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What is Money and is Bitcoin money?

Money is our madness, our vast collective madness. — D.H. Lawrence

We use it every day, and yet do we really know what it is? If you had to explain money to someone, how would you do it? Maybe you would pull out some bills and coins to underline your explanation. However, thinking about it, most of your money you don’t handle in cash, but simply as a string of data from your banking app or your online banking account.

And then in 2008, Satoshi Nakamoto created a new kind of money that was aimed to be an alternative to the money we currently have. But is Bitcoin money?

To answer that, we have to start with Money itself.

Money has 3 main functions:

  • Store of Value: you can store your money and use it at a later point to exchange it for goods. It keeps its value (inflation put aside)
  • Unit of Account: money makes it easier to assign value to different things. Just imagine how difficult it was in the barter system to figure out how many shells you needed to buy a cow and then how many cows you would need to buy a house. With a single unit, it’s a lot easier to measure value cohesively.
  • Medium of Exchange: money can be used to facilitate trade, it allows us to buy and sell from and to each other.

Money these days is a very abstract thing. So how did we get to this point?

A short history of money

As mentioned previously, early trades were settled by exchanging different goods for one another. This was somewhat very impractical so we moved on to using coins made out of precious metals to buy and sell. With coins, it was easier to value different goods, yet you still had the problem that supply was limited, which limits the growth of your economy — but we’ll get to this later.

The first one to try making paper money the dominant currency was Kublai Khan, a Chinese emperor — and a pioneer in terms of money. When he started reigning, each region in China had its own hard currency, which made it difficult to trade seamlessly between different regions. To solve that problem Kublai Khan decreed that all money should take paper form.

People started exchanging goods and labour for a piece of paper. When Marco Polo visited China, he marvelled at the sight of this — just as if an economy was made out of thin air.

Nevertheless, this idea of paper money wouldn’t really take off just yet. In Europe for a long time, empires were built on precious metals. The first step towards paper money was the bill of exchange introduced in medieval Italy.

Merchants unwilling to store all their coins by themselves started giving them into storage at banks. These would give them a bill of exchange that prooved to others how much the merchant was holding in the bank. As the bill was basically worth the gold backing it, merchants could travel with it and started using their bills to pay instead of actually touching their coins.

Abandoning the Gold Standard

So far money is still backed by precious metals, especially gold. This would finally change in the 20th century with WW1. Entering the 20th century, most western countries were still holding onto the Gold standard, which meant they would issue only issue money in a certain ratio to the Gold they held in reserve. The Gold standard stabilized money, but it also caused deflation. As populations grew, governments didn’t have the means to grow the gold supply equally, which ended up deflating their currencies. So when World War I came around, governments started simply printing money to pay for all the weapons and damage, which was a lot easier than having to obtain gold first.

Fast forward to today, money is an abstraction. It’s backed by nothing but the authority of the government issuing it, it’s fiat. Most currencies in the developed world are rather stable. Yes, there is inflation, but usually, it’s fairly low and even inflation has benefits, as it stimulates investments.

Who makes money?

While we’re at it, let’s come clean with a common misconception surrounding money. Recently, we often hear about central banks using the money printer to rescue our economies. It’s nice imagery, yet it’s a bit off from what really happens. What actually happens is that the central banks start buying governments securities like bonds from commercial banks. As result banks have more money on their balance sheets and this is where the magic happens. Banks only have a certain ratio that they need to adhere to in terms of reserves because most of us won’t just run one day into the bank and withdraw all our money. So Banks start using that money, that is not part of their reserve and lend it out.

“Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money.“ Bank of England

For instance, if the reserve rate was 10% and you deposit $100, the bank can lend out $90. In doing so, they create a new entry on the account of the borrower, while your deposit remains untouched. Voila, $90 were just created.

Enter Bitcoin

Bitcoin was created in 2008 during the aftermath of the financial crisis as peer-to-peer cash that could not be censored, nor stopped by anyone. It relies on a decentralized network and is governed not by people but by code. The problem many previously envisioned digital cash systems faced were those of double-spending — when someone spends the money they own twice. In the case of bitcoin, the proof of work algorithm prevents double-spending from happening.

The total supply of bitcoin has been determined at the birth of the protocol and new bitcoin are issued at declining rates in the form of mining rewards. Whenever someone loses Bitcoin, they are lost forever and reduce the total supply. It’s estimated that more than 20% of the supply could already have gone lost.

While at the beginning Bitcoin seemed merely a toy for developers and gamers, it has kicked off a whole new industry (blockchain) and is one of the best performing assets by now. But is Bitcoin money? To assess that, we’ll look at the 3 properties of money.

Store of Value

The debate if Bitcoin is a good store of value is still ongoing. It’s often compared to the more traditional store of value gold, which has given it the association of “digital gold”. There’s no definite answer to whether or not it is a good store of value, and it might be that we have to wait a bit longer to actually see it play out. The debate is ongoing with opponents mainly quoting that the high volatility of Bitcoin makes it an unsuitable store of value, while proponents highlight the properties of Bitcoin such as its limited supply, ease of storage and prospect of future price increases due to decreasing mining rewards. Both sides have good arguments and personally, I think it’s something you should probably build your own opinion on. However, we’ve already seen an increase in the use of cryptocurrencies in countries with hyperinflation, which speaks for Bitcoin being seen as a store of value.

Unit of Account

With a unit of account, you can value and compare different assets. Within the world of cryptocurrency exchanges and token offering, it’s common practice to charge in BTC or denote the value of another cryptocurrency in Satoshi. As long as you’re convinced that Bitcoin can only go up in the long term and you pay all your bills in BTC, you shouldn’t encounter any problems. However, with price fluctuations and bills denoted in fiat, it can be a bit of a risky practice. Outside of crypto, Bitcoin is not used as a unit of account. If its use increases and it stabilized in price, it could well be used as a unit of account.

Medium of Exchange

A medium of exchange lets you easily buy and sell with and from others. This is certainly true for Bitcoin as long as you stay within an environment where merchants accept cryptocurrencies. Despite tremendous growth since its inception in 2008, Bitcoin is still more of a niche payment method in most countries. To be frank, it’s also not the most user-friendly payment as of now, but many cryptocurrency companies are working on making it easier to use. Another challenge for Bitcoin is its scalability that doesn’t necessarily allow us (just yet) to support big throughput which would be required if it was a widely accepted payment method.

So what. Is Bitcoin money?

Bitcoin doesn’t have all the main functions of money just yet. However, who knows what will happen in the future. If it is more widely adopted and its price stabilizes to a certain degree, it could well become some kind of money. Will it replace all other money? I doubt it. Our current monetary system has grown over centuries and centuries, that’s not something governments would be willing to abandon anytime.

One thing that clearly differentiates Bitcoin and money is that money is basically just trust. Trust, that your bank will give you your money back, trust that your government is not going to mess with the money supply.

Bitcoin in return is trustless. No one can mess with the system and it’s held up by a decentralized network of miners that put in computational work to create new Bitcoin.

To wrap it up, there are no easy answers and it’s really up to you to build your own opinion. However, if you’re interested in Bitcoin, I highly recommend learning more about money in the first place. You might be surprised.



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