Bitcoin is an open-to-anyone, incorruptible, uninflatable, self-sovereign, borderless, provably-scarce new asset in which to store wealth.
Before we dive in, let’s preface this question just a bit. Bitcoin, much like the term “money” can mean different things to different people. If you asked people from all over the world, “What is money?”...
An American might say, “The paper bills in my purse minted by the U.S. Federal Reserve.”
Someone from Sweden, which has grown into a nearly cashless society, may answer, “Money is now just digital numbers in my bank account that I use to purchase goods via my credit card.”
And someone from Venezuela, which is suffering from extreme hyperinflation, may exclaim, “Money is the currency we are forced to use by our government that loses value every second. Now it’s just a meaningless number that keeps going up and up while I look for other ways to keep my wealth from disappearing.”
And these are just part of the story. What about the answers to questions like where money comes from? Who controls it? Why did we once use shells? And then gold? And then paper? And now computers?
So, I think you see the point. Most things aren’t just ONE thing. A car may be just a box used for transportation to one person, a collector’s item or investment to some, or something you shoot into space for marketing reasons for someone else (looking at you Elon Musk).
However, generally speaking, societies across the globe and throughout history have grown to expect their money to do three things:
- Serve as a unit of account: Individuals in a complex society require a standard or “benchmark” in order to value items, conduct trade, and calculate output. Money eliminates the mental burden of having to know how many apples a house costs or how much drinking water a hatchet can buy. Money serves as a common denominator for all trade and commerce, reducing the friction innate in a barter economy.
- Act as a medium of exchange: A good money eliminates the “coincidence of wants” issue in a barter economy. Rather than having to find a trade partner that will take your watermelons for their dresses, each individual can now sell those specialized items for money and use that money anywhere. A good money is fungible, liquid, and facilitates trade among all (discussed more in later sections).
- Serve as a store of value: Most people earn money for being productive and adding value to society via their work. However, sometimes they do not have immediate needs or use for that money. A good money will preserve that value across time and space, enabling the owner to use it in the future at the time of their choosing.
However, money today is complex, and today’s standard of “” money is actually a relatively new deviation from the historical norm for money. For much of history, currencies were either backed by commodities, privately issued, or both. This allowed citizens to choose the way in which they wished to transact, free from monopolistic restrictions enforced by their governments. However, in the nineteenth century, the notion of “legal tender” began permeating through different nations and governments, essentially making legal the monopoly over the issuance of currency. People of certain countries were now forced to accept money in exchange for goods and services simply because the government decreed it so.
Fiat money is the term for government-issued money that its citizens are forced to use because they happened to be born within that country’s borders. Fiat money is not valuable because of some superior quality or inherent value but because governments force usage upon its citizens at the threat of jail and violence. The U.S. dollar (USD) is simply backed by people’s fear or faith in the U.S. government, but if the public loses its trust in the central authority, the money will lose its value. USD is not backed by gold or anything else, a fact that of Americans still do not know.
Even more difficult to grasp is the idea that not all dollars are equal. One crucial concept to understand about money is its inherent hierarchical structure. At the peak of this hierarchy lies money itself, a universally accepted medium of exchange, a unit of account, and a store of value. Conversely, at the base of the hierarchy is credit, which represents a promise of future settlement using a higher-order form of money. This concept is known as "moneyness," which quantifies the closeness of a given financial instrument to the apex of the hierarchy.
Central Bank Liabilities: The Pinnacle of Moneyness
In the present day, liabilities issued by central banks, which encompass cash and central bank reserves, are generally regarded as the epitome of money. Both cash, a physical liability accessible to everyone, and central bank reserves, a digital liability primarily accessible to banks and nation-states, are claims on the asset side of a central bank's balance sheet.
In the United States, for instance, the Federal Reserve's assets are primarily U.S. government bonds. However, these claims are seldom exercised by "redeeming" their cash or reserves for Treasury securities, as they are widely accepted as a medium of exchange, unit of account, and store of value in their own right. As a result, they possess a high "moneyness" score in the current financial landscape.
Commercial Bank Money: A Step Down the Hierarchy
Following cash and reserves in the hierarchy are deposits issued by commercial banks. Commercial bank money is essentially a promise to pay higher-order money — cash or reserves. While most users perceive it as money rather than credit, thanks to safeguards such as deposit insurance, bank supervision, and the central bank's role as a lender of last resort, commercial bank deposits are merely liabilities issued by a commercial bank. They are claims on the bank's assets, essentially loans given to the commercial bank by depositors, and are inherently exposed to credit risk. If a bank's assets fail to exceed its liabilities, the value of the money it issues may be compromised.
Further down the hierarchy, we find additional forms of credit-based money, such as securities. These represent a more distant promise to pay a higher-order form of money and serve as the foundation of the shadow banking sector.
Historically, gold was frequently regarded as the pinnacle of the monetary hierarchy due to its limited supply and perceived store of value. However, the gold standard has been abandoned in many economies due to the constraints it imposed on government responses to economic conditions. The shift to a system where money is backed by the government's capacity to issue debt and collect tax revenue represents a more credit-based design, allowing the state to define and control "moneyness."
Banking today operates as a public-private partnership, where banks function within the private sphere but are backed by public guarantees. These assurances enhance the safety and efficiency of money but can also foster a false sense of security around the concept of "moneyness."
