Yumna Sohail

Mar 18, 2021

4 min read

How Money Works

Photo by Josh Appel on Unsplash

These days with the price of Bitcoin skyrocketing once again and the popularity of Fiat money starting to wane, there’s a sense of belief that a new system of money should be adapted which not only incorporates all the new technologies and regulations which are now regular part of our everyday life, but also fills some of the gaps left by the previous system.

So the question we now have to ask is: what is money?

Money is a commodity used by everyone since time immemorial. However the form it has taken has varied over time, depending upon the various meanings, interpretations and utilities derived from it, because really it can be anything which people consider precious and valuable. However historically it has mostly been items thought to contain intrinsic value which have been used.

Fiat Currencies And The Gold Standard

The Gold Standard is a standard which became popular with the rise of Fiat money in the 20th century. It was the backdrop of the Fiat currency.

The initial concept for the Fiat currencies was actually very sound. When it was originally invented, the idea was to put individual gold into banks in return for equivalent Fiat money, which was lighter, easier and much more convenient, very much like cryptocurrencies are now measured against the Fiat currencies. Therefore during a transaction if you received one dollar Fiat money — I’m saying one dollar, but it could just as easily be Riyal, Yen or anything else — you could exchange that dollar for a corresponding amount of gold from the bank. Hence the phrase ‘Gold Standard’.

However in the last few decades this standard seems to have been abandoned by most governments in favor of printing the Fiat currencies for themselves or using other Fiat money as standard. This — although simplifying the system as a whole — creates a different set of problems.

Such as Inflation. Or the nullification of a currency outside of its own boundaries.

The Cryptocurrency Predicament

Cryptocurrencies actually have a lot in common with commodities such as Gold and Silver. Their decentralized aspect, their divisibility etc. This article presents a very good analysis between Bitcoin, Gold and Fiat currencies and how they rate on factors such as portability, divisibility, established history and so on. So although the article focuses mainly on Bitcoin, the metrics it employs can be used for other cryptocurrencies as well.

The main idea of cryptocurrencies — and this is a very popular idea — is that Bitcoin (or any other cryptocurrency), instead of being measured against something, should be measured as a separate entity. The article I mentioned previously was an analysis of what constitutes the value or worth of an entity, with due consideration of what constitutes modern criteria of value, being taken into account.

However there is one problem with this theory.

It is the production end date of the cryptocurrencies.

A production end date is the date at which the mining of the cryptocurrency will stop. This would affectively result in escalated value of the cryptocurrency shortly before its production will end, and completely make it redundant thereafter. Additionally this phenomenon is universal to all cryptocurrencies, although not all the end dates of the cryptocurrencies have yet been confirmed. As an example of this, the production of Bitcoin will end completely by 2140. Ethereum — another popular cryptocurrency — has yet to state an end date.

So here’s what’s confusing me.

Why propose a system based on an entity whose end date is already known? Isn’t that just asking for trouble or at least setting up trouble for future generations?

How the Future Holds

The truth is that all systems will come to an end at one point or another. Nevertheless, as people our goal is always to make systems as efficient as possible and as long-lasting as possible. The problem with an own-value cryptocurrency system is that every time the production end date would occur the entire system would halt and essentially need to be restarted again, and this cycle will continue to repeat itself every time a cryptocurrency is replaced by another one.

In case of Bitcoin which has the mining capacity of 21 million. If this Bitcoin system were taken on its own and ends by 2140, it may be replaced by say, Litecoin, which has the mining capacity of 84 million. The system itself is completely practical but the amount of work and the continuous cycles may become arduous and tiresome over time.

At the end of the day money is not something that a few people will use to become rich overnight and paupers the next day. Money is something that people use to buy and sell things; both which they want and that which they need. That means its price needs to be relatively stable, which means the system needs to be relatively stable and continuous. Moreover the system has to allow for technological innovations in addition to any replacements and changes it may be going through at any point in time. So here’s the thing: Is this system stable enough? Or does it need some sort of backing or support?