By Deepak Machado (@dpkmac)
In this series of articles I expect to cover bitcoin. In part 1 of the series, you will learn about what makes money, money. To understand bitcoin and digital currencies, we must first understand what money is. We could then appreciate how bitcoin makes perfect sense.
Year 2013. This was the first time ever I had heard of bitcoin. I read about how the Silk Route promoter, Ross Ulbricht was arrested dramatically. Silk Route was a darknet website, which helped peddle drugs, contrabands and accepted bitcoin as a payment. I thought, well, criminals have gotten better, with their own currency. Not gonna touch this or bother.
The next time I heard about it was the news when a gentleman named Charlie Shrem was arrested for assisting in 'money laundering'. This was in the year 2014. Charlie was the founder of BitInstant, an exchange company for bitcoin. I said to myself, this is it, never going to bother about this. Governments and news were still bashing bitcoin for what it has enabled criminals and money launderers do.
Till that point in time, I was never drawn to bitcoin and never made any serious efforts to learn about it. Then one day a colleague and I were discussing about our investments and how to keep our money growing and this is where my colleague mentioned, 'bitcoin'. Yes, you heard it right. I rolled my eyes. But thought to myself that I would read and understand more about bitcoin and not brush it away as I had done in the past.
The more I read, the more I wanted to read. I read different books about bitcoin, watched YouTube videos, read blog posts and a revelation dawned on me that, bitcoin is a revolutionary new way to store wealth, it’s a medium of exchange, a unit of account and however you could define money. Bitcoin made perfect sense. Bitcoin is not a solution to all problems (neither is Rupee or Dollars.) but it has brought with it a new wave of innovation and creativity that rivals any other forms of money present.
Evolution of money
To understand bitcoin, you must first understand what money is. At this point you are probably saying, I know what money is. It’s my national currency. Dollar for some, Dirhams for some, Rupee for some, Pounds for some. Money has different uses for different people. For some it can act as a medium of exchange, for someone else it is store of value, for some it is standard of measure and so on. Money has different properties, like, Fungibility, Durability, Portability, Cognizability, Stability of value.
We have come a long way from barter, which had its own inefficiencies due to limitation of scale and geography. The biggest disadvantage of barter was double coincidence of wants (2 people wanting to exchange each other’s goods/services perfectly).
Over time, humans evolved and started accepting 'valuable collectibles', like rare sea shells, feathers, stones etc. These goods served as collectibles and thus 'store of value' rather than 'medium of exchange'. Compared to the current day money, these kinds of money had low velocity (circulation) and changed hands only few times in their lifetime.
At this point, humans would face a rather strange dilemma, 'what would be in demand by other humans in the near future or the distant future?' Would it be that rare feather? A strangely shaped stone?’ If you were to correctly predict which objects or goods would fetch higher demand in the future, you'd be the wealthier individual in the society. If more people desired for the similar good, the higher would be the demand for it. In simple words, the money was meant to store wealth (primary use) rather than be a medium of exchange back then. In the current context, think about unique car numbers, unique mobile numbers etc. Think of why people in India still believe gold, land and property are the best investments.
So, now, different cultures, countries had different forms of money. And when the trade routes grew between nations, so did the competition among the money of different societies. Traders from different parts of the world faced a dilemma whether to accept trade in their store of value or the foreign store of value or a mix of both. Each had its own advantages and disadvantages.
In the 19th century, most of the world would agree on a single most store of value, Gold. And the reason for all the developments leading up to 20th century and beyond can be attributed to this. The world trade exploded in the 19th and 20th century. So, whoever had more gold commanded the trade routes and demand for goods and services.
What makes a goods store of value?
When we have multiple competing stores of value, the key attributes that win or lose arguments are as follows.
A store of value has to be:
- Established or known history
- Censorship resistant
Gold wins hands down in this department. Gold mined has been durable over many centuries, from the ancient kings of India to the Pharaohs of Egypt and to the present day. It has stood the test of times. Compared to Gold, Fiat currencies and bitcoin are in digital format, unless you convert fiat into paper currency or coins. The durability of fiat currencies or bitcoin should be looked at from the point of view of the institution which issues them. Many national currencies have disappeared in this century itself. You might think, the Pound or the Dollar will survive any test of time. My friend, if history is a lesson, there is always a lesson to be learnt. For bitcoin, it is the network which secures bitcoin that can be considered durable. However, due to a limited history of bitcoin, it is wrong to consider it a contender in this parameter. However, the signs are positive. In the past 9+ years, bitcoin network has withstood the test of time, proving a promise. The bitcoin protocol has never been hacked or compromised.
Bitcoin can be considered the best store of value which is portable. If you have owned bitcoin, all you need to access your wealth is the private key that can be stored on a hardware wallet, on a software wallet, on a paper, in your brain and access to the bitcoin blockchain. It is easily portable across the world. By being a digital store of value, bitcoin trumps both gold and fiat currency here.
By fungibility I mean that one unit of the money is indistinguishable from the other. 1 gram of gold is exactly the same as another 1 gram of gold melted. Fiat currencies do not play well here and governments can render this quality void as it happened in India in December 2016 when the government demonetised 500 and 1000 bank notes. This caused the same notes to be traded at a discount. At a network level, bitcoin is fungible. However, some bitcoins may be tainted due to their use in illicit usage. To be perfectly fungible, bitcoin network must make improvements to its privacy and anonymity protocol.
Gold and currencies can be easily verifiable due to their physical attributes. However, we know that due to the usage of sophisticated technology, fiat currencies have been counterfeited and are thus carry this risk. Bitcoin on the other hand can be easily verified through cryptographic signatures.
One bitcoin can be divided into 100 million units, each known as Satoshi. Fiat and gold can also be divided up to the level required.
There can only be 21 million bitcoins ever in circulation. At the time of this writing there are 17 million bitcoins in circulation. Gold on the other hand has been scarce throughout the history and this is one reason why it is valuable. But, a new gold reserve could be discovered and the supply increased overnight. Fiat currencies can be printed out of thin air by central banks across the world. This has a huge amount of pressure on existing circulation. By printing fiat without control, the value of the existing fiat diminishes and also causes inflation; more and more money chasing few and few goods.
Gold has the most established history among all forms of money. Gold has been there for millennia and still is relevant. The same gold coin which was minted thousands of years ago still has the same value (in some cases more due to the history.). However, same is not true for Fiat currencies. Fiat currencies can not be trusted to carry value over medium to long periods of time. Think of what happened to Deutsche Mark after the world war. Bitcoin, though has a short history has perfectly weathered all kinds of attacks on the protocol and network. The longer bitcoin exists, the higher will be the confidence.
Nothing compares here to bitcoin. Gold can easily be confiscated (think about customs at Mangalore airport or any other port.), fiat currencies can be dealt worthless overnight (Remember demonetisation of November 2016?). But bitcoin can not be censored. In the initial, formative days of bitcoin, it was thought to be of best use for illicit affairs like drug purchase, financing illegal activities etc and was thought to be anonymous. However, bitcoin is not anonymous, but pseudonymous. Every transaction in the bitcoin blockchain is recorded forever in an immutable database, which is public; meaning, with careful analysis, bitcoin's transaction history can be easily traced. This means, bitcoin would be least preferred by perpetrators. In fact few law enforcement agencies have gone on record and mentioned that they would be happy for criminals to use bitcoin for them to trace the perpetrators easily.
How money evolves
We attribute so much value of money in terms of its role in transactions. Whereas, in fact, money evolves in following stages:
1. Money as collectible
2. Money as a store of value
3. Money as medium of exchange, and
4. Money as unit of account.
Gold used to satisfy most of these roles until the time governments intervened to transfer the medium of exchange role to fiat. Currencies in the same country may play different roles. In countries like Zimbabwe, Venezuela, Argentina, the local currencies do not anymore play the role of store of value given the inflation and play a role of medium of exchange.
Bitcoin is currently in the transition stage of being a store of value. It may take decades before bitcoin becomes a prominent medium of exchange. I am not saying fiat or national currencies are not required. I foresee a world where both fiat currencies and bitcoin will be complementary to each other. With bitcoin, there is a huge knowledge gap currently and it could take couple of decades before the knowledge gap is filled. I envisage the current and future generation will really appreciates what bitcoin enables. Think for yourself, if someone in 1994 said that you would be reading articles on something called internet and you would be buying things on internet. You’d call him a fool, wouldn't you? Bitcoin can be referred as Internet 2.0.
We sometimes need to keep an open mind.
In the upcoming part, I will write about what bitcoin is, how bitcoin works and what gives bitcoin value.
Disclaimer: The contents of the article are gathered from various sources and are for information purposes only and are not to be considered as financial advice. The opinions expressed are that of the author and do not necessarily reflect that of Daijiworld Media Pvt Ltd.