactions are scattered through a worldwide network of servers to which anyone can join. All you need to create your own money and transact it is a computer and internet.

Bitcoin reclaims the condition of being trustworthy at an individual level, while retaining and improving the evolved properties that came with each previous stage.

At Lastbit, we believe this is the next step in the history of money. We are building a global payments network based on Bitcoin’s Lightning Network to allow you to transact cheaply, instantly, and securely with anyone, anywhere. Don’t miss out! lastbit.io

Value, Trust and Power Visualized

Value: Over the centuries, value has drifted further away from being intrinsic, and towards being purely extrinsic.

Value over time: During history, all stages of money have had value increasing and value decreasing factors. That is, until Bitcoin, which is the first to only have value increasing factors within its structural nature (short term volatility aside).

Trust: Trusting the system and its institutions has increasingly become the norm due to the individuals inability to evaluate the payment instrument by themselves. Bitcoin appears to have reversed that trend by allowing individuals to personally validate it, hence, trust it.

Power: Centralization of power has been on the rise for millenia, reaching astounding heights during the 20th century. Bitcoin, yet again, appears to be subverting that trend by being decentralized by nature. For the first time in centuries, decentralizing power at a large scale is possible.

Recommended Posts