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The School of Crypto Finance : A History of Money & Crypto Finance

A History of Money

Overview

Pre-Commodity

The history of money began in about 9000 BC in Egypt, when humans first began “bartering” to trade physical commodities. They bartered for “grain, wheat, and cattle which were common commodities used by farmers and other kinds of agricultural professionals of the time.” (source) Other earlier examples of money included “gift economies,” in which goods and services were given without any expected return, but rather emphasized good karma and honor for giving.

 

Commodities & Coins

The first case of commodity money came in 3000 BC, when Mestopotemians “developed a large-scale economy based on the shekel, which represented a specific weight of barley grain.” (source)  The first known physical coin currency was created by King Alyattes in Lydia, now Turkey, in 600BC. Following this, many forms of coins began to develop and spread across the Mediterranean region. Gold and Silver coins were introduced during the Qin and Han dynasties in China and gained popularity.

 

Paper Money & The Gold Standard

Paper money began to be accepted as a commodity during the 11th century in China. Through his travels, Marco Polo brought the idea of paper currency from Asia to Europe. However, during this time, Florian, a gold coin minted in Florence, was the most popular form of currency across Europe. For this reason, it took a long time for paper money to catch on. It wasn’t until 1661 that the first banknote was issued in Sweden, and the benefits were quickly realized. Merchants and businesses realized how much more convenient paper money was compared to coins, which were heavy and could be easily stolen. Despite this convenience, paper money faced many setbacks because of how easily it could be counterfeited.

 

In the 17th century, England’s supply of coins were running low and the government was running out of money due to war with France. “This led the state to partner with the private sector to create the Bank of England—a private institution which had the legal authority to create money in the form of loans to the state.” (source) Eventually, the bank received interest on its loans as well, leading it to become the first-ever central bank. As the central banks, it has the power to “synthesize public authority and private investor interest to create a standardized and expandable currency for use in both the public and private sector.” (source)

 

Paper money continued to grow in popularity; therefore, countries began establishing the gold standard. The gold standard is “a monetary system where a country’s currency or paper money has a value directly linked to physical gold.” (source) Given that gold had been such a popular form of money for centuries, it made sense to convert paper money into a fixed amount of gold. England adopted the gold standard in 1816, followed by the U.S. in 1879. The gold standard was used until the 1930s, when it was replaced by fiat money. This term describes currency that is used because of a government’s order, or fiat, that the currency must be accepted as a legal means of debt payment.

 

Digital Currency

The first origins of digital currency trace back to 1860, when Western Union conducted the first electronic fund transfer via telegram. As technology developed in the 20th century, the first credit card, the cardboard Diners’ Club card, was introduced in 1950. Mobile banking was introduced in Europe in 1999 through the first wave of primitive smartphones.

 

Cryptocurrency

In October 2008, a whitepaper titled “Bitcoin: A Peer-to-Peer Electronic Cash System” was published by pseudonymous Satoshi Nakamoto, detailing Bitcoin’s underlying blockchain technology. On or about Jan. 3, 2009, Satoshi mined the first 50 bitcoins and started the Bitcoin payment network. The first ever transaction with Bitcoin occurred in 2010, when programmer Laszlo Hanyecz purchased a pizza for 10,000 BTC ($25 at the time). Since the introduction of BTC, thousands of new cryptocurrencies have emerged.

 

Philosophical underpinnings of Cryptocurrency

As outlined above, the current concept of fiat money and floating currency means that money has no value without a legal tender from the state (a central authority). Many believe that if the state controls money, they can utilize their governance of the financial system to exert authority and control.

 

The idea that underpins cryptocurrency is decentralization, providing the potential to disentangle the institution of money from the authority of the state. Blockchain eliminates the need for a centralized third-party to verify the authenticity of a transaction. This is possible because transactions are confirmed on the blockchain via consensus of a decentralized network of nodes. Anyone with a computer and an internet connection can participate in maintaining an immutable and distributed ledger, eliminating the need for one central authority to oversee transactions.

 

Privacy and anonymity are also key underpinnings of cryptocurrency. There are no usernames, logins, and emails associated with blockchain, which, unlike signing up for a bank account, requires personal details such as name, address, social security numbers, etc. With cryptocurrency, the identity of each user is encrypted, or concealed behind a complex and very secure code. In an era where personal information and data is becoming increasingly available to companies and governments, blockchain ensures ownership of your identity.

 

The root problem with conventional currency is all the trust that’s required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve. We have to trust them with our privacy, trust them not to let identity thieves drain our accounts.”

-Satoshi Nakamoto

 

What Makes Money Money?

How can something be considered money? There are three main requirements:

  1. Medium of exchange: Money enables us to carry out trade and commerce. There must be an exchange rate (amount of money) established for the goods/services one is trying to secure.
  2. Store of value: Money needs to be worth something in order to use it. While it can fluctuate, money stores its value over time.
  3. Standard of value: Money must represent a standard value that everyone who uses it agrees upon. For example, the agreed-upon worth for a transaction in a country’s medium of exchange could be the euro, dollar or peso. With one standard value, we can measure and compare the value of all kinds of goods and services using one scale.

 

Cryptocurrency vs. Traditional Money

As Wall Street financial institutions like JPMorgan and Fidelity enter the cryptocurrency space, how does traditional money and the established financial system differ from this new kind of digital money?

 

While the debate continues about whether crypto will completely replace fiat or just be a digital version of it, the essential differences of crypto are indisputable:

 

  • No central authority. Our current financial system is controlled by a central authority, whether it be a bank, government or other trusted third-party (like PayPal). That authority  is in charge of verifying and keeping track of transactions. The fundamental innovation of that blockchain technology enables is a distributed ledger (official record of transactions).

 

The ledger is decentralized across a network of computers (nodes). No one person or organization owns these computers, rather everyone who participates “owns” the network. The blockchain eliminates the need for a centralized third-party to verify the authenticity of the ledger.

 

  • Trust-less or permission-less. This may sound like you cannot trust cryptocurrency, but ironically, it’s actually more trustworthy than traditional money. Why? Because with traditional finance, you must the parties with whom you are doing business. In crypto, the transaction is “trust-less” because the system is designed to create trust. It’s completely transparent, with all transactions recorded and verified, so you do not need to trust another party. This is also called permission-less, because you do not have to ask permission from a third-party bank, payment processor, etc. to transfer money. In theory, anyone with a computer and an internet connection can send and receive money.

 

  • Finite supply/scarcity. In the original white paper, Satoshi set the limit on the number of Bitcoin that can be mined at 21 million. The reason for this is simple supply and demand. If the demand is higher than the supply, the value will increase. Also, this finite amount means that price cannot be manipulated with “quantitative easing” (i.e. minting more money) by a third party. This is modeled after the physical mining for precious metals like gold, which derives value from its scarcity.

 

  • Sovereignty. Fiat money is tied to a government or nation-state that designates it as the legal tender for its citizens. Governments can also leverage control over its citizens by controlling the treasury and the rules that dictate the financial system. Most tangibly, governments can tax their citizens and only accept payment in their designated fiat currency. In a world where money is quite literally power, cryptocurrency gives its users sovereignty — liberating them to transact across borders without having to answer to a government.

 

Where Crypto and Fiat Collide

Despite their differences, cryptocurrency and traditional money are part of a larger financial ecosystem that overlaps. While the popularity of Bitcoin soared following the 2008 financial crisis, when people lost faith in the banking system, it now bears many similarities.

Traditional investors are recognizing the potential of crypto, and companies are creating services that mirror the existing financial system. Also, the Securities & Exchange Commission as well as other government agencies are starting to recognize the need for regulation to protect against fraud and corruption.

Here are some areas of similarity:

  • Exchanges. Cryptocurrency or digital currency exchanges are businesses that allow customers to buy and sell crypto assets. Just like in the fiat world, these third-party exchanges either charge a commission or transaction fee for trades.They exist as for-profit entities. Some popular crypto exchanges include: Binance, Coinbase, and Kraken.
  • Custody. Crypto custodians like BitGo, Bakkt, DACC (Digital Design Asset Custody Company) offer a service in which they hold crypto assets on behalf of the owner. The reasons they exist are the same as why brokerages and other financial institutions hold traditional securities: to reduce the risk of loss or theft of assets.
  • Regulations. As the crypto industry grows, financial regulators are beginning to take notice. Agencies like the SEC (Securities & Exchange Commission) and the New York Attorney General’s office, are creating new laws or enforcing and interpreting existing ones to better regulate the crypto marketplace. Regulators are also more clearly defining the different types of assets.

Go Deeper:

 

A History of Crypto Finance

In 2008, the world economy was a mess as the U.S. government spent billions of taxpayer dollars to bailout the banks. Since then a series of data breaches have exposed hundreds of millions of people’s private information. These two factors are key parts of the crypto finance ethos that led to Bitcoin and the many other cryptocurrencies and blockchain projects that would follow it.

Today, the community is still strongly distrustful of large entities and third parties accessing their data or censoring their transactions. While crypto finance seeks mainstream adoption, it’s also learning how to comply with regulators while protecting individuals. Decentralization is at the heart of crypto finance as a movement.

 

Traditional Finance Crypto Finance
A Bank controls the money and can freeze accounts or ban transactions so it meets regulatory compliance such as Know Your Customer (KYC) laws You hold the money directly
Limits on payments No limits
Consumer protectionist regulations based on the 1920s Great Depression and 2008 recession Emerging regulations from FTC, CFTC make crypto finance unclear as these two departments figure out where crypto “fits”
Centralized – a middleman or company lays down the rules Decentralized – a network of computers verifies transactions
Know Your Customer and Anti-Money Laundering Laws mean traditional finance needs your identity data Privacy is generally more valued, though large sectors of crypto are proactively complying with KYC/AML laws
Trust required – you have to trust the bank or company will do the right thing with your data and your money Transparency – no one owns the Bitcoin blockchain but the records are fully public
FDIC Insured – money in the bank backed up by the US government Lose your wallet – lose your money, no backups

 

Decentralization vs. centralization

Decentralization aims to be democratic, sharing decision-making across a larger group of people. Decision-making includes more voices, but can make the process take much longer.

Centralization is a top-down structure where a single or very small group makes top-down decisions. A bank, for example, may limit who you can send money to and how much money you can send in a day.

 

Impacts

Global Payments

In traditional finance, banks act as the middleman between transactions. Being the intermediary offers some protection to both parties (ability to freeze or reverse transactions), but it doesn’t come free. In exchange for using a banks services, the bank sets fee pricing and all the terms of working with them.

 

Cutting out the middleman creates opportunities for the global payment system. Borderless payments, for example, are a huge advantage created through crypto finance. Without the middleman, bitcoin for example, can be sent for a fraction of the fees centralized banks charge to send a SWIFT/wire transfer in a direct, person-to-person manner without needing a bank as intermediary.

 

Traditional finance laughed it off in the early days (Warren Buffet, Jaime Dimon), but they are taking note now. Many banks including Chase have a blockchain department. Others are using Ripple technology or creating their own to lower costs on international money transfers.

 

International Trade

Borderless payments also facilitate smoother transactions on the supply-chain where global manufacturers need both contracts and payment processing. Crypto finance offers a paper and cost reduction from removing middleman escrow services and contract providers. Using a smart contract, individuals and businesses can interact directly, forming a paperless agreement stored on a blockchain that releases funds as certain actions are completed.

 

An estimated 2.5 billion people don’t have access to banking services and most of them also lack a digital thumbprint, or identity. Crypto finance has a big opportunity if they can figure out how to reach this unbanked group.

 

Anti Money Laundering

Blockchain is a tool. It can shed more light on transactions, helping banks provide diligence against money laundering. Blockchain creates a real-time receipt of data on the payments. This increases the safety of information, so we can trust what was spent where, while helping financial institutions meet their obligations.

 

On the flipside, crypto can totally hide transactions. People unfamiliar with crypto think all crypto is untraceable, when in reality, only a fraction of cryptocurrencies, namely privacy coins like Monero and ZCash allow untraceable transactions. Even though Bitcoin is fully auditable, its association with drug trading on the deep web still persists.

 

Global Politics

Foreign Relations, economic sanctions, and disaster relief are further areas where crypto finance carries potential to change the status quo. Blockchain use cases for international relations have stayed mostly theoretical but recently blockchain charity, Bifrost partnered with MakerDAO for a blockchain-based foreign aid payments to send money to crisis zones. Here, the blockchain creates a publicly verifiable trail of how money is distributed, discouraging corrupt actors from dipping into funds.

 

Cybercrime Security

Crypto may be able to provide transparency, but it has a seriously bad reputation to overcome. Crypto is attributed to tripling the amount of cybercrime committed since 2017, mainly as a result of exchange hacks.

 

What’s Next for Crypto Finance?

Crypto finance can help the global economy by connecting the globe with borderless payments, digital identity, and supply chain solutions for businesses, governments, NGOs, and banks. Without stable cryptocurrencies and payment channels, porting to an all digital system of cash could wreak havoc on the global economy.

 

 

Go deeper:

https://hackernoon.com/how-crypto-will-change-international-trade-6329696702a6

https://www.forbes.com/sites/leslieankney/2019/01/30/who-should-you-trust-understanding-crypto-exchanges-and-regulation/#6a9eab2766ae

https://bitcoinmagazine.com/articles/crypto-cybercrime-has-tripled-2017-nearly-1-billion-lost-2018/

https://siteresources.worldbank.org/EXTGLOBALFIN/Resources/8519638-1332259343991/world_bank3_Poster.pdf

 

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