Learn The Bitcoin Rabbit Hole  

This is chapter 2 of a 10!


Money is arguably the most important concept in modern society, though most people have no idea how money works or how we ended up with the money we use today. The goal of cryptocurrencies like Bitcoin is to improve money, so if we want to understand crypto first we need to understand money.

Money is a tool for measuring, exchanging and storing value. The more important or useful something is, the more valuable it is. Value can be created. One popular way to create value is to save people time. For example:

  1. You buy lettuce, carrots and dressing ingredients for $5
  2. You convert those ingredients into a salad and sell it for $10
  3. You created $5 of value

Now let’s say you wanted to buy a car. You need money because:

  1. you can’t pay for your car with salads 😂
  2. you might not want to buy the car until two months from now
  3. you haven’t sold a car’s worth of salads yet

Money enables you to do three things:

  1. Measure Value – Money is a unit of account, a standard numerical unit which allows you to measure and compare the value of one thing to another. For example, $5 vs $10.
  2. Exchange Value – Money is a medium of exchange, used to exchange value for goods and services. For example, exchanging a salad for $10.
  3. Store Value – Money is a store of value, a way of maintaining value over time. For example, sticking the $5 of value you created in your wallet.

So what should we use as money? What object can best fulfill those three requirements? For hundreds of years many things like beads, shells, cows (seriously!) were used as money, but we learned (the hard way) that the best form of money contains the following properties:

  1. Portable – Money should be easy to move and carry around
  2. Fungible – One unit of the same denomination should always equal the exact same amount as another unit of the same denomination (a $1 bill should equal every other $1 bill)
  3. Divisible – Money should be easily divisible into smaller units of value
  4. Durable – Money should be able to be used over and over again without breaking down or dissolving
  5. Transferable – Ownership should be easily transferable to someone else
  6. Verifiable – You should be able to easily verify money’s authenticity
  7. Scarce – There should be a limited or finite amount of money to ensure it can’t be diluted or manipulated

Scarcity is the most important property of money because authentic scarcity creates trust. If you knew someone who could easily create money for themselves without creating any value, would you trust that money? Of course not.

Eventually humans discovered that gold fulfills all the properties required of money and also can’t be created by man (although people have tried). If all the gold on earth (185,000 tons) was melted into one giant brick, that brick would only be the size of one olympic size swimming pool!

Other precious metals like silver were used as money as well, however compared to other precious metals only a tiny amount of new gold is discovered each year (3,000 tons). This gives gold the highest stock-to-flow ratio (185,000 / 3,000 = 61.666) of any naturally occurring element. So not only is gold incredibly scarce, but it can’t be created by man and only a small amount of new gold is discovered each year making gold a stable and trustworthy form of money.

Stock-To-Flow – The amount of precious metal already above ground (stock) divided by the amount of new precious metal discovered each year (flow). Gold and Silver are the only precious metals with a stock-to-flow ratio well over 1 making them the best form of money.

Comparing various precious metal’s stock-to-flow ratio

Money Is Gold

#1 – Gold and Silver become the most widely accepted form of money

So gold was the best form of money ever discovered, but it wasn’t perfect. For example, melting gold into exactly the amount you want to spend and verifying the authenticity of the gold each time you use it is cumbersome. So people entrusted their Kings, Emperors and governments with converting their gold into coins.

Eventually these trusty rulers did exactly what you’d expect them to do, they melted the gold coins and recasted them with cheap plentiful metals. With the extra gold, they created money for themselves which they spent expanding their empire and funding their wars. This debasement of the money supply is said to be a leading cause of the collapse of the Roman Empire.

Also, storing and protecting large amounts of gold is unsafe (especially back in the day!). So wealthy merchants would work out a deal with the local goldsmith to store their gold in his vault. In return for storing the merchant’s gold the goldsmith would issue them a paper certificate exchangeable for their gold. Turns out these paper certificates were a lot easier to use as money than gold was, so people began transacting in gold backed certificates instead of gold itself.

Money Is Certificates For Gold

#2 – The thing of value (gold) is separated from the thing used as money (gold certificates)

So goldsmiths were transformed into banks and banks quickly realized that no one ever converted their gold certificates back into physical gold. So the bankers began printing 2nd, 3rd and 4th certificates against the same amount of customers gold and lending it out to generate interest. This was the beginning of fractional reserve banking. As long as these bankers could be trusted to manage this paper money supply no one would realize that there was more paper than gold.

Imagine the complexity of hundreds of private banks competing to issue their own paper money. Sounds a lot like the 100’s of cryptocurrencies today doesn’t it? 😉 Throughout the 1800’s some money in the U.S. was convertible into gold/silver, some was just IOUs, some was interest bearing, some could be used to pay taxes and some couldn’t. This confusion created massive distrust in the nation’s money.

The U.S. eventually landed on a national gold backed currency with the passing of The Gold Standard Act in 1900 which pegged one ounce of gold to $20.67. However pressures from WWI and The Great Depression caused the U.S. to increase the peg to $35 to $38 to $42, each time creating more money for themselves the same way Roman Emperors did in the 2nd and 3rd centuries.

In 1933, in an attempt to maintain a gold standard, President Franklin Roosevelt passed Executive Order 6102 forcing every American to turn their gold into the bank. This was followed by the Gold Reserve Act of 1943 which nationalized all gold forcing every bank to turn that gold into The Federal Reserve in exchange for gold certificates.

Gold Certificate
Notice all the references to gold?

During World War II, many European countries sent their gold to The U.S. to protect their gold from the Nazis. After the war, The U.S. hedl more than half of the world’s gold. Instead of sending the gold back, The Bretton Woods Agreement in 1944 made the U.S. Dollar the reserve currency of the world so the U.S. gave them U.S. Dollars instead.

As had happened many times throughout history, growing expenses related to (the Vietnam) War pressured President Nixon to break the Bretton Woods Agreement abandoning the gold standard for good in 1971. This was meant to be a “temporary measure”, however in 1976 new U.S. dollars were issued, this time with no reference to gold whatsoever.

Fiat Money
What happened to the gold?

Money Is Debt

#3- Certificates for gold are now just IOU’s

From 1971 until today (only 50 years) an entirely new form of money exists: fiat money. Fiat money is money created by governments and managed by Modern Monetary Theory (MMT). MMT proposes that money can be managed by Central Banks by tracking employment, GDP, inflation and thousands of other data points. Sounds foolproof right?

One particularly nefarious highlight of MMT is the Federal Reserve’s stated goal of targeting 2% inflation. Remember how Rulers printed more money to fund their wars? Now slowly debasing the money supply is literally built into the system. It’s done in the name of “stability and employment”, however in practice it’s stealing value from people who save.

In fact new money is created as debt. Here’s how it works:

  1. The U.S. government prints bonds (debt) & sells them to banks
  2. The banks sell the bonds to The Federal Reserve who buys them with “new money”
  3. The “new money” is loaned to people/companies who deposit it into their bank
  4. For every $1 deposited in the bank, they can loan out $10 to someone else, who deposits their $10 into another bank who can now loan out $100 and so on.

When you deposit money into a bank, its no longer your money – its the bank’s. Assuming everything goes smoothly, they’ll give some of it back to you when you need to use it. Just don’t try asking for all of it at once.

Money Is Broken

The world was bait and switched. What was once the world reserve currency certifiably backed by gold is now pieces of paper representing nothing but the full faith and credit of The United States Government. With trust in the government at an all time low, what does this mean for our money?

When you hear that The Fed is printing TRILLIONS of dollars to fight the Covid-19 pandemic, you have to ask yourself: Where is this money coming from? Who’s value is that money representing? Why force me to pay taxes when you can print infinite amounts of money at will?

The fiat experiment has only been going on for 50 years, but we have thousands of years of civilizations who rose to power by instituting a trusted money supply and then fell due to greed and pressure to inflate it – exactly like what we’re seeing today.

A New Money

The goal of Bitcoin is to take all we’ve learned about money and program it into unchangeable software that manages the money supply better than rulers or governments ever could. With Bitcoin, trust in money can be restored.

Next up: A Better Money

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