The Laws of Currency

Chapter 1 – “Will Cryptocurrency be the Money of the Future?”

To begin to understand the history of money, we have to go back to ancient times between 710 and 995 AD in the Chinese province of Sichuan where they used iron coins. This is known as species currency. Species means 

the money’s value is derived from the value of the material it is made out of. 

Iron was useful for making many things so it had some value but it wasn’t very rare so it didn’t have much value. Its lack of value meant people needed to carry around a lot of iron to buy common items. For instance, it took one and a half pounds of iron coins to buy one pound of salt! 

These coins didn’t meet the modern standards for a viable currency. For money to be viable it needs to meet three criteria:

  1. Viable currency needs to hold value over time. This is generally true for iron. The worth of iron might shift a little over time as more is discovered but all currency will shift in value over time. Iron coins will remain valuable for a long time, though they will eventually rust.  
  2. A viable currency needs to be a generally agreed upon medium of exchange. Iron met that standard too in Sichuan at the time. The government declared it legal tender and everyone agreed to use it. 
  3. A viable currency has to be easy to handle and exchange. Here is the problem with iron. You need too much of it to buy things. We still have metallic currency today, quarters, dimes, nickels, and pennies. These are of little use to most people because you need so much to buy anything. It would be a challenge to buy all of your groceries with just change.

The problem with using iron coins as currency was evident to people in Sichuan. That is why a wealthy merchant came up with an idea to improve financial transactions. The merchant started taking people’s heavy iron coins, and holding them. He would then give a person or depositor a receipt or an IOU that said he owed the depositor a number of coins. 

The depositor could retrieve the coins from the merchant at some point in the future. These IOUs were interchangeable and anyone holding them could exchange them for iron coins with the merchant. People quickly realized that these receipts were much easier to carry around and use than the coins. 

Because the merchant was very wealthy, people had faith in him because they believed that he wasn’t going to suddenly run out of iron. These IOUs were essentially paper money and this idea of using paper to represent species currency was so popular that other wealthy merchants in China started doing the same thing. 

The system was eventually adopted by the Chinese government. They started issuing paper money and importantly they declared that taxes could be paid with coins or this paper. As the saying goes, the only certainties in life are death and taxes. 

Being able to pay taxes with a specific money, meant that many people wanted the money to use. It also meant the money held value, since every year people needed to pay their taxes at a set rate. Paper money worked so well in China that eventually the government realized there was no need to make it redeemable for iron or any other metal.

In 1287 the Chinese government, now under control of the Mongols, printed money with pictures of bronze coins on them, but this money wasn’t redeemable for anything. It was just paper. People began to use the money just because the government said it was valuable. This is called fiat currency, or currency that is valuable because of a government declaration. 

The problem for people holding a lot of iron, bronze, or gold coins after this declaration, was that the coins were not as valuable as they had been. People didn’t need them in order to perform financial transactions. Soon everyone in the world decided to use paper money. 

You might think that this is the end of the story for coin currency, but as we pointed out early change in money systems has been a constant over time.

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In 1368, the Mongols were pushed north of The Great Wall and by the middle of the 1400s the Chinese government had reverted back to traditional money with coins made of metal and paper backed by metal. If you were holding a lot of the old paper money with the bronze coins printed on it when this transition was happening, you might have lost a lot.

Over the years, gold has been used as money and it seems to solve the problem that inspired the original transition to paper money in Sichuan. Gold is rare and valuable and you don’t need much of it to buy the basics of life. However, there is a problem with using gold and silver coins. 

Let’s look at a scenario to uncover the challenge: 

Pretend you are an old-time store keeper, and you bought 100 gold coins worth of scythes (a real old-timey farming tool), and you bought it on credit at no interest. Now let’s say you aren’t a smart store keeper so you sell all your scythes for the price you bought them. At the end of the day, you have 100 coins. Once your creditor gets their money back, you have netted zero profit but at one point during that day, you had 100 coins made out of precious metal in your hands.

If you were really devious, you could still make money by taking some metal shears and clipping a little bit of gold off of the edge of each coin, ideally so little that nobody noticed. You could pass on those clipped coins to your creditor and if they didn’t notice, your debt would be paid, but you would still have 100 little gold clippings. 

If you clipped coins many days in a row, you would eventually get a lot of gold. This was a species currency “hack” called debasing. Coin clipping or debasing was a real problem for cultures using species currency. 

At one that time, coin clipping or debasing was so pervasive that people didn’t trust that coins had the actual amount of metal in them compared to what the coins’ face value said they had. These coins were no longer an agreed upon medium of exchange. To use the coins, people would have to weigh them and this meant the coins were not quick and easy to use.

“Will Cryptocurrency be the Money of the Future?”

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