Cryptocurrency: The future is here.
I avoided any kind of Bitcoin news until recently. That was an excuse, an excuse because I didn’t understand the technology.
Learning about cryptocurrency and how we humans define value, opened up a new world.
This article shares a few of those distilled learnings and is highly simplified. The next in this series will focus on specific cryptocurrencies, how they work and how to start trading or investing in these new digital commodities.
Money has been undeniably one of the greatest inventions of humankind along with language. First known use of commodity money was back in Mesopotamia around 3000 BC, where the ‘shekel’ unit of weight (about 160 grams of barley) could be exchanged for goods. Another example of commodity were shells, decided on a value beforehand.
These items exchanged value but overtime we moved to light weight representative money. Carrying a piece of paper representing 1 kg (2.2 lb) of gold coins was easier on your pocket than carrying gold or silver coins.
In 1919 William Stanley Jevons analyzed money, easily remembered by this romantic couplet:
Money’s a matter of functions four,
A Medium, a Measure, a Standard, a Store.
Pause and ask an important question; why didn’t we stick to barter? A sheep for your goat? A bag o’ wheat for your boat?
Because this representative medium of exchange avoids a problem of coincidence of wants. If you wish to trade a boat for wheat, you can only do this when the built boat and wheat are both available at the same time and place.
Money (representative money) solves this problem by being a medium of a standard store of value.
What gives currency ‘value’? It used to be Gold
Traditionally, various global currencies were based on some tangible physical asset. Back in 1812, a formal gold specie standard (coins) was established in Britain, followed by the United States in 1873. However, the gold standard came to an end a little after World War 1.
Why gold and any other metal? In short; it doesn’t corrode, so it doesn’t lose value over time. [Podcast on why Gold]
It was tremendously difficult to peg currency value to a fluctuating reserve & value of gold. Pegging a currency value (price) to the weight of gold (grams/oz) is known as mint price.
For example, Canada’s Gold standard in 1853 defined 101.3 grams of gold equal to a Canadian pound and 1/4th of 101.3 grams of gold was equal to the Canadian Dollar.
In 1913, United States passed the Federal Reserve Act mandating banks to have 40% of printed money to be backed by gold bullion reserve. Remember this for our story ahead.
By 1914 several European countries moved away from the gold specie (coins) to gold bullion represented by four hundred ounces troy (12 kg gold bars).
But who decides what’s 12 kg of Gold worth?
Valuable Space Rocks
Imagine you and four of your friends, on a cool autumn night, hear a roar — a loud rattling roar sounding like a blast of a thousand jets. You five decide to check it out. A meteorite fall. Let’s call this a lump a Space Rock (SR).
Imagine this, the space rock is unique and none of you have seen one before. An idea!
You take it home and each of you cut out an equal piece from this space rock (SR) for safe keeping. Remaining space rock lump stored in a locker.
What’s the value of these five pieces?
Depends on how you five define value.
All five of you are appreciating your space rock luck, just as Xing offers $10 for your piece of space rock. After spending sometime with your space rock, you decide to sell your 1 SR piece to Xing for $10.
Now she has two pieces and you are $10 richer.
What’s the value of these five pieces?
Perception. Everyone seeing you and your friend exchange $10 for a piece now puts the combined 5 pieces to a value of $50! In other words, that evening at your basement, commodity volume for 5 SR became $50.
Another friend want’s to get in on the action. He asks his friend beside him to sell sells his SR for … and so on.
Similarly, value is given to an agreed system through consensus and economic factors. The remaining meteorite SR lump stored in locker has value because of the exchange between you and Xing.
The Great Depression: An insightful lesson
There are several theories on what exactly caused the great depression in the United States back in the 30’s. We skip the reasons of cause and discuss what could have at least slowed it down. Recommended reading list is provided at the end for interested readers.
Some theorize that at a time of crisis, governments are expected to step in (spend reserves and cut taxes) to keep companies afloat and people employed, as the companies hold back investments.
This cycle of unemployment — because of private sector holding back investments, and thus low buying power of the masses — can only be broken by government spending and cutting taxes, i.e. running a federal reserve deficit for a while.
On the other hand, some theorize that the great depression was exasperated by the banking crisis. The initial dip snowballed into panic leading to 33% of banks closing down. The Federal Reserve could have injected liquidity into the banks, i.e. more money flowing into large public banks to stimulate new businesses, existing companies and thus employment; breaking the cycle.
They could not. Remember the Federal Reserve Act of 1913?
By 1920s, over and above gold bullion backed printed money, the Federal Reserve was reaching a limit of issuable credit that could be backed by gold in its possession. These ‘demand notes’ or ‘promise of gold’ wasn’t enough as the 40% limit was already reached with the printed notes.
During the panic, some of those demand notes were redeemed for Federal Reserve gold by these large banks.
Since the Federal Reserve reached its limit on allowable credit, any literal reduction in it’s vault stored gold had to be accompanied by a greater reduction in value of gold!
Too little too late, President Roosevelt signed the Executive Order 6102 prohibiting private ownership of gold certificates, coins and bullion, reducing pressure on Federal Reserve gold.
Here comes fiat, free floating currency
Fiat, latin for “it shall be” is currency that a government has declared to be a legal store of value, but it is not backed by a physical commodity.
It’s value is derived from the relationship between supply and demand rather than the value of material that the money is made of.
Some may argue that fiat currency isn’t worth anything, since it’s not pinned by anything tangible like gold or silver.
Well, as per our Space Rock story the value of any currency, is only relative to what economy, government and people think it’s worth.
In conclusion, an important question to ask, when will the current free floating fiat currency (not pegged by Gold or anything else) be replaced with cryptocurrency which in itself isn’t pegged to anything other than it’s perceived value? Can deficit be ‘issued’ in state of emergencies?
We are witnessing the future unfold
Gold and space rock scenario are similar to cryptocurrency but with a twist. Cryptocurrency is weightless, on the internet, yet measurable and tangible.
Unlike gold and space rock, digital money isn’t heavy or needs extensive physical security. Furthermore, few courageous lot can store their cryptocurrency ‘wallet’ in their memory.
Cryptocurrency is certainly a Medium, a Measure, a Standard and a Store. It’s the future, and we are a part of it.
In the next section, we will simplify Bitcoin and alternative cryptocurrency, and learn to create your wallet and purchase some.
Feel free to leave a constructive comment. No obligations but your donations would help with a flat white while writing articles like these:
Bitcoin Donations: 1BX1kuHXmTPdWgwMi4yp6wwLceZs7n5xPS
Ethereum Donations: 0x152f97dcaAC3E6D4790A2745cb496A296696b8D5
Read & watch list for the interested
What would bitcoin Gold Standard look like?
The Great Depression crash course
Keep an eye out for 7:42 on using Cheetos as currency ;)