The First and Last Word in Money: How Bitcoin is more like Ancient Sumer than the Federal Reserve
The newest forms of money – bleeding edge, blockchain-based cryptocurrencies – look a lot more like the oldest forms than anything that appeared in the meantime.
Over the millennia money has taken many different forms. For seven thousand years or more, gold and silver have remained perennial favorites, but the nature of money is highly dependent on context. Precious metals, grain, axe heads, beads, animal pelts, rum, cigarettes – money is simply whatever people agree is money in a given situation, governed by whatever is available and convenient to use.
Monetary economists agree that money serves at least three distinct purposes: it is a unit of account, a store of value and a medium of transfer. In other words, you can use it to keep track of who owes what to whom; to defer spending to a later date; and to carry out commerce.
A number of properties facilitate these functions. Money should be durable, portable, divisible, hard to counterfeit, rare (though not too rare) and fungible – that is, one unit should to all intents and purposes be the same as another. In practice, different forms of money display these properties to a greater or lesser extent. Micronesian rai stones, for example, are huge disks of limestone weighing up to four tonnes. What they lack in portability and divisibility, though, they make up for in durability and resistance to counterfeiting.
Rai stones provide an interesting precedent for the newest forms of money, the digital currencies hosted on a network of shared ledgers, such as bitcoin. When a rai stone was (and occasionally still is) used as payment, typically for an important transaction like a dowry or arranging a political alliance, it was rarely physically moved. Instead, the community got together and agreed amongst themselves that the stone had changed ownership. So it is with bitcoin: the ledger is updated to reflect what belongs to whom.
The origins of money
Whilst money has taken diverse forms over the millennia, humans have always gravitated towards gold and silver. Attractive, scarce, malleable and resistant to corrosion, they have been a default at least since Sumerian times. David Graeber, author of Debt: The first five thousand years, notes that some of the earliest written texts establish a fixed exchange rate between silver and barley: effectively a silver standard. Money may even have arisen in the huge and elaborate temple complexes of the Ancient Near East as an accounting tool to facilitate payments for labor and much else besides – rather than being a development used to address the shortcomings of a barter economy, as a competing theory holds.
Either way, money at this stage in history typically meant pieces of silver, weighed out at the point of transaction and assayed using a touchstone to determine purity. It may not have been the most efficient system, but it worked and it was egalitarian. Money could truly be used as money; it was a technology of the people. Market forces might increase or decrease the value of silver against other commodities like grain or textiles, but no one controlled it or could tamper with supply.
At some point around 2,600 years ago, probably in Lydia (modern-day Turkey), the first coins were developed. Seigniorage, or the right to create money, was quickly appropriated by the king. Thereafter, money became a tool of the state, not of the people. The king could reduce the proportion of precious metal in the country’s coinage, replacing it with cheaper metals like copper, and pocket the difference – a lucrative source of revenue and one that was tapped repeatedly by Roman emperors to fund wars. Of course, this had the effect of devaluing the currency and often causing runaway inflation, as in the case of King Henry VIII, who earned the nickname ‘Old Copper Nose’ because he so heavily debased the English penny that the silver surface quickly rubbed off to display the copper underneath – particularly around the raised relief of his nose.
The Rise of Free Money
Seigniorage and the inflation that frequently accompanied it had the effect of transferring value from the end users of money, ordinary people, to those who created it, the state. Far from being a simple, decentralized technology – it may seem strange to call the use of pieces of precious metal as a medium of exchange for goods and services ‘technology’, but the impact cannot be overestimated; this truly was fintech, 5th millennium BC-style – it became a means to wield power.
Further interference came after the first banks were established. The basic idea was sound: it’s risky to keep large quantities of gold and silver in your home, so wealthy individuals would pay a bank to do it for them. Clients would withdraw funds as they needed them. After a while, it became evident that you didn’t physically need to take the gold out at all. The bank could write you a contract that gave you a claim to the gold they held in their vaults – the first banknotes. The state took the same approach with so-called representative money, or notes that were backed by holdings of gold. You could, in theory, redeem a note for its face value in gold. But both banks and states realized they didn’t need to hold 100 percent of the gold their notes represented. They could lend it out at interest or, in the case of the state, spend it elsewhere. The logical conclusion of this process was fiat money: money not backed by any precious metal but created at will (fiat: Latin, ‘may it be so’) by the issuer. In most countries, the central bank plays a role in creating money but outsources much of the responsibility to commercial banks, and both profit from seigniorage. Inflation is built into the system. It works, more or less, so long as there is confidence in the issuer. Overdo it and you end up with rampant inflation or hyperinflation, as in the Weimar Republic in the 1920s or modern-day Zimbabwe. Quantitative easing may have been a necessary evil – the least-worst solution to a problem that never should have arisen in the first place – but the long-term effects of creating so much new money will not be known for many years.
This is the context within which bitcoin arose eight years ago. Bizarrely, bitcoin is in many ways more like the earliest forms of money than it is like fiat – a remarkably recent development in the broad historical sweep of cash.
Bitcoin’s ledger of accounts is shared amongst tens of thousands of computers around the world, rather than being controlled by a single entity like a bank or government. Like the Micronesian rai stones, ownership is agreed by consensus. No one can tamper with the ledger without everyone else asking questions and ignoring fraudulent transactions. Unlike rai stones, though, bitcoins are highly divisible, down to eight decimal places. Existing in cyberspace, verified by thousands of computers, they can be considered tremendously durable. They are portable – they can be sent anywhere in the world in seconds – highly fungible, rare (with limited supply) and extremely hard to counterfeit. The earliest transactions required buyer and seller to weigh out pieces of silver, assaying them with a touchstone to verify purity. Instead of scales and a touchstone, bitcoin uses maths: coins are tested to establish their cryptographically-guaranteed ‘purity’, which in this case is a binary matter of legitimate or fake. Like money was for its first 4,500 years or more, bitcoin is a tool of the people, the slight technical hurdle to usability notwithstanding (see 3 Easy Steps to Get Started with Bitcoin). The process of money creation, whilst not perfect, rewards those who protect the security of the network, and inflation is not unlimited. Other digital currencies have fixed supply from the outset, rewarding their ledgers’ guardians with small transaction fees.
Arguably for the first time since the development of coinage, more than 2,500 years ago, cryptocurrencies like bitcoin are returning money to its original purpose, without the inherent power dynamic that state- and bank-controlled issuance brings. Of course, fiat money isn’t going anywhere in a hurry, and those who claim that bitcoin will replace one or other national currency are likely to be waiting a long time (there are, after all, advantages to state-sponsored currencies, as well as vested interests). There will, most likely, ultimately be a plurality of different forms of money, catalyzed by blockchain technology – perhaps even a free market of competing currencies similar to the one foreseen by the Austrian economist Friedrich Hayek in The Denationalization of Money. These will include blockchain-improved versions of fiat currencies and other assets. The Waves platform, for example, was designed to bridge the gap between the complexities of the 21st century monetary system and the blockchain, as well as allowing new financial instruments like gold and silver on the blockchain, and much else besides.