Digital money

In the previous?chapter, we understood the technological revolution Satoshi invented by having a decentralised peer to peer distributed ledger.

But does this technology makes bitcoin a form of money?

To answer this question, we need to go back in time to understand what makes money, what money must be, what it must do and see whether Bitcoin can be seen as such.

The Origins

The first forms of money emerged from the scaling limitations of barter. Humans started using arrowheads, shells, grains as the first forms of money. It was a superior way to measure the value of things and exchange them between each other’s.

These forms of money evolved afterwards into monetary metals, because of their rarity, durability, portability, and desirability. They offered a better guarantee against a sudden increase in supply that previous forms experienced. That’s how the world converged towards bronze, silver, and gold.

Gold soon became the superior form of money because of its rarity and desirability. This led to the introduction of gold as an underlying for the first paper form of money: gold receipts, aka the first banknotes.

These banknotes became afterwards government backed, instead of gold backed, which led to the modern Fiat monetary system.

Nature of money

Looking back at the various forms of money, we can find some common main attributes to all historical forms that ever existed: scarcity, divisibility, portability, durability, and acceptability.

Scarcity in a sense of difficulty to produce and/or resistance to supply manipulation. All the monies used in the past shared this feature. It is a feature also shared by the evolution of money, with people constantly changing towards harder, scarcer forms of money.

Divisibility is the simple fact that money needs to be split in several pieces to be conveniently used for exchange of goods of all values.

Portability defines the convenience to handle and transport. This feature clearly lacked in the first forms of money, like salt, which needed up abandoned.

Durability is the importance to have a long-term expiry date on the money used, as the longer the expiry, the longer the exchange possibilities.

Acceptability is the ease with which it can be identified and valued by our peers.

Looking at these criteria, we can understand more clearly how money evolved through history from one for to the other, based on improving each one of those criteria.

Bitcoin is engineered as a local optimum of this criteria-based equation, as it beats all previous forms of money on scarcity (there can be only 21 million), divisibility (up to 8 decimals), portability (being natively digital) and durability (virtually indestructible).

The acceptability criteria is a work in progress, with people, companies, cities, and countries acceptance growing every day. It is only a question of time and peer recognition that will make this process effective.

Therefore, it is still work in progress, but lot has been done.

Use of Money

Economists usually agree that money performs three functions: unit of account, store of value and medium of exchange.

1)??Unit of account

A unit of account is something which can be used to value services and goods, make calculations and record debt. Bitcoin can do all of that as it is highly divisible (Bitcoin is divisible up to the eighth decimal), fungible (two different bitcoins have the same value) and countable.

2)??Store of value

A store of value is something that people use to transfer purchasing power from the present to the future. Value is given to something when it is desired and when there isn't enough of it to satisfy everyone. The scarcer the asset used as money, the most likely it will replace the previous one. That principle is known as the Gresham Law, coined by Sir Thomas Gresham in 1558, that states that ? bad money drives out good ?.

Gresham’s law is the concept of good money (money which is undervalued or money that is more stable in value) versus bad money (money which is overvalued or loses value rapidly).

The law holds that bad money drives out good money in circulation. The bad currency is then the currency which is regarded as having an equal or less intrinsic value regarding its nominal value. Meanwhile, good money is the currency which is considered to have more intrinsic value or more potential for more value than its face value. Logically, people will choose to make deals with bad money and hold good monetary balances because good money has the potential to be more than its face value.

If we follow down this reasoning, then bitcoin represents the absolute scarcity of an asset as it has a limited supply. As a result, scarce resources create competition for their property, as demonstrated by Gresham. On this front, Bitcoin gain this way as store of value status as it is scarce, has a limited and predictable supply and its production cost will likely grow with time.

All in all, what is exceptional about Bitcoin is no asset in history has followed such a predictable supply trajectory.

3)??Medium of exchange

A standard of payment is something that buyers exchange with sellers when they want to purchase goods or services from the seller.

With the growth of Bitcoin’s acceptance, it is growing, slowly but surely, to become a standard of payment. In El Salvador, for example, the country has recognised it as legal tender and most stores accept payments in Bitcoin.

Superior Money

All these advantages that Bitcoin provides over traditional forms of money make its progress quite rapid towards becoming mainstream. This roots back to the problem Satoshi Nakamoto was attempting to solve in the first place: create a decentralised monetary system that is more robust, trustworthy, secure and efficient than our traditional monetary system.

By doing so, he built a digital asset that is engineered to meet our psychological definition of money.

But is bitcoin only money? Answer in the next chapter...