What Is Money?
Cryptocurrencies have had a lot of ups and downs. A lot of questions have been asked about whether they’re actually viable or not. These conversations have been focused on the technical problems such as slow transactions, preventing the 51% attack, bugs in smart contracts, etc. Yet, solving technical problems won’t have as much of an effect as other factors.
To understand those other factors, we need to start thinking about what money is. If I asked you if you wanted money, the answer would probably be yes. But why? Can you eat money? Can it provide you shelter from the rain? Can it charge your smartphone?
Money can’t do anything of these things by itself. It only allows you to purchase stuff that provides for your needs. But now we have the question of, why do people give us these things in exchange for our money? Yes, they too can spend our money (now their money) on providing for their needs, but how did everyone start agreeing that this piece of paper with very little utility was the way to mediate these exchanges?
The alternative to using money is barter. There is a very classic problem with barter. If I make apples and you make oranges, I could try to trade some of my apples for your oranges. But what if you don’t want apples? What if you want fish? I could go and find a fisherman to exchange my apples for fish so that I can exchange fish for oranges. But what if I can’t find a fisherman that wants apples?
Imagine going through this process for everything you use in a day. You would spend your entire day bartering instead of making apples (or whatever it is you make). Money solves this for us by providing some medium for which we can exchange anything. But that alone does not answer the question of why people accept money. Why accept my US dollar rather than a BeekumsCoin or a bottlecap?
Most Americans, including myself, have taken this question for granted. Everyone accepts the US dollar. Most people prefer to have US dollars. Some countries actively prevent their citizens from trading their currency for the US dollar.
Money has always been imprinted with it’s creator. The Roman Denarii. The Venetian Ducat. The British Pound Sterling. The US Dollar.
These are the most popular and widely accepted currencies in history. Through trade and empire expansion, they became well known. More importantly, they were backed by a powerful entity that people could trust would be around. Ignoring the fact that Rome fell, if you were alive when it was around, odds were it would be around before you died. That fact meant you could trust in the value of that money because it was guaranteed by some powerful central entity.
People trust in what they know and what other people know. People trust in power that will be around, regardless of whether that power is benevolent. People trust in the stability of that power. There is a difference between a currency backed by the Roman Empire or the United States versus a currency backed by some random person (BeekumsCoin is going to be huge by the way).
That leads us to the answer of what money is: Trust.
Without trust, money is worthless. It’s just a piece of paper, a shred of metal, or some digital bits floating around somewhere. One of the justifications in cryptocurrencies was based on a loss of trust in the institutions that manage our money. Yet, despite all the quantitative easing (aka printing money), the US dollar is still fairly stable. Most widely accepted currencies are still fairly stable. When we freak out about currency fluctuations, we usually are looking at single digit percentage fluctuations. For a stable currency, a single digit percentage is a big deal.
A large part of that stability comes from it’s utility. The value of a currency is determined by how much you can buy with it. If $100 can pay rent, then a dollar is worth a lot. If $100 can only get you an apple, then a dollar isn’t worth much at all. If someone tried to sell you an apple for $100, you would trust that there would be someone else willing to sell it for $1 instead. Your trust in the value of the dollar keeps you from taking an action that would devalue it.
Inflation doesn’t necessarily happen when central institutions print money. Inflation happens when you are willing to see $100 for an apple as a reasonable exchange. This can be caused by printing money, but that’s just one factor out of many. Your unwillingness, and the unwillingness of other people, to pay a high price for goods and services can prevent money from losing value.
Usage creates a fundamental value for your money. It’s not just a piece of paper. It’s rent. It’s food. It’s heat and water. So long as you can spend your money on these things, your money (regardless if it is dollars, euros, or yuan) will always be worth something.
Therein lies the biggest issue with cryptocurrencies. Can you pay rent with bitcoin? Can you buy food with ethereum? No amount of technical wizardry will create a fundamental value for cryptocurrencies. Only utility can do that and right now the primary usage of cryptocurrencies is speculation. They have value because people believe they will increase in value. But there is no underlying fundamental to back this belief up. Cryptocurrencies will have value so long as this belief is maintained, but it’s more fragile than if we could actually use cryptocurrencies in our everyday lives.
The technical challenges with cryptocurrencies are important, but solving them isn’t enough to make cryptocurrencies successful. What needs to be done is to create trust that allows cryptocurrencies to be used in your normal day to day. Amazon and Walmart would need to accept Bitcoin. Your utility company would have to accept Ethereum. Your landlord would have to accept Ripple. These entities don’t trust cryptocurrencies enough yet. That trust has never before been created without a powerful central entity, which could arguably taper the wild fluctuations in crypto markets that prevent trust from being built.
This is one example of many in a common oversight in software development. We software developers are very good at building software and solving technical problems. We became developers because technical challenges are what excite us. But the ultimate success of our software is going to rely on our ability to understand the real world factors that govern how our software will be used.