For many, money is already digital with smartphone banking applications and contactless payments. But with the emergence of Bitcoin, digital money took on a whole new meaning.
The history of money
By tracing the history and evolution of money, we gain insight into how & why people interact with their chosen currencies, and what the financial future could look like. In Layered Money, Nik Bhatia lays out the 'layered money concept' when exploring the history of money.
Coins (first-layer money)
For thousands of years, humans used seashells, animal teeth and livestock, as tokens for barter. Eventually, gold and silver became the globally accepted forms of currency.
Coins were a revolution in simplicity and changed money forever. They eliminated the need to weigh and test the purity of each piece of metal before a transaction. Coins were made with metals that were considered precious, durable, and rare. Gold and silver had been used for thousands of years as money, so having coins made from these metals ensured there would be natural demand for them.
The idea of fungible or interchangeable money was another revolutionary step. When two things are fungible, they have equal value and can be interchanged with one another. Coins from the same mint were identical and uniform, making them perfect accounting denominations.
Worldwide demand for coins grew and governments became the largest supplier. Coins led to government influence over currency.
Gold certificates (second-layer money)
Then emerged gold certificates, which were printed and circulated in place of gold coins. In 1928, in the USA, a gold certificate was printed with the following phrase:
“This certifies that there have been deposited in the Treasury of the United States of America ten dollars in gold coin payable to the bearer on demand.”
The piece of paper has value to whoever holds it. Both the coin and the certificate are forms of money, but they’re qualitatively different from each other. The difference between a gold coin and a piece of paper that states, ‘X will pay one gold coin to the bearer on demand.’
The piece of paper exists only because of the gold that it represents, it’s 'second-layer money,' as Bhatia puts it, that is created as a liability on a balance sheet.
Second-layer money is a promise to pay first-layer money. This comes with counterparty risk. Placing trust in counterparties is necessary for our current financial system to function, otherwise, we’d still be using gold and silver coins for every transaction.
Second-layer money is inherently unstable, as the power to create it will be subject to human abuse. Gold coins cannot be created out of thin air, but bills could. Money can be expanded when it doesn’t have to be fully reserved with gold coins in a vault.
After the second layer of money emerged, governments and central banks moved to take control over people’s monetary affairs. Liabilities of banks and businesses exist on the third layer of money.
Emergence of Bitcoin in 2008
Bitcoin, a peer-to-peer version of digital money, allowed online payments to be sent directly from one party to another without the need for a financial institution.
On Bitcoin's ledger, Satoshi (its creator) placed a British newspaper headline referring to the ongoing financial crisis:
“The Times 03/Jan/2009 Chancellor on brink of second bailout for banks."
Through this message, he suggested that Bitcoin may offer a necessary solution to the traditional banking system.
A few weeks after Bitcoin's release, Satoshi offered a little more detail on his reasoning for the project and revealed an awareness of the instability of traditional monetary systems:
"The root problem with conventional currency is all the trust that’s required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve.”
What changes are coming to our financial system?- a system, as Bhatia puts it, "that temporarily erupts in chaos every few years only to be calmed by increasing amounts of government and central bank intervention.”
“With its pervasive spread throughout minds and markets across the world since 2009, the science of cryptography is forcing the financial world to abandon old systems for new ones, much like the Internet has done to countless industries since the turn of this millennium.”
Cryptocurrency could offer a path to a more stable future. But will Bitcoin coexist with traditional currencies or replace them?
Disclaimer: NOT FINANCIAL NOR INVESTMENT ADVICE. Only you are responsible for any capital-related decisions you make, and only you are accountable for the results.
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