The history of time has three fundamental milestones: the inception of the universe in the Big Bang (14 billion years ago), Homo Erectus emerging as Earth’s first hominid species (1.9 million years ago), and the invention of a concept that is almost indistinguishable from civilisation itself: money (7000 years ago). For a very long time, money was metal. This is evinced even in our etymologies: ‘geld’ meaning ‘money’ in German and Dutch for example, ‘argent’ in French, and the Chinese radical for metal or gold (金 jin) in the character for money (錢 qian). The money landscape today is littered with alternative forms of money (and payments), particularly as technological capacity has increased. Looking back, regime shifts from barter, to commodity money, to the gold standard and paper money, and ultimately to fiat was by no means smooth, but one can discern a tendency over time for political jurisdictions and common economic spaces to converge on a single currency. By elucidating this long evolution from barter to digital currencies, we hope to give context for these recent innovations, including the alternative ideals of the first cryptocurrencies as well as the geopolitical design behind central bank digital currencies. The world has changed, and money has too.
‘To trust someone as far as you can throw them’ – A dissection of barter
Barter is a transaction entailing the physical exchange of goods and services. Particularly in a time where civilisation did not boast criminal, law or justice systems and trust remained dubious at best, barter proved a quick and efficient solution between two parties who could not ascertain each other’s creditworthiness or perhaps did not share a common language. Instead they could place their faith in the value of the items to be exchanged. Though anthropologists can only substantiate barter back to Mesopotamia’s tribes in 6000BC, it was likely the system of choice for our Homo Erectus friends. Two adjacent conditions supported the barter system: i) lack of standardised exchange rate and ii) the double coincidence of wants. So where these conditions didn’t always obtain, barter was under pressure. The former exposed the fragility of the system to savvy arbitrageurs, and the latter (“I’ll give you my orange for your banana and you’ll give me your banana for my orange”) seemed increasingly impossible as production became progressively complex. Given not everyone will accept a payment in oranges, this created demand for something that could be redeemable for products/services of equal value, i.e. money. If I desired a banana now and you desired my orange next week, I could write an ‘IOU’ on a piece of paper, promising to deliver you your orange next week. Now integrating the rest of society with similar wants and desires will create a complex web of IOU’s whereby one might end up trusting people they have never met and in a slip of paper which might be a forgery. The natural solution to this IOU system is centralising it within a body that society can truly place their faith in.
The temporary reign of Gold, then the Gold Standard
The first form of this IOU came in the form of commodity money – if a clan or a tribe had a particular affinity with a shell, jewel, or a metal then such communities would attribute a value to a unit of commodity. The value of a unit of commodity money is perceived directly by the user, who recognised the utility of the token as valuable in itself (a concept encapsulated by Marx’s ‘commodity fetishism’). And so with metallic commodity money came the birth of the ‘coin’ (first traced to greater Greek region in 7BC). Gold outshone its metal peers aesthetically, and in terms of its malleability and durability. So, especially in the West it became first among metals: the explorer Christopher Columbus quipped in a letter from Jamaica in 1503, ‘Gold is a wonderful thing! Whoever possesses it is master of everything he desires’ . The very idea that a metallic coin carried an intrinsic value was a fundamental support behind the policies of ‘Mercantilism’, developed by Adam Smith. This economic philosophy generated the political fallacy of identifying money (gold) as the source of wealth, which produced state policies that encouraged the hoarding of gold in fear that outflows of gold would derail the tax base. This idea discredited the mutually beneficial advantage of international trade, rather positing it as a zero-sum game whereby countries should hoard gold by retaining large export surpluses.
The impracticality to the layperson of holding gold bullion gave way to the printing of paper money, whereby private banks issued notes redeemable for gold held in its reserves. They placed these reserves behind interest-bearing loans and bills conditional on the idea that not everyone would require bullion at the same time (otherwise leading to a bank run). Consequently, this led private institutions to issue more notes than reserves with which to pay them, and led to the birth of the fractional-reserve system. Regardless, paper money—convertible as it was into gold, silver, or copper, in fixed rates set by the authorities—was more a convenience than a test of confidence. Gold had long been first among equals, but during the 19th century, it became in many places the sole de jure metal of conversion. It was a ‘good housekeeping’ seal of approval in finance and trade. Coupled with the emergence of centralised banking authorities, the adoption of the ‘gold standard’ first occurred in the United Kingdom in 1821, closely followed by other major nations, further bringing the ‘Gold Bloc’ into solidarity.
While it existed, the gold standard seemed so natural to participating countries that not only quitting it was unthinkable, but also, once it had happened, it was blamed for everything from disrupting international trade and discouraging foreign investment to extending the Great Depression. But it had been too thoroughly battered by World War I and following events; after an interwar renewal, it was abandoned in the 1930’s. Hoarding of gold reserves by the US and France had caused worldwide deflation and banking crises. Even the seemingly natural Bretton Woods system centering the global monetary system by fixing major currencies to the US dollar and the US dollar to gold lost its credibility as the Federal Reserve printed haphazardly to fund war plights abroad, disintegrating in August 1971. And so the world came to float.
The bridge to fiat
The world after 1971 entrenched the modern monetary system ruled by ‘fiat money’ – backed only by the credibility of the state-as-issuer to enforce it as legal tender. This money is characterised by cash, deposits and the numbers in our banking app. Just like commodity money, fiat money is ultimately a medium of exchange, a unit of account, and a store of value. Fiat money has little-to-no intrinsic value. Thus while money has always had value only because we think it does, now instead of a global and lengthy tradition of metal in our hands, we have central banks to trust in.
But our social trust is not just in the monetary authority, but in its synergy with the private sector banking and credit system. Under modern fractional-reserve banking, monetary authorities issue a small fraction of the IOU’s in the economy (cash and deposits at the central bank). It is the commercial banks that create the majority of money when they create deposit accounts and issue loans to our everyday John Does. Centralised monetary authorities can still exercise control over this process by imposing reserve ratios at commercial banks. Many (Austrian) economists cite the dangers of a fractional-reserve banking system, blaming it for the existence of business cycles. Our monetary authorities are arguably encouraging lending booms (and thus asset bubbles), generating the risk of bank runs and more generalised liquidity stress in times of political, economic and social chaos. Can we perpetuate our faith in such monetary systems? Only time will tell.
Digital currencies – a friend of fiat?
And what does this all mean today against the backdrop of technological development and the internet? Fiat money has dominated the monetary system globally since the collapse of the Bretton Woods System in the 1970’s, solidifying its role amidst fractional-reserve banking and the rise of the payments system that saw the inception of debit and credit cards. The Age of the Internet and subsequently fintech (technologies used and applied in the financial services sector) naturally led to the revolution of mobile payments, money transfer, and P2P lending between smaller businesses during the last two decades. Ultimately, fintech is just diversifying the transaction processes of cash and credit, expanding its electronic applications while catering to the millennial generation that crave efficiency and coral-coloured debit cards.
The more eye-catching by-product of the Age of the internet which has created the possibility for a fundamental break from fiat systems is digital currencies – a broad term covering the likes of both digitised fiat money as well as jargon-heavy, futuristic sounding currencies. Although cryptography applied to money started in the fully digital space with cryptocurrencies such as Bitcoin, the fiat system has also adopted it and now represents an active frontier of its development. Stablecoins represent a privately-created cryptocurrency with a perpetual 1-to-1 exchange rate with fiat money, like USD. From here, central banks have been experimenting with ‘skipping the middle man’ and creating a fiat-crypto hybrid directly known as a central bank digital currency (CBDC). It has the benefits of security offered by crypto, but keeps attributes of fiat money, in that the central bank still determines its supply. There remain a few open questions about such a system’s design. Firstly, would these CBDCs be available only to qualified banks, as with ‘reserve deposits’, or would they be available to individuals? Secondly, could this type of money serve as the base for fractional-reserve banking? Economists in the EU have seen CBDC as a chance to replace fractional-reserve banking with direct control over the money supply. In contrast, the UK has taken a more traditional view which includes fractional reserves.
And are cryptocurrencies such as Bitcoin money? Relying on the classic three-fold definition of money, it could be illuminating to examine whether it serves as store of value, a medium of exchange, and a unit of account. In a uniquely circular way, Bitcoin is a store of value when society believes it will be a good store of value. That’s why its volatility (in dollar terms) has frustrated confidence in it. In this sense, it may have more in common with gold than its fiat counterparts. Limited supply may make it a good store of value in the long run, but that does rely on ‘consensus confidence’. More importantly, the reality that transactions are priced in fiat money, not gold or Bitcoin, means that price level stability is more likely to be found in fiat terms, reinforcing its store-of-value function. Gold or Bitcoin as a store of value (potentially) shows best in the long run, and in inflationary environments. Regarding the second test, virtual currencies can only act as a medium of exchange insofar as there is infrastructure to support these transactions. When some constraints exist on fiat transactions (in the case of capital controls, or for contraband), Bitcoin can serve as an alternative medium. Yet, it is safe to say that while its uptake in places like Starbucks has some symbolic value, there is no mainstream critical mass of Bitcoin payment infrastructure. Regarding its function as a unit of account, it is very rare to see Bitcoin as a unit of account, except in Bitcoin wallets. Goods may sometimes be priced in Bitcoin, but this is a very temporary value based on its dollar price in that moment. Empirically, there has been limited evidence that virtual currencies meet all money functions that fiat does. Fiat money still continues to dominate, though there has been a notable shift to electronic money. Take the case of Sweden – a quasi-cashless economy with only approximately 1% of GDP circulating in cash. Regardless of the ease and efficiency of a majorly digitised economy, it has also perhaps signalled that Sweden’s citizens are comfortable with (and trust) the digital world. Coupled with the threat of increasingly privatised and decentralised digital currencies, this has naturally led to the Riksbank announcing in February a trial of its own CBDC, the e-krona, for one year.
A lesson from history?
Perhaps the question really is about offering complementary alternatives to fiat money rather than its replacement, and how the monetary system can still efficiently function with an expanding universe of digital currencies. The historical timeline of barter, commodity money, gold and the gold (paper) standard, and finally fiat has not been in any linear or successive fashion (even though most classroom economic textbooks teach as such). Even the gold standard and Bretton woods seemed to be ‘trial and error’ experiments in an attempt to hone the most versatile and efficient global monetary order. The dialogue surrounding stablecoins and central bank digital currencies has begun in such a fashion too – in March 2020, the Bank of England published a discussion paper on the opportunities, design, and challenges of introducing a CBDC. With the aim of supporting a resilient payment landscape, avoiding the risk of private money creation, and addressing the consequences of declining cash use, the central bank has firmly stated they see a CBDC as a complementary product to the traditional cash and deposits system, not a means to uproot it (and thus decimate the modern monetary system). The dialogue has even spread to possible research synergies with the private sector. It is understandable that the introduction of a CBDC, an alien concept for now, will meet firm resistance, particularly regarding transaction anonymity and the implications for commercial banks. The political sphere will also have its influence as countries such as China come closer to launching their own CBDC. So perhaps we do not need to require a fundamental rethinking of “what is money”, but focus on reducing the friction between opinions on “fiat” and “digital” hardliners, which requires something that lies at the heart of money – trust.
 In Columbus’s diary from his first travels to America, the world ‘gold’ was mentioned 65 times