Lesson 7 of 10
In Progress

7. What is money?

Any form of money acts as a medium of exchange, store of value, and unit of account. Like everything, money has evolved over the centuries from “livestock” barter to “computer code” in the form of cryptocurrencies. 

Barter – the first form of money

Money is anything that can be used as a medium of exchange. Interestingly enough, recent research suggests that money only came into existence after the invention of debt. At first, we had a form of barter – people exchanged items to which they assigned equal value. 

In the earliest eras of civilization, societies denominated money in livestock such as cows, goats, and camels. Thereafter, everything from kauri shells to salt was widely used as a form of money before giving way to a more familiar form – precious metal coins. 

Coins – the first revolution of money

The difficulty of barter led to the creation of coins made of precious metals. As a result, around 700 BC, the first coins began to be minted. A small town called Lydia still has the oldest archaeological evidence of the first coins in the world.

Later, with the conquest of Lydia by the Persians, they started minting coins, and from there the expansion of coins around the world began to grow. The Greeks, Romans and Chinese joined the revolution. These early coins were usually made of precious metals. The Lydians minted their coins in gold and silver, weighing from about 4 grams to 60 grams. This all depended on the quality of the material, the metal alloy, and the size of the coin struck.

New coins quickly became a very desirable medium of exchange. This greatly simplified the buying process and put aside some of the injustices that had taken place in the barter trade.

The origin of modern money

The concept of banks dates back to the very origins of money in Mesopotamian times (loans were made with interest). In the Middle Ages, they played a fundamental role in the evolution of money with the invention of paper.

The first banknotes, of which there is evidence, appeared in Sweden in 1661 (17th century), by the hand of the moneychanger Johan Palmstruch, who gave them as “receipts” to those who deposited gold or other precious metals in the Stockholm Bank, which he founded.

This is where paper money secured by gold is born. This means that people’s gold coins, which were heavy and difficult to divide, are stored in well-protected safes in exchange for documents that indicate something like: “This document is equivalent to this amount of gold in bank X”.

It all grew in strength until the death of King Charles X Gustav in 1660, when the government decided to mint new copper bars of lesser purity. Depositors gathered to withdraw their best copper bullion, but because Palmstruch had borrowed it, they could not. For this reason, in 1661, the ingenious Palmstruch decided to disentangle the issuance of “bills” from the deposits in such a way that the only guarantor of the bills was the bank itself. These bills are Kreditivsedlar and secretly represent the birth of fiat money (backed only by faith or trust).

Palmstruch did not expect that this money would trigger a new phenomenon in Sweden: inflation. After a tumultuous period of economic crisis in 1667, the time came when the bank, unable to meet its obligations under Kreditivsedlar, went bankrupt. Palmstruch was initially sentenced to death, but was later pardoned and sent to prison.

The Rise of the Central Banks

But the Swedish parliament recognized the power of banking and decided to establish the first ever central bank: the Swedish Assets Bank, in 1668, with exclusive rights to issue banknotes. Years later, the institution was renamed the Central Bank of Sweden, which in 2018 celebrated 350 years as the world’s oldest. It wasn’t until 26 years later, in 1694, that the Bank of England was established, a central bank that has served as a model for most central banks around the world.

This meant that the creation of paper money was privatized and institutionalized in governments, making it impossible for any person to issue money. Only a country’s central bank would have the ability to issue valid money, really ensuring that there was gold on which the bills were based.

Gold Standard

Until recently, banknotes were backed by gold, which was known as the gold standard, meaning that every issue of money made by a country’s government had to be backed by a certain amount of gold. This lasted until 1971, when the United States formally withdrew this promise, stopping the use of gold as currency backing.

Although there are those who believe that the euro or dollars are backed by gold, this is not the case. Money as we know it today is not backed by anything; it is issued by a country’s central bank, which from its position of power determines that it is money that people should use.

Fiat money – FIAT

Today, fiat money (e.g., the zloty, euro, dollar) – government-issued legal tender – represents the most dominant form of money. For many, paper bills and coins are the only forms they have ever known. Fiat currency has replaced gold and commodity money. Paper fiat money originated in China (11th century) and did not reach Europe until the 17th century. 

Today, more than 150 currencies are used worldwide, and 70% of the world’s monetary value is denominated in U.S. dollars, euros, British pounds, Japanese yen, and Chinese yuan.

In addition to the traditional cash exchange, transactions using FIAT take place through an intermediary – the banking system, financial institutions, or apps are necessary to complete transactions. When we use a card, we need a third-party company like VISA to make transactions or pay for goods and services. In such cases, we talk about centralized finance. 

The central banks of many countries have started to issue money without control, and we are facing the first problems of an exacerbated devaluation of purchasing power. Even the dollar itself, the standard currency, is measuring up to this reality. So much so that $100 in 1956 would be the equivalent of $956 today.

This issue, along with other unhealthy practices in economics, has led us to economic crises like the one in 2008. Given this reality, a new form of money was needed that would not be controlled by governments and central banks. No one would have thought that this would come true in 2009 with the launch of the new evolution of money and the rise of cryptocurrencies.