The History of Money: From Barter to Bitcoin

Barter

Centuries ago, before humans had money, they would barter goods or haggle over how to trade one unique item for another good or a service.

Imagine you wanted to eat at the local restaurant and offered the owner a broom. The owner might say “no, but I’d be happy to accept three hats instead, if you happen to have them.”

You can imagine how difficult and inefficient a “barter economy” would be!

With money, by contrast, you can hand over a 100-kroner note or a 20-kroner coin. And you know the restaurant owner will accept it straight away.

Coincidence of wants

The earliest human societies traded through barter, but this method had several limitations. One problem was the “coincidence of wants”, where two people had to want each other’s object at the same time to complete a trade.

To overcome this problem, humans began to collect and value certain objects for their scarcity and symbolic significance, such as shells, animal teeth, and flint.

These collectibles served as a way for early humans to store and transfer wealth, and gave them an evolutionary advantage over other species such as Homo neanderthalensis.

Store of value

As human societies and trade routes developed over time, the forms of store of value that emerged in different societies began to compete with each other. Merchants and traders had to decide whether to keep their surplus in the form of store of value used in their own society, in the form used by the society they traded with, or a combination of both.

Holding a foreign form of store of value allowed merchants to complete trades more easily in that society, and also gave them an incentive to promote the adoption of that store of value in their own society, since it would increase the purchasing power of their savings held in that form.

When two societies adopt the same form of store of value, they see a significant reduction in the cost of trading with each other and an increase in trade-based prosperity. In the 19th century, most of the world converged on a single store of value — gold — and this period saw the greatest increase in trade in history.

The gold standard

In the past, some governments tied the value of their currency to a specific amount of gold, a system known as the ‘gold standard’. This meant the government had to hold a certain amount of gold in reserve in order to issue a given amount of currency.

This system limited a government’s ability to borrow money, because it couldn’t simply print more currency to cover the cost of borrowing. Governments often borrowed money to finance wars or other expensive projects, but the gold standard made it difficult for them to do so without first having accumulated enough gold to back the new currency they wanted to issue.

The gold standard was also problematic for citizens, because it gave no guarantee that their deposits in the bank would be safe, since the value of their money depended on the government’s ability to maintain its gold reserves.

Divisibility

The ability to divide a good is an important property for it to be a good store of value. Imagine you have a 100-kroner note and want to buy a pack of chewing gum for 10 øre. The success of the trade depends on the seller having 99.90 kroner in change available at that moment.

In societies where trade is widespread, the ability to divide a good into smaller amounts allows for more precise exchange and can make it easier to use in everyday transactions.

Bitcoin is particularly useful in this respect, since it can be divided down to one hundred-millionth of a unit and transferred in small, precise amounts. Fiat currencies are typically divided down to small change, which has little purchasing power, making fiat currency sufficiently divisible in practice.

Gold, although it can physically be divided, can be difficult to use in small amounts for everyday trade.

Central banks

To solve the problem of bank runs, governments created their own banks called ‘central banks’.

These central banks have a special power to create money. They act as a backup plan for when commercial banks run out of reserves and need extra money to stay open.

Because of this function, central banks are also called ‘lenders of last resort’, meaning they can create and issue money when commercial banks need liquidity to service obligations, such as when people and businesses want to withdraw their money.

Global reserve currency

A global reserve currency is a type of money that is widely used in international trade and financial transactions. It’s the preferred or most sought-after currency for settling transactions, since it’s generally stable and widely accepted.

Changes in the global reserve currency can have significant geopolitical consequences, as they can affect the balance of power between countries.

The dominant global reserve currency has typically had a lifespan of several decades, with the US dollar being the dominant global reserve currency for most of the 20th century.

The Nixon Shock

After the First and Second World Wars, many countries were economically exhausted and didn’t have much money. The US had a lot of gold, because it sold a lot of weapons and other military equipment to other countries during the war. As a result, the US controlled about two-thirds of the world’s gold.

To repair the global economy, a new system was created in which countries would tie their own currencies to the value of the US dollar.

The US dollar, in turn, would be tied to the value of gold. This meant that the value of other countries’ currencies would be based on the value of the US dollar, which was based on the amount of gold the US held.

The Bretton Woods system was a monetary system established after the Second World War to address global economic instability and high levels of debt.

Under this system, many countries tied their own currencies to the value of the US dollar, which itself was pegged to the value of gold at a fixed exchange rate. This meant that the value of other countries’ currencies was indirectly linked to the value of gold through the US dollar.

In 1971, US President Richard Nixon instructed the US Treasury Secretary to stop allowing foreign governments to exchange their dollars for gold, a process known as ‘convertibility’.

The sudden end of dollar-to-gold convertibility shocked the world and became known as the Nixon Shock, and it effectively ended the Bretton Woods system of fixed exchange rates. It marked the beginning of a new monetary system based on floating exchange rates.

Fiat currency

‘Fiat’ is a word that comes from Latin and means ‘let it be done’. When used in connection with money, it indicates that a government creates a currency by decree alone.

Since the Nixon Shock in 1971, fiat money is no longer backed by gold or silver, nor can it be directly redeemed for a fixed amount of gold, as was the case earlier.

This means their value comes from the fact that the government declares them valuable, and that people trust they can use them to buy goods. In addition, governments often make it law (legal tender) that merchants must accept this type of fiat currency, and that it’s the only type of currency that can be used to pay taxes.

Governments can print fiat currency in unlimited amounts. By contrast, the amount of bitcoin is fixed — and can never exceed 21 million coins. A continuous increase in the amount of fiat money creates inflation. This means the money you have today is worth less in the future. The limited supply of bitcoin has the opposite effect, namely deflation. This means bitcoin is designed to be more valuable in the future — because it’s scarce.

Digital fiat currency

Digital fiat currency is a type of money that exists only in digital form, such as on a computer or phone. It’s a digital representation of physical cash, such as paper money or coins.

Digital fiat became possible with the spread of digital communication networks, like the internet, and the growth of consumer devices such as computers and phones that can connect to these networks. Standardized payment protocols, which are established ways of making payments online, also played a role in the emergence of digital fiat.

Digital fiat is increasingly replacing physical fiat because of lower costs, faster speeds, and increased surveillance capabilities. In other words, it’s cheaper and faster to use digital fiat, and it’s easier to trace transactions made with digital fiat.

Credit cards

The credit card is a type of payment card that allows people to borrow money to pay for things. When people use credit cards, they borrow money from the credit card company to pay for things now, instead of saving up and paying for things later.

This has gradually normalized the act of borrowing to consume, something that affects users’ time preference. Instead of waiting to save up, the invention of the credit card has made it more common for people to borrow money to buy things they want right away.

Today there are around three billion credit cards in use around the world.

Central bank digital currencies (CBDCs)

Central bank digital currencies (CBDCs) are digital versions of traditional currency, issued and backed by a central bank.

CBDCs are not decentralized or permissionless like Bitcoin; instead, they’re intended to compete with other forms of digital payment methods for market dominance.

One of the main reasons for developing CBDCs is the surveillance and censorship capabilities they give the issuer.

Moreover, the rollout of CBDCs often goes hand in hand with the phasing out of physical cash, especially in times of negative real interest rates (when the inflation rate is higher than the interest rate), which can lead to a devaluation of the currency in real terms.

Surveillance capitalism

There are many problems associated with modern fiat currency.

First, it can be extremely difficult to move money around the world. Governments will often restrict the movement of money — and sometimes even seize money — without a valid reason or explanation. And even when you can send money, high transaction fees make it very expensive.

Second, there’s been a complete loss of privacy, since most people pay with debit and credit cards, as well as online with other systems like PayPal and Apple Pay.

Have you ever noticed how an ad pops up in your social media or Gmail just moments after you searched for a particular product or service? This is called “surveillance capitalism” and is based on companies selling your personal financial data.