Estimated reading time: 6 minutes, 18 seconds
Is Bitcoin money? What exactly is money? What gives money value? What makes good money?
The history of money is fascinating, from salt, to gold coins, to rai stones, to paper or the “fiat” money that we’ve been using for a last few generations.
But what is money, and why do we use it?
Well money helps us to communicate and transfer value with our fellow humans.
The classic example here is to look at how money improves upon a barter system.
Imagine I raise chickens, egg producing hens, and I want a new pair of shoes. I can go to the shoe maker and offer her one of my hens for that awesome pair of leather boots that I’ve had my eye on. …but maybe she’s a vegan and doesn’t want my chicken. Or maybe she loves chicken and those boots are on sale for only ¾ of an egg producing hen … how do I give her ¾ of my chicken without killing it and eliminating it’s egg producing potential?
Well you can see why money is so much better in this situation. Money has three properties, or three things that it does for us.
1. A medium of exchange. Handing the shoe maker $50 and asking for a bit of change back is so much easier than trying to give her 3/4’s of a chicken.
2. Unit of account. This means instead of thinking about prices in terms of chickens… or fractions of chickens, I can think about prices in terms of gold coins, or Euro’s or Dollars.
3. A store of value. That chicken of mine is going to get old and stop laying eggs, so I can’t really use it as a savings account. But if I have a stable currency, then I can sell that chicken to someone who wants it now, take the money and stash it in a hole in my back yard waiting for a raining day.
So we can see how useful money is, but how does something become money? Why do we use gold coins or pieces of paper instead of pumpkin seeds or cat hair? What makes for good money?
In the history of money, gold has probably been the most popular. let’s look at why.
Gold is a good medium of exchange. You can carry it around. You can have big coins or small coins. You could even chop a gold coin in half and it wouldn’t destroy all its value.
So it’s “divisible”.
Gold is also “fungible” which means one gold coins is worth just as much as another of the same quality and size.
If we are using chickens instead, well everyone might know that Sussy lays better eggs than Ethel. So if you lone someone some money, Sussy, but he pays you back with Ethel… well that’s just not as good is it? And this complicates things.
Gold is portable, divisible and fungible which makes it a good medium of exchange.
How about as a store of value? Why is gold a good store of value?
The short answer is scarcity. Let’s imagine that we tried to use laminated leafs as money and a store of value. If I want to save some money I can try stashing some a bag of leafs under my mattress,
But leafs literally grow on trees, and so the supply of money would expand dramatically every spring and your bag would be worth less and less.
This is basic supply and demand. Price level varies directly with the supply of Money. The money supply goes up, prices go up and the value of your savings account, or pile of leaves, goes down. Good money has a stable supply to preserve it’s purchasing power. The exact quantity is far less important than the stability of that quantity.
So now that we understand a little bit about money.
How does Bitcoin do here? Is Bitcoin good money?
Is it a store of value? Here things get interesting. Well a very necessary property of money is scarcity and Bitcoin has a limited and predictable supply. There are currently about 17 million bitcoins and there will only ever be 21 million bitcoins.
While Bitcoin’s value relative to national currencies such as the US dollar or the Euro has fluctuated, sometimes wildly, this limited supply leads many supporters to predict that bitcoin will be an excellent store of value.
And for monetary nerds such as myself this is a really important point.
Let’s go back to paper money or “fiat” money. “fiat” money is money that a government has declared to be money or legal tender and that is not backed by or linked to any commodity. With this kind of money the government controls the supply, sometimes directly, sometimes in a roundabout way.
With fiat currency there is a problem called inflation, it’s when the the money supply increases and the value of the money in your bank account goes down and everything get’s more expensive. It’s like springtime in our laminated leafs example. Now this can happen for a lot of reasons, but being able to print money is a really powerful tool and sometimes monetary authorities just can’t resist.
Inflation of fiat currencies has certainly been an issue in the states, but it’s been a HUGE issue elsewhere in the world. Germany in the 1920’s, Yugoslavia in the 90’s, Venezuela right now! And these are just the most dramatic examples. The history of government managed, non-commodity backed, currencies is concerning.
These issues are possible because fiat currencies are centralized, as in that there is one entity that controls the health of that currency for the entire population of the country.
While with bitcoin there is no government that controls it, because no one controls it. Bitcoin is decentralized. So inflating it away for political benefit isn’t even a possibility.
And this perhaps the biggest reasons to like Bitcoin as a monetary system. Just like commodity money such as gold, Bitcoin is not under the control of a central authority and so can not be abused by or inflated away by that central authority.
And Bitcoin is definitely being used as a store of value in places that have these currency issues.
Now Bitcoin hasn’t quite made it to unit of account status just yet, but is it a medium of exchange? Yes!
You can buy all kinds of things with Bitcoin! Check out http://openbazaar.com
And like gold bitcoin is portable, divisible and fungible. But even better than that it has digital convenience. Because of that it’s often called digital gold.
Imagine trying to buy something from someone on the other side of the world with gold. Would you ship the gold to them? Gold is really heavy. Would you deposit it somewhere and then transfer ownership of the account to the other party? That involves trusting a middle man.
Gold works well in person but not so much for online commerce.
Bitcoin, and crypto-currencies in general are a huge improvement to this situation. You get a currency with monetary properties of gold but with global convenience like credit cards and all without having to trust any third parties!
This hasn’t happened before in the history of money. Cryptocurrency is a new form of money it’s the evolution of money!!