THE EVOLUTION OF MONEY
By Hans Christian Ekne
From cowrie shells to cryptocurrencies — the co-evolution of money and our economy
Bitcoin will be 10 years old next week. The new digital money has experienced one of its worst bear markets to date, with a drawdown of over 80% from its all time high. Many pundits are proclaiming the death of cryptocurrencies and view them as nothing more than elaborate pyramid schemes. Are cryptocurrencies just a fad or will they have a lasting effect on our economy? If we take a step back and view monetary developments on a more coarse grained timescale, we might shed some light on this question.
Our economy and the medium of exchange we use for trade, has been co-evolving ever since humans first started trading with each other. Newer and better forms of money have been able to support a growing and increasingly complex economy. We are moving towards a more fluid system of payments — with declining friction for trade and reduced transaction costs. This article explores the history of money, the key trends in its evolution and why cryptocurrency might be the future of money.
A Short History of Money
Humans likely began to use money in what historians refer to as prehistory, i.e. in a time before we have written records, so pinpointing an exact beginning of money is difficult. In addition, money probably developed in several different places around the world as humans started transitioning from hunter and gatherer societies to an agricultural lifestyle.
Inside smaller social units there was no need for a medium of exchange because we were able to coordinate our efforts towards common goals and were not very specialized. It was only when we started to coalesce into larger social constructions that a medium of exchange really was needed to allow the economy to develop.
“When the inhabitants of one country became more dependent on those of another, and they imported what they needed, and exported what they had too much of, money necessarily came into use.” -Aristotle
The first type of money we started to use was probably commodity money. Commodity money is a medium of exchange that has value in and of itself, as well as its value in money. An example of this type of money was cowrie shells, which were used in China, India and Africa. It is also assumed that metals such as gold and silver were used as commodity money because in addition to being valuable as jewelry, the material is scarce, divisible, portable and durable. Key characteristics of a good form of money.
The move from a barter economy to using commodity money was one of our greatest economic inventions. Before we had money, trade was typically bilateral, and we exchanged one type of goods or service for another. But as the economy grew this became difficult, because the information processing needed for efficient trading exploded. With only 10 different types of tradable goods you suddenly need to know the relative value of each of them to each other. Money and markets solve this problem by denominating all goods in the same base units. Without adopting money, our economy would likely be stuck in the stone age.
Coins appear to have been invented separately in India, China and areas around the Aegean Sea in the time period between 700 and 500 BCE. For instance, in 600 BC, King Alyattes of Lydia minted one of the first official currencies. These coins where crafted from electrum, a naturally occurring mixture of silver and gold, and stamped with the denomination. The electrum was scarce and durable, making it good choice of material for making coins.
The evolution from commodity money to coins made it easier and faster to conduct trade. Money no longer had to be weighed, and one could just read of the denomination and calculate the value. Also, the value of the coin is decoupled from its size and makes the process of moving money around easier. This innovation in money was instrumental in allowing the economy to grow further.
As was the case with commodity money and coins, paper money also developed in several places at different times. The Song Dynasty in China was one of the first to introduce this new form of payment in the 11th century. It originated from merchant deposit notes during the Tang Dynasty where merchants and traders were looking for ways to reduce the amount of copper coinage needed for larger transactions. In Europe as well, paper money developed from bills of exchange that had been used in the Middle Ages, and in 1661 the Swedish Banco (a precursor to Riksbanken) introduced the first European banknotes, replacing copper plates.
Again, paper had several benefits over coins. There was no longer a need to carry around heavy loads of coins and larger transactions became easier. Storage and transfer of wealth was also improved as the notes required less space. It is speculated that this innovation also helped the growth of the economy the Americas as it was easier to transfer money across the Atlantic Ocean.
In 1958, BankAmericard — the first modern credit card — was introduced. It was launched in Fresno California, and eventually licensed to other banks around in the US. After several years, these lincencees where united under the Visa brand in 1976. In parallel we also saw the growth and beginning of the Master Card brand.
Money as plastic was yet again another improvement in money. Carrying around large sums of money became unnecessary and we could now conduct large and small transactions without having to worry about cash. In addition, the credit card added never before seen functionality into money. Critically, it opened the possibility of remote payments. This would have a tremendous effect on our economy, especially coupled with the advent of the internet. Many of the largest companies in the world today would likely not have been viable had it not been for plastic money.
Almost ten years ago, on January 3. 2009, the genesis block of the bitcoin blockchain was mined. This pivotal moment marked the beginning of not only a new type money but also an entirely new asset class. Bitcoin was able to solve the central problem of double spending, and showed how we could have digital money that really was scarce.
Fast forward to today and we have had an explosion in the amount of available cryptocurrencies. Coinmarketcap.com currently lists 2071 different cryptocurrencies. This wide landscape of money is not new, and an historical analogy to this wide variety of coins can be seen in the US in the 19th century. Before the Federal Reserve was given the sole rights to distribute currency in 1913, there were more than 5000 different types of banknotes in circulation, issued by various private banks around the country.
Economic Growth and Monetary Developments
If we view the development of money alongside total global economic growth, we see that as our economy grew, new types of money were introduced to help fuel the exponential growth.
Higher economic activity propelled the innovation of better money which again has fueled even more economic output. This type of positive feedback mechanism illustrates the importance of money in our economic infrastructure. And maybe most importantly, if we want to understand how money will further evolve we need to examine the trends that shape our current economic landscape.
Key trends that will further shape the evolution of money
To understand what types of money we will use in the coming years and why cryptocurrencies might be the answer, looking at where the economy is moving and what it will need to grow can give some clues. There are a few clear trends, such as digitalization, IoT and AI that are already strongly influencing our economy and we will need a type of money that support and fuel these trends.
The world is becoming increasingly digital every day, as businesses continue to improve their processes by digitizing them and consumers continue to increase their demand for digital services. This digital economy would perhaps be better served by a natively digital money. A type of money that could be easily transferred and used in the digital realm.
Natively Digital Money
For instance, if we had a money that could be integrated into our web browsers, spending money online would become even easier. Amazon has one-click shopping, but imagine if this was something that could be done across the whole net and not just inside gated sites like the Amazon marketplace?
As we digitize our business processes it might also be beneficial to have a type of money that could be programmed. For example, we could program money such that it would only be sent to a given set of participants if a specific set of criteria was met. Cryptocurrencies with smart contract functionality could be used for this. A purely digital incentive structure could be used to create new and innovative forms of cooperation.
Internet Of Things & Smart Machines
The rapid growth of the internet of things (IoT) paired with the developments we are witnessing within artificial intelligence will likely require a new type of payment infrastructure. We will have billions of smart machines, operating autonomously, and they could be required to transact with each other. A few examples illustrate that our current infrastructure will not be the optimal solution for machine-to-machine payments.
Micropayments and beyond
Firstly, some payments might be very small, and would be uneconomical to do without a new type of money. What if a machine wanted to send another machine $ .000001? This transaction would be difficult to if not impossible with our current systems, but a recent experiment on the Lightning Network — a second layer scaling solution built on top of the bitcoin blockchain — showed that it was possible to conduct a millisatasohi payment with a value of $ 0.000000037!
Capacity and Scalability
Secondly, the capacity of our current global payment networks might not be large enough. For instance, VisaNet currently processes approximately 2000 TPS and have stated that they could do around 50.000 TPS. If billions of machines need to send transactions to each other, 50k TPS will perhaps be on the low side of what we will need. There are several projects that aim to address the TPS of various cryptocurrencies and if they are successful this would likely have a strong impact on the adoption of cryptocurrencies.
Thirdly, the settlement process we currently use in many of our existing payment networks might not be optimal. If we wanted payment and settlement to be nearly instantaneous and work 24 hours a day, 7 days a week, then we will also likely need to move into cryptocurrencies. Current crypto solutions usually process transactions within seconds or a few hours a most. Additionally, when the transactions have been processed, they are final and cannot be undone. For some applications this might be an attractive attribute.
The Future of Money
As the history of money clearly shows, money is not static but constantly evolving into something better and more suited to our changing economic needs. Money is becoming easier to carry around and use. Transactions can be performed faster, and we are increasing the capacity of our economy, i.e. the volume of transactions it can handle. We have also integrated new functionality into our money, such as remote payments, and now recently with the advent of cryptocurrency, programmable money. These trends will likely manifest in any new money that we adopt.
Furthermore, as the current technological trends continue to unfold this is creating a demand for money with new functionality and other characteristics that our current fiat systems have yet to provide. Cryptocurrencies already have shown a lot of promise as they can further reduce the cost of transactions, increase the speed of transactions and create new functionality to money.
It can be argued that key stakeholders such as governments and central banks will never allow the growth and adoption of competing forms of money. They might claim that it will be too costly to loose control over money. Although, if the added economic benefits of adopting newer and better types of money outweigh the costs then cryptocurrencies likely will have a future alongside the existing fiat systems.
History shows the interdependence between the complexity of our economy and the capabilities of our payment system. We are still searching for the optimal solution and will probably continue to do so, but cryptocurrency seems to hold some promise to elevate our economy to the next level.
Article written by @hc_ekne
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This article was originally posted on Medium.