The Worlds First I.O.U.

The Transition to Currency — Post #5

Humans eventually figured out that precious metals made great money. Let’s take gold as an example.

1. Gold is divisible(ish). You can slice it into pieces.
2. Gold is portable(ish). You can move it.
3. Gold is durable(ish). It is hard to destroy.
4. Gold is uniform. When pure, is the same as every other piece of gold in the world.
5. For a long time, gold was the best balance between rare and abundant objects. (And still would be, if it weren't for computers.)

Gold was the best object that fit all these characteristics of money. So humans used gold and other precious metals as a way to store their value and trade with other people.

I like to think the creation of paper money happened something like this.

People were given gold coins to represent how much grain (or another commodity) they stored in the city vaults. Now instead of trading bags of grain, they could trade coins with their friends because 1 coin was equal to 1 bag of grain (1 coin = 1 grain). This worked out great because now the farmer could pay for his beer with coins instead of grain. Gold was hard to find and grain was hard to grow, so they represented similar value.

Then something happened.

The dudes guarding the grain (cause someone has to guard it), started running out of gold coins.

But people were still lining up to give the vaults grain in exchange for gold. So instead of giving them gold, the guards gave them an I.O.U. (a note on piece of paper) that said, “This note equals 1 gold coin”.

Stay with me here.

If 1 gold coin equals 1 bag of grain. (1 coin = 1 grain)

And 1 note is worth 1 gold coin. (1 note = 1 coin)

Then 1 note is equal to 1 bag of grain. (1 note = 1 grain)

Now a farmer could take his note and trade it as he did with gold coins. He can buy a beer with the note because the bartender knows he can trade the note for grain or gold.

This system works because all the money (coins and notes) equals all of the value (the grain). That means if everyone went back to the grain vault to exchange their notes and coins for grain, there would be enough grain. This requires TRUST that the guards are being honest, or someone is going to get screwed.

This type of money is called representative money because it represents an object of value. It doesn’t matter what the object is as long as it represents something of value.

In this scenario gold coins can also be called commodity money because gold is valuable as an object even if not being used as money. It is intrinsically valuable.

… to the next post!

This is post #5. The others are located here.

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Any comments, suggestions for improvement, or topic requests? Get in touch or email me at miketalksaboutbitcoin@gmail.com