History of Money and Our Financial System
Money, as a medium of exchange, a unit of measurement and a store of wealth, have played vital roles in our lives.
Throughout history, money has taken in many forms.
It has taken in a form of shells, gold nuggets, metal coins, pieces of paper, or plastic.
The Barter method
Ever since approximately 3,000 years ago, humans started bartering goods and services with one another.
For example, if I needed some fur clothing to warm myself up during night time, I can exchange my skills of sharpening a harpoon with someone who actually has some fur.
But the barter method proved to be ineffective, as if I had to wait until someone needed their weapons sharpened, I could have already died from the cold of night.
The barter method continued as Homo Sapiens transitioned from a hunter gatherer to agricultural lifestyle, but resulted in a relatively slow economy, as matchmaking business transactions this way was a slow process.
What followed was the use of a certain commodity that are easily trade-able to be used as currency in prehistoric times, such as sea shells, salt, or weaponry.
Sometime in the year 700 BC, the Chinese first started using Bronze coins.
Gold, silver and bronze, in addition to being valuable as jewelries, possesses characteristics of money, which are scarce, divisible, portable and durable.
Then in 600 BC, the King of Lidya first issued a ‘national’ currency in form of gold coins.
The Birth of Paper Money (Banknotes)
Following that, the Chinese came up with another breakthrough, inventing paper money sometime in the 10th century.
The concept originated because during the Tang Dynasty, merchants and traders were looking for more efficient ways to handle large transactions than using a large and heavy amount of bronze and copper coins.
These paper money, or banknotes, acted as notes that represented actual commodities and precious metals stored in bank vaults.
Technically, (although it was reportedly rarely practiced) people can claim the precious metals from the banks using these notes.
The first form of paper currency among the European governments were issued by the American colonies in the 17th century, in form of IOUs, similar to banknotes.
This was done to make business transactions more efficient, as gold and silver coins amounted to a great deal of weight when transacted and carried in large amounts in the voyages across the Atlantic Ocean.
The use of paper money boosted the economic growth in the Americas.
Fiat system
Since its creation at around the 11th century, paper money that represented commodities were widely used in the world until the 20th century, when President Richard Nixon, pressured by costs of war and government borrowing for economic growth, decoupled the US dollar (the dominant global currency at the time) from gold.
Previous to that, from 1944 to 1971, the Bretton Woods agreement fixed the value of 1 troy ounce of gold to 35 US Dollars, while other currencies were pegged to the U.S. dollar at fixed rates.
The decision of the US Dollar to adopt the fiat system, at the time the dominant global reserve currency used in international trade, was followed by other countries.
Thus was born ‘money without intrinsic value’, as the notes, or money, that was used was not backed by commodities or precious metals any longer.
The strategies of nations to pay debts to their creditors by consigning newly printed cash without assets to back it up poses the risk of hyperinflation, and continued inflation.
This continuous inflation is the result of excessive growth of money supply, boosted even more so with the application of the Fiat system, where money in the economy is printed by its Central Bank without being backed by precious metals to match its supply.
Ever since its inception, the Fiat system has resulted in continuous inflation that has lasted until now, with the US Dollar having lost 98 percent of its purchasing value since the implementation of the system.
International Currency Wars
As more and more countries adopted their own currency and their own form of paper money, international trade also grew.
Banks from one country started purchasing currencies from other nations.
The resiliency of one currency depended on the country’s political stability.
Competition between one currency and another led to wars and trade tensions between one country and another, giving birth to ‘free global market’.
“When the inhabitants of one country became more dependent on those of another, and they imported what they needed, and exported what they had too much of, money necessarily came into use.” -Aristotle
Money in form of plastic cards
When carrying large amounts of paper cash started to become a burden, money in form of plastic was the next evolutionary step.
Payment cards opened doors to remote payments that can be done from anywhere in the world, where previously, payment using cash could only be done directly hand to hand in person.
The Visa brand was founded in 1976.
Plastic money, combined with the power of the internet, gave birth to some of the biggest companies and businesses the global economy has ever seen.
That combination enabled Mobile Payments, which are done through electronic devices, such as computers and smart phones.
Bitcoin and Cryptocurrencies
In 2009, on the brink of a financial crisis (primarily driven by the enabling of banks to trade derivatives backed by mortgages, which consisted of a lot of bad and defaulted home loans), a pseudonymous programmer, Satoshi Nakamoto, created a new decentralized monetary system solely based on the internet, with no central banks and human intervention needed for its governance.
Bitcoin is built on top of the Blockchain technology, which is a growing list of records, called blocks, that are linked using cryptography.
These blocks contain information of Bitcoin transactions, what time they occur, who is sender and receiver, and its amount.
With each blocks created, new Bitcoins will be minted, until all 21 million are minted.
This set of records is accessible to all parties online for verifying transactions and ownership involving all Bitcoins, providing transparency and immutability not seen in normal monetary policies.
The cap limit of 21 million Bitcoin to ever be in circulation makes many analysts and economists to dub Bitcoin with the terms ‘hard money’ and ‘digital store of value’.
The first Bitcoin block which consist of the first Bitcoin transactions, created in 2009, had a message written on it by Satoshi Nakamoto.
‘The Times 03/Jan/2009 Chancellor on brink of second bailout for banks’
Satoshi Nakamoto’s message coincided with the economic recession at the time, where large banks were in dire need of stimulus bailouts to prevent bankruptcy.
Currently there are more than 2,000 cryptocurrencies in the world.
This scene is similar to the 19th and early 20th century in the US, where there were more than 5,000 different bank notes in circulation in the US economy, issued by different banks throughout the country, before the Federal Reserve was given sole rights to distribute currency in the year 1913.
So with more development of money, the global economy also grew with it.
More economic activities required more efficient forms of money.
Which leads us to the next evolutionary process of money.
Digital Currencies
One of the biggest transformations in the current financial landscape is the introduction of China’s Central Bank Digital Currency (CBDC) in early April 2020.
Elsewhere, other countries’ Central Banks are also exploring to apply Central Bank Digital Currency.
What does a Digital Currency bring to the table?
A digital financial architecture will bring about more transparency of money flow, resulting in more sound monetary policy, better financial inclusion, and a more seamless flow of money.
The incorporation of Blockchain technology for a digital currency creates transparency when it comes to flow of money.
Current e-payment and mobile payment apps all operate within a closed loop, meaning one payment app with another can’t interoperate directly without a bank mediator.
A single digital payment network that encompasses all banks and financial entities in an economy will result in seamless flow of money, fast, boundless and efficient, with no unnecessary intermediaries in costs.
In a cashless world, interest rates could plunge because there is no need for us to store our money to a bank.
A central bank could reduce the policy rate from, say, 2 percent to minus 4 percent to counter severe recession.
The interest rate cut would transmit to bank deposits, loans, and bonds. Without cash, depositors would have to pay the negative interest rate to keep their money with the bank, making consumption and investment more attractive. This would boost lending, boost demand, and stimulate the economy.
A POTENTIAL GAME CHANGER
Another revolutionary breakthrough that Digital Currencies and Electronic Payment (DCEP) bring is recognizing final settlement as soon as possession changes.
With other forms of cashless payments and apps from cards and wire transfers, is that the deal isn’t settled and can be reversed until the banks record and settles it.
This is a game changer, as banks have been intermediaries for so long in our monetary system.
But since a mediator is no longer necessary, money can be executed with software.
Both the payer and payee can convey ‘if X, then Y’ commands with Digital Currency towards one another, creating automation in their business transaction processes.
A future possibility would be, if a store require more supply of items A in its shelves detected by its sensor, then it can send digital payment to its distributor, which upon receipts would ship it to the store.
This entire process would require minimum or no human supervision.
Internet of Things
The development of artificial intelligence and internet of things will require a new payment infrastructure.
Smart machines operating autonomously will be required to transact with one another, and even the largest global payment network currently, Visa, can only handle 50,000 transactions per second.
Imagine if all machines in the world will autonomously transact with one another! Even Visa’s capability will not suffice.
Currently there are a number of cryptocurrency projects that can handle more transactions per second than Visa.
Indeed we live in unprecedented times of emerging and life changing technologies involving money and how we transact with one another.
Exciting times indeed.
