From Barter to Digital Money

Cryptocurrencies generally are not even a form of money but just a general financial asset. I discuss this a bit in this post. However, I do think fiat money will eventually take on some “crypto” form, some digital form backed by cryptography. Not exactly in the decentralized nature as cryptocurrencies like Bitcoin as it would still be backed by a central bank, it but it’d likely take on many concepts used in cryptocurrencies.

Fiat currencies will eventually embrace some sort of cryptographically secure digital form, and this is quite a natural progression in the development of money. Let’s take a look at the history of the development of money and how it has changed forms over time.

“Money” started as simply as things people set aside to facilitate trade, because if one person wants to barter for X, but the person who produces X only wants to barter for Y, but the former person does not want Y and the latter person does not want X, then the barter will be impossible.

But when the division of labour first began to take place, this power of exchanging must frequently have been very much clogged and embarrassed in its operations. One man, we shall suppose, has more of a certain commodity than he himself has occasion for, while another has less. The former, consequently, would be glad to dispose of; and the latter to purchase, a part of this superfluity. But if this latter should chance to have nothing that the former stands in need of, no exchange can be made between them. The butcher has more meat in his shop than he himself can consume, and the brewer and the baker would each of them be willing to purchase a part of it. But they have nothing to offer in exchange, except the different productions of their respective trades, and the butcher is already provided with all the bread and beer which he has immediate occasion for. No exchange can, in this case, be made between them. He cannot be their merchant, nor they his customers; and they are all of them thus mutually less serviceable to one another.

— Adam Smith, “The Wealth of Nations”

Hence, it makes sense for people to quickly barter away much of what they produce for some sort of commonly desired commodity, like salt or sugar or oxen or gold, to then make it easier to barter for directly for the thing they want in the future, since the person will likely desire something common more.

In order to avoid the inconveniency of such situations, every prudent man in every period of society, after the first establishment of the division of labour, must naturally have endeavoured to manage his affairs in such a manner, as to have at all times by him, besides the peculiar produce of his own industry, a certain quantity of some one commodity or other, such as he imagined few people would be likely to refuse in exchange for the produce of their industry.

— Adam Smith, “The Wealth of Nations”

Precious metals like gold or silver were the best at this task because metal does not decay and also can be evenly divided. You can’t divide an ox into two halves without killing it. A problem with metals is it’s easy to fake gold and silver, so businesses would have to spend a lot of money on weighing and assessing the purity of the metals to verify its value.

The use of metals in this rude state was attended with two very considerable inconveniences; first, with the trouble of weighing, and secondly, with that of assaying them. In the precious metals, where a small difference in the quantity makes a great difference in the value, even the business of weighing, with proper exactness, requires at least very accurate weights and scales[…]The inconveniency and difficulty of weighing those metals with exactness, gave occasion to the institution of coins, of which the stamp, covering entirely both sides of the piece, and sometime the edges too, was supposed to ascertain not only the fineness, but the weight of the metal. Such coins, therefore, were received by tale, as at present, without the trouble of weighing.

— Adam Smith, “The Wealth of Nations”

Specie/coined money was still an inconvenience, though, because money is incredibly heavy and also costly. A lot of your precious metals have to be set aside to create coined money, which also means a lot of labor has to be set aside to mine that money. You also have to set aside a lot of extra labor to constantly transport that money, because metals are very heavy, and so transportation of large amounts of money is expensive.

A society’s goods and services should not be measured in the amount of money that society has, because “money” is not consumable. I can’t eat a $5 bill. The only reason I value a $5 bill is because I can spend that bill to buy something, like some food, which I can then eat. It is not money itself which is valuable, but what we can get for it.

The amount of money in society would always underrepresent how much wealth there is in society because that same $5 can then be circulated many times by many people to facilitate any number of financial transactions. I can buy something for $5, and the person I give the $5 bill to can then use that same bill to buy something else for $5. That would mean there would have to be $10 worth of products produced, yet these transactions were facilitated by only a $5 bill.

Therefore, real wealth in society is the totality of goods and services produced, and not the money itself. Money is just the wheel used to circulate commodities, and, in fact, the more expensive it is to maintain that wheel, the less wealth you have in society. You can’t eat money. If you have to expend a huge amount of labor on producing the wheel to exchange commodities, then that labor comes out of a pool of labor which could instead be used to produce actually consumable goods and services.

[…]as the machines and instruments of trade[…]by means of which the whole revenue of the society is regularly distributed among all its different members, makes itself no part of that revenue. The great wheel of circulation is altogether different from the goods which are circulated by means of it. The revenue of the society consists altogether in those goods, and not in the wheel which circulates them. In computing either the gross or the neat revenue of any society, we must always, from the whole annual circulation of money and goods, deduct the whole value of the money, of which not a single farthing can ever make any part of either[…]Money, therefore, the great wheel of circulation, the great instrument of commerce, like all other instruments of trade, though it makes a part and a very valuable part of the capital, makes no part of the revenue of the society to which it belongs; and though the metal pieces of which it is composed, in the course of their annual circulation, distribute to every man the revenue which properly belongs to him, they make themselves no part of that revenue.

— Adam Smith, “The Wealth of Nations”

If this is the case, then making the cost of maintaining and transporting money cheaper would therefore free up labor resources that could be used in producing consumable goods and services for society. If less labor needs to be used to mine gold and silver to produce money to facilitate circulation, then that labor could instead be used to produce food, video games, clothing, computers, etc.

Hence, we then get paper money. Paper money began by private banks replacing money with I.O.U.s representing money, and as this system caught on, eventually this system was adopted by the central banks that produced the coined money themselves, and they started to issue state-backed banknotes, pieces of paper representing a certain amount of gold in the bank.

Transporting paper currency is extraordinarily cheaper than transporting precious metals. As transactions of precious metals began to be replaced by transactions of banknotes representing precious metals, the cost of these transactions dropped significantly.

More than this, you don’t even need to maintain an equal amount of precious metals in the bank equivalent to the amount of banknotes in circulation, because the bank actually only needs to have a store of money large enough to meet regular demand for withdraws, thus allowing for the actual currency in circulation to exceed the metal supply, and thus requiring less precious metals to facilitate the same amount of commodities, freeing up these precious metals to be used elsewhere.

The substitution of paper in the room of gold and silver money, replaces a very expensive instrument of commerce with one much less costly, and sometimes equally convenient. Circulation comes to be carried on by a new wheel, which it costs less both to erect and to maintain than the old one.

— Adam Smith, “The Wealth of Nations”

This system also gave central banks control over its currency that it did not have before, such as being able to artificially inflate or deflate prices through printing or destroying banknotes, and some level of being able to track and influence transactions for better regulation.

This “gold standard” backed by state-issued banknotes was the norm all the way up until the 20th century, when governments began realizing that with an already established economy trust an already established and trusted currency and central bank, that they would simply liquidate their gold and no one would even notice or care, as long as the central bank made sure to maintain trust in its currency and control the supply of that currency to avoid any rapid price fluctuations.

The little bit of gold needed to be mined, weighed, assayed, and maintained in banks could also be liquidated and were not necessary for the establishment of a currency. This again freed up much more resources, but it also gave the government even more over its currency.

We can see that there is a pattern of the form of money constantly developing in such a way to may transaction more efficient. The more expensive it is to produce money, the more costly transactions with that money are, the less wealth you have in society, as money is merely a wheel to circulate wealth but is not wealth in and of itself, and so you want this wheel to be as inexpensive to maintain and transactions using it to be as cheap as possible.

While paper fiat money is the cheapest wheel of circulation invented so far, it still comes with expenses. The central bank still needs to produce paper, and the private banks still have to maintain a store of paper. Transporting large sums of money requires transporting large sums of paper, which can still carry a cost.

Many private banks have been repeating what they did in the past, but this time with paper money. Private banks have been replacing paper money transactions with effectively digital I.O.U.s. I can send $5 from my bank account to yours over the internet. You will a number on your computer screen increase by $5, but the bank does not actually have to even transport $5 worth of currency. They can simply log digitally that $5 were transferred, and your bank transaction is simply an I.O.U., and they do not have to actually transport $5 worth of paper currency unless you request to redeem that I.O.U.

It would therefore make sense for central banks to eventually catch on and realize they can do this themselves. They don’t need to even produce paper money at all. They can simply use cryptography and digital bank accounts to log transactions without printing any paper to back it at all. In the same way paper money which came to represent gold eventually became money in and of itself, digital logs which have come to represent much of the transactions in society could thus become money in and of itself if a central bank gets involved.

This would be the natural progress of money, from fiat to digital-fiat, otherwise known as Central Bank Digital Currency, as it would be far cheaper to carry on transactions simply by changing numbers in digital logs rather than transactions with paper money. There would be nothing that has to be physically transported at all, and nothing that has to be printed or minted at all. It would be the cheapest and most efficient wheel of commodity circulation ever invented, and thus seems like digital-fiat money is the natural progress of money to me and its natural next stage in the evolution of money, it will also provide far more ability to control and regulate the money and track transactions than physical fiat money ever has.

Some central banks are already beginning to adopt some sort of digital currency.

This doesn’t mean something like Bitcoin-type “cryptocurrencies” will inevitably disappear, because things like Bitcoin are fundamentally not money as I explained in the link at the very top. They are simply a financial asset typically used as a middle-man to facilitate transactions. They serve as a way to either facilitate transactions, get around laws and sanctions, or to preserve anonymity.

These kinds of Bitcoin-type cryptocurrencies thus have a place in the economy and they are currently fulfilling that place. That place is not the place of money, they will never replace money, and thus the adoption of cryptographically secure digital money by a central bank won’t necessarily kill cryptocurrencies like Bitcoin since they are fulfilling a separate role: one fulfilling the role of financial assets used as middle-man between trade, and the other fulfilling the role of actual money, and could thus still potentially exist side-by-side.

I have a Bachelor of Science in Computer Science. Coding and Marxian economics interests me. I write code for a living.