What is Money?
On the surface this is a silly question. Money is all around us: it’s there when we go to the cashier to pay, it’s there when we open our mobile banking app, and it’s also there when we swipe a piece of plastic given to us by VISA or Mastercard. In fact, money is such an integrated part of society that we hardly stop and question the validity of it all. On the contrary, the only time that people pause to think about what money is and how it works is when it stops to work such as in current day Venezuela or Zimbabwe.
Money at its core is a technology, one that is older than writing itself. How do we know? Some of the earliest stone slabs with cuneiform writings excavated were ledgers describing ordinary transactions accounting for sheep, grains, chickens etc. These are the first excel spreadsheets recorded in history.
Simultaneously, money is also a language because it isn’t value itself but instead represents an abstraction of value. There’s nothing inherently valuable about a shell or a piece of paper but these things come to represent value if we believe they do. We use this language to communicate value when we buy a product, a service or when we leave a tip. Similar to language, money has taken many different forms over several millennia.
A Brief History of Money
Before we can talk about cryptocurrency and its inevitable accession as the future of money, we have to look to our past to understand how money came to be. Although economics and currency aren’t widely studied by archaeologists, there nonetheless exist many conflicting views on the evolution of currency. Adam Smith proposed that societies bartered at first, but when that became cumbersome, switched to a medium of exchange that prefered precious metals. However, David Graeber, author of “Debt: The First 5000 Years,” writes that societies (both modern and ancient) that don’t use money, don’t barter either. Instead, Graeber found that people used a system of credit; I help my neighbor build a barn today because he’ll help me tomorrow. The complicated history of money has transitioned (non-linearly) between, first, credit/barter, then coinage, and finally, fiat (from the Latin “let it be,” used here to describe government-issues money not backed by gold or other commodities).
Credit/Barter System — For most of human history, people lived in small communities where most exchanges took place using credit. It turns out that when people know each other on a first name basis, they are more willing to provide goods and services with the expectation that sometime in the future, they will be repaid in kind. There was no need for money in small localized economies, because if someone owed you something, you would remember. In this way, everyone was indebted to everyone else. Thus, debt was and is the social glue that holds us together. Concurrently, the barter system was reserved for trading with people outside the community who couldn’t necessarily be trusted to repay their debts.
We see this with the ancient Sumerians in the Fertile Crescent, where bureaucrats recorded credits/debts in shekels, but this silver did not actually change hands in the beginning. It was used as a representation of worth, and people preferred to be paid in wheat or barley instead.
Coinage — Coins were first used as payment in China, India, and Lydia (western Anatolia) simultaneously in around 600 BCE when states started to form. These small nations developed a currency in order to pay for their professional armies. According to Graeber, war creates uncertainty. Merchants don’t want to extend credit, especially to soldiers who might soon perish. Likewise, professional soldiers, uncertain about their life expectancy, don’t want to get paid in promises either.
Fiat — Starting in 1450 AD, bankers determined that moving gold and precious metals from place to place to settle a transaction was cumbersome and also dangerous. Thus, they started issuing banknotes backed by their deposits of gold in the vault. Banknotes were similar to the paper money that is issued by governments today. The use of banknotes issued by private commercial enterprises gradually became phased out and was replaced by central banks, such as England in 1694, and the U.S.in 1913. National legal tender was at first authorized in the form of representative money, like banknotes, and could be redeemed for gold or silver. However, over the past century that has largely been done away with. In modern times, a country’s currency is backed by the full faith and credit of said country. Thus the value of a national currency to other national currencies comes from the strength of its economy relative to other economies.
Additionally, another technological leap in the type of money was developed in 1950 when Frank McNamara paid his restaurant bill using a cardboard charge card that would later become known as Diners Club. Since then credit cards have increased in popularity because of convenience of use in everyday transactions.
Functions and Characteristics of Money
All forms of money have one of these three things in common while the best currencies have most or all properties present:
First, money is a store of value. If I get paid today, I want to be able to hold on to it for several days, months or even years. Historically, precious metals, such as gold and silver, served that function because they were durable. Corn or barley on the other hand does not make for a good store of value because it can rot. Store of value is measured by 1) durability and 2) limited supply.
Second, money is a unit of account. One of the key roles for a currency is to allow you to value goods and services. For example, we measure worth in dollars such as a house might be worth $100,000 and a car might be worth $20,000. A currency like the dollar lets us measure value much easier than trying to value a house with cows or kegs of beer. Unit of account is measured by 3) divisibility and 4) uniformity.
Third, money is a medium of exchange. Money exists to make transactions possible between buyers and sellers. It works best when you can easily access it and transport it. Thus people will accept money if they trust that value will be retained and transaction costs are low. Medium of exchange is measured by 5) acceptability and 6) portability.
To summarize, there is no perfect currency that can satisfy all of the above and thus money is measured on a spectrum from good to bad. Throughout history money has taken one of two forms; first physical assets (such as gold, feathers, shells) and later fiat (government backed coins or paper notes). For example, gold has a long history of being money because of its durability and scarcity, however, it’s not easy to transport gold and it’s tough to divide a bar of gold to facilitate transactions.
Fiat currency on the other hand is uniform and extremely portable but it’s not durable (average lifetime of a fiat currency is 27 years) nor scarce (government can inflate/print more of it when it chooses).
These two weaknesses of Fiat currencies is the main reason why a digital currency not owned by any governments and operates on a protocol (mathematical system of rules driven by consensus) such as Bitcoin is desired. Throughout history we have seen different methods of payment emerge but one everlasting theme is the impermanence of money. Countries rise and fall and their currencies that were safe one day are are burned for fuel the next.
Banks have and will continue to exclude six billion people from the financial system, governments have and will mismanage the economy and as we’ve seen in 2008, that system came to a screeching halt and almost collapsed. Trust was at an all-time low and in the ashes emerged a different type of money. A decentralized, peer-to-peer money and payment network with a fixed supply that exists on the Internet.