As the above quotes indicate, money has been around for a long time, and some would argue since the beginning of time. Money is so common that everyone has experience with it and likely interacts with it on a daily basis. This familiarity does not, however, mean that money is universally understood. Therefore, we will begin by providing the following definition of money as described by the International Monetary Fund.
While crypto currencies do not necessarily meet all of the definitional requirements at the moment, they do represent a natural evolution of money. Additionally, many of the most appealing aspects of crypto currencies attempt to address many of the issues that have plagued money throughout history. From the perspective of these challenges, we will start by providing a brief history of money.
Barter
While one of the earliest forms of money is often considered barter, it actually falls short of the International Monetary Fundâs definitional requirements for money. In a pre-currency society it is certainly easy to see how barter naturally evolves, with the baker looking to trade his bread for butchered meat as envisioned by Adam Smith in The Wealth of Nations. Of course, the limitations also become obvious as the baker has to first find a butcher interested in trading for bread before even determining the ratio of the two goods. These two parties also need to find farmers with wheat and ranchers with cattle that are interested in providing the baker and butcher with their inputs. While there are aspects of a medium of exchange, the requirements that bread (or meat) is a store of value and unit of account are not accomplished in this example.
These types of exchanges eventually gave way to a more standardized approach that facilitated a greater variety of transactions. Within each community, there were generally some agricultural products that were widely demanded by a large portion of that population, such as grain that could be ground or planted. In these instances, merchants of all kinds would be more willing to accept the broadly desired commodity if there was a general ability to exchange that product for something else. In our example above, while the butcher may not want bread, he would accept grain from the baker that could then be used to exchange for livestock from a farmer. The farmer in turn would be incented to accept grain as payment if it could be used to acquire tools from the blacksmith. These are broad examples of the development of commodity money, with salt, tea, and seeds widely accepted forms of âcommodity money.â
There are a few key points to take away from our example; firstly, grain has the potential to evolve into a unit of account and a medium of exchange, although its store of value is only as long as the grain does not spoil. An additional observation is that the success of grain as a currency is based on the broad-based belief in its convertibility into other goods and services. If that belief were suspended by enough of the communityâs population, the appeal of accepting grain would be hampered and only those that naturally needed it would continue to partake in this form of barter. This situation would then convert grain into just another bartered product that is limited by many of the issues described above. One last issue concerns the store of value, where a grainâs shelf life is limited, but can also be broadly replenished on a year-to-year basis. In fact, a bumper crop may flood the market with grain that would lead to devaluation of that currency. As we shall see a little later in this discussion, this is akin to drastically increasing the supply of money, which in practical terms leads to inflation as there is a greater supply of currency available in the economy. For purposes of this chapter, we refer to currency as a medium of exchange, most closely associated with fiat currency issued by a central bank that generally has no intrinsic value. Money can be anything that fits the definition provided above.
From Shells to Coins and Paper
The next stage for the evolution of money was the introduction of coinage. Metal had been used as a medium of exchange almost as long as barter and shells, but the first minting of coins is thought to have occurred in the sixth or fifth century BC. The Lydians, an Iron Age empire that existed in parts of modern-day Turkey, are often cited as the first culture to introduce standardized metal coins. These early coins were likely created for ornamental purposes or as souvenirs, but were soon used as money. Further adoption and refinement saw standardized coins emerge in many cultures, including Greek, Persian, Indian, and Chinese societies.
Early coinage was made from electrum, a naturally occurring mixture of gold and silver. Other metals were subsequently utilized to make coins, including gold, silver, copper, and bronze. The use of these precious and semi-precious metals was by itself a store of value. Most cultures minted multiple sizes of all these metals, thereby allowing the facilitation of trade for all types of goods, big and small. The availability of precious metals also had an impact on the type of coins that were introduced. It was thought that some of the earliest pure gold coins were minted by the Persians as they held much of the worldâs gold at that time. In contrast, other cultures, such as the Greeks, did not have easy access to gold and chose to store their limited gold instead of converting it into coinage. Silver was therefore also widely used in coinage, particularly as gold became scarcer.
Gold and other precious metal coins ultimately gave way to paper money. That is not to say that gold has fallen out of favor, as we still have official gold coins being produced, such as the American eagle, Canadian Maple Leaf, and South African Krugerrand. While coins fulfilled all of the definitions of money, they could still be cumbersome, particularly for large transactions. In addition to the logistics of carrying around large sums of metal coins, such practice also opened the bearer to theft.
Evidence suggests that paper money had its origins in China, as the invention of paper naturally gave way to the development of paper money. Dispersed and growing trade routes made transportation of large quantities of coinage increasingly challenging. Additionally, the limitations of coinage were evident either when there was not enough metal to produce currency needed to support growth or when inflation required the transportation of more coinage. The earliest forms of paper money were private transactions, where traders deposited their coins at their companies, which issued a promissory note based on this collateral. Governments eventually saw the benefits of issuing paper money, with broad introductions around the eighth century AD. Governments eventually established themselves as the only entity that could issue paper money, with the concept of the ministry of finance becoming formalized 500â600 years after paper money was first introduced.
The development of paper money was not without hiccups, however, as the temptation of unlimited printing of money eventually led to rampant inflation in China. Paper money was actually eliminated for several hundred years following an especially deep financial crisis. This entire life cycle of paper money in China occurred before the Europeans even considered issuing their own paper currency, even though Marco Polo reported on its use in the late thirteenth century.
Development in Europe followed a similar path, as banks held gold and silver for its customers providing a receipt promising the repayment of the collateral on demand. These notes then became demand notes for the bearer, making them an ideal vehicle in facilitating business transactions. The first official European note is credited with the Swedish, with the private Bank of Stockholm issuing notes backed by copper and silver holdings in collaboration with the Swedish government. Similar to the Chinese experience above, too many such notes were printed, which declined in value when the bank was not able to meet the demand of its depositors who wanted the return of their silver and copper. The bank eventually collapsed, was taken over by the government, while its founder was imprisoned within ten years of its founding. Sweden also banned the issuance of new banknotes until the eighteenth century.
Despite these setbacks, paper money continued to flourish although initially it was banks that were the primary issuers of paper money. The growth of international trade in the thirteenth and fourteenth century in Europe evolved with the issuance of notes that represented holdings of gold or silver at a depository. Initially these notes only entitled the depositor to the precious metals, but evolved to provide the bearer with the right to the collateral. Merchants then started to request multiple notes for their larger deposits as the concept of multiple denominations emerged.
Banks themselves started to issue banknotes that were backed by gold or other collateral that they held, which often resulted in floating more notes than were physically backed by collateral in their vaults. This was possible as banks did not expect all note holders to demand collateral at the same time, very similar to the modern banking system. Of course, as illustrated above, the temptation of issuing too many notes is ever present. In those instances, bank solvency becomes a problem for banknote holders, as was the case of the Bank of Stockholm. In the Swedish example, the Riksbank, or Swedish central bank, was established in the aftermath of this early crisis. Given that the monarchy was involved in the establishment of the Bank of Stockholm, which initially provided the venture with credibility, the Riksbank was established outside of the government, with the primary task of maintaining price stability. These principles became the foundation of modern central banks, and the Riksbank is considered the first and oldest central bank.
While Sweden is credited with the first banknote and the first running modern bank, out of caution, the Riksbank did not issue new bank notes for over 100 years after its establishment. During that time, other countries stepped in to fill this void and advance modern financial theories. England played a pivotal role in this sequence of events, but it was from a position of necessity that its financial innovations were first introduced. The English military was ravaged after a long war with France that required significant resources to rebuild. With credit tight, the Bank of England was established in 1694 to raise 1.2 million pounds in order to rebuild the navy.
Over the course of several hundred years, standardized banknotes issued by the Bank of England were first introduced. Counterfeiting also became rampant as private banks and the Bank of England both continued to print notes, causing some confusion as to which notes were real and which were fake. While the sentence for counterfeiters was death, fake notes continued to cause problems, leading to the Bank Charter Act that granted note printing monopoly powers to the Bank of England. The US printed its first government note in 1862 declaring it legal tender, meaning that they must be accepted to settle debts. These advancements in finance and the payment system have been largely replicated around the world.
As we will review the development and role of central banks a little later in this book, we will jump to some of the more important developments with regard to currency which paved the way for crypto currencies. Crypto has been a natural extension of the digitization of money, which began with the advent of the charge card. By way of background, a charge card is characterized mainly by the requirement that the balance be repaid in full by at the end of each month. Earlier versions of electronic charge cards were introduced by the likes of Diners Club, Carte Blanche, and American Express. Credit cards are distinct from charge cards in that they are essentially forms of revolving credit, with less than full payment due each month, with outstanding balances subject to interest charges. Earlier versions of credit cards were pioneered by large merchants, which evolved to general use credit cards in the 1960s.
While charge and credit cards began making consumers comfortable with the digital payment system, users were still accessing their money through traditional bank channels. They either needed to get cash to pay these bills or wrote a check in order to facilitate the payment. The ATM further advanced how we access money by tying our bank accounts to a card that contained our identifying information. The first ATMs started in Europe in the late 1960s but quickly spread around the developed world. The development of interbank networks further advanced easily accessing our money, while also making access to money outside our domestic markets possib...