A Quick History of Money

April 30, 2021

A Quick History of Money

Money is a central element to human relationships and the society we live in. Understanding the history of money helps to put in context the circumstances that led to where we are today, with the rise of blockchain-based technologies and cryptocurrencies such as Bitcoin. 

Money was introduced to solve the problem of “coincidence of wants” in a growing global economy. Whatever its form,  money had to create consensus and fulfill three key functions: a unit of account, a store of value, and a means of payment. As long as a given form of money  was  able to fulfill these three key functions across time, space, and people, we had a great solution to the coincidence of wants in a global economy. In its first form, a barter system was used to exchange value, and over the course of history, people have used everything from valuable shells to rocks as money. Eventually, there was one rock that emerged as the leader: gold. Communities and countries came to consensus that gold was able to demonstrate all three key functions of money. Gold is “sound” or “solid” money because it is scarce, easily divisible, and universally accepted as valuable.

This led to the creation of the “gold standard,” which allowed the shift from carrying physical gold to the issuance of paper money backed by the gold held in central banks. This cash represented an IOU worth the  equivalent amount in gold. Interestingly, the gold standard was created around 1717 in Britain by Isaac Newton. By 1900, 50 other countries had followed suit. 

Devaluation of money during wartime

With the onset of World War I in 1914, every government needed money to fund wartime efforts. Governments began to increase their money supplies by printing more and more money. However, this newly printed money was not backed by an equivalent amount of gold in government reserves, and thus paper money was no longer freely convertible to gold. Because the system was highly centralized, governments could always create more printed money without actually acquiring more gold. Although this allowed for governments to support their war efforts for longer periods of time, there was a resulting legacy of economic imbalances and currency devaluation. 

No longer the gold standard

After World War II it became apparent that there was more money in circulation than mined gold. Gold-backed money had become replaced by government-backed money, which created widespread concern about the diminishing value of paper money.

Governments were not able to re-evaluate the gold standard due to political unpopularity (people would realize just how much damage the wars had done) and were unable to revert to old rates (people would reclaim their gold and sell it elsewhere). This led to the creation of fiat money (government-issued currency that is not backed by any physical commodity) through the Bretton Woods Conference. As a result, the International Monetary Fund was created to oversee tying the USD to gold — and all of the world’s other currencies to USD — each at fixed exchange rates. In practice, this system would work well if governments acted in a trustworthy manner. In reality, no one played by the rules. In 1971, US President Robert Nixon shut down gold convertibility, officially ending the gold standard. 

Limitations of our financial systems

With the end of the gold standard, we ushered in the era we are in today, using freely shifting exchange rates. Those who follow the stock market will agree that this system appears to be working well; Over the past 20 years there have been some ups and downs—the dot com bubble, the 2008 recession, and the recent COVID-19 pandemic, but over time we are seeing steady growth. 

If you take a look at the stock market priced in gold instead of USD over the same time period, you will see a very different story. Gold represents the actual value behind the system, not just the dollars that are being printed. When priced in gold, the stock market is actually only just seeing a recent return back from pre-2008 recession levels. This shows that there is a serious distortion in the system: the dollars we see today in the stock market may not necessarily reflect the value that’s being created over time.

S&P 500: 1997 - 2020 Priced in USD vs Priced in Gold

Priced in USD
  Priced in Gold

Today, there is a lot of manipulation in the markets driven by fake news, pump and dumps, spoofing, wash trading, and bear raiding. Over time, this will compound and lead to situations where it becomes hard to trust that your money will have as much worth tomorrow as it had today. When that happens, it will lead to widespread distrust of the entire system. This brings us to a situation where we need a solution that will allow for trust in a system and trust for the future, ultimately setting the stage for the emergence of Bitcoin and cryptocurrencies.

Emergence of Bitcoin

The emergence of the internet set the stage for Bitcon and is a parallel disruption that happened about 20 years ago, creating a platform for global sharing and connectivity, and creating an opportunity for disruptive business models. Napster, for example, enabled the proliferation and dissemination of digital content on a global scale at an unprecedented rate. With the emergence of the internet also came the earliest forms of internet money, planting the seed for innovation and the disruption of our current financial systems, with Bitcoin leading the way.

Problems with internet money

Some of the earliest versions of electronic money included David Chaum’s eCash and DigiCash founded in 1999. This was followed by Douglas Jackson’s infamous E-gold, whose customer deposits and reserves grew to be valued at US$85 million. 

Internet money has created what is known as the digital double-spend problem, which occurs when a single digital token is spent more than once. Unlike physical cash, digital tokens are digital files that can be duplicated or falsified. Double-spending leads to inflation and currency devaluation. Early attempts to solve this included creating a digital equivalent of a reserve, but this relied on a central party who governed the entire network, exposing the entire system to a central point of vulnerability and failure.

Solution to the double-spend problem

A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another, without going through a financial institution. However, this does not solve the issue of double-spending. With the understanding that a trusted third party is required to prevent double spending, Bitcoin proposed a solution that would enable the effective use of a peer-to-peer network—the network could timestamp transactions and encrypt them in a blockchain. 

Bitcoin emerged in early 2009 as a system of transferring value around the world. Bitcoin’s trustless framework produced a proof-of-concept for subsequent “altcoins,” which expanded on the initial principles laid out in the famous 2008 whitepaper by Satoshi Nakamoto, the pseudonymous person who developed Bitcoin. This whitepaper outlined a solution to the double-spend problem by creating a peer-to-peer electronic cash system protected by cryptography and governed by the proof-of-work (PoW) consensus algorithm. 

A Bitcoin wallet could be on your phone, your laptop, or even represented by a Bitcoin address written on a piece of paper. The idea is that we don’t need an intermediary such as a financial institution to confirm or deny our requests to transact money to any person at any time. It is different from previous solutions primarily because it is decentralized—there is no single party managing the network. It solves the double-spend problem and has reshaped the possibilities for peer-to-peer transfer of value, allowing for an entirely new ecosystem to develop. Today, Bitcoin is the digital version of gold. 

This disruptive business model presents a huge opportunity for the globalization of digital commerce at a never-seen-before level. After the emergence of Bitcoin, many companies and projects following the framework of Bitcoin started emerging. These new companies differentiate themselves in the form of the many digital assets you hear of today. 

In the 12 years of Bitcoin’s existence, it has never been hacked and the network has never been down. It is the most successful example of digital money and digital value seen to date.

Stay tuned for our upcoming guide on Blockchain fundementals!

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