History of money: From fiat to crypto, explained

Money as a concept has been a cornerstone of human civilization and economic development. To start with the latter, money is a method of storing value and worth, and it also functions as a medium of exchange that allows individuals to exchange goods, services and proxies thereof. 

Money is fundamentally a unit of account, and it can take various forms, such as coins, paper currency, virtual currency or digital assets. Indeed, money has evolved from simple objects of barter to cryptocurrencies. Nowadays, money in the form of fiat currency is issued by central banks, after which individuals, businesses and other entities use this money for various purposes. 

Today’s money is mainly digital, highlighting the notion that money is ultimately a construct of society. This means that it is ultimately a shared fiction created by humans to facilitate trade and value creation. 

Undoubtedly, exchanging goods, services and proxies can arguably only be facilitated if parties have trust (the opposite of suspicion). It may be enabled by direct trust (if items are directly exchanged) or indirect trust. In that latter case, deals are nowadays enabled via a neutrally perceived yet value-loaded type of entity: money.

If money depends on trust, it has no inherent value. The acknowledgment of people merely determines its worth. This belief gives money its power and makes it an almost ideal medium of exchange. One very early example of this is Yap Island’s unique system of currency known as the “rai stones,” an example of commodity money.

The value of this stone was determined by its history and characteristics. The unique feature of this monetary system is that the rocks were not physically exchanged during transactions. Instead, ownership was transferred through a system of oral tradition and memory as long as the community acknowledged the transfer.

Arguably, money is a product of political institutions, where the state and the central banks have the power to regulate and create money, respectively. Central banks control the amount of money in circulation and may mint new money. While the state’s ability to control money is crucial to its power and authority, human faith in money ultimately helps facilitate this process. 

Apart from the value of money created by trust in the state and the economy, its value is also derived from its need and demand. Ultimately, the notion is that money is scarce and available to us in a limited supply. However, phenomena such as inflation, deflation, stagflation and hyperinflation directly counterbalance the idea that the value of money is constant. 

Money has evolved from simple objects of barter to cryptocurrencies. Money emerged as a means of facilitating trade and cooperation among strangers. As human societies grew more extensive and complex, the need for a common medium of exchange became increasingly important.

From a realist political perspective, concepts like value and possession played a part in human interactions from their early days. The first forms of money were objects of barter, such as stones and livestock. These objects were used to facilitate trade and were valued based on usefulness, scarcity, demand and supply. 

With larger human settlements and the propertization of humans’ surrounding environment after the agricultural revolution, notions like the economy, trade and, eventually, money arose. The use of commodity money can be traced back to ancient civilizations, where goods were used as currency. However, it was the emergence of metal currency as a new medium of exchange that had a significant impact on the evolution of money.

Metal money was an essential tool in developing centralized political structures and the rise of modern states. Metal money allowed rulers to build bureaucracies and armies necessary to maintain control over large territories. The use of money also facilitated trade and commerce, leading to greater wealth and growth. It allowed for the development of uniform exchange rates, which fostered further economic growth and trade. 

In the early days of banking, goldsmiths would store the gold and other metal money in their vaults, issuing receipts that could be used as a form of payment. These receipts soon evolved into representative money. Individuals used paper certificates to depict the value of the commodity, ultimately leading to the development of paper money, which is still in use today. 

Until about 50 years ago, money was only physical. In the modern era, fiat money in the form of digital money has become a dominant form of value exchange, utilizing electronic record-keeping of banking transactions. Fiat money is backed by the government and the central bank and is valued based on people’s trust in said institutions. Indeed, the government has the power to control the money supply. It can increase or decrease the value of fiat money through monetary policy, such as by printing more money or raising interest rates.

Fiat money today is typically not backed by a commodity, such as gold, or linked to a stockpile of other physical reserves. Fundamentally, fiat currency is inconvertible and cannot be redeemed for a commodity because it has no intrinsic value.

Money has taken on new forms in the digital age, such as credit cards, digital assets, central bank digital currencies (CBDCs) and cryptocurrencies. Mobile payments and online banking have also become increasingly popular. Moreover, since Bitcoin’s (BTC) inception in 2008, cryptocurrencies have challenged the fiat currency system. The widespread adoption of mobile payment technologies and the upcoming nature of cryptocurrencies have transformed how we interact with money and are indicative of the evolving nature of money and its role in society. 

The gold standard was used in many countries until 1971. It was a monetary system in which the value of a country’s currency was gold-pegged, meaning that paper money could be redeemed for gold at a fixed rate. Some consider that abandoning the gold standard caused economic instability and weakened state power. In contrast, others see the shift as necessary for a more dynamic global economy.

The gold standard was abandoned because of its limited monetary policy flexibility; central banks could not adjust the money supply to respond to economic conditions. The United States dollar was removed from the gold standard in 1971, de facto making money a form of debt. Compared to gold, the value of the U.S. dollar has declined by over 95% since 1971. Crucially, gold was valued at $35 per ounce in 1971, while its value soared to nearly $2,100 per ounce 50 years later. This discrepancy represents a substantial loss of purchasing power for the dollar. 

This contrast is reflected in the many implications that the state, individuals and society have undergone ever since. The abolishment led to greater currency volatility and a lack of financial discipline among governments, causing economic instability and inflationary pressures across the board. Indeed, the loss of the gold standard has led to a shift in economic power from the state to the market, further declining state sovereignty and influence over its monetary policy.

Moreover, abolishing the gold standard has harmed the middle and lower classes. Inflationary pressures from the lack of financial discipline have disproportionately affected those with less financial means, leading to greater economic inequality.

Others view abolishing the gold standard as a necessary step toward a more flexible and adaptable global economy, in which state power was not weakened but merely shifted due to new means in the monetary policy toolkit. In this stance, the gold standard’s abolition has allowed for a flexible financial system, enabling governments to respond more effectively to economic crises and pursue policies to foster economic growth. 

It may also be argued that the shift opened up new opportunities for economic mobility and wealth creation through the expansion of credit and the growth of the financial markets.

The barter system is a system in which goods and services are exchanged for other goods and services. The barter system had limitations, such as the lack of a standard measure of value and the difficulty of making exchanges. The monetary system is a system in which money is used as a medium of exchange. Money provides a standard value measure and makes facilitating trade easier.

The barter system was the earliest form of (decentralized) trade, while the monetary system is a central system in which money is used as a medium of exchange. Fundamentally, the barter and monetary systems are shared fictions created by humans to facilitate trade. Both approaches require the trust and acknowledgment of all parties involved in the transaction. 

In a barter system, goods and services were exchanged directly without the use of money or a centralized intermediary. People would trade items they had in excess for items they needed or desired. This system was prevalent in early civilizations before the invention of currency. 

Today’s monetary system provides standard value measures, making it easier to facilitate trade. In contrast, the barter system lacked a standard estimate of value, which resulted in difficulty in making tailored exchanges and transactions. While the barter system was mainly a product of humans, today’s monetary system is also a consequence of centralized political institutions. For instance, states and governments decided to abolish the gold standard and replace it with modern monetary policy frameworks.

Its centralist characteristic makes the monetary system vulnerable from several perspectives. Indeed, it requires a central ledger, which is sensitive to censorship and doesn’t allow for anonymous transactions (unless cash is used). 

As the next step in the evolution of money, cryptocurrency has several advantages over the barter and monetary systems. Cryptocurrency allows for highly efficient and convenient transactions. With bartering, both parties needed something suitable for the other party to execute the trade. Similarly, with today’s monetary system, trust in the value of money remains a fundamental element despite high inflation rates and decaying confidence in governments and central banking. Ultimately, they control access and the use of the system. 

In contrast to both systems, cryptocurrency is open to anyone, offers fast peer-to-peer transactions without trust, and offers a better security and privacy system. 

Monetary policy is the central bank’s process of managing the money supply and interest rates to achieve particular economic objectives. If central banks set low interest rates, they make too much money available for lending, causing inflationary pressures on consumers’ wages and prices or vice versa. Central banks today have found new tools for monetary policy in the forms of wholesale CBDCs and retail CBDCs.

One of the central bank’s primary objectives is maintaining price stability, which means keeping inflation in check. Central banks do that via their monetary policy, which involves manipulating interest rates to try and stimulate the economy. 

Central banks use a low interest rate policy to decrease the cost of borrowing money. Ultimately, more money will flow in circulation, implying more money chasing the same amount of goods and services. This makes prices go up. The other side of the coin is that yesterday’s capital is less valuable today. That is called inflation. 

When a central bank prints money, for instance, through quantitative easing, more inflation or even hyperinflation may be caused. This would imply that prices rise rapidly and people must bring tremendous amounts of money to purchase essential goods and services.

As another form of monetary policy, interest rates can also reduce the amount of money in circulation to decrease the money supply. This may boost economic growth over time. However, it can also lead to deflation and less economic growth because less money is available.

Today, wholesale and retail CBDCs can also be used to establish monetary policy by adjusting the interest rate on deposits of banks’ digital currency held at the central bank. Indeed, by controlling the supply of a wholesale CBDC, a central bank can use it as a direct tool for monetary policy. Besides, a central bank could set interest rates on retail CBDC deposits or implement limits on the number of retail CBDCs that individuals or businesses hold, de facto impacting the supply and the demand for a currency and, as a result, its inflation rate.

Cryptocurrencies are a relatively new form of money, and they can be inflationary or deflationary, depending on their native monetary policy and design. To qualify a cryptocurrency, one must carefully examine its supply dynamics, the demand incentives, their usage and whether they preserve value and stability. 

The monetary mechanisms and supply dynamics of inflationary and deflationary tokens carry critical implications for their usage and value. If a cryptocurrency has a fixed supply, it tends to be deflationary because the currency’s value will arguably increase over time if demand increases. 

Deflationary tokens are adept at incentivizing holding and reducing spending, ultimately resulting in increased scarcity and faster adoption of the token as a store of value. This leads to a progressive rise in purchasing power over time. Finally, a decreasing token supply is a rampart against inflationary pressure arising from external factors such as government policies or economic events resulting in inflation, hyperinflation or stagnation. 

If the cryptocurrency has a variable supply, it can be inflationary or deflationary, depending on the rate at which new coins are created and other factors involved. Inflationary tokens may incentivize spending and discourage hoarding. These properties facilitate such a token’s adoption as a medium of exchange, alongside bolstering its liquidity.

Interestingly, inflationary tokens’ flexibility implies that the token’s inflation rate can be tailored to align with the company’s needs, such as for airdropping new tokens or for any other reason as specified by the tokenomics of said company.

It is also important to mention that classifying a given cryptocurrency as inflationary or deflationary can be subject to varying perspectives. For example, classifying BTC as either inflationary or deflationary can be contingent upon multiple factors. BTC is considered inflationary due to the continuous mining of new coins and their subsequent integration into the supply. However, disinflationary measures, such as halvings, mitigate the inflationary effects over time. The same goes for altcoins, such as Ether (ETH). 

 

Humanity lives in a time with technologies that will bend the development curve of money into a new inflection point. With the rise of cryptocurrencies and crypo wallets, money continues to evolve, becoming increasingly decentralized, digital and open. On the other hand, states heavily intertwine their destiny with the future of money, implying that the future will also bring about additional attempts toward establishing centralized political governance and binding rules over the usage of money. 

Money has a long history, from bartering to digital currencies. Many currencies worldwide are no longer tied to a physical commodity or a reserve of the commodity. Instead, they are backed by the government’s ability to manage the economy and control inflation via fiat currencies. The value of fiat currencies today derives no longer from their scarcity but from individuals’ trust in central authorities minting the money. 

Ever since the abolishment of the gold standard, it became clear that the value and stability of fiat money can be hurt by inflation and other factors, including loose monetary and fiscal policy, bad management practices and gross institutional decay. Arguably, the future of money is closely tied to the future of political institutions. The state and central banks will continuously seek to play a crucial role in creating and regulating money. 

Money will inevitably continue to evolve, becoming ever more digital with the rise of new payment methods, including cryptocurrencies and digital wallets. Arguably, the use of cash will continue to decline, with many countries already moving toward cashless societies, with or without CBDCs. Importantly, this ongoing evolution toward digital fiat money has significant implications for privacy, security and economic inequality. 

To ensure individuals’ security, new forms of regulation and governance may emerge, or a new monetary system may replace the existing one. Time will tell whether cryptocurrencies alongside Web3 and a new decentralized finance (DeFi) system will bring humanity a complete decoupling of money and institutional power. Eventually, such decoupling may result in a genuinely trustless and transparent economy.