Money as a system has been in existence for thousands of years and as time goes on it is becoming quite apparent that the current system is flawed. In order to fully understand why Cryptocurrencies can be seen as a solution, we need to fully understand the problems.
In 6,000 B.C, Mesopotamian tribes introduced bartering, a system where participants trade items such as livestock, vegetables or grains with each other for other items that they needed. Bartering requires system to ensure that both parties receive a fair deal and was often only effective when executed by experienced traders who were able to negotiate with or manipulate their counterpart. Was every trade fair and equal? Most likely not, so we can already see that a system for fairness and measurement thereof was required.
As bartering evolved, the process began making use of newer items that had some form of perceived value. Animal skins, salt and weapons were frequently used for many years when bartering. These were all items frequently in demand, Roman soldiers were even paid in salt, but supply may have been limited to specific regions or climates thus creating the need for trade. This supply and demand guided value, and while acting as effective components in a unit of measurement, it was also inherently flawed by the risk of fraud and the manipulation of either component.
Fraud can be executed in many ways. One of the earliest was the counterfeiting of goods to make an easy profit in the market. While the punishment was often extreme, in China, the punishment for counterfeiting an animal skin that was branded with the imperial insignia was death, but it did not stop people from doing it anyway. The reward was outweighing the risk and so the act of counterfeiting thrived and continues to do so today.
Items used in bartering continued to take many shapes and forms along with the civilizations that made use of this system. Ultimately items that were easy to transport, simple to measure and widely agreed upon became the standard. 700 B.C, the Lydians produced metal coins that triumphed in this regard and revolutionized the commodity based monetary system.
This monetary system continued to exist in one form or another until a single precious metal was settled on as global trade boomed. Gold was agreed as the new store of wealth and the use thereof was simplified by using it to back paper-based money.
Paper money was introduced about 1,000 years after the Lydians began minting coins, but did not fully catch on until becoming gold backed in the 19th century. The gold standard guaranteed the bearer of the note that the issuing government would redeem its value in gold when demanded. The paper was representative of gold being stored elsewhere.
However, the bankers holding the gold could issue more paper money than what they had in gold and in order to prevent people from taking all the gold when trying to cash in their paper money, a restriction bill was enforced that suspended the conversion of notes into gold - and so people were stuck with their paper money but with the emergence of the gold standard, the paper money would hold the value.
Nearly every developed nation was using the gold standard and this proved to be a remarkable success, for just 50 short years until the start of World War 1 after which the Gold standard was suspended until it drew its final breath in the early 1970’s.
The severance of the tie between gold and paper gave rise to a resurgence of a different form of money. Fiat money.
Like paper money, fiat money has its roots in China and has been used over the course of history on many occasions since 1,000 A.D. A trend has also developed when making use of fiat money. Because it is relatively simple to produce without the need for some form of backing, be it salt or gold, it can be issued in massive volumes. The scarcity is impacted and thus the perceived value of the money drops. This causes runaway inflation and devaluation ultimately leading to a collapse of both the currency and the economy making use of it
Along with inflation and devaluation, fiat currency is also susceptible to a risky practice known as fractional-reserve banking. This requires a bank to hold only a fraction of reserves when compared to the total value of issued loans, or liabilities. A bank traditionally acted as an intermediary between a borrower and a lender, and for every $1 loaned out to a borrower, $1 was held in reserve on behalf of a lender, a 1:1 ratio. Fractional-reserve banking allows for this relationship to be broken.
For example, if you were to deposit $100 in your bank, they would hold $10 in reserve and grant an additional $90 worth of loans to a new borrower. This new borrower would deposit the loan into their account where $9 would be kept in reserve and $81 loaned out again. The next borrower borrowing the $81 would have it deposited into their account and the bank would keep $8.1 in reserve and lend out the other $73 and this continues and on. You can see that each iteration results in further supply being added to the market which affects macroeconomic stability, in fact 80% of all money allocated today is just 1’s and 0’s in a computer.
It should also be noted that banks earn far more income in fees to service these newly created accounts than if they were to maintain a 1:1 ratio. They are also now able to charge interest on these loans increasing their earnings even further.
Banks do however have their vulnerabilities due to this system. A bank run is when deposits being withdrawn exceed the value of reserves being held and can have crippling effects on economies. As a result, fractional-reserve banking requires strict policing of Central Bank policies.
Cryptocurrencies, a digital asset, are the next evolution of monetary systems to address the problems highlighted above by securing the supply and processing of transactions.
Unlike fiat currency, cryptocurrencies are decentralized, or peer-to-peer. There is no Federal Reserve System, corporate or government influence governing the supply, maintenance or value of the currency. Because of this, the fees are generally much lower than traditional banking due to the lower number of parties involved in the transaction. At the time of writing, PayPal’s 2.9% transaction rate means $2.9 is given to them for every $100 transacted, the same transaction using Bitcoin could be done for free in certain situations, large transactions of thousands of dollars costing a mere $2
This decentralization also addresses the risk of shutdown or theft due to concentrated interests. A failing government cannot make a grab for its citizens assets if they exist on a decentralized network as there is no sole source of control to exploit.
Cryptocurrencies are also less susceptible to events of fraud thanks to cryptographic algorithms that drive the supply of the currency through a process known as mining and validate the authenticity of a transaction. This means the risk of counterfeit currency is mitigated and so are events such as charge back fraud, currently affecting the credit card industry.
Accessibility to cryptocurrencies is also drastically improved when compared to fiat counterparts. Decentralization doesn’t only refer to control, but also to the topography, or layout, of the currency. Cryptocurrencies are a global phenomenon and the support network reaches all corners of the globe. Some of the most remote corners of the globe are favored for the extremely wintry conditions to help offset the heat generated by what are known as mining farms – vast collections of processing power validating transactions and mining new coins.
The size and reach of cryptocurrencies and their lack of centralized control help prevent crisis related to inflation and devaluation because of interference. As mentioned previously, these are two traits of a failing fiat monetary system.
Making use of cryptocurrencies, such as Bitcoin, is simple and almost anyone can participate. Be it a representative or commodity based transaction, the underlying technology of cryptocurrencies, known as Blockchains, enables us to develop a monetary system that will revolutionize the world as we know it.
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