The Evolution of Money
Market Recap
Another Great Week for Digital Assets
Introduction to The Evolution of Money
Last week we released a piece titled the origins of money, in it, we covered how the money a society uses starts its evolution as a collectible item, generally chosen due to its peculiarities and perceived rarity. Through extensive research, we discovered that throughout history there have been countless forms of money. The interesting conclusion we arrived at though was many of them fail early in their evolution due to large changes in their supply. The assumption that they are rare is often misplaced.
However, with time, some forms of money emerge where the assumption around their relative scarcity holds true. Gold is currently our best example of a market selected money; it possesses key characteristics that allowed it to become a form of money that has existed through millennia.
Economist William Stanley Jevons in his book titled: Money and the Mechanism of Exchange, explained that:
“Historically speaking … gold seems to have served, firstly, as a commodity valuable for ornamental purposes; secondly, as stored wealth; thirdly, as a medium of exchange; and, lastly, as a measure of value.”
How Does Money Transition from Unique Collectible to Store of Value?
“Once it is demanded by enough people for its peculiarities, money will be recognized as a means of keeping and storing value over time.” - Vijay Boyapati
As the demand for the collectible increases, the purchasing power of each individual unit increases and begins to represent and store greater value. It is during this period that early holders of a collectible are heavily rewarded with vast increases in what the item can purchase from others.
Once you enter these transition periods if the collectible proves to posses the characteristics of sound money it correspondingly begins to store more value. As this process accelerates, it begins to absorb wealth stored in other inferior types of money circulating in society. It is explained by Gresham’s Law, the law states that citizens will choose to spend the inferior form of money while storing wealth in the harder, superior alternative. Eventually, this form of sound money will drive out the need for its inferior counterpart. One money primarily for saving, the other for spending.
Becoming a Medium of Exchange
The society we live in today is obsessed with the idea that monies only role is operating as a medium of exchange. After all, this property of money is essential, if nobody wants to transact using it then it’s not exactly useful as money. However, there is always an opportunity cost when using money. This cost has a lot to do with a market participants time preference. Time preference refers to the ratio at which individuals value the present compared to the future.
Our money in its current form incentivises short term thinking. The inflationary policies applied by central banks all around the world have fuelled the obsessive spending and malinvestment we see today.
Scarce money (such as gold) promotes long term thinking. This is due to the large opportunity cost associated with its usage. Holders of a scarce money are rewarded for saving, this is because they have chosen to store wealth in an asset whose supply doesn’t fluctuate dramatically relative to other goods and commodities.
Currently, market participants are not incentivised to use bitcoin as a medium of exchange. A famous example of this opportunity cost is the story of a man spending 10 000 BTC to buy two pizzas. This is a great lesson in time preference of sound monies. That 10 000 BTC is worth more than $133 million as of today. This concept is further illustrated by the cost of food denominated in gold.
Sound money will only replace inferior money as a medium of exchange when enough value is stored in it, when enough people are holding it thereby incentivising merchants to make it a payment option, and when the opportunity cost of using it in trade is lower than the cost of completing a trade without it.
Becoming a Unit of Account
Before addressing monies role as a unit of account we need to discuss market competition. A market is a place where the producers of goods and services in society try to satisfy the needs and wants of consumers. The market is constantly, through competition, in a process of discovering the truth. Truth in this sense being the best way to satisfy any given need or want.
Markets in this process of discovering truth establish prices. Prices are simply a reflection of the ratios at which various goods and services can be exchanged, these ratios are usually determined over many years of trade.
Money is the language (point system) in which these exchange ratios are denominated, it is the tool used to calculate, negotiate, and execute trades most effectively. It can either serve as a conduit through which truth is determined or it can be used to distort the truth.
Sound money such as gold has been able to protect value across time and space. This gives people a greater incentive to think of their future and correspondingly lowers their time preference. Fiat money on the other hand has historically lacked the ability to protect wealth across time, resulting in less thought of the future and therefore a higher time preference.
This brings us back to the concept of debasement. Money is only as good as its ability to prevent debasement. If it lacks this key feature it leads to distortions in the truth discovered by market competition. In our research, we have seen how the unit of account used can produce untruthful price signals.
Below are several charts denominated in US dollars and ounces of gold. Before dismissing the following charts, remember that gold has been a form of money used for thousands of years. Even today, almost every central bank holds it on their balance sheet, a clear signal of its monetary value.
These charts prove that gold does one thing very well, preserve purchasing power for those who choose to store their wealth in it.
Conclusion
At Etherbridge we believe that the further back we look, the further forward we can see. When analysing the rise and fall of market selected forms of money over time we observe a consistent pattern. A distinct four-phase cycle is present in the rise of any form of successful money. Bitcoin is not immune to the evolution of money and will pass through all four stages like its sound money predecessors.
Next week we will cover sound money characteristics that enable certain collectibles to survive the evolution of money.
Notable Articles and News Stories This Week:
A Legendary Hedge Fund Billionaire Just Flipped To Bitcoin—Calling It ‘Better’ Than Gold
Legendary Hedge Fund Manager Stanley Druckenmiller has revealed that he owns bitcoin. He has reversed his previous comments made in 2018 when he said that he "didn't want to own bitcoin". He expects bitcoin to "work better" than gold saying it has more beta to it. He also believes that "Bitcoin could be an asset class that has a lot of attraction as a store of value to both millennials and the new West Coast money and, as you know, they got a lot of it".
Read the full article here
Wall Street Legend Bill Miller Reveals ‘Strong’ Bitcoin Recommendation Despite Massive Price Surge
Bill Miller, founder of the investment manager Miller Value Partners has said that he "strongly" recommends buying bitcoin, even at current prices. "[Bitcoin has] been very volatile, but I think right now it's staying power gets better every day," Miller told CNBC. "I think the risks of bitcoin going to zero are much, much lower than they've ever been before." Bill Miller's fund is famous for beating the S&P500 consecutively between 1991 and 2005.
Read the full article here
ECB’s Lagarde Has ‘Hunch’ Digital Euro Will Launch in 2-4 Years
President of the European Central Bank Christine Lagarde has stated that she expects the regions monetary authority will launch a digital version of the euro within the next two to four years. She does believe that it will still take some time to develop though, noting how China's central bank has been working on their own digital yuan for several years now. She also believes that it will not replace cash but act as a complement to the current monetary system.
Read the full story here
Family Offices May Now See Bitcoin as Alternative to Gold: JPMorgan Report
JP Morgan has published a report on bitcoin describing how investment vehicles such as the Grayscale Bitcoin Trust are currently exhibiting greater demand when compared with other more traditional products such as gold ETF's. They believe that it is being driven by institutions such as family offices and asset managers. They conclude that "the potential long-term upside for bitcoin is considerable if it competes more intensely with gold as an ‘alternative’ currency given that the market cap of bitcoin would have to rise 10 times from here to match the total private sector investment in gold via ETFs or bars and coins.”
Read the full report here
World’s Second-Biggest Bank to Issue $3B in Bonds Tradable for Bitcoin
China Construction Bank has tokenised and issued bonds worth $3 billion over a blockchain. They have decided to use the blockchain in order to reduce the costs traditionally associated with financial intermediaries and reduce the barriers to entry for the average investor who may not have the necessary liquidity to purchase a full bond.
Read the full story here
The Potential Impact of Increased Capital Allocation to Bitcoin
Messari, an institutional digital asset research provider published an article explaining the impact of increased capital allocation to bitcoin. There has been an increase in corporates using their treasuries to buy and hold bitcoin. It is estimated that the amount of idle cash on S&P500 companies balance sheets alone amount to 7x of bitcoins market capitalisation, we may see this trend continue and absorb a portion of this cash. Sovereign wealth funds have also started increasing their allocation both directly and indirectly due to the benefits it can provide an overall portfolio.
Read the full piece here
Your Car Insurance Salesman is Now an AI Bot Connected to Blockchain
A Malta-based virtual assistant firm has managed to integrate IBM's Watson with the Cosmos blockchain in order to sell car insurance. The platform provides an end-to-end sales solution that interacts with the customer via voice or text in order to determine the most appropriate insurance product. Once chosen the contract is stored on the Cosmos blockchain and the AI monitors the deal and automatically begins extending the coverage once payment has gone through.
Read the full article here
Whilst we all have the option to look, to seek to understand, it’s often easier not to. Bitcoin, Ethereum and distributed ledger technology are complex systems that require significant due diligence. At Etherbridge we aim to lower the barriers of understanding this fast-growing digital economy.
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This is not financial advice. All opinions expressed here are our own. We encourage investors to do their own research before making any investments.