Go ahead and remove a euro note from your wallet. What is it worth? Your first reaction would be the face value of the note; €5, €10, €20, €50 or €100. But what is its real worth? What is its intrinsic value of that piece of paper?
Like many other contracts, the euro note, is not valuable for its material but for the claim it represents on the banking system. The notes, or currency, is valuable because we think so. Money's value as a currency is an abstract social construct. In a thought-provoking book; Money: The Unauthorised Biography, Felix Martin argues that to focus on money as a 'thing' is to miss the powerful, civilisation-building force that this invention unleashed and changed the world. Calling money as a 'social technology,' he declares that money allowed for a new form of social organisation beyond tribalism. It democratised wealth and changed the nature of power.
One of the key defining features of any currency, be it traditional fiat money or stones used on remote islands or cryptocurrencies issued by a computer program, is that it must win the trust of the community using it. Trust is at the core of any system of money and the collapse of currencies and even civilisations has always been closely related to the erosion of trust in the system.
A brief history
In our analysis of cryptocurrencies and in fulfilling duties as money it is important to trace back the evolution of money over the past millennia.
Most historians agree that the first recorded monetary system appeared in Mesopotamia, modern-day Iraq, around 3000 B.C., where the Babylonians began using silver and barley as universal mediums of exchange and units of value. It coincided with the development of the Code of Hammurabi, one of oldest surviving pieces of writing and law books.
Fast-forward to the Greek civilisation and Aristotle believed that money was crucial for the emergence of trade between nations, "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." This is a view that was shared and resurrected by Adam Smith in The Wealth of Nations.
The Roman Empire's vast reach was synonymous with its coins being legal tender across huge the entire empire stretched from Europe to the Middle East. The political instability that ensued and brought down the Empire was driven by the decreasing purchasing power of the currency itself. Soon after the Dark Ages descended on Europe and it was only during the Renaissance that the importance of money and currency took off. The invention of modern day banking by the Medici family financed an explosion of global commerce and the artistic revival of the era. However, the creation of modern day banking brought to the fore a discussion on the struggle between public and private sectors for control over money since the creation of the écu de marc by the Italian bankers was in fact de facto private money. The écu de marc allowed the exchange of bills of trade from different banks in different countries whereby the real profit was made by each manufacturer but by the trader of the bills of trade. This was revolutionary since for most of its history, currency has been issued by those who rule. This monopoly over such power led to abuses of the system which led to a number of destabilising revolutions such as the French Revolution.
However, this new founded private sector money-making machine and the tension which ensued with the sovereign money creator led to the royal charter that founded the Bank of England in 1694. The then privately owned bank would lend the crown £1.2 million, a staggering amount for the time, and could then issue banknotes against the debt, effectively relending the money. Then, to give the banknotes value as a de facto currency, the sovereign agreed to accept them in payment of taxes. This was the dawn of modern banking and it helped shape England's economy by not only finance the royal naval which conquered the world from pole to pole, but it also financed the industrial revolution.
This financial leap not only gave an exponential boost to liquidity but also to risk bringing back to the core the importance of trust in the system. Over time, economies lurched form crisis to crisis giving rise to modern central banking. An initiative spearheaded by Walter Bagehot, the nineteenth-century editor of The Economist this led central banks to become lenders of the last resort. The importance was best seen during the 2008 financial crisis which showed the effects of broken trust in the financial system.
The history of money reveals a central challenge: how to design a system that facilitates the exchange of goods and services, generates prosperity and at the same time preventing the institutions that manage the system from abusing the trust that comes with the role.
Whether bitcoin or other cryptocurrencies represent a viable solution to this challenge remains to be seen. The first step will be for them to be accepted as viable money; that is, to become themselves trusted as a means of facilitating exchange and building prosperity.
JP Fabri is the Managing Director of ARQ Economic & Business Intelligence, a specialised unit forming part of ARQ Group (www.arqgroup.com).