What is Money?

Why Money

At some level, we all know what money is. It's the number attached to our bank accounts and stock portfolios that tells us what we can buy and when we can retire - measured in something like Dollars, Euros, Yen, or Pounds. Well, not quite. Those are , different from money in that they have no "intrinsic value." We'll come back to that. For now we will examine money specifically but many of the considerations for money and are the same. In broad academic terms, money (or currency) is something like "a distributed medium that transmits information about value and scarcity over time." It is what gives everything a price, and allows one to price everything in terms of everything else. Historically, money has been gold and silver. To really understand money, though, or why it was historically gold and silver, it is useful to think through the implications of using other things in that role.

Let's imagine we're a baker in a world with no money. What immediate problems do we have? Well, we have needs to produce our primary good, bread let's say, but no means to store the value of our labor across time. That is, if we make a loaf of bread, we have to trade it for whatever the person who needs a loaf of bread has to trade. Or, if we need flour, we have to hope that whoever has flour wants some of our day old bread. In short, we are in a bartering system, and each transaction we make carries with it a cost of transaction in that we may not have what our suppliers need, or need what our customers have. We need to invent a kind of money.

Well, what do we have? We have bread. Suppose we have hundreds of loaves of bread; our first immediate problem is that they have a shelf life. In a week or two our bread will rot. So we've discovered the first problem we must solve - whatever we use for money must not degrade over time. Let's call this durability. Whatever new money we choose must be durable. We have flour, why not use flour? With a shelf life in months it is certainly more durable than bread. The problem with flour is that it is easy to produce in large quantities (at least in modern times), and very heavy if we have such a quantity of it that we could, say, buy a new bakery. So we've discovered two new problems. The money we pick must be hard to create. Let's call this scarcity. The money we pick must also be easy to transport. Let's call this portability. What is durable, portable, and scarce? Now it's getting interesting. Diamonds? They certainly meet all criteria so far. Well, arguments over scarcity aside, diamonds aren't very divisible - how many loaves of bread would we have to sell in each transaction if they were priced in diamonds? So our money must be divisible. And how do we value diamonds? Each diamond has a unique worth based on weight, clarity, color, and cut. Let's call this fungibility. That is, each unit of our money must be interchangeable with other units of that money. And so, finally, we have our list. Money must be durable, portable, scarce, divisible and fungible.

This brings us to gold. Gold is durable - pure gold does not tarnish, does not rust, and has a high melting point, nor will it evaporate or deteriorate across long periods of time. Gold is portable - all of the gold in the world could fit in a few Olympic-sized swimming pools. Spread over the population, this roughly 200,000 tonnes of gold translates to less than 1 troy ounce per person, were it all to be divided equally. So its scarce as well. Gold can be divided into grams or grains, so it's divisible (albeit not easily, historically necessitating silver as a kind of micropayment substitute for gold in small transactions). Finally, gold is fungible - even gold of dubious origin can be melted and recast, making it indistinguishable from any other gold.

Why don't we use signed Babe Ruth baseballs. They're durable enough, if well kept. They're portable due to their small size. And pretty scarce. Well, now we run into the final few problems we must solve. What if we want to buy something worth less than the value of such a ball? This is a problem. So our new money must be divisible into smaller units. And what if someone claims that our signed Babe Ruth baseball is a forgery? Well, now its tainted by the accusation, and given how few there are in circulation, it's possible that anyone trading for it will recognize it and not want it due to the risk of it being a forgery. So it must resist forgery. And, finally, how many different signed Babe Ruth baseballs are there? Hundreds or thousands.

Why is it that you can give somebody 500 thousand dollars and they will, in turn, give you a house? It may seem obvious that you would want the 500 thousand dollars or the house. You may even prefer to have the 500 thousand dollars. But why is that? You can't do anything with the 500 thousand dollars. And obviously this is situational. If you were stranded in the desert you might rather have a gallon of water or a beat up (but working) truck than the 500 thousand dollars. The short version is that you want the money because you believe others will want the money. A house is a house, but 500 thousand dollars, in a working economic system that can support it, is a car, a burrito, a computer, a trip to Venice and a thousand other things. If or when you want those things.

The 500 thousand dollars provides you with the ability to satisfy future planned or unplanned needs or desires. It does this because of the mutual and mass delusion that it has value. We want it, simply, because other people want it and because we believe they will continue to want it in the future. The role money serves in the broader market is as a distributed communication medium for information about value and scarcity.

Imagine there's some global nuclear war and your country of residence starts printing money to fund their part in it. They'll still collect taxes in it, as best they can, and expect others to transact in it. The government hasn't changed their decree that money has value, and the intrinsic properties of alternative monies haven't changed, yet all of a sudden people are unlikely to want them anymore. More valuable will be tangible assets that serve immediate needs - food, weapons, medicine, etc. The subconscious calculation that everyone is simultaneously doing at this moment is neglecting the chance at transactions in the future for current immediate needs. The risk that someone might not take your 500 thousand dollars in the future makes that 500 thousand dollars (or brick of gold or Bitcoin or diamonds or whatever) much less valuable. Its easy to calculate that nobody else will want it, because you don't want it, because it doesn't serve an immediate need and it is easy to project your thoughts on the current (and accurate) assessment of the situation to others. If you don't want it, they won't want it for similar reasons. If you do want it, others will also want it for similar reasons.

Storage of Value Across Time and Money Alternatives

There is an old proverb in the Talmud that says, "let every man divide his money into three parts, and invest a third in land, a third in business, and a third let him keep by him in reserve." The modern equivalent portfolio would look something like, 33% invested in the stock market, likely an index fund, 33% invested in real estate or possibly a REIT, and the remainder invested in something like dollars or euros. But this isn't what we see in modern times, at least recently. Instead we see investors, on average and depending on their risk profile, invested heavily in stocks and bonds with only a small allocation to liquid assets like dollars, euros, or gold. This is because the modern consensus wisdom is that one should be

Money vs Currency and Intrinsic value

What is money and what is currency? The distinction that you'll often hear is that money has an intrinsic value where currency does not. That is, money has all of the properties of a currency except that it is also used for something aside from storing value for future transactions. The classic example here is that gold has intrinsic value because it is used for things, while fiat money has no intrinsic value, it has only value as a promise (as it used to be backed by gold) or government decree. This sneaks in the assumption that something called intrinsic value exists in a meaningful way. Lets unpack and explore that assumption. What does it mean for something to be intrinsic? Well this may be the easier of the two parts; it means that whatever quality you are discussing is essential to or contained within whatever object you're talking about. Great. What does it mean for something to be valuable? Oh, buddy, here we go.

First, lets tackle the problem of measuring value. Lets suppose we agree that gold has some value. Its used as jewelry, its nice to look at, its used in electronics, great. Gold is valuable. But if you put a brick of gold and a brick of silver and a piece of chocolate on a table in front of kindergartners it may not surprise you which would win the popularity contest as being the most intrinsically valuable. Many adults would even take a $5 bill over a gram of gold - value, it seems, isn't intrinsic. Value must be explained.

Value is a multi-dimensional equation and a negotiation between one valuer and another valuer. You cannot open some book and look up the value of something and have everyone agree across all time and space. Value to whom? Denominated in what? In what context? If you're trapped in the desert the value of water denominated in sand to you at that moment might be immense. If you're trapped in the ocean the value of a boat denominated in water to you at that moment might be immense. If you owe millions in taxes and you're about to have your property repossessed the value of fiat currency to you at that moment might be immense. Does fiat currency have intrinsic value now? Oh, brother. If you're on a desert island, it might well be the case that a bar of gold would be more valuable than a Bitcoin. You could smash yourself in the head with it. Being trapped on a desert island would suck. But what if you're not trapped on a desert island? What if you're trapped in a global economy that is becoming increasingly distributed and digital?

Another common thought is that value has to be tangible. There are easy counter-examples. Take your home PC. Lets say we wipe it of all the data it has. Is it still as valuable to you now as it was before we wiped it? Would you pay a dollar to have all that data back? Well, there you go, to you that data was valuable to the tune of at least one dollar, despite not being physical. Another example of intangible value is the widely used Kenyan/Tazanian M-Pesa. Essentially, it is a currency backed by cellular air time - non-tangible but still valued universally enough that it is used as currency.

Value by Decree

Some would argue that value can be given to something by decree. That is, the U.S. dollar is valuable because the U.S. government has declared it valuable. That the U.S. government collects taxes in the U.S. dollar lends further credibility to this claim. More pessimistically put, the dollar is backed by men with guns who say you must accept and pay taxes in the dollar. This enhances the value of the dollar for sure, but its not sufficient. Nobody has declared gold valuable, and nobody backs gold, yet it has value. Likewise, the Zimbabwe government declared the Zimbabwe dollar valuable, collected taxes in it, and had men with guns enforcing the declaration. Yet it has near-zero value. There is a famous story of a man with a wheelbarrow full of hyper-inflated currency who is asked along the lines of "aren't you afraid they'll steal your money?" To which he responds something like, "no, I'm afraid they'll steal the wheelbarrow. Its worth more than the cash in it." Decreeing something valuable only helps to enhance the feeling people already have that it is valuable. The value comes from the game theoretic implications of a collection of people deciding something is valuable, and their assessment of whether or not other people in the future will also think its valuable. When this is present, decree or not, something will have value. When this is absent, decree or not, something will have no value.

History of Money

Many things across history have been used as money. In antiquity, salt was used as currency. This is where the word salary comes from, and the saying "not worth your salt." In prison, cigarettes have often been used as currency. As we look through these examples, a few common properties emerge. One, they are all scarce in the location where they were used. In mountainous regions historically you see seashells being used as currency, because seashells are rare in the mountains. By the ocean, you do not see this. By the ocean you see crystals or minerals being used as currency because, while common in mountainous regions, they are scarce near the ocean. Over time, gold emerged as the standard because it was the thing that checked all of the boxes for a good currency that was globally scarce and (so far) hard to create more of outside of dedicating large quantities of human time and effort to the task of mining more of it. WEAK.

The quantity of silver chosen in 1792 to correspond to one dollar, namely, 371.25 grains of pure silver, is very close to the geometric mean of one troy pound and one pennyweight. In what follows, "dollar" will be used as a unit of mass. A troy pound being 5760 grains and a pennyweight being 240 times smaller, or 24 grains, the geometric mean is, to the nearest hundredth, 371.81 grains. This means that the ratio of a pound to a dollar (15.52) roughly equals the ratio of a dollar to a pennyweight (15.47). These ratios are also very close to the ratio of a gram to a grain: 15.43. Finally, in the United States, the ratio of the value of gold to the value of silver in the period from 1792 to 1873 averaged to about 15.5, being 15 from 1792 to 1834 and around 16 from 1834 to 1873. This is also nearly the value of the gold to silver ratio determined by Isaac Newton in 1717.[32]

That these three ratios are all approximately equal has some interesting consequences. Let the gold to silver ratio be exactly 15.5. Then a pennyweight of gold, that is 24 grains of gold, is nearly equal in value to a dollar of silver (1 dwt of gold = $1.002 of silver). Second, a dollar of gold is nearly equal in value to a pound of silver ($1 of gold = 5754 3/8 grains of silver = 0.999 Lb of silver). Third, the number of grains in a dollar (371.25) roughly equals the number of grams in a troy pound (373.24).

The actual process of defining the US silver dollar had nothing to do with any geometric mean. The US government simply sampled all Spanish milled dollars in circulation in 1792 and arrived at the average weight in common use. And this was 371.25 grains of fine silver. The British pound has its origins in continental Europe under the Roman era. Its name derives from the Latin word "poundus" meaning "weight". The pound was a unit of currency as early as 775AD in Anglo-Saxon England, equivalent to 1 pound weight of silver. This was a vast fortune in the 8th century. Before decimalisation in 1971, the pound was divided into 20 and each into 12 pence, making 240 pence to the pound. The symbol for the shilling was "s."—not from the first letter of "shilling", but from the Latin . The symbol for the was "d.", from the French denier, from the Latin (the solidus and denarius were Roman ). A mixed sum of shillings and pence, such as 3 shillings and 6 pence, was written as "3/6" or "3s. 6d." and spoken as "three and six" or "three and sixpence" except for "1/1," "2/1" etc., which were spoken as "one and a penny", "two and a penny", etc. 5 shillings, for example, was written as "5s." or, more commonly, "5/–". Various denominations had, and in some cases continue to have, special names—such as crown, farthing, sovereign and guinea. See Coins of the and List of British coins and banknotes for details.

Rai Stones

This wouldn't be a cryptocurrency e-book without a mention of Rai Stones. On the Yap islands in Micronesia as late as the 1800s, large circular stones called Rai stones weighing as little as a few ounces to as much as a few tons or more were used as currency. For the large stones, transfer between owners was not physical (the stones were not moved). Instead, any transfers were recorded via oral history to all members of the tribe. This is interesting because it inverts one common dynamic of money - instead of transferring physical objects from person to person, the ownership of said objects was transferred while the objects stayed in place. Instead of the new owner taking physical possession of the stones, everyone in the tribe updated their records to reflect new ownership. The modern equivalent of this may be real estate, which many use to store value and which has its ownership transferred via title instead of physically relocating said real estate.

Properties of Good Money

It's interesting to look at things that have historically been money, and to think critically about the properties that those things had and what would have been different had those

Scarcity The most important property of good money is scarcity. No good, service, or promise can serve as money if it is not also scarce (or, at least, believed to be scarce). If you are a prehistoric mountain tribe, seashells work perfectly well as a money so long as you don't discover a way to find too many more of them to flood the market. Indeed some did exactly this. Likewise, in modern society, gold can (and does) serve as a very good money so long as we don't discover a way to extract gold from the Earth at too fast a rate for too long. Scarcity is the most important property of money, but not the only property. Californium for example is very scarce, at around 27 million U.S. dollars per gram. Much scarcer than gold. This does not make it a better money than gold, however, given all the other trade-offs in the other properties listed below.

Inflation plays negatively to the value proposition of scarcity. Gold inflates at about 1.5% annually. The official numbers for inflation of the U.S. dollar are about 2.5% annually. If you believe these numbers then from a scarcity perspective this makes gold only slightly more scarce than U.S. dollars. What is different between the two is the mechanics for inflation, the mechanics for transfer, and the risks for hyperinflation. The risk for gold hyperinflation is that we find some way to mine on the sea floor, or mine asteroids, or expend energy to create gold from more common elements through some kind of modern alchemy (lets call this risk low; but who knows). The risk for hyperinflation for the U.S. dollar is that the Federal reserve increases the money supply so much that it becomes a problem. In the first your counter-party risk for inflation is technological discovery. In the second your counter-party risk for inflation is politics.

Acceptability

This is arguably interchangeable with scarcity in this list as the most important property. Suppose you could have 5000 U.S. dollars or 5001 U.S. dollars worth of gold. Most would take the 5 thousand U.S. dollars, despite being worth marginally less than the 5001 U.S. dollars worth of gold. Why? Because you can buy things with the U.S. dollars. Very few places accept gold directly, and services that let you spend gold as though it were U.S. dollars require yet another middleman and yet another layer of trust and yet another conversion from the conventional currency (U.S. dollars). To spend the gold, you'd likely have to sell it first. U.S. dollars are also spendable online if you own the digitally native version. The friction of doing business with U.S. dollars is less than that of gold, so despite the increased risk to the scarcity proposition of U.S. dollars, they are widely chosen over gold for transactions and settlements.

Portability Stealing from the example above, portability is the reason we don't use many otherwise scarce and acceptable resources as money. You might just as well look at this as the value-per-unit- volume of an asset. Gold does well in this category because the amount of value that can be contained in a few ounces of gold is enormous. Looking back at Californium as an example of why this isn't the most important property, you could store a tremendous amount of value in a very small space with Californium. You could never make a payment with it, however, as its not divisible. Gold has this same problem. The U.S. dollar, particularly when digitized, is infinitely more portable than gold, which is another mark in its favor for use as a worldwide monetary standard.

Divisibility

Divisibility is an important property in money because it allows money to be exchanged for items of varying value. Historically, this is why silver has had value relative to gold even though it is neither as scarce nor as portable as gold. If you wanted to buy a cow, you might well pay an ounce or two of gold. If you wanted to buy a chicken, paying in gold is impractical because of how small the unit of gold would have to be. Historically this led to a 1:16 valuation between an ounce of gold and an ounce of silver as this is roughly how rare they are relative to each other in the Earth's crust. With the advent of paper promissory notes backed by precious metals, the use case for silver as a micropayment for gold went away and prices collapsed to favor gold as a rarer asset. This also is a mark in favor of the U.S. dollar as a monetary standard - divisible down to a penny (or less when digital), you can conduct transactions of any useful size.

Durability

Durability is another important factor. Imagine using helium as a money. It may be scarce, and divisible, and have a number of other properties that make it desirable as money, but losing a significant portion to the atmosphere in the process of transferring it makes it a poor money. Its clear that this alone isn't a deciding factor, though. Diamonds, for example, are durable and scarce and portable but make a poor money due to not being particularly divisible or uniform.

Uniformity/Fungibility

Uniformity is the final required property for a good and useful money. Gold can be melted and recast into coins or bars of any size, and so no mechanism exists to differentiate one piece of gold from another. Minting gold coins with state emblems does not forever taint that gold, as it can simply be recast. For diamonds, though, this does not apply. Diamonds are scarce and portable but also have varying sizes and grades. You can imagine buying two diamonds of the same weight and paying different amounts for each due to their quality. Obviously if diamonds are what you are paying in, this is untenable and leads to high friction in transactions.

Programmability Bitcoin is the first money that is natively programmable.

Sovereignty

Bitcoin is the first money that can be owned jointly and in whole (in contrast to, say, an ounce of gold where join ownership and possession would imply subdivision and colocation.

The Perfect Money

The perfect money would have all of these properties in the extreme. It would have absolute, verifiable, risk-free scarcity. It would have universal, global acceptability, it would be trivially portable, infinitely divisible, highly durable and entirely interchangeable.

Punctuated Equillibrium, "Sometimes nothing happens for years then years happen in weeks" - technological step functions. Black swan.

Revision #26 Created 2 years ago by Admin

Updated 11 months ago by Admin