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The birth of Bitcoin from the perspective of monetary history

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Is Bitcoin a historical inevitability?

The Birth of Bitcoin from the Perspective of Currency History

Original source: Crypto Valley Live

In October 2008, a pseudonymous programmer named Satoshi Nakamoto published a white paper in which he described a protocol for a decentralized digital currency. He called the protocol Bitcoin. A few years later, Satoshi Nakamoto disappeared without a trace, but the technology he created continues to change the world.

Bitcoin is now a global phenomenon. But why was it created? Why did it succeed when its predecessors failed?

It's tempting to start such a course by talking about cryptography or blockchain, but if we want to understand these things from first principles, we have to start with something simpler. To understand why cryptocurrencies were invented, you first have to understand what problem they were designed to solve.

So let's try to answer a simple question in the first place: What is money and why does it exist?

The Origin of Money

Imagine that we are two neolithic farmers. You have some grain, I have some cattle, and we both decide to trade. This direct exchange of goods is called barter trade.

Barter sounds lovely in principle, but barter is very inefficient. This is because of the so-called double coincidence problem of bartering. In order for a transaction to take place, each party must want something the other party is willing to trade. What if Jane gets a cow from Jim, but Jim gets grain from Joe, and Joe gets wool from Sally? In a barter economy, this market cannot be cleared and everyone is forced to wait until a perfectly configured transaction arrives. This means that many desirable deals will never happen.

Anthropologists believe that it is unlikely that money actually emerged from barter trade, but it is instructive to use barter as a base case.

Often there is a commodity in high demand throughout the economy and that commodity starts to dominate the trade. This could be cattle, yams -- or, if you're in prison, cigarettes. If the commodity becomes widespread enough, it becomes, in effect, a form of money, called commodity money. But most forms of commodity money are not very scalable, and the most valuable goods tend to be different in different early societies.

The earliest proto-currency observations were in the form of collectibles. Collectibles are small, mostly homogeneous objects, such as shells or beads. Collectibles tend to be durable, easy to store or hide on the body, difficult to find or forge, and easy to value. This makes them more robust than many commodity-form currencies, such as cattle.

Wampum beads. Credit: Lise Puyo, Upenn

The adoption of collectibles as currency was key to human evolution. Tribes often specialize in hunting a particular species, but because of animal migration, a tribe may have very little food for part of the year. By foraging for their collectibles during the low season, they could trade with other tribes during the high season to obtain surplus food. Through the trading of collectibles, food could be distributed more evenly over different periods of time, and all tribes could flourish.

Some historians claim that money originated from collectibles, others that it originated from credit. Credit here refers to the simple accounting of human favor. I asked you to borrow something and I'm sure you'll pay me back later. Given the closeness of human tribes, credit is likely to dominate many social relationships.

Even when human tribes settled in the Neolithic period, villages tended to be small and tightly knit. Therefore, most people know each other's credit standing. When the bartender gets to know you, your family and your place in society, it's possible to have a permanent bar label at the local pub. Over time, these credit relationships evolved into promissory notes and were traded directly in the local economy.

But informal credit systems do not extend to cities, where it is impossible for everyone to know everyone. To co-ordinate the larger society, you eventually need a mature monetary system.

So this raises the question: what makes money?

Property of money

The mainstream economic definition of money was first developed by William Stanley Jevons in 1875. According to Jevons, money has three main properties.

Value is stored

medium

Unit of account

When an asset acts as a store of value, it means that you can reliably get back the value you paid for the asset. This disqualifies perishable assets such as sweet potatoes from being a currency. If your money is perishable, it's a terrible store of value. So for an asset to be a store of value, it has to be durable.

However, durability is a necessary but not a sufficient condition. Recouping the value paid for an asset means being able to sell it to someone later for its original price. Therefore, the second condition for an asset to be a store of value is that it must be continuously valued by others in the market.

A medium of exchange is an asset that we use to settle trades directly. This is the easiest obstacle to remove. You can use Starbucks Rewards points to buy a latte, so Starbucks points function as a medium of exchange. But of course, Starbucks points aren't a great store of value -- people instinctively know that and don't store their savings in Starbucks points. Not only is this impractical, Starbucks has been known to modify their rewards program to devalue the points, but there is no stable market for selling the accumulated points.

But as a medium of exchange for buying coffee, Starbucks points are perfectly acceptable.

The unit of account is your unit of valuation. B: That's easy. How do you quote the room price? Is it in dollars, euros, or cowhide? This is your unit of account.

Sometimes a legally recognized currency is no longer a unit of account. The Zimbabwean dollar, for example, was experiencing rapid hyperinflation in 2009. As commodity prices soared, it became impractical for companies to continually price themselves in collapsing currencies every day. Instead, the company priced in US dollars and simply listed the daily exchange rate for US dollars/ZD. As a result, the Zimbabwe dollar ceases to be a unit of account and has no meaning as a currency.

So what Jevons is ultimately telling us is that, fundamentally, almost anything can be money, but very few things are actually money. If you're looking for a candidate, whether it's a physical object or a digital object, whether it's made of metal or paper -- if it's durable and there's more than one of it, in the right circumstances it can be money.

This may sound like an abstract point of view. But there have been many examples of humans converging on unconventional forms of money, and seeing a concept stretched to the extreme is often helpful in understanding the concept. So let's move on to one of the strangest forms of currency: the Apai and their Rai stones.

Rai stone

Yap Island is a small island in Micronesia. The Yap people have a strange practice that dates back at least 1,000 years: the Yap people use stone money.

These giant doughnut-shaped discs of limestone are called Rai stones. The largest stones weigh tons -- too big for a human to move easily, let alone carry in a wallet. So how could the Yap people have traded these huge stones?

Rai stone. Source: Gerald Zinnecker, Flickr.

It's simple: the stone never moves. Instead, the Yap "traded" stones entirely through social agreements.

The Rai Stone is considered a transfer as long as the parties agree to use one Rai Stone (or a small part of it) for the transaction. The physical position of each stone was considered meaningless. Such transactions are recorded only through oral history.

On one occasion, a highly respected Yap man was carrying a Rai stone across the sea. Entering a bad storm, the ship capsized and sank to the bottom of the sea.

It was widely believed that the family was too noble to be reduced in wealth by such an accident. So it was decided that the rock was still in force, and that even though no one was entirely sure where it lay on the ocean floor, it would still retain its value and continue to change hands.

Today, the Yap mainly use US dollars, with Rai stones exchanged only for special occasions such as marriage or political negotiations. But the story of the Rai stone illustrates an important lesson: as long as society has a stable consensus about its value, anything can be used as money. While it's good for money to have some intrinsic value, it's not strictly necessary.

As Yuval Noah Harari says in his book Sapiens.

Why would anyone trade a rich rice field for a handful of useless colored paper? People are willing to do these things when they trust the fiction of their collective imagination. Trust is the raw material of all currencies.

Or, as Peter Thiel puts it:

Money is just a bubble that never bursts.

The Rai Stone illustrates an important point: money can come in any form. What matters is the basic function it performs in society.

But let's go back to our world. Next, we will trace the historical evolution of money.

Metal as money

The evolution of modern currency actually started from precious metals. The first use of metal as money is thought to have begun around 1000 BC, with the advent of the Iron Age.

Now, the value of precious metals may seem obvious, but it's worth asking: Why do so many societies tend to use metals as a form of money? There are some intrinsic reasons why precious metals are more suitable as currency than collectibles. Precious metals are:

Strong visual impact, can be used for decoration and jewelry

scarcity

Durable and resistant to corrosion

Hard to forge

divisible

At first, gold and silver pieces of metal were used directly as a form of money. Eventually, around 600 BC, a monetary system began in modern Turkey. These first coins were made of gold and silver alloy.

Lydian coins, c. 600 BC. Source: RomanCoins.info

Why are coins made? This is a very troublesome matter. What's wrong with using gold and silver sheets?

The obvious answer is that coins standardize the amount paid. But that's not the whole answer -- after all, most small societies operate on credit relationships, with little need for gold to settle in local trade networks.

Anthropologists like David Graeber speculate that coins were created to satisfy the needs of organized armies and mercenaries. The soldiers traveled long distances and they didn't have long-term credit relationships. So, the only way they can get paid is through a form of currency that would be recognized in a far-off place. Even if the counterparties do not recognize the sovereignty behind the coin, they will be willing to value the precious metals of the coin itself.

Paper money, on the other hand, would not appear until the year 1000, a full 1,600 years later. Paper money was first invented in China during the Song Dynasty and was later exported to Europe by Marco Polo. This paper money is an interesting case study.

Song paper money could have been exchanged for gold, silver or silk at a fixed rate. In practice, however, they were never allowed to be exchanged. So paper money is traded almost entirely without any commodity backing it up. Therefore, the first paper money can also be said to be the first legal tender.

What is fiat money? The literal meaning of the word fiat money is "by faith". Legal tender is money that has no intrinsic value, but has value only because both parties to the exchange agree on its value, or because a third party uses its power to maintain that value. This sets money in sharp contrast to commodity money, which has an intrinsic value. Without the implicit backing of a third party, fiat notes are essentially worthless pieces of paper.

This begs the question: why didn't money come sooner? It is much cheaper to print fiat money than to mint gold coins. Paper was invented in China, of course, and made its way to Europe in the 13th century, but you don't necessarily need paper to create legal tender. Today's pennies and nickels are legal tender because their base metal is worth less than its face value. Why not earlier?

David Graeber speculates that fiat money first emerged in China because it is the only centralized government powerful enough to exercise top-down control over its domestic economy. Keep in mind that history often places too much emphasis on Kings and their kingdoms -- after all, they dominate the history books, but Kings and their affairs have little impact on most People's Daily lives. As an ancient Chinese proverb says, the sky is high and the emperor is far away. As a result, money not usually minted by the government circulates in the local economy.

Over time, thanks to technological advances and more developed bureaucracies, the government's control over the domestic economy has greatly increased. As control has increased, economic standardisation has also spread to sovereign currencies.

The history of modern banking

Today, most financial transactions are mediated by banks. But banks are a relatively recent invention in monetary history. Money exchange, usury and deposits have ancient roots, but the first modern banks were in Renaissance Italy, run by merchant families like the Medici family. During this period, bank failures were common, and most banks did not survive for long.

Paper money finally arrived in Europe in 1661 in the form of Swedish paper money. Before the central banks, all banks were privately run. Each bank issues its own bank notes, which are usually redeemable for gold in the bank's reserves.

Since the dollar is now the world's reserve currency, it is worth rethinking America's monetary history. When the United States was founded, the federal government minted silver and gold coins, and the dollar was defined as a precious metal of fixed value. Yet most of the money circulating in the economy was private bank notes issued by commercial banks-at one point there were more than 5,000 different types of paper money in circulation. In 1861, the United States briefly printed paper money to fund the Civil War, but has since returned to a currency backed by precious metals.

Twenty dollars of private bank notes. Source: Business Library

Since most of the paper is issued by private banks, the structure of the financial system is very loose. This led to frequent panics and bank runs. To stabilize the banking system, the United States created an independent central bank, the Federal Reserve, in 1913. The Fed was given exclusive authority to print dollars with the explicit mandate of preventing bank panics and currency crises. It was initially required to have 40% of its outstanding paper backed by gold.

After World War II, the United States rose as the world's financial superpower and took the lead in establishing the Bretton Woods system of international monetary system with this power. Under the Bretton Woods system, the world's major powers fixed their currencies against the dollar (with a margin of about 1 per cent), and the dollar itself was pegged to gold. This has stabilized exchange rates between the world's major currencies.

But the enforced stability of the Bretton Woods system will not last. In the 1970s, when the U.S. economy was booming and the government was ramping up spending for the Vietnam War, the Federal Reserve was printing more dollars than gold was supporting. That made the dollar overvalued under the Bretton Woods system. Foreign governments began to withdraw from the Bretton Woods system and convert their surplus dollars into gold, depleting America's gold reserves. Nixon realized that if this continued, there would be a crisis. So in 1971 Nixon broke the Bretton Woods system and abolished the international convertibility of the dollar into gold, permanently breaking the gold standard and turning the dollar into a pure currency.

The front page of The New York Times, Aug. 22, 1971. Source: The New York Times

With the dollar as legal tender, the Fed has greater freedom to determine the nation's, and to a large extent the world's, monetary policy. Since then, all the world's major currencies have become legal tender, managed centrally by their central banks.

At first glance, the transition to fiat money seems an odd thing to do. One day, the dollar is valuable because it can be exchanged for gold. The next day, it's worth it because... ?

What makes fiat money valuable? Like the Rai stone, it's only valuable because we all think it's valuable, right?

This is partly true. And of course there will be value in dollars, because American businesses like to pay in dollars, and a lot of people want to buy things from American businesses. But what's to stop the U.S. economy from benchmarking against another currency? Technically, US businesses are legally free to accept payments in any currency.

The dollar has held its value because the US government has two important guarantees on the dollar. The first is that the U.S. government and the Federal Reserve will take reasonable action to maintain stable purchasing power in the market. The second guarantee is that US taxes can only be paid in dollars. As a result, there will be a lot of demand for dollars (which will supplement the demand for petrodollars), since there are a lot of people who have to pay taxes to the U.S. government. These guarantees, basically, are the value of the dollar as a currency.

Fast forward to the 21st century, and a lot has happened since the end of the gold standard. In 2008, we saw that a financial crisis had the potential to destroy the global banking system. In response to the rash of bank failures, central banks around the world have bailed out financial institutions, printed vast amounts of money and engaged in massive asset-buying operations -- a practice known as quantitative easing.

Against this backdrop of financial chaos, a pseudonymous programmer named Satoshi Nakamoto was pondering the Bitcoin protocol. And in the midst of the financial crisis, when the U.K. bailed out its banks, the founding block of bitcoin was born.

The cover story of the January 3, 2009 issue of The Times. Source: The Times

But we're not quite ready to understand bitcoin. To fully understand why cryptocurrencies came about, we need to look not just at the money, but also at the history of payments: how money has been transferred historically.

The development of payment technology

Since the advent of money, there have been many convenient technologies for payment: paper money, cheques, letters of credit all have ancient origins.

But modern payment technology really took off with the invention of the credit card. Although credit cards have been around since the 1920s, early versions of credit cards were issued by individual merchants for use in their own stores. It wasn't until the 1950s that the idea of credit cards as a universal payment scheme emerged.

Original Diner's Club credit card.

The first commercially successful credit card was the Diner's Club in 1950. The original credit card was made of cardboard and was only accepted at 27 restaurants in New York. That number has ballooned as consumers have moved to cashless payments. Visa would be founded in 1958 and MasterCard in 1979. Given that credit scores and financial monitoring were not common in the early days of credit cards, many credit card networks have guided consumer adoption through direct mail campaigns, in effect sending a card to every address throughout the zip code.

By the 1980s, credit cards had become ubiquitous in American society. They quickly spread to Europe and beyond, and have since sparked a cashless revolution.

The next iteration of payment technology will be initiated by the Internet, which began to gain mainstream consumer adoption in the late 1990s. In the early days of the Internet, almost all payments were made with credit cards. That's because the credit card network is so robust that almost everyone already has one. But internet-based payment solutions will eventually emerge, such as CyberCash and DigiCash. The first widely successful online payment company was PayPal, which went public in 2002 and was later acquired by eBay for $1.5 billion.

Nowadays, the way consumers make online payments varies greatly. In most countries and the United States, consumers prefer to use credit or bank cards. But other common methods include PayPal, electronic wallets (such as Alipay or Skrill) and, in some countries, cash on delivery. With the emergence of cryptocurrencies, this pattern has been further developed.

The birth of Bitcoin

Throughout human history, there have been many evolutions around the forms and incentives of money. Of course, there is much more to the history of money than we can cover in this short article. But any monetary history must now end with the same final chapter: the invention of cryptocurrencies.

Since its launch in 2009, Bitcoin has taken the world by storm. In 2010, a single bitcoin was worth $0.003. In December 2017, bitcoin hit an all-time high of nearly $20,000 a single bitcoin, an increase of 60 million times. Today, the price of bitcoin hovers around $57,000 per bitcoin. There are an estimated 25 million bitcoin holders worldwide -- a small number in global terms, but still growing.

It's an amazing story. But Bitcoin's story is not just about price: its origins are deeply rooted in ideology. We'll now turn to another aspect of how cryptocurrencies were created: from the subculture known as cyberpunk. In the next lesson, we'll look at cyberpunks, their previous attempts to build a digital currency. We will analyze why they failed and why Bitcoin succeeded.