The origins and history of money
When you think about it, money is quite an odd phenomenon. We use it every day to pay for our groceries and love receiving it as salary, but what is money precisely? Explaining the concept of money is quite a challenge. Actually, it's weird that simple pieces of paper exist that represent money to us and that we can use to buy groceries and exchange for food. The only reason it works is that people can believe in concepts en masse. People are also able to conjure stories and then believe in them and have faith in them. Try to convince a monkey to trade his bunch of bananas for a five euro banknote. He'd call you crazy; what should he use the five euro note for? No, the only reason money works for us, is because we put much confidence in the notion that we can use it to pay for goods and services. If that confidence did not exist, like it's the case for a monkey, the five euro note wouldn't be worth anything. Well, you could still use it as toilet paper or to kindle a fire, but that's about it. However, let's start at the beginning before we explore this topic in depth.
From barter trade to the first means of payment
How and why did the first types of money come into being? To answer this question, we have to go far back into history, to a time when the idea of money was still inexistent. Imagine that you are a highly skilled shoemaker who can produce three pairs of the most exquisite shoes. How would you convert these shoes into groceries or a house? Without a commonly accepted means of payment, you would need a tremendous amount of shoes to exchange them for a home. Besides, you would also have to find a real estate agent who would be interested in trading 100 pairs of shoes for one of his houses. The contrary is true for your daily groceries. Your shoes are much more valuable than the basket of food products that you could exchange it for in the prehistoric Sainsbury's. Wouldn't it be helpful to introduce some commonly accepted currency, and to stop bartering goods? Something that you could easily take with you; a universal ware accepted by everyone? In short, that's the foundation of money and the foundation of a sound currency. The first types of money helped flourish commerce and trade.
These forms of money looked very different from what you might expect. We didn't start with coins; before we started using those, much time had already passed. The first forms of money were often relatively valuable products, such as rice, salt, precious metals, cocoa beans and glass beads. Different means of payment were used in different parts of the world.
For instance, glass beads were used from the 16th until the 20th century as a means of payment in West Africa. It was relatively difficult to obtain the rare beads in this region, which rendered it an ideal means of payment. After all, it's not convenient to use something readily producible to pay with. Within no time, the market would become flooded with glass beads, which would cause a substantial value depreciation. The more units of the means of payment are available on the market, the higher the prices of wares. The glass beads in West Africa serve as an excellent example of how a market surplus could go wrong. What happened is that the Europeans eventually found out that glass beads in West Africa functioned as a means of payment. Now, as luck would have it, it was much more convenient to produce glass beads in Europe, which is why European merchants started to transport shiploads of glass beads to Africa. These merchants subsequently bought up all riches and wares that they considered valuable from the Africans and then flooded the market with glass beads. The once so useful means of payment was no longer rare, which is why it also lost much of its value. Before the local population had learned of what happened, they found themselves with heaps of useless glass beads. European merchants had already usurped all the riches. The glass beads were also used to set the slave trade in motion, which is why these beads are also referred to in the history books as slave beads. It’s one of the many historical examples of why a means of payment has to remain scarce. Scarcity is perhaps the most crucial aspect of a payment method, as it retains value. It's also why gold has been such an effective means of payment throughout history, and why it's been so effective at storing wealth (store of value). Gold is namely so rare that only 1.5% to 2% of the total available resources are delved every year. No product is as scarce as gold. This changed when, in 2008, Bitcoin launched and established a digital asset, with a maximum circulation of 21 million units. In theory, it serves as an ideal means of saving or payment. But before we proceed with Bitcoin, we will first explore monetary history for a bit. You will better understand the value of cryptocurrencies if you also appreciate the entire history of money.
The rise and fall of the gold standard
The next phase in the development of money consisted of the foundation of banks. Merchants accepting gold for payment quickly faced a new problem. They would eventually end up with too many precious metals to store or secure. They had no idea how to solve this problem; there was just not enough space. Local goldsmiths knew what to do, however. They obtained gold from the merchants and stored it into gold vaults, which they had already made. They charged a small fee for this service. In exchange for the money, the merchants received a piece of evidence from the goldsmith, which indicated how much gold they had stored and whether it was in good quality. This is how the first banknotes came into being.
Over time, the inventories of the goldsmiths became bigger and bigger, and before long, a smart goldsmith realised that it would be problematic if everyone would start to withdraw gold simultaneously. How smart would it be to lend part of the gold to merchants in exchange for a small fee? After all, they did not use physical gold as commodate; instead, people borrowing gold were issued a promise. In exchange for the promissory note, the goldsmith could issue the gold claimed by those who were interested. These promissory notes started to function as banknotes. Nobody ever felt the need to exchange them for gold, because everyone trusted the goldsmith to guarantee its promise. Goldsmiths became the first banks this way, and the promissory notes served as early forms of money creation based on credit supply. By providing loans, i.e. promissory notes, the goldsmiths lent money that wasn't theirs in the first place. This is what is meant with the term fractional reserve banking, which you may have come across before. Private banks first conducted it. It may be hard to believe, but until the 19th century, there were about 5000 different kinds of banknotes in circulation across the United States. Different banks issued all these banknotes, and everyone accepted only the notes issued by the largest banks with the highest credit ratings. In a certain sense, you can compare this craze with the thousands of altcoins that are currently appearing on the crypto market.
After a while, governments started to issue banknotes instead of private banks. The Bank of England became the only bank in England with the right to issue banknotes in 1694. In the United States, this right was granted to the Federal Reserve Bank in 1913. In Europe, the European Central Bank carries this responsibility. Governments of course aptly realised that the exclusive right to money creation entailed enormous power. Until the 70s of the previous century, forms of money issued by governments were primarily backed by gold. In theory, you could always go to the national bank to exchange your banknotes for gold, as the banknote indicated.
However, this promise then slowly disappeared from the banknotes, and in 1971, the gold standard became forever abandoned. Former U.S. President Nixon announced in that year that it would no longer be possible to exchange American dollars for gold on the international markets. In fact, at that moment, all forms of money issued by governments became nothing more than simple pieces of paper. The only reason why coins and banknotes carry value and are of use is that we put high confidence in their value retention. Most people do not reflect on the wafer-thin layer of trust that allows us to obtain salaries that retain their value each month. It's only natural for us to be able to pay rent and our groceries upon receiving our wages.
For most people living in well-off countries, it appears self-evident that our money will always retain its value. A euro is still worth a euro tomorrow, right? Indeed, but because governments print extra money to resolve their debts, money circulation slowly continues to expand. This causes the annual inflation that we've gotten so used to. For those who are unaware: inflation refers to the increasing prices of goods and the subsequent decrease in the value of our money. The official inflation rate amounts to about 2-3% on average in prosperous countries, even though small groups of people doubt the trustworthiness of these numbers. Inflation rates of this level don't form an enormous problem, but some countries face hyperinflation. In countries like Venezuela and Zimbabwe, it wasn't unusual for people to storm the supermarkets as soon as they had received their salaries, because they may otherwise perhaps not be able to buy bread. How bizarre is that?
The reason for the formation of Bitcoin
A growing group of people started to become worried about the workings of our financial system, in which inflation and money creation had become commonplace. According to them, we should return to the gold standard, to at least partly guarantee the value of our money. But why would governments listen to this, when they can simply impose their will on our society and economy through their monopoly on money creation? What we need is an independent form of money that cannot easily be constrained by governments. When you start to create and use your own money, it will pose a severe threat to governments. This is especially true when the alternative becomes extremely popular and is used instead of regular currencies. As such, it's not surprising that the American government informed Facebook by letter that it should immediately halt the development of the Libra project it had announced just before that. The government demanded an additional investigation. The letter explicitly refers to a threat to the current monetary system, i.e. the U.S. dollar.
It's precisely because of that reason that decentralised cryptocurrencies, like Bitcoin, are so exciting. If they eventually become decentralised enough, there's no way to stop them. The only way out here would be to pull the plug from the internet, but that’s not likely to happen. Another exciting aspect of a coin like Bitcoin is that its code contains a circulation limit of 21 million units. No additional Bitcoins will ever be printed nor issued. The release of Bitcoin marked the first time in history that a digital asset managed to acquire the ultimate form of scarcity. In a certain sense, you can compare cryptocurrencies to gold, even though this doesn't do sufficient justice to digital coins. They are, after all, also easily transferable; how bizarre is it that you can transfer a couple of millions for only 30 cents? Without any need for an intermediary? Besides, (properly decentralised) cryptocurrencies are not threatened by political influence; they cannot be stopped at the border. It's a unique form of money and a highly extraordinary new asset.
Of course, it's difficult to make any predictions concerning the future. The technology has only been around for a bit over ten years, and there are many steps to take before it can function as a global means of payment. We are certainly very curious what the world — and especially our financial system — will look like in ten years following the rise of Bitcoin and other cryptocurrencies such as Ethereum, Ripple and Litecoin. Indeed, much may change!