A Crash Course in Money (Old and New)

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In this blog post, I will delve into a brief history of money and our fiat system, examine its many problems and pains, and explore new solutions that have emerged due to blockchain technology.

Have you ever thought about money? Like truly thought about it. Why it was created? The structures built around it? The people who designed it and perpetuate the system? How you interact with it? Most people probably have not. Money is something that we engage with on a day to day basis, it is fundamental to our understanding of ourselves and our society at large, but for many, the concept and underlying features of money rarely are considered or questioned.

Trust and the Fiat System

Our current relationship to money can be described as operating within the fiat system. The fiat system is our global monetary infrastructure and the rules of engagement we have created around it. The money associated with the fiat system is called fiat currency, which is specifically currency that is backed by a government. The U.S. dollar is one such example of fiat currency. Thus, the aforementioned rules of engagement, like borrowing and lending, are built upon the government’s guarantee that paper currency has value and purchasing power.¹

Historically, however, another type of currency was used, called commodity currency. Commodity currency is instead backed by a physical commodity with intrinsic value. The gold standard, for example, was a monetary system that pegs currency to gold, a scarce and valuable commodity. The gold standard was used mostly up until World War I, when paper currency was adopted to expense the war.² Battered and bruised, especially after the Second World War, Europe was in pretty rough shape, while the United States became a major lender, supplier, and owner of the majority of gold. In 1944, allied countries came together in New Hampshire and negotiated the Bretton Woods Agreement, essentially tying the countries’ currencies to the U.S. dollar, making it the primary reserve currency for much of the world, creating a structure for foreign exchange, and building central bank dominance.³ Though this agreement eventually dissolved in the early 1970s, it facilitated global monetary stability, as well as prompted the establishment of the International Monetary Fund and the World Bank.⁴ Besides the historical importance, however, the Bretton Woods Agreement shines a light on how money has been conceived, shaped, and enforced. Namely, how large, world-shaping decisions are made in small rooms, rooms that have historically contained mainly white men.

Furthermore, this agreement demonstrates how our financial systems have always relied on trust. Trust that the people involved have all of our best interests at heart, trust that they continue to fulfill their end of the bargain, and trust that the system they have built, which we all participate in, will continue to support our livelihoods. Trust is the underlying reality of our fiat system: one that is made up of the Federal Reserve, the government, and the banks. Let us look at them one by one in order to assess the trust implicit in their structures.

Perhaps you have heard about the Federal Reserve and how Fed Chair Jerome Powell will hike up interest rates because of inflation. Inflation is the decline of a currency’s purchasing power. Inflation is the reason why gas used to be $2-$3 dollars a gallon and now it is over $4 for the same amount. The decision of raising the interest rate falls under monetary policy. Monetary policy refers to the tools available to Chair Powell and the other members of the Federal Reserve to support the economic goals of the country. In addition to changing the interest rates, the Federal Reserve relies on open market operations, meaning they regulate the economy’s supply of money through buying and selling securities or financial assets, essentially a way to print more money. Therefore, it is important to note the enormous power and control the Federal Reserve holds over the economy and therefore the livelihoods of millions. Thus, by participating in the fiat system you are placing trust in the Federal Reserve to do right by you. Additionally, it is worth keeping in mind that though all members are qualified and experienced, the Fed is still a small group of non-elected, mainly white and male, members.

Now we are turning to the broader government beyond the Federal Reserve. The government, as we all know, is run by people, indicating it is also inherently trust based. The government is in charge of fiscal policy, meaning they decide on general spending and set tax policies. These decisions have large effects on the economy, the dollar, and therefore the individual. In the U.S., the dollar is relatively stable. This, however, is not true for every country. Places, like Argentina, have seen rapid inflation, and whether it be because of poor monetary and fiscal policy or a corrupt government, it always falls hardest on the individual whose entire life savings ends up being worth nothing.⁵ Beyond the immensity and rippling effects of government decisions, its leaders, like those of the Federal Reserve, have historically been dominated, almost exclusively, by white men. Even considering recent improvements in diversity, government officials still are not representative of the wider population, in terms of both race and gender, particularly at senior levels.⁶ ⁷ Thus, the current structure of our society make it so that we need to place trust in an institution that was not built for all and has long perpetrated bias and discrimination against marginalized communities.

Most people I know, including myself, are reliant upon banks. But just because you deposit your cash into your bank account, does not mean it is actually there. Like much of everything nowadays, it is all just zeros and ones in a computer. And what banks do to make their billions and billions of dollars, is to lend out that money supposedly in your account to a bunch of different borrowers, making profits through large interest payments. Meanwhile, the individual receives just barely a taste of that profit. What if, say, your bank decides to freeze your accounts? Because they do in fact have this power. And for many people, this would not just be a major inconvenience, but it could have a profound impact on their livelihoods. All this to say that we trust that banks behave in accordance with the rules of engagement and that our money is our money. Unfortunately, in reality that is not how things work, which we will discuss later…

Bitcoin, A Trustless Solution

Sometimes you place your trust in something and it lets you down. The Financial Crash of 2008 is just one example. Banks got greedy and they handed out lots of loans to people who could not necessarily pay them back. This high level of risk eventually led to a market collapse and millions of people losing their homes and jobs.⁸ This failure on the part of banks greatly eroded trust, and it was in this landscape that Satoshi Nakamoto released the Bitcoin White Paper, which discussed a system that was not trust based and did not rely on centralized institutions.⁹

But what does it mean exactly for Bitcoin to be trustless and decentralized? How is that even possible? Blockchain is a public, decentralized, and trustless digital ledger that immutably stores data. There are many big words in that sentence, so I am going to take it one at a time. Blockchains are usually, but not always, public. Anyone can access them by joining the network. You do not have to have a certain credit score or a powerful connection. Next, Decentralization. Decentralization is a big, important idea. It is the opposite of centralization. Banks, as noted above, are centralized institutions, which is what our world mostly operates around. To be decentralized, on the other hand, means that the blockchain is not owned by one individual person or entity. Then, trustlessness means that you do not have to rely on an individual or entity, since there is none. There is no one person, like the Fed Chair, with massive amounts of power, making changes and decisions. Immutable means that the data on the blockchain cannot be changed, which has to do with the technology central to blockchain. Lastly, blockchains can be thought of as a digital ledger because it stores a history of transaction data.

Putting this all together, let us examine what this means in practice. In particular, we are now going to talk about the technology behind Bitcoin in layman’s terms in order to understand how it substantiates these seemingly abstract notions like trustlessness. Firstly, Bitcoin is not made out of thin air. To have a valuable asset, there needs to be some mechanism in place to ensure that no single entity can suddenly decide to create new coins. The solution to this is a mechanism called the consensus algorithm and it is how trust is established without a singular authority.¹⁰ Thus, in order for a bitcoin to be created, or minted, a lot of things have to happen. It starts with the people who mint bitcoin, or miners, participating in a game. The end goal of this game is to be the first miner to solve a puzzle. This puzzle, however, requires lots and lots of energy to solve, but the first person who solves it receives the newly minted, valuable coin as a reward for the work that they have done.

Now that a coin has been minted, it is necessary to only have one valid record of this, as well as any other transactions. This is done by the winning block (the solved game) being validated by neighboring miners. Only then will it be added to a long chain of previous valid blocks, creating a digital ledger of verified bitcoin transactions. Afterwards, the whole game starts all over again.

Furthermore, in order to have trustless digital money, it is important that the individual or entity storing the valid data cannot modify the system at their own will. Because there is not one copy of the blockchain, rather it is decentralized and available on many different machines, any change to data on one blockchain will alert the others that it has been tampered with. For Bitcoin specifically, it is hard-coded that only 21 million coins will ever be minted. This anti-inflationary mechanism makes it so that there is a finite supply of this digital currency, unlike our fiat currency.

Also, applications to support digital currency, like wallets, allow for the storage and exchange of these coins, passing ownership between people through transactions on the blockchain. By using a decentralized wallet, you have sole control over your assets, as opposed to your money in a bank account, which could at any moment be frozen, lost, or altered.

Now that I have gone into how Bitcoin is minted, the massive energy consumption has to be addressed. We have all heard it, the statistic that states, if Bitcoin was a country, its energy usage would be in the top 30 worldwide.¹¹ Circulated in headlines everywhere, Bitcoin has given blockchain and digital currencies a bad name in terms of sustainability. It should be noted, however, that this incentivized game of who has the most computational power is not behind all types of digital currencies. And in fact, across the board, people in the space have taken strides to address the environmental impacts of this technology. For example, Ethereum, another large blockchain network, is moving from Bitcoin’s consensus system (proof-of-work, which was described above), to a drastically more energy efficient system (proof-of-stake), reducing consumption by 99%.¹² Other strategies, like mining using renewable energy, is not a new idea. It is estimated that 39% of proof-of-work mining is powered by renewable energy.¹³ Other companies, like Algorand, are founded on principles of sustainability and are a carbon negative network, utilizing carbon offsets.¹⁴ Ultimately, many people in the decentralized space have realized that in order for their blockchain projects to scale successfully, sustainability has to be addressed.

Beyond Bitcoin

Nakamoto’s Bitcoin was the first to establish a mechanism for consensus and hard code these ideas of trustlessness and decentralization, but Bitcoin is no longer the only digital currency out there. Since its inception, there are many who built upon Bitcoin’s technical and ideological frameworks to create their own projects with unique purposes, innovative applications, and even new ways of establishing consensus. Simply put, the field has exploded. Now, the term digital currencies is commonly considered to be an umbrella term for many different types of electronic money. Under this, cryptocurrency specifically refers to a digital currency that enables peer-to-peer payments using cryptographic and decentralized technologies. Today, there are over ten thousand different cryptocurrency projects.¹⁵

Stablecoins are another type of digital currency and cryptocurrency tied to an asset, or even multiple. USD Coin, for example, is a fiat collateralized stablecoin and pegged to the U.S. dollar. This, however, muddies the waters of the idea of decentralization, as stablecoins have ties to the fiat system, built on centralized institutions. Central bank digital currencies (CBDCs) are yet another type of digital currency. Currently, only Federal Reserve notes, or cash, are in the use of the general public. CBDCs would be an additional type of Federal Reserve notes for digital transactions. Like cash, CBDCs would not have any liquidity risk or credit associated with it.¹⁶

A More Equitable Financial Future?

All of these different types of digital currencies make up the landscape of a rapidly transforming financial system. A financial system that no longer operates around centralized institutions or works only for certain groups of people. Now with the emergence of blockchain technologies and its applications, people can explore different avenues of wealth. They no longer have to rely on their own country’s currency or government, but can hold numerous different types of currencies and rely on trustless systems. Furthermore, this money does not have to be stored at a bank, making returns for someone else, but can be kept secure in your own digital wallet instead.

There are also fewer barriers to entry, as anyone can become a user and participate if they have access to the internet. This is opposed to our fiat system, on the other hand, that has a guise of being public and fully accessible. In reality, however, there are many people who, for example, do not qualify for universally marketed financial services. Take for instance the large unbanked and underbanked population in America. Before the pandemic, roughly 60 million Americans (22%) fit into this category.¹⁷ This population remains invisible to traditional institutions, underserved and unable to benefit from financial services. Additionally, the un- and underbanked are disproportionately represented by marginalized communities. In America, 64% of the unbanked and 47% of the underbanked are Black and Latinx families.¹⁸ Moreover, 60% of the unbanked are women.¹⁹ Globally, in fact, women constitute the majority of the unbanked population.²⁰ Thus, these centralized institutions have historically and systematically perpetuated the marginalization of certain groups of people. Furthermore, actions of fiat actors have not helped in closing this wealth chasm, as over the last few decades, the racial wealth gap has actually notably widened and wealth inequality has substantially grown.²¹

As digital currencies are poised to rewrite the story of money, the most pertinent task is creating a system that does not just repeat the inequities of the past, a system that has continually sustained the marginalization of certain groups of people, circulated money and power amongst centralized institutions, and hardcoded biases. For this to happen, technologies must be built with all groups of people in mind. Thus, the best action we can take to ensure blockchain and its applications scale equitably and with integrity, is to give more people a seat at the table. Ultimately, having a diverse group of people shape and design this technology will allow its implications to accurately reflect, benefit, and empower all communities.

[1]: Chen, James. “Fiat Money.” Investopedia, 26 Oct. 2021, https://www.investopedia.com/terms/f/fiatmoney.asp. Accessed 1 April 2022.

[2]: Lioudis, Nick. “What is the Gold Standard?” 4 March 2022, https://www.investopedia.com/ask/answers/09/gold-standard.asp. Accessed 1 April 2022.

[3]: Chen, James. “Bretton Woods Agreement and System.” Investopedia, 21 March 2022, https://www.investopedia.com/terms/b/brettonwoodsagreement.asp. Accessed 1 April 2022.

[4]: Chen, James. “Bretton Woods Agreement and System.” Investopedia. Accessed 1 April 2022.

[5]: “Argentina’s Economic Crisis.” Congressional Research Service, 28 Jan. 2020, https://crsreports.congress.gov/product/pdf/IF/IF10991/5. Accessed 1 April 2022.

[6]: “A revealing look at racial diversity in the federal government.” Partnership for Public Service, 14 July 2020, https://ourpublicservice.org/blog/a-revealing-look-at-racial-diversity-in-the-federal-government/. Accessed April 15 2022.

[7]: Reilly, Maura. “Leading the Way: How the U.S. Government Can Normalize Women in Leadership Roles.” Ms. Magazine, 23 March 2021, https://msmagazine.com/2021/03/23/government-women-politics-leadership-governor-cabinet-diversity-inclusion-gender-balance/. Accessed April 15 2022.

[8]: Singh, Manoj. “The 2007–2008 Financial Crisis in Review.” Investopedia, 27 Nov. 2021, https://www.investopedia.com/articles/economics/09/financial-crisis-review.asp. Accessed 1 April 2022.

[9]: Nakamoto, Satoshi. “Bitcoin: A Peer-to-Peer Electronic Cash System.” 31 Oct. 2008, https://bitcoin.org/bitcoin.pdf. Accessed 1 April 2022.

[10]: Sergeenkov, Andrey. “What is Bitcoin?” CoinDesk, 1 April 2013, https://www.coindesk.com/learn/what-is-bitcoin/. Accessed April 1 2022.

[11]: Criddle, Crisitna. “Bitcoin consumes ‘more electricity than Argentina’.” BBC, 10 Feb. 2021, https://www.bbc.com/news/technology-56012952. Accessed April 1 2022.

[12]: “Ethereum energy consumption.” Ethereum, 2 April 2022, https://ethereum.org/en/energy-consumption/. Accessed April 2 2022.

[13]: Schmidt, John. “Why Does Bitcoin Use So Much Energy?” Forbes, 8 April 2022, https://www.forbes.com/advisor/investing/bitcoins-energy-usage-explained/. Accessed April 9 2022.

[14]: “Algorand Pledges to be the Greenest Blockchain with a Carbon-Negative Network Now and in the Future.” Algorand, 22 April 2021, https://www.algorand.com/resources/algorand-announcements/carbon_negative_announcement. Accessed April 2 2022.

[15]: De Best, Raynor. “Number of cryptocurrencies worldwide from 2013 to Februart 2022.” Statista, 2 Feb. 2022, https://www.statista.com/statistics/863917/number-crypto-coins-tokens/. Accessed April 15 2022.

[16]: “The Future of Money: Centering Users in the Design of Digital Currency.” Maiden Labs. https://www.maidenlabs.org/_files/ugd/93b65a_242f6839b55a4a80a752b986b39a62e3.pdf. Accessed April 6 2022.

[17]: Terentev, Sergei. “How Fintech Is Meeting The Needs Of The Unbanked–Now And In The Future.” Forbes, 19 Nov. 2021, https://www.forbes.com/sites/forbesbusinesscouncil/2021/11/19/how-fintech-is-meeting-the-needs-of-the-unbanked---now-and-in-the-future/. Accessed April 15 2022.

[18]: Newsom Reeves, Kedra, et al. “Racial Equity in Banking Starts with Busting the Myths.” Boston Consulting Group, 2 Feb. 2021, https://www.bcg.com/publications/2021/unbanked-and-underbanked-households-breaking-down-the-myths-towards-racial-equity-in-banking. Accessed April 15 2022.

[19]: Principato, Charlotte. “How the Roughly One-Quarter of Underbanked U.S. Adults Differ From Fully Banked Individuals.” Morning Consult, 17 Aug. 2021, https://morningconsult.com/2021/08/17/unbanked-underbanked-demographic-profile/. Accessed April 15 2022.

[20]: Thompson, Joseph. “Tech can reach the world’s unbanked women–but only if they tell us how it should work.” World Economic Forum, 22 Jan. 2021, https://www.weforum.org/agenda/2021/01/women-banking-digital-divide/. Accessed April 15 2022.

[21]: Aladangady, Aditya, and Akila Forde. “Wealth Inequality and the Racial Wealth Gap.” Federal Reserve, 22 Oct. 2021, https://www.federalreserve.gov/econres/notes/feds-notes/wealth-inequality-and-the-racial-wealth-gap-20211022.htm. Accessed April 15 2022.