Throughout human history, many items have been used as a medium of exchange. But as the economy continued to grow, some simple methods of exchanging value became impractical and new methods were invented.
Money is one of the most interesting concepts in the world. It is one thing we all desire yet we have little understanding of how it works. This article will break down everything you need to know about the origin of money and whether bitcoin is real money or not.
What is money?
According to Merriam-Webster, money is something generally accepted as a medium of exchange, a measure of value, or a means of payment.
Now let me explain this concept with an illustration.
Let’s assume Tom, who is just 2 years old, sees his friend Harry with a new toy he likes. Tom could offer Harry a piece of cookie in exchange for the toy for a few minutes. If Harry agrees to this deal, then a transaction has just taken place.
While you might not be willing to accept a piece of the cookie as a method of payment today, this is exactly how money started. And it is called barter. In the next few minutes, I am going to explain how money has evolved from a simple barter system to the complex financial institutions we have today.
The history of money
Barter
It is hard to trace the true origin of money or tell the type of trading system that first existed. This is because the history of money itself precedes written history and ancient civilizations happened at different paces making record keeping complex or nonexistent. But in many cases, Brater is often regarded as the earliest form of exchange system.
In this case, you exchange goods and services directly for other goods and services that you desire. Since this was done by peasant farmers in small communities, items exchanged included food items, livestock, farming tools, and clothing.
Of course, this system had many flaws. For example, if I have yams and need some wheat, I must wait until I see someone who has the exact item I want and is willing to exchange it for my yams. This is called the coincidence of want.
Another flaw of this system is that my tubers of yam might not be perceived to have the same value as the quantity of wheat I want. Now, that’s the coincidence of scale.
What if I needed land and all I have is tomatoes? Even if I have enough to buy a piece of real estate, it is not durable and hence, no one will want to do business with me.
Because of these flaws in barter, it was soon replaced by another more effective system. This takes us to the next system which is commodity money.
Commodity Money
Since one of the major flaws of barter was the coincidence of want, many cultures around the world started adopting commodity money. That is, the use of objects that have intrinsic value as a method of paying for goods and services. So instead of going around with yams looking for who will exchange it for wheat, I can carry a metal coin and use it to buy wheat.
Finally, a brilliant idea to solve the flaws of barter.
Examples of items that have been used as commodity money include silver, gold, copper, salt, cowries, beads, cows, nails, even alcohol, and cigarettes.
Seeing some of the examples on this list, you may wonder how come they have an intrinsic value. Well, the explanation for this is that commodity money is accepted as a form of money because of its salability. In other words, it means that these commodities can easily be exchanged for goods or services whenever the holder desires.
There are two main properties that make commodity money valuable. The first property is that it must be immune to deterioration and rot while the second property is that there must be a certain level of difficulty in producing a new one.
Hence, any material with these two properties can be used as money as long as the people accepting it perceives that it has some form of value.
Let me explain this using the bizarre example of the rai stone used by the native inhabitants of the Yap islands in Micronesia. These stones with disc shape with a hole in the center were carved out of crystalline limestone. While some can be as small as a few inches, others can be as tall as 12 feet and weigh more than 8,000 pounds. To put that in perspective, a single stone could be as heavy as two Tesla Model S put together.
Although these stones were large and difficult to move, they were valuable to the people on the Yap islands because they were durable and not easily produced.
This monetary system worked well for the Yapese for many centuries until they made contact with the European explorers. They discovered they could produce more rai stones using iron tools. But sooner, these stones became less valuable as they were now easy to produce.
Silver, gold, and the transmission to banknotes
Silver and gold are two commodity money that has withstood the test of time. As human technical capacity increased, it became easier to produce uniform coins from gold and silver. This made it easier to use them as a medium of exchange. And since they are rare metals, it also made them more valuable.
But people soon realize that they don’t want to carry gold and silver coins everywhere especially when they want to perform large transactions. Banks helped them solve this issue by allowing them to deposit their coins in banks while using paper receipts to make payments anywhere. This solved the problem of scalability and soon, banknotes became very popular.
These banknotes were not money but a form of representative money. It shows the value of the precious metal that you have deposited in the bank. No wonder the British called their money Pounds which is a unit of weight.
Unfortunately, this system of money had its own flaws. Even though these precious metals were rare (good quality of money), the banks could easily print more notes to exaggerate how much money they truly had. This resulted in the loss of public confidence in banks and a need for another system of money.
This leads us to the next form of money which is government money or fiat money.
Fiat money
This is a type of money issued by the government of a country but is not backed by anything but the people’s faith in the government. Unlike the original banknotes that represent the value of the gold you have in the bank, fiat money does not have intrinsic value. It is only valuable because the government of a nation says so and because the citizens agree to it.
The earliest record of this type of money was during the 11th century in China. It has its own flaws because the government can easily print money thereby leading to inflation.
But what I find more interesting is the next type of money I’m going to talk about which is payment cards and digital money. And this is not even about cryptocurrency or bitcoin yet.
Payment cards and Digital Currency
Today, almost 60% of consumers prefer using cards to make a purchase. But have you ever asked yourself what happens when you swipe your card and the payment is successful? Does your bank withdraw the exact amount of cash and send it to the seller’s bank?
Payment cards have been around since the late 20th century. They are the debit cards and credit cards used all around the world today. But do you even know how they work? When you transfer money from your computer phones, where do they really go?
To help you understand, think of it this way. Let’s assume that there is a large financial ledger where all transactions are recorded. Since your cards are electronically linked to your account, each time you make a payment, the particular amount is recorded on the debit side of your balance while the same amount is recorded on the credit side of the seller.
If you now understand how you’ve been able to shop for your groceries and pay for your coffee without physical money, I believe you’ll find bitcoin fascinating too.
Cryptocurrency
Finally, this is the part where we get to talk about cryptocurrency with an emphasis on bitcoin.
In 2008, a computer programmer under the pseudonym Satoshi Nakamoto proposed a digital currency called Bitcoin. He called it a “new electronic cash system that’s fully peer-to-peer, with no trusted third party.” In other words, what he proposed was a form of digital money where the banks or the government are not involved.
But this was not the first time someone came up with such an idea. In the 1980s, David Chaum introduced the idea of digital cash which he called DigiCash but it failed. Nick Szabo designed a mechanism for a decentralized digital currency called bit gold in 1998. And in 1999, Wei Dai published an essay on an electronic cash system he called “b-money.
However, what makes bitcoin different from all other forms of digital currencies before it was that it is secure, has the properties of real money, removes the barrier of sending money to anyone anywhere, and of course, it is free from third parties like the banks and government.
So, What is Bitcoin?
Bitcoin is a decentralized digital currency that uses peer-to-peer sending and cryptography to secure its network. In other words, bitcoin is a form of digital currency free from banks and governments but relies on the people using it to keep it secured.
But how is this even possible?
If bitcoin relies on peer-to-peer transactions, why can’t it be manipulated?
How does bitcoin work?
It’s easy to get confused when reading about how bitcoin works. So instead of using technical terms and jargon, I’m going to explain how bitcoin works using everyday language.
It is okay to think of bitcoin as a computer file that is stored in a “digital wallet” on a computer. So when you send bitcoin, you are basically transferring this file to another user without an intermediary, hence the term peer-to-peer.
Each transaction is then recorded on a public ledger called the blockchain. But before the transaction is approved and recorded on the blockchain, it must be verified by the miners.
These miners are millions of people across the world who operate specialized computers with high processing power to verify and approve each transaction.
I know you might want to ask, why does bitcoin need to be mined?
Well, this is because the transactions are entirely digital and to prevent fraudulent activities such as the risk of double-spending the same coin more than once or letting hackers have access to your account. The whole network is secured by a technology called cryptography. So what these miners do is that they use their computers to solve complex mathematical puzzles. The first miner to solve this puzzle (that is, come up with a 64-digit hexadecimal number called a hash) is rewarded with bitcoin. And this is how bitcoin enters into circulation.
One last thing on how bitcoin works before I talk about why it has value.
It is wrong to think that bitcoin transactions are anonymous. Rather, the transactions are pseudonymous. Since each transaction is recorded on the public ledger known as the blockchain, it is available to anyone.
However, this is how bitcoin keeps the identity of the owner. Anyone on the bitcoin network has what is known as the public address and private key. Think of the public address as your email address and the private key as your password. People can see your email address when they want to see you a message but no one can know your password except you share it with them.
Why does bitcoin have value?
Now the last thing I’m going to talk about in this article is why does bitcoin has value?
People say bitcoin is not real money or that it is a fad that will soon go away but we’ve seen time and again how its value keeps increasing.
Many people call bitcoin digital gold because it shares some similarities. You’re not going to adorn yourself in bitcoin made jewelry, but here are some of the reasons why I think it has value:
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Scarcity. According to the whitepaper of bitcoin, only 21 million units of bitcoin will ever be available.
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Divisibility. Bitcoin can be divided up to 8 decimal places (0.000 000 01) and potentially smaller units in the future.
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Acceptability. Bitcoin is yet to be adopted in many places as fiat currency, but as more people see it as a form of money, the value will keep increasing.
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Portability
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Durability
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Resistance to counterfeiting.
Thank you for reading this article.
Also published here.