What Is Money? (Yes, We're Talking About Bitcoin)

What is money?

We all assume we know, because money is a commonplace feature of everyday life. Money is what we earn and exchange for goods and services. Everyone thinks the money they’re familiar with is the only possible system of money — until they run across an entirely different system of money.

Then they realize money is a social construct, a merging of social consensus and political force — what we agree to use as money, and what our government mandates we use as money under threat of punishment.

We assume that our monetary system is much like a Law of Nature: since it’s everywhere, it must be the only possible system.

But there are no financial Laws of Nature for money.

In the past, notched sticks served as money. In other non-Western cultures, giant stone disks (rai, a traditional form of money on the island of Yap) and even salt served as money.

In our experience, 1) money is issued by a government or central bank (i.e. a currency), and each of these currencies is the sole form of legal money in the nation-state that issues the currency…

2) Each of these currencies is available in physical coins and paper bills and digitally as entries in bank and credit card accounts…

3) Our currency is borrowed into existence by the central bank or by fractional reserve lending in private banks, and…

4) This currency meets all the utility traditionally required of money (it can be divided into smaller parts like quarters or dimes, that it is easily transferable, it has a market value that’s easily discoverable, etc).

But history informs us that money doesn’t have to be issued by governments. Nor does it have to be borrowed into existence by banks, nor does every form of money have to satisfy every condition of utility. It’s possible to have multiple forms of money which each serve different purposes.

In other words, our system of money is merely one of many possible systems of money. With the advent of digital cryptocurrencies, the range of monetary systems has expanded greatly.

We tend to look at money as value-neutral and apolitical, but as a social construct, it reflects specific social and political values. Our money is created and distributed at the very top of the wealth-power pyramid.

This feature of our money optimizes the accumulation of wealth and power in the top of the pyramid, and thus our social contract of money guarantees the concentration of wealth and thus rising wealth-power inequality.

To understand why, we need to start with money’s three basic functions. As a general rule, money is:

A store of value (i.e. it serves as a reliable repository of wealth)…

As means of exchange between buyers and sellers…

And a tool for recording transactions of credit/debt (i.e. it facilitates recording transactions and keeping track of credits, debts, assets and payments).

Modern-day government-issued currencies perform all three roles. The U.S. dollar, for example, acts as a store of purchasing power, a global means of exchange, and as a tool to keep track of transactions, debts and financial assets.

But in other social constructs, different kinds of money perform different functions. The giant stone disks on Yap (rai) are a store of value, and a means of exchange for high-value items.

But the recording of transactions involving the rai is done in an oral-history ledger. The transfer of ownership of a particular rai is recorded in the community memory, and so the heavy 2-meter-high stone doesn’t have to actually move in physical space to transfer ownership.

As a result, a stone rai resting at the bottom of the lagoon is a perfectly functional store of value and means of exchange.

The rai are quarried on another island, and not easily counterfeited. They are not necessarily interchangeable; the value of each one is recorded in the oral record. But since a rai isn’t divisible, or easily transportable, another form of money is used for day-to-day transactions.

The point here is there is no intrinsic reason why the three primary functions of money have to be satisfied by one single currency.

Nor is there any intrinsic reason why one form of money has to be equally tradable for all goods and services. In some cultures, certain forms of money hold symbolic value and are used solely for transactions of symbolic import, for example, as a wedding dowry.

We assume money has been stripped clean of symbolic or moral value, that it has no connection to anything but its current market value. Yet once again, there is no intrinsic reason why money must be stripped of symbolic or moral value. That our money has no symbolic or moral value is entirely a result of our specific social construct.

In cultures with forms of money that aren’t issued by a government, social consensus defines what serves as money and what functions it fulfills.

Which brings us to bitcoin…

Bitcoin’s limitations are well-known: the blockchain/mining consumes vast quantities of electricity, and bitcoin can’t be scaled to replace all the credit card transactions in the world. But as noted above, every type of money does not need to perform all the functions of money.

Thus some commentators anticipate bitcoin being used for large, infrequent transfers rather than the purchase of consumer goods and services. Other cryptocurrencies may arise to fill that role.

I recently paid translators in South America with bitcoin. The transaction fee was about $4.50. Clearly, bitcoin functions as a means of exchange.

I made a few dollars of profit using bitcoin for transactions like this last year and I paid income taxes on those modest gains. Clearly, bitcoin is a legal financial instrument that the federal government accepts as the source of taxable capital gains.

For those who don’t know the situation in Venezuela, its government has destroyed the value of the nation’s currency, the bolivar, which traded at roughly 10 to 1 U.S. dollar as recently as late 2012, when bitcoin was roughly $10.

The black market exchange is now over 98,000 bolivars to the dollar, and one bitcoin is now worth over 1 billion bolivars. Clearly, bitcoin has acted as a store of value. The resident of Venezuela who traded 100 bolivars for $10 and traded the $10 for one bitcoin how has 1 billion bolivars or $13,000 US dollars.

Clearly, bitcoin is a means of exchange, a legal form of capital that accrues taxable capital gains and it’s a store of value. So by the conventional definition of money, bitcoin is money.

It’s our right to think it a nonsensical form of money, just as it’s our right to mock the stone rai, and deride the packages of ramen noodles that serve as money in prisons. But our mockery doesn’t change the functionality of these forms of money.

No doubt the conventional wisdom in Venezuela dismissed the functionality of bitcoin in late 2012, just as the conventional wisdom continues to dismiss bitcoin’s functionality as money. So who was right, and who was wrong?

The believer in the status quo who held onto his 100 bolivars as a means of exchange and store of value, or the independent who traded bolivars for bitcoin?

Good ideas don’t require force. That describes the Internet, mobile telephony and cryptocurrencies. Bad ideas require force: that describes the Venezuelan government’s management of its currency, and the central bank/central state form of money that dominates the global economy.

Regards,

Charles Hugh Smith
for The Daily Reckoning