What is Money?
By: Mark Roddy
Tags: Cryptocurrency, Money, Insights, Bitcoin, Fiat

One of the difficulties that people have in accepting bitcoin, is that it’s not tangible- they can’t see bitcoin- therefore it’s incredibly hard to associate a value with it. It’s common to hear people rebut that they “prefer money that I can touch and feel” .

Financial abstraction, is the notion that money is becoming more of an idea and less tangible, and therefore more abstract. Consider the fact that more than 90% of the money in the world today is digital — In essence money is fast becoming an illusion.

Cryptocurrencies are considered to some, the future of money- but before anyone can accept that, it’s important to ask ourselves a question, that for years has laid dormant until the rise of bitcoin, “What is money?”.

Money can be broken down to simply a system of trust — the island of Yap in the Pacific Islands is a great example of this, as well as showing us just how abstract money can be.

On this island the people of Yap used huge limestone rocks, or disks, as money. It’s unclear exactly how this started but we know that at some point the people of Yap agreed that these large limestone rocks represented value i.e. money.

Limestone Rocks were considered value on the island of Yap

What is more interesting is that the discs were so large that they were often too difficult to move — so they wouldn’t bother moving them. The ownership would transfer between the villagers but the rock would remain in one place. In fact there is one story of a rock that fell into the ocean as it was carried back to the island of Yap. Rather than write it off as lost — the villagers agreed it still had value, and so the rock that laid at the bottom of the ocean retained its value and ownership was transferred to it.

This system works because the people of Yap agreed the rocks had value — they trusted that they could pass ownership of the rock onto someone else, and in return receive something of value. The people of Yap are obviously very isolated, and their form of money has evolved to be something quite different to what most are use to but the principles are the point here.

Below is a summary of how our money system has evolved over time, in fairness this is a much simplified version and the order of certain events has occurred in different time frames across the world but it helps to explain why it is important to now ask the question again “what is money?”

The Evolution of Money

Barter — If we start hundreds of thousands of years ago when humans were merely hunter and gatherers, money did not exist. As societies began to form there was a need to barter — to exchange something that you have, for something that you need. The problem with bartering is that it is difficult to trade, as the item that you have may not be wanted by the person you want to trade with — this is called the “ double coincidence of wants ”. This means that multiple parties are often needed for a successful transaction to occur. Not an ideal means to exchange value.

Commodity Money — Although it is unknown, it is believed that to get around this people began stockpiling universally wanted goods i.e. metal, salt etc. and it’s argued that this in fact is the first form of money — also known as commodity money . The problem with commodity money is that it still doesn’t eliminate the ‘double coincidence of wants’. It is important for money to allow frictionless transactions considering one of its main functions is to be a ‘ medium of exchange ’. This leads us to the next stage of money.

Cowrie shell are one of the longest running forms of currency anywhere.

Representative Money — From commodity money, society begins to drift into what we call representative money. Representative money is money that represents something of value but does not have intrinsic value itself. Cowrie shells are the earliest (and longest running) example of representative money.

Metal coins are also often considered representative money — although some would argue that metal coins are commodity coins. Throughout history metal coins have slowly moved to be more representative than commodity based. Our gold coins would be much more valuable if they were actually gold. Representative money allows for much more seamless transactions, and works well so long as there is an agreed value for the representative money.

Fiat Money — Although Fiat money is considered somewhat of representative money, we seperate it to highlight how far the abstraction of money has come, as well as the distinct difference that fiat has by being issued by a government body. Fiat has value because the ‘government enforces this’ and the people exchanging it agree. Fiat money is the money that we are all familiar with today — the specifics of how fiat money works are too detailed for this post but there is one fact that is important to understand. The average life of Fiat currency is a mere 27 years! Fiat works because we have trust in the government behind it- we have trust that the money that we hold can be exchanged for something of value.

The reality is that fundamentally those rocks on the island of Yap are no different to the numbers in our bank account — the numbers move but the only thing that stands behind those numbers is a trust in the system (our government), that they can be exchanged for something of value. Bitcoin is often coined a trustless system but in fact it just offers an alternative, whereby the trust in the system is based on mathematics oppose to an individual entity. It is not for anyone to tell you what, or who you should trust, it’s just a sense of- do you trust it? Currently, cryptocurrencies are volatile and in their infancy but the system has proven itself, so much so that bitcoin alone represents $130 billion dollars worth of value. More than many fiat issued currencies.

Is it really that unfeasible to think that software code can represent value?