The global corona pandemic has not only turned all of our private lives upside down, but also changed the financial market considerably. Central banks are printing more money than they have done in a very long time out of an emergency situation, national debts are increasing and we have a record-high unemployment rate.
These are all factors that are crumbling confidence in the state and its currency.As a result, many people want to protect themselves, and the 12-month record high of the crypto currency Bitcoin may show that it is seen by many as a viable money alternative. But could Bitcoin really replace our current currency, the dollar? And what are the advantages of Bitcoin over fiat money?
You can continue reading this article or watch my detailed YouTube Video on that topic:
To understand this, one must first understand the fundamentals of money, starting with the question:
What exactly is money anyway?
Money is what people use to pay each other. That answer is simple, of course, but how do you determine which means of payment is best suited for this purpose?
In order to answer this question, one must first answer what money must be able to do. There are three main functions:
- Store Value
The value of money should preferably not be subject to high fluctuations. This is easy to understand: if I work and bring value, I earn money through it. With this money, I should of course be able to get an appropriate equivalent value in the future.
- Be easily exchangeable
Money is only really money when you can get something really useful in exchange, like food. Money must therefore be able to act as a medium of exchange – preferably as quickly and easily as possible.2
- Have scale
Money must have a fixed scale and be easily calculable. Diamonds, for example, may fulfil the above two points reasonably well, but the value is difficult to calculate and can vary even though the diamonds are the same size, for example.
Money is nothing more than a means of payment, which should fulfil these three functions as well as possible. Some means of payment can of course do this better and others worse, but more about this later in this article. Before I do so, I would like to briefly mention another function that money, especially money issued centrally, often fulfils:
4. Control instrument
Much of the money currently in circulation is, in my view, only not disappearing and being replaced because large states, companies and banks can use it to influence and manipulate a large part of the population – especially in connection with the third point, the scale. But more on that later.
What is the best means of payment?
Now that we know what functions money has to fulfil, the next logical question is: which means of payment is best suited for this? What, no matter what happens, is subject to hardly any fluctuations in value, is extremely easy to exchange and has a fixed, easily calculable scale? Of course, there is no single true solution, and opinions on this are sometimes very different, but there are seven basic points that make a means of payment – if it meets all seven – really very good and useful.
Of course, a means of payment should not have an expiry date or otherwise be able to disappear or become unusable, such as rusty metal.
In the past, people sometimes used large, heavy lumps of stone as means of payment. Not very practical.
A technical term. It means, for example, that a 1-euro coin must have the same value as another, and two 5-euro notes the same value as a 10-euro note. This is problematic in the context of diamonds, for example.
Another point why diamonds, gold, etc. drop out: the value of the means of payment must be easily and quickly ascertainable for everyone.
Imagine we had nothing smaller than 100 dollar bills. Wouldn’t really work, would it? A good currency should be divisible into smallest pieces.
The means of payment should be difficult to obtain: if pebbles were used, anyone could simply go and get them themselves without much effort, and without really bringing value (work).
No money in the world is of any use to you unless it is recognised as money. That is also the reason why the dollar is the reserve currency: there is no more globally recognized means of payment.
A brief history of money
So before we now think about what the best means of payment could be, let us have a look at what mankind has used as money so far, and how it performs under the seven aspects mentioned.
At the very beginning there was the barter trade.
Eggs, bread, cows, your own labor… People bartered all sorts of things, and there was no standard means of payment.
The big problems here:
- None of these things are really durable
- It’s not fungible. To uniformly value a cow against a piece of bread etc. is difficult and impractical
- It is also not divisible
Surprisingly, however, the barter trade does still work, as it is:
- is jointly recognised. It is not an abstract concept like a dollar bill, everyone can see a value in a piece of bread.
- The remaining points are also met: the transportability is ok depending on the object, everybody can verify if it is really an egg or a chicken, and just magically creating a cow does not work either (scarce)
From the barter trade developed have collectors’ items such as rare stones, shells, feathers, etc.
The key advantage over “classic” bartering is one thing above all: durability. It is only dead things, which do not spoil, die, etc., but the other points like verifiability suffer a little bit from it, and it is not yet divisible or fungible. So it is still a relatively unsuitable means of payment.
In order to also solve these major problems, In order to also solve these major problems, the pool of collectibles had to become more specific and smaller. Precious metals, above all gold, have prevailed here. In the case of gold, one notices relatively quickly that a large part of the previous problems became better:
- Durability: We have gold that is thousands of years old
- Transport: compared to today’s digital solutions, not as good, of course, but at that time gold was not inferior to the alternatives
- Fungible: for the first time a means of payment is really fungible here, namely an ounce of gold is worth exactly the same as another ounce of gold
- Verifiability: for the layman, it was not at all easy to differentiate stretched gold from full-value gold, but overall it was possible
- Divisible: unfortunately gold was still not really divisible, it is difficult to buy low-value goods with it
- Scarce: gold is definitely scarce, even though I want to mention this could change again in the future due to asteroid mining etc.
- Acceptance: everyone sees gold as valuable, but gold only works offline and not digitally
So you can see: Gold has already solved many problems here, but not all. First and foremost, the lack of divisibility, verifiability and, of course, digital use nowadays. Gold may also be acceptable in some other aspects, but does not yet fully meet the criteria to be a “perfect” means of payment. A huge plus point is of course the long history and the resulting great trust that we humans have in gold today.
The first centralized money
Until now, we did not have a central party responsible for the monetary system. Anyone could create “money” in barter, anyone could mine for gold, but that will change with the next historical currency:
The basic concept behind it is relatively simple: you take the physical gold, keep it safe (for example in a state bank) and instead of using the physical gold, you issue a written certificate that you own the gold. At first glance, of course, this is a wonderful solution, because now you don’t have most of the problems of physical gold anymore: it is much easier to transport, much easier to verify, and now it can be divided quickly and easily.
The acceptance in society was also very good for the time being. However, a huge problem caused by this centralized system was that banks relatively quickly handed out sometimes more paper gold than they actually held in safekeeping. So for the first time the scarcity aspect became a problem. And for the first time money also fulfils the fourth function which I mentioned at the beginning: It becomes a control instrument, as states now begin to “print money” at will, creating something out of nothing that should actually have some value attached to it.
The Year 1971
This year they decided to do something that had long been foreseeable at that time: they officially abolished the so-called “gold standard”, and from that point on money existed that was not covered by anything – for which no gold was deposited – so-called fiat money, for example euros or dollars.
This decision is more serious than one might think, because until now one just had to trust history: when productivity increased and value was created, money increased. From then on, however, people now had to trust a central party, the government, and money could also rise without productivity increasing.
But let’s look at fiat money and see the seven points that a perfect means of payment would fulfil: Fiat money is digitally portable in seconds, durable, verifiable, fungible, divisible, and as long as there is stable government, extremely well accepted. One thing, however, it is no longer at all: scarce
The big problem with that? The money inflates. This means that by creating new money, for example by printing dollars, your saved 10,000 dollars are worth less (you can buy less with it), because all of a sudden there is simply more money in circulation to be spent – while the supply of services and goods is still the same. And this is the monetary system we are still in almost 50 years later, in 2020.
The Consequences today
As I mentioned at the beginning of this article, an extremely large amount of money is being printed at the moment – but you don’t notice much of a strong inflation and a loss of purchasing power, do you? Food costs about the same and also otherwise it doesn’t seem as if you have lost purchasing power with your saved money. However, this appearance is deceptive: very many people have sold their investments, such as shares, out of necessity. All in all, many people currently hold Fiat currencies. However, these investments in particular have risen sharply in price instead of falling or not rising further due to a flood of supply and little demand. Why? There has been a huge amount of money printed, a lot of it has been allocated to companies, and fiat currencies have lost purchasing power as a result – especially in the investment sector. The stock did not increase in value, but the currency decreased in value.
The comparison with gold: if you compare the development of share prices with non-inflationary money such as gold, for example, the prices look quite different. Gold also appears to have “risen in value” this year – compared to fiat currencies – in reality, fiat money has simply fallen in value.
One thing becomes evident: the lack of scarce in fiat money is a big problem
Fiat money fulfils six of the seven points of a “perfect” means of payment, but it is becoming increasingly clear that this one missing point is serious, especially in the long term. Is there really no means of payment that could fulfil all 7 points?
Can Bitcoin function as a means of payment?
Let’s consider the seven points when using Bitcoin as a means of payment:
- Durability: since Bitcoin is digital, it never expires
- Portable: it is just as portable as fiat money, sometimes even faster (bank transfers often take several days, especially internationally. Bitcoin transfers only take minutes)
- Fungible: Isn’t really behind fiat money here either.
- Verifiable: perhaps even more forgery-proof and verifiable than fiat money
- Divisible: the smallest unit of Bitcoin is a Satoshi – currently worth well under a cent
- Scarce: since with Bitcoin you don’t trust any government but logical mathematics, Bitcoin is the scarcest means of payment in history
- Acceptance: Bitcoin is not yet recognised as money by general society
So you can see that Bitcoin is doing extremely well in six of the seven points, just like Fiat money, with the difference that in Bitcoin the missing point is not a fault of Bitcoin and can be changed at any time by us as a society, which would make it meet all seven points.
So can Bitcoin function as a means of payment? Yes, Bitcoin would work perfectly as a means of payment – even better than our current fiat money!
Then why is Bitcoin not yet used as a means of payment? Well, the Society has had barely 11 years – since the invention of Bitcoin in 2008/2009 – to recognize Bitcoin as a means of payment. Another reason is that Bitcoin was not very user-friendly, especially in the beginning, and you had to be technically very well versed to use Bitcoin. In the meantime, this has become much easier, and in the long term, our society is also developing into more and more people who are so-called “digital natives” and who have no problems at all in finding their way around applications such as Bitcoin.
So do I believe that Bitcoin will establish itself as a means of payment in our society? No, I think so-called Stablecoins as a means of payment are much more likely – but more about that in a future article.
What I do believe however, is that Bitcoin has already partially established itself as an investment opportunity and digital gold and will continue to do so. And if you want to get returns on your Bitcoin in a completely transparent way similar to shares or real estate, you can register now at Cake: https://cakedefi.com/
Am pleased to read your feedback in the comments!
Youtube CAKE: https://www.youtube.com/channel/UCkRa0RHkJ9Udd_mVWl8fa8A