Understanding the Origins of Cryptocurrency — Pre WW2 Currencies
An educational 3 part series on currency and cryptocurrency
Since the creation of Bitcoin, and increasingly so in the past few months, there have been countless debates by crypto thought leaders, bankers and government officials on what exactly cryptocurrencies are. Are they currencies, assets or something else altogether? This debate will probably go on until either bitcoin takes on a larger role in the global financial system or as skeptics predict, the bubble bursts completely and all investors return to fiat, defeated.
However, this is not the focus of this blog post. I was having a discussion with one of my colleagues and we came to the conclusion that in order to know what cryptocurrency is, we should first understand what currency is!
The history of currency:
Today, we generally accept currency as something in circulation that serves a medium of exchange commonly used for bartering, a unit of account and a store of value. Here in Singapore, we trust that the dollars we possess can be used to purchase goods and services and are genuine (counterfeit notes flooding the money market will negatively impact the trust people have on the currency and ultimately reduce its value for obvious reasons).
Before the existence of states, Adam Smith, the father of modern economics, argued that economies and markets already existed. Instead of using coins minted by monetary authorities or precious metals, goods and services were exchanged through barter trade. So how does barter work?
Imagine a farmer and a blacksmith living in a closed off village with no access to external markets and a standardised form of currency. The farmer needs metal wires to build a new fence for his cows and the blacksmith needs meat to feed his family. They meet, and the blacksmith agrees to provide 10 metres of metal wire and 50 nails in exchange for 1 cow’s worth of meat.
Trading of resources has been around since the beginning of humanity;cattle, grain and other forms of livestock and plant produce have been used as currency since centuries ago.
However, the need for a centrally recognised currency soon arose as trade became more widespread throughout Asia and Africa over three thousand years ago. Imagine one day a group of foreign traders arrive at the village carrying silk and other trinkets from their homeland. Their cart’s wheel has fallen apart and they need the blacksmith’s help. The blacksmith doesn’t want or need any of the silk and trinkets the foreigners had to offer. Such a dilemma could easily be solved if there was a mutually recognised currency.
Africans and Asians solved this issue through the use of cowry shells beginning as early as 1700 B.C., as the internationally recognised currency used in the slave trade, China, and the Asia Pacific region up until the 19th century. In China, they were used as gifts between royalty and nobles. Go to any gift shop today and one would be able to easily find shells of different shapes and sizes. So why was it considered precious for such a long time? The answer lies in the rarity and attractiveness of shells back then. They were only readily available in the Maldives, and given the technology back then, counterfeiting cowries was impossible.
During that time, precious metals like gold, silver, bronze, and copper were also used all around the world. Like cowries, these metals were valued for their rarity, beauty, and the effort required to extract them.s. The first known coins were created by the Lydians (image below). Go read more about them! I personally find them beautiful and fascinating.
How the gold standard works: Gold is promised for every dollar you own at a fixed rate. Essentially every piece of paper currency you own is a certificate for a piece of gold held by the central bank. The authorities can sell you gold on demand in exchange for money.
Without turning this into a lengthy blog post about economics and finance, let us move forward to recent history. A quick Google search reveals that the gold standard had been abandoned by most countries at a few points during the 20th century, during WW1 once fully and a second time for foreign exchange, caused by increasing amounts of debt which resulted in them quickly depleting their gold reserves to maintain the float. Following the end of the Great War, the United Kingdom and the other Western powers returned to the gold standard.
Some economic historians have accused the return to the gold standard for bringing about the Great Depression. Adhering to a gold standard led to deflation and the inability of the government to expand the money market led to poor growth, high interest rates and lowered investor confidence. While this occurred a hundred years ago, many of us have probably seen images of the iconic bank runs, investors and normal wage workers alike queuing outside banks to withdraw money, fearing that banks are on the brink of collapse, exacerbating the problem (no money deposited, and with low amounts of reserves left, very little to loan out to develop businesses). Most countries except the United States abandoned the gold float. America’s decision to stick to the gold float caused the Great Depression to hit her harder than the countries that gave up the gold standard.
Written by Kiat Goh
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Originally published at medium.com on February 1, 2018.
