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A brief lesson on money

January 4, 2018 9:00 am Published by

You know that thing everyone is chasing these days? The thing that everyone has stuffed inside wallets or in magical plastic cards? Everyone wants a lot of it. No one can live without it.

We’re talking about money.

Have you ever wondered what makes a thin piece of paper (or plastic in some places) more valuable than the food we eat, the water we drink and the air we breathe?

To put it bluntly, ‘money’ has value because we assign it value. And because we assign it value, we can trade money for any commodity we desire.

Why can’t you just trade commodities for other commodities?

Well you can.

But this only works if both have a commodity that the other wants, in the quantity that the other wants, e.g. Nelson has fish but wants chicken and Angela has chicken but wants fish. In this case, the swap makes sense.

But what if the Angela wants fish, and but Nelson wants squirrels? Furthermore, John will only accept berries and the person with berries only wants to trade for chicken? It gets pretty hard to follow… imagine how difficult that would be to action in real life.

Waaala! Money.

We needed a universally recognised form of value which could be conveniently traded for everything. Money was the answer.

How did people decide what became money?

Historically speaking, money was usually a commodity that was relatively limited in supply or relatively difficult to extract, and could not be easily destroyed.

The process for acquiring the commodity would be fairly time consuming and difficult so that no community can be oversaturated with it.

Let’s take a look at five properties of a good currency:

  • Scarcity: having a limited supply
  • Fungibility: currency should be freely exchangeable
  • Divisibility: easily divisible into smaller units
  • Durability: currency should not be easily destroyed or worn down.
  • Transferability: money should be easily transferred from one person to the next.

Examples of money

The most popular and oldest tool for trade is Gold.

The pretty, shiny yellow metal.

Gold became the international store of value across Europe because it was relatively difficult to extract without using intensive mining operations. It was easily melted down and formed into coins and so the size of an individual’s trading power could be measured in either the size of the gold coins that person has or the number of gold coins.

Other cultures used different commodities. Some, like Pacific tribes, used large donut-shaped stones where the larger the stone, the greater the store of value. Other more coastal cultures used seashells.

Despite their differences, they all fulfilled the same function.

How did money become this green, paper thing we all know today?

The major problem using physical commodities like gold is transferability and portability.

Back in the day, carrying around a small sack of gold would be necessary if you wanted to purchase items. But, it was risky to do so as a thief could acquire your entire life savings in one robbery.

If this was an issue for the average person, imagine the struggles of the wealthier, who were in possession of more gold.

In Europe, to solve this, Gold miners and traders would issue paper receipts. Each receipt would allow the holder to redeem gold at a moment’s notice. In the Mongolian empire, the Khan would issue similar paper receipts for certain weights of gold.

Over time, people realized that the paper used to redeem gold was just as viable as the gold itself. This enabled the birth of Centralised banks that would issue standard bank notes, backed by gold(similar to the ones we use today).

So can I just go to my bank and change my bank notes to gold?

Unfortunately, no.

With the introduction of Fractional Reserve Banking, all Fiat currencies we use today are no longer backed by Gold or physical assets.

They’re backed by the population’s trust in the financial organizations and governing bodies of a country. If you were to go to your bank and try to exchange banknotes for gold, or any other asset, you would be given another banknote of the same value in exchange.

But because Fiat currencies are not commodity-based, this does not mean that all currencies are not commodity based.

Some new crypto-currencies are backed by an asset like electricity or by its scarcity, similar to what made physical like gold valuable in the past.

Enter Bitcoin

We now have over 1000 cryptocurrencies and tokens so we won’t have time to discuss all of them. Let’s break down the original digital currency, the grandfather of all cryptocurrencies, Bitcoin.

Does Bitcoin satisfy the five properties of currency?

Let’s assess:

  • Scarcity: Yes, there will only ever be a maximum of 21 million coins.
  • Fungibility: As bitcoin has hit $10,000, the amount of users and merchants has increased. Bitcoin acceptance is on the verge of mainstream adoption.
  • Divisibility: Bitcoin is divisible to 8 decimals.
  • Durability: Being digital, and having computers from all around the world, confirming transactions makes it nearly impossible to destroy.
  • Transferability: users are able to send bitcoin to anyone around the world at any time or place.

So is Bitcoin a good form of currency? It certainly satisfies the five properties. But as we mentioned above, things have value because we assign value to them.

We’ll let you decide for yourself.

At Wirex, we certainly think Bitcoin its valuable ($10,000!!!) and we’re doing our best to help improve its transferability and fungibility. If you need a way to send and spend your bitcoin, sign up with Wirex.

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