Our ancestors started off with the barter system — something like “I will give you 2 horses in return for 5 shiny new super-sharp axes”. Soon they realized that the barter system had too many limitations — everyone didn’t want horses, horses were neither divisible (not too many people would want 0.35 horses) nor very portable (imagine having to carry a horses on your shoulders while going shopping).
So they moved on to more acceptable, divisible, homogeneous and portable forms of money — cowry shells, salt, gold, silver and lots more. The Chinese invention of paper eventually led to the birth of paper currency, which was initially backed by gold or other precious metals.
Then the world moved on to fiat money — currency that’s declared as legal tender by a government but not backed by a physical commodity.
This brings us to an essential question — what is money? Money’s a matter of functions four, a Medium, a Measure, a Standard, a Store. So goes the couplet based on William Stanley Jevons analysis of money in 1875. This meant that for something to be called as money, it must function as a medium of exchange, a measure of value, a standard of deferred payment and a store of value.
Money’s a matter of functions four, a Medium, a Measure, a Standard, a Store.
The track record of Government issued currencies isn’t spotless:
- In post World War I Germany, the Rentenmark was introduced to replace the existing currency at the exchange rate of 1 for 1 trillion!
- In 1983 Argentina issued the new peso to stabilize its currency. One new peso was equal to 100 billion of the original pesos (pre-1983)!
- In the 1990s, Peru replaced its currency at a conversion rate of one billion to one!
- In 2008, Zimbabwe introduced the new dollar that was equal to 10 billion of the old dollars!
One of the lessons in all this is that a nation’s currency is not exempt from the laws of supply and demand. The more currency that is printed, the less it is worth.
2. Digital money
The birth of computers and the Internet brought in many electronic payment systems including debit cards, stored value cards, giro transfers, credit cards, net-banking, electronic bill payments, electronic cheques, mobile wallets, digital gold currencies, digital wallets, electronic funds transfer at point of sale, mobile banking, SMS banking, online banking, payment cards, real-time gross settlement systems, SWIFT, wire transfers and more.
And then came Satoshi Nakamoto’s path breaking invention — Bitcoin. This brought the world its first truly peer-to-peer virtual currency.
Bitcoin earned a lot of notoriety primarily because of its use by members of the now shut-down Silk Road — an illegal online marketplace that facilitated the sale of almost a billion dollars worth of drugs, guns, stolen financial information, counterfeit documents and more. All Silk Road transactions were conducted exclusively in bitcoin.
A lot of virtual currencies piggy-backed on Bitcoin’s underlying innovation — the blockchain. In fact we now have more than 750 virtual currencies being used around the world.
A virtual currency has all the features of money. Just as fiat currency is not backed by any asset (just the promise of the issuer), virtual currencies like bitcoin are also not backed by any asset. And there is no promise since technically there is no identifiable issuer. The only difference is that fiat currency has legal tender status in at least one country while a virtual currency is not recognized as legal tender by any country.
Fiat currency has legal tender status in at least one country while a virtual currency is not recognized as legal tender by any country.
3. Introducing Oil-COIN
Let’s consider Oilistan, a fictional oil producing country. At any given time Oilistanhas 10 billion dollars worth of oil in stock. This oil is not earning them anything. It’s just sitting around waiting to be shipped off to buyers.
Oilistan decides to issue Oil-COIN, a virtual currency backed by this stock. The Initial Coin Offering offers Oil-COIN at a price equivalent to 85% of the last 3 months average price of oil.
Technologically speaking, Oil-COIN is run on a permissioned blockchain run by Oilistan with nodes located in multiple countries.
After the Initial Coin Offering, buyers are free to buy, sell, exchange Oil-COIN. Merchants around the world are free to accept Oil-COIN for products and services. A small transaction fee of 0.01% is charged by Oilistan on every transaction.
Would you use an oil-backed virtual currency?
No matter what your answer, virtual currencies are going to grow and this will have implications for all of us — banks, businesses, consumers, Governments, organized criminals and law enforcement.