From barter to Bitcoin, the crazy evolution of money
By Vladimir DENIS on ALTCOIN MAGAZINE
1) The birth of money
To understand money, you have to come back many years ago. The latter dates back to the Neolithic period, between -14,000 and -12,000 BC, so that men could exchange value in barter. In prehistoric times, money could represent various things: herds of cattle that were traded, food, weapons, raw materials, cotton or tobacco… people have always sought to exchange value. But it was not easy to transport heavy metals or bulky materials. A few centuries later, men began to exchange shellfish that, according to some anthropological studies, were used as currency because they were smaller and more easily transportable.
Then, it was the turn of silver and copper, which had a market value as early as the 8th century BC and came from Asia Minor (gold was first used for ornamentation and was therefore only used in a second time). Indeed, they are easily divisible and their intrinsic value is significant.
In seeking to simplify their exchange, several civilizations have sought to implement a new form of currency, simpler and more easily exchangeable: paper money: the banknote. The value of the latter was not, unlike the old exchange units such as barter or coins, in the intrinsic value of the object exchanged itself, but in the confidence that consumers had in the organization that issued the note. This marked a first step in the evolution of money and exchanges between human beings but required several millennia of evolution.
The Chinese used the banknotes since the 1st millennium BC in their trade. Banknotes were used in parallel with traditional coins, but merchants soon realized the considerable advantages of using paper money rather than heavy metal sums.
The government of medieval China had a monopoly on the production of banknotes by being the only one to have the woodcuts that allowed the printing of the said banknotes.
Thanks to Marco Polo’s travels in the 13th century to the Mongolian Empire and his many accounts, the Chinese banknote was discovered in Europe.
The note had the role of a bill of exchange between creditor and debtor and took the name of “banknote” since it was essentially issued by banking institutions. The banknote then underwent a tremendous expansion throughout Europe, especially among merchants. We can, therefore, consider that the dematerialization of money goes hand in hand with the birth of the banknote.
In the 17th century, European banks, and in particular the Bank of Sweden, decided to issue banknotes based on their gold stocks, following the same model as those of the Chinese Empire.
In the 18th century the Bank of England, France, and the United States printed many banknotes but some printed more banknotes than they had gold, which led to the bankruptcy of the Royal Bank of France in 1720.
The states understood that, to ensure the stability of the banknotes they issued, a certain counterpart exchange value had to be held, and that is why the British government declared, as early as 1844 (Bretton Woods Agreement), that all Bank of England banknotes would now be guaranteed for their gold value: the gold standard was born. This system was “copied” by many countries, including the United States and several European countries.
This system underwent numerous modifications during the First and Second World Wars, including the gradual abandonment of several countries in this gold standard system and it was finally following a decision by the Nixon administration that the United States definitively abandoned the gold standard in 1971. This decision to no longer index the dollar to gold was a major turning point in the history of the currency.
But would money be neutral in itself or would it have real influences on the economy?
2) The role of money and its supposed neutrality
The classic model
According to the classical school, whose “Treaty of Political Economy” (1803) will be cited, Jean Baptiste Say, the French economist of the 18th century formulated a “law on opportunities” also called “Say’s law”. According to him, any supply creates its own demand and overproduction is only temporary but will be corrected by the interplay of prices. The currency would then be a “veil” only intended to facilitate trade and would, therefore, be neutral, not playing a role itself. It would thus have no influence on the real economy.
Jean Baptiste Say takes up the value-utility theory according to which “the utility of things is the first foundation of their value”, which excludes the notion of value reserve, the notion of hoarding. This, therefore, excludes any use of the currency other than its main purpose: to carry out transactions.
The Keynesian model
This theory is in total opposition to the work of another famous economist: John Maynard Keynes. According to the Keynesian school, not all offers necessarily meet their own requirements. Income is not always spent, which would mechanically limit overall demand. The main difference with the traditional school is the reason for holding the currency. Keynes admits the transaction reason, like the classics, but adds two other reasons: the precautionary reason and the speculation reason.
The precautionary ground is qualified by an accumulation of money to deal with uncertainty. The reason for speculation, on the other hand, encourages the various economic agents to carry out arbitrations with the objective of realizing capital gains.
In this economic model, currency would therefore not be neutral and would influence the real economy. It would be possible to stimulate demand by adjusting interest rates: an increase in the quantity of money can change the general level of prices.
Thus, according to Keynes, economic agents would use money for at least three reasons:
- To exchange (reason for transaction)
- To accumulate (precautionary reason)
- To speculate (reason for speculation).
Jean Maynard Keynes was one of the first economists to insist on these concepts in his world-famous 1936 book “The General Theory of Employment, Interest and Money)”.
The monetarist model
Their more recent approach is halfway between the school of classics and the Keynesian school. Indeed, the idea that money is neutral or not is debated. For monetarists, neutrality is a question of time: if the evolution of the money supply only affects prices among monetarists, Keynesians advocate, in contrast, evolutions that influence the behavior of economic agents.
According to the monetarist school, the variation in the money supply in the short term would disrupt the entire economy, but this disruptive effect would disappear in the long term. Thus, Milton Friedman, in his 1956 book “Studies on the Quantitative Theory of Money”, advocated a change in the money supply in line with the speed of production to ensure price stability and avoid hyperinflation. Thus, monetarists believe, unlike the Keynesians, that the only intervention of the State should be on the control of the money supply, and nothing more.
The current model
It is easy to understand that there is no definition of money, but there are almost as many as there are economists to talk about it. To each his own definition, his own criteria of relevance and it would be futile to try to decide this partial basket debate.
However, the importance of these discussions is proven: while the question of the supposed neutrality of money is raging, three essential functions are now emerging from these theories, functions that are now taught in universities and the most prestigious schools by modern economists and by a large number of academic professors.
First, money is a unit of value, it measures the value of goods traded in a common measure.
Secondly, money is an instrument of exchange, it facilitates transactions for all because it is recognized and accepted by consensus and makes it possible to avoid a well-known and yet impractical type of exchange because it is unequal: bartering.
Finally, money plays a role as a store of value because it can be hoarded, that is to say it can be saved for later use.
These are the three essential functions played by the so-called’’modern’’ or’’official’’ currencies. There are even several hundred of them throughout the world and this has not prevented them from living together in a rather peaceful way (with the exception of trade wars). Could we then consider integrating a new currency into the existing classroom, an “encrypted” currency?
The foundations of money applied to crypto-currencies
Although highly criticized, cryptocurrencies nevertheless fulfill these three functions.
As a unit of value first, a cryptocurrency is exchanged at a certain price that everyone knows and accepts, the value is common to all. Although this can lead to problems as crypto-currencies are extremely volatile, this function is still fulfilled.
As an instrument of exchange then, because they are exchangeable either for another good or between them: they are exchanged every day through digital payments and are interchanged on the many exchange platforms that exist.
As a reserve of value, finally: many crypto-currencies, starting with Bitcoin, are now being hoarded as we will see soon.
Thus, and this has been a point of contention in recent months between the supporters of these assets on the one hand and the political and financial class on the other, crypto-currencies meet all the modern criteria that can be met by a currency, at least in fundamental terms.
Do they nevertheless acquire the official status of’’currency’’? Not exactly….
In reality, these assets cannot — and still are not — considered as currencies in the strict sense of the term. What exactly are they missing? Or, more precisely, what is being blamed on them?
Two major disadvantages.
First, they cannot be legally considered as currencies because they do not meet the criteria of a currency within the meaning of the Monetary and Financial Code. We will return to this legal point in more detail later in this brief.
Secondly, their creation (and therefore their control) does not come from any supervisory authority and is therefore not the prerogative of a central bank or a State. There is no doubt that governments do not want to lose control over their currencies and monetary creation is an essential part of this control function.
To understand how these assets pose a threat to money creation, and thus better understand the hostility of central and national banks towards these assets, we need to ask ourselves about the money creation process and the actual use made of it.
3) Monetary creation
The banking system as a whole as we know it today is composed of central banks and so-called commercial banks. This system can offer credit and therefore create money. Indeed, today, money creation is essentially based on credit. When you borrow from your banker, say €1,000, he lends you this €1,000 without the assets (the solvency ratios, formerly Cook’s* ratio, are now about 10%), which means that of this €1,000 he only has about €100.
By repaying your credit, you will repay the €1,000 + interest, which, presented succinctly, amounts to creating money. This cashless currency, on a global scale, represents about 90% of the current money supply, yet it is the monopoly of commercial banks.
Fiduciary money (which comes from the Latin FIDUCIA, which means trust) is the monopoly of central banks and represents a little less than 10% of the money supply.
But the role of a central bank is not limited to the issue of fiduciary money in the strict sense of the term. Countries place their surpluses with their central banks and, conversely, when a bank lacks liquidity, it borrows either from the central bank or from the interbank market (from other commercial banks).
The surpluses of some offset the deficits of others. The central bank also checks that payments are functioning normally: it ensures that the currency can be used reliably and that so-called commercial banks can credit each other. The central bank approves banks and imposes different ratios on them. This contributes in part to ensure the beginning of stability in the banking and financial system.
The central bank is also responsible for monetary policy, which means that it tries to match the distribution of credit with the financing needs of the economy and businesses, in particular by matching the amount of money created by banks with the objective of monetary stability.
Finally, it affects interest rates by adjusting rates upwards or downwards according to various factors such as inflation (it should be remembered that one of the central banks’ stated objectives is controlled inflation of around 2% each year, considered by many economists as healthy inflation).
When there are threats of economic depression, it can lower interest rates to the lowest level, to zero, as was the case for the 2008 economic crisis.
In theory, these are known dates in advance at which central bankers meet to discuss a potential increase/decrease in key interest rates.
These meetings are preceded and followed by a large communication in order to avoid any surprising effect. In practice, this strategy has only one and only one objective: to reassure the financial markets to which economic objectives generally remain subject. Indeed, the 0.25 point change in key rates is used as a signal for rate increases more than it has a real impact on credit….
Does money creation constitute an exorbitant power granted to central banks and especially, as we have just developed, to commercial banks? Some people think so, and even claim that they make this power pay with high-interest rates or by carrying out transactions that are contrary to the general interest but only beneficial to them.
The death of cash: a more or less displayed will….
Over the past few decades, the structure of the total money supply has changed significantly: the share of currency (coins and banknotes) has steadily declined in favor of cashless money. If we take the French example, from 1960 to today the share of coins and notes has decreased from 40% to only 5%. This seems to be a logical evolution: cheques are also less important since the first means of payment has become electronic: it is the bank card.
But some countries go further: Sweden, for example, would like to make cash disappear in favor of what could be described as 2.0, purely electronic money, in particular by using the telephone. Many costs of printing money, distributing and maintaining ATMs would be eliminated, according to his supporters. But the real interest in the world of finance is not there. Above all, it is about better traceability of money: taxation for banks, taxes for governments… The traceability of money is an essential point to which we will return.
4) Loss of confidence in the current financial system
The 2008 crisis known as the subprime crisis is based on what could be described as ultra-liberalism, first in the United States and then in the developed countries of Europe. The completely unbridled use of the various techniques used by modern finance, including a field of application called securitization, subprime or derivatives, and based on the American real estate market, caused a shock wave first at the national level, then at the international level, which will surely continue to be discussed in 90 years in the same way as we still talk today about the famous Wall Street Black Thursday, that damned day of 24 October 1929 when the American stock market lost almost 23% in one day.
This subprime crisis can be compared to an investment crisis. In the United States, many neo-liberalists had, for some years now, won a huge battle by succeeding in removing the barriers between two major banking activities: deposit banking and investment banking, which is nowadays rather considered a speculative activity on behalf of banks. Commercial and investment banks can join forces and merge. The expansion of modern finance and the recognition of the free movement of capital led to a real boom in banks’ activities, particularly in the investment area.
Deregulation being in the era of time, there was not much left to rely on banks’ products, except the famous ratings of rating agencies. Nevertheless, these rating agencies were unfortunately far from being impartial in the ratings they gave to the banks, insofar as they were remunerated by the same banks they were supposed to rate. Part of the 2008 crisis was (rightly?) attributed to these rating agencies. Let us note a somewhat confusing example: Lehman Brothers was rated AAA just a few weeks before its bankruptcy on September 15, 2008…
The collapse of the global financial system during the 2008 financial crisis took place in several stages.
This started in the United States with the fall in house prices.
The second stage comes from the collapse of structured financial products, which were “stuffed” with real estate, the famous subprimes.
The third factor is a serious general liquidity crisis: many products considered liquid (saleable at any time on the financial markets) found themselves without people to buy them, thus causing the investment bank, which was very fond of these products, to be significantly unable to repay the loans granted to it by the liquid banks, namely the deposit banks.
With the financial system globalized and interconnected, it did not take long for this crisis to escalate from the national to the international level, from the banking to the insurance level, before finally contaminating the entire global financial system.
The question began to be asked, and then, very quickly, a central question emerged: should we let the bankers honor their commitments, even if it meant letting them go bankrupt, with the inherent risk of a sudden loss for millions of savers around the world and a global financial catastrophe, thus relieving the sad era of 1929?
Or were we going to help the banks overcome this, even if it meant looking for the culprits once the bleeding had stopped?
This is the second option that was favoured by our governments, which were also affected by a crisis that no one — or almost no one — had anticipated until now.
But this rescue had a not insignificant cost: the world finally noticed the banking practices.
This was the reason for the separation of deposit and investment banking activities: to allow institutions that are surplus to currencies (deposit banks, thanks to savers’ assets) to ensure the liquidity and guarantee of loss-making institutions (investment banks). Individual deposits were not used to finance any economy, but simply the financing needs of speculative activities.
And it was the global financial system that was damaged: so this is what the banks were doing with all the power they were given! They created money for themselves far from the concerns of the people whose assets they hold, and made these same little people who trusted them pay for their excesses!
We refused to imagine that failures could lead to this. Having a few’’struggling’’ banks should not be a problem in the United States given the number of players involved. One bank could be sold to another in a better financial situation, but it had not yet been fully realized that savers themselves could simply be robbed of their life savings in the event of a mastodon’s bankruptcy, since the entire financial system is now interconnected, as it is centralized.
The consequences of this crisis were many, including the violent criticism of banks and the financial system as a whole, which turned into a kind of “anti-bank” propaganda, some of which, on a global scale, had become almost too big (the famous Too big to fail) and whose balance sheet sometimes exceeded the GDP of an entire country. The slogan’’ nationalization of losses, privatization of gains’’ was placed on the reputation of major banking institutions and the media coverage was deadly.
So shouldn’t this financial liberalism have been curbed much earlier?
It was in response to this large-scale financial crisis, caused by the financial and banking sectors, that the famous cryptocurrency “Bitcoin” was created.
5) The creation of the most famous cryptocurrency
The adventure began at the end of 2008 — in the midst of the financial crisis — but is difficult to date precisely. An anonymous cryptographer (probably several people in reality, because the complexity of encoding such a blockchain suggests that it would rather be a team of coders and computer scientists) answering to the pseudonym Satoshi Nakamoto, still unidentified today, publishes a message on the Internet. He summarizes his project “I have tried to work on a completely peer-to-peer payment system, removing any intermediaries or “trusted third parties” and lists several characteristics of his innovative project. First, he explains, “double spending is made impossible in a peer-to-peer network with validation. There is therefore no longer any need for trusted third parties. That’s a first. Indeed, until then, all experts agreed that it was impossible to create a peer-to-peer payment system without a trusted third party to validate the transaction (such as a bank for example). Money sent over the Internet must only be able to be spent once, otherwise, the money would be infinitely replicable (as is a computer image for example) and would lose its intrinsic value… hence the need until now for trusted third parties.
The second parameter of the equation: anonymity. In reality, the participants in a blockchain operate under a pseudonym (we should, therefore, speak more of pseudonymization than anonymization) which corresponds to a sequence of numbers and letters that may seem chaotic at first glance. Bitcoins are therefore issued by all network members, who know and must validate the transactions. It is a hashcash-style proof of work system, a rather technical point to which we will return later, instead of being issued by a bank or a government as in the traditional financial system.
Satoshi Nakamoto thus created the first digital currency in history, but also and above all the first blockchain in the world.
At the origin of the Bitcoin, a libertarian spirit…
Satoshi Nakamoto has not been talkative in the few messages that can be found from him on the Internet. Almost all of them are of a technical nature. All, except for a few, which confirm the libertarian spirit of the project and the stated desire to remove power from the great powers and institutions of this world: in particular banks and States, to give it back to individuals.
When Satoshi Nakamoto really launched the Bitcoin network in 2009, he didn’t do it in a risky way. In the first block of the Bitcoin blockchain, he cryptographically writes a series of numbers and letters corresponding to a newspaper title: “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks” (1).
For many Bitcoin experts, putting a big newspaper headline in the first block allows them to date the launch ’’officially’’.
But the one in question was certainly not chosen at random: there is this stated desire for counter-power, hostility, and mistrust towards the banks.
Two years later, Satoshi published a final message on the forum, which was very popular with BitcoinTalk, and then disappeared permanently. Several people have since been suspected of hiding under this pseudonym without ever being able to prove anything.
Rumour has it that Satoshi Nakamoto owns 1 million Bitcoins (the equivalent of $8.5 billion at the time of writing). No wonder he wants to be discreet.
During the first years of its life, Bitcoin did not enjoy a very good reputation. Indeed, it was allegedly used for illegal purposes and thus acquired the reputation of a currency “of drugs, weapons, and illegal sex on the Internet”. It is true that the relative anonymity of cryptocurrency and the ease of trading on the Internet attracted dealers and other criminals, which led to a crackdown in 2013, leading to several entrepreneurs in prison in particular.
In everyone’s mind, Bitcoin remains marked by the SilkRoad episode and is likely to suffer from it for many years to come. SilkRoad was a black market (mainly focused on weapons and drugs) on the darkweb, the hidden Internet, and on which many transactions were carried out in Bitcoin.
But since the closure of SilkRoad in 2013 by the FBI (and which led its creator Ross William Ulbricht to life imprisonment) the activity of Bitcoin has been largely regulated: According to Chainanalysis, a young company that specializes in monitoring the various transactions carried out on blockchains, what could be described as illegal activities represent around 6% of the volume, and is now far ahead of speculation activities by the financial markets on Bitcoin, unlike in 2012 and 2013, when nearly half of the transactions carried out in crypto-currencies were due to illegal activities.
This change is due to the democratization of Bitcoin in the first instance and its acceptance in the second.
Marc ANDREESEN, the computer scientist who created the first web browser and crypto-currency specialist in 1993, addressed the New York Times in response to some people’s comments about the illegal nature of Bitcoin: “To all those who shout that Bitcoin is only used as a paradise for criminal or terrorist activities, or that you can transfer money anonymously, you know nothing about it because it is a myth. Bitcoin works like email which is easily traceable because it is pseudonymous and not anonymous. In addition, each transaction on the network is tracked and recorded in the Bitcoin blockchain, an unalterable register visible to all. Finally, Bitcoin is much easier for law enforcement to follow than cash, gold or even diamonds. It is much more discreet to buy drugs in cash than in crypto-currencies”.
The Ethereum blockchain
The Bitcoin blockchain, although the first of its kind, is only used to exchange value. No other application is possible but the exchange of Bitcoins. And it is on this observation that in 2015, a 19-year-old cryptographer named Vitalik Buterin launched a promising blockchain: Ethereum.
The latter takes up the main axes of the bitcoin blockchain while adding the possibility of registering intelligent programs, called smarts contracts. Freed of this libertarian ideology that sticks to the skin of Bitcoin, this blockchain and all its possible applications promise countless possibilities (in insurance, connected objects…) and seems much more promising in the eyes of the financial and business world.
A few months later, Blockchain technology made the headlines of the British weekly The Economist. A Bible from business circles, the magazine summarizes the interest of the blockchain. This was followed by an extraordinary media hype about crypto-currencies but above all about the technology that had allowed them to exist: the blockchain.
But to understand crypto-currencies and how they can exist, we need to go back for a moment to the technology underlying this asset class: what is really a “blockchain” and what is behind this barbaric name?
To find out, I invite you to read the article I wrote on the subject, which explains in a simple and summarized way the differences between the blockchains: https://medium.com/altcoin-magazine/the-different-types-of-blockchains-456968398559.
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