The History of the Financial System and Why Bitcoin Changes Everything
Barter
Humans started out trading with each other. If I had apples and I wanted fish, I would find someone who had fish and wanted apples to trade with. This meant I had to find someone who (1) had what I wanted before my food went bad and (2) wanted what I had. As you can probably tell, that got annoying. Then something called a “medium of exchange”, like coins, were introduced. I could trade my apples for coins and then trade those coins for fish. The medium of exchange could be anything, but it needed to have certain properties. These properties were: (1) durability, (2) portability, (3) divisibility, (4) uniformability, (5) limited supply, and (6) acceptability.
Gold
Gold became the medium of exchange because it had all of these properties. But gold had one flaw: it was heavy and not very convenient to carry around. People would store their gold in the bank in exchange for something easier to carry like paper money. Now, people trusted that they could go to the bank and exchange their paper money for gold, hence the term “backed by gold”.
Fiat currency
At some point, the president of the United States decided that we would no longer be on the gold standard. Instead, we would be on a fiat standard. Fiat means backed by faith — faith in the government. Instead of the money having value because it was backed by gold that took time and energy to dig out of the Earth, now the money has value because “the government says it has value”. But gold was used as a medium of exchange for several reasons — one of them being a limited supply. Gold can only be made when stars explode in the universe. At some point in time, this happened and some gold particles landed on Earth. Over time, these particles got buried in the Earth and we dug them out. Gold worked as a medium of exchange because we had to put a lot of energy into digging it out and there is a limited supply of it on Earth. When we switched over to the fiat system, there was no limited supply and it cost very little to create more money. Therefore, when the government needed more money for government spending, it would simply create more.
Creating money without putting in the work to earn that money causes inflation. Inflation is when there is an increase in the money supply, causing every existing unit of money to go down in value. Because the government could create paper money easily, while everyone else had to go to work to earn money, whoever acquired that newly created money had put less work into earning the money than other people did.
Digital banking
At some point, the internet came along and we started to have digital versions of banking through web applications. But this version of banking was still controlled by a central authority and a few “trusted” people had access to changing the database that records everyone’s money. This means inflation was still present — just in a digital form.
Bitcoin
Bitcoin is a piece of software that was released to the world in 2009. Software that was pre-programmed for people to trade energy for a form of money. Bitcoin is owned by nobody — it is a decentralized monetary network where other people verify the transactions that occur. This means it is controlled by no one organization, business, government, etc. Nobody can change the database and records of how much money each person has. Nobody can add more to the system. Nobody can double spend. All the transactions between people are recorded on a public ledger that everyone can see.
Remember, humans got used to using the bank because we needed an easy way to carry money around with us. Over time, we forgot the purpose of the bank. The bank was supposed to allow us to store gold, in exchange for bills that represented how much gold we have in the bank. The fact that the dollar was backed by gold was important because there is a limited supply of gold on Earth. Now that those bills can no longer be traded for gold and we don’t know how much money supply there is.
Bitcoin has been called digital gold because there is a limited supply of bitcoin. There can only ever be 21 million coins. After all the coins have been “mined” there will be no more bitcoin added to the existing supply. Bitcoin mimics all of the properties that gold had, and more — it is software. Software that runs on the internet and provides instant, global access. Anyone who can connect to the Bitcoin network can use bitcoin. This is why Bitcoin is all the rage right now — because it is a scarce asset in the form of software that has instant, global reach.
Other Cryptocurrencies aside from Bitcoin
The rest of the cryptocurrencies are also software but most of them don’t have the supply cap like Bitcoin does. Understand why the supply cap is important. Some of these cryptocurrencies, like ETH, are utility tokens. If you want to use the services on the Ethereum blockchain, you will have to use ETH to pay for it. Whether or not these cryptocurrencies are going to become a medium of exchange will depend on the properties and adoption of these currencies.
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