Money was invented [Crypto indexing part 4]
If you had to store all your savings in cash and put it under the mattress for 20 years, which currency would you choose? Out of the hundreds of currencies available, the most viable options are U.S. dollars, euros, British pounds, Swiss franc, Japanese yen, and maybe — depending on where you live — your own home currency. The limited number of reasonable answers out of the many possible choices reveal an important fact about money: some are better than others.
Money had to be invented for trade. Before there was money, societies relied on gifts and barter — both of which severely limits trade. Gifts limits a transaction’s value and the counter-parties we can trade with, since knowing the person or having a history of successful gift exchanges would be required for valuable trades to take place. Another drawback with gifts is that they rely on humans remembering the quality and amount of the good which was received — a common source of conflicts. Barter limits the liquidity and frequency of trade, because if paying in-kind is the only option then both the buyer and the seller must be willing to buy and sell each other’s goods simultaneously. This requires a coincidence of wants, which is unlikely. For example, what should the fisherman do when he has caught more than he is able to eat? Perhaps the fisherman need clothes, but if his village relies on barter then he must find a tailor today — otherwise the extra fish will be worthless. The tailor may not be hungry. In this case, the fisherman might be able to trade the fish for nuts, the nuts for beer, and the beer for clothes. Obviously, the coincidence of wants introduces liquidity and accounting problems: will there be a path from fish to clothes via trading, and what are the appropriate exchange ratios for all goods? In an economy with 100 goods there are 4950 prices to keep track of. Another drawback with barter is that it is almost impossible for a musician to pay his rent.
Money solves these problems. The invention of money allows us to trade more valuable goods at an increased frequency with more counter-parties. Moreover, all goods can be priced in terms of only one other good so that there are not thousands of exchange rates to keep track of (money is a unit of account). And the musician can receive money when he plays the piano at a bar (money is a medium of exchange). He can use this money later to pay his rent (money is a store of value). Money can be defined in terms of its functions as a medium of exchange, store of value and unit of account. Anything that fulfils these properties can be used as money.
A more direct way to define money is to say that it is any item (or verifiable record) that is generally accepted as payment for goods and services as well as repayment of debts. From this definition, whose keyword is “accepted”, it is clear that money works because we believe in it. Consequently, money works only if we believe in it.
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Jacob Lindberg, the author of this post, is the founder & CEO of Vinter — an index provider and data analysis firm specialized in cryptocurrencies.
This blog post is a part of our intro blog series on crypto indexing. Read the other posts on medium.com/vinter
