Layered Money, From Gold And Dollars To Bitcoin And Central Bank Digital Currencies

1. Money evolved from coins to a layered system of promises

Money is a layered system.

From barter to Bitcoin. The evolution of money spans millennia, beginning with barter systems using seashells and animal teeth, progressing to precious metal coins, and eventually developing into a complex, layered system of promises. This layered money framework consists of:

• First layer: Physical gold and silver coins
• Second layer: Paper certificates promising payment in precious metals
• Third layer: Bank deposits and other financial instruments

The transition from physical coins to paper money and bank deposits allowed for greater economic flexibility and trade, but also introduced counterparty risk – the possibility that the issuer of a promise might not fulfill their obligation.

2. Central banks emerged to control the pivotal position between money layers

Governments moved to take control of the pivotal position between the first and second layers.

Centralization of monetary power. The creation of central banks, beginning with the Bank of Amsterdam in 1609 and followed by the Bank of England in 1694, marked a significant shift in monetary control. Central banks:

• Monopolized the issuance of second-layer money
• Provided instant settlement between depositors
• Acted as lenders of last resort during financial crises

This centralization allowed governments to exert greater influence over the monetary system, but also introduced the potential for currency devaluation and financial instability when mismanaged.

3. The gold standard gave way to fiat currencies and the dominance of the US dollar

Gold transitioned to the informal role of neutral money, still held today by governments and central banks around the world as first-layer, counterparty-free money.

The rise of the dollar. The 20th century saw dramatic changes in the global monetary system:

1. Abandonment of the gold standard
2. Bretton Woods agreement establishing the US dollar as the world reserve currency
3. Nixon Shock in 1971, ending dollar convertibility to gold

These events led to the current system of fiat currencies, where money's value is based on government decree rather than backing by precious metals. The US dollar's dominance as the global reserve currency has persisted, despite challenges and criticisms.

4. The 2008 financial crisis exposed vulnerabilities in the global monetary system

The Fed fulfilled its role as lender of only resort by launching a slew of consecutive rescues to stave off systemic collapse.

Cracks in the foundation. The 2008 financial crisis revealed deep-seated issues in the global monetary system:

• Over-reliance on complex financial instruments and interbank trust
• Inadequate regulation and risk management in the banking sector
• The Federal Reserve's unprecedented interventions to prevent systemic collapse

The crisis led to:

• Quantitative easing programs
• Near-zero interest rates
• Increased scrutiny of financial institutions

These measures, while stabilizing the immediate crisis, have raised concerns about long-term monetary stability and the potential for future crises.

5. Bitcoin introduced a new paradigm of decentralized digital currency

Bitcoin had arrived as digital gold.

A monetary revolution. Created in 2009 by the pseudonymous Satoshi Nakamoto, Bitcoin represents a radical departure from traditional monetary systems:

• Decentralized: Not controlled by any government or central authority
• Limited supply: Only 21 million bitcoins will ever exist
• Transparent: All transactions are recorded on a public blockchain

Bitcoin's key innovations include:

• Proof-of-work consensus mechanism
• Cryptographic security
• Peer-to-peer transactions without intermediaries

These features have attracted millions of users worldwide, challenging conventional notions of money and sparking a new industry of cryptocurrencies and blockchain technology.

6. The Lightning Network and smart contracts expanded Bitcoin's capabilities

Lightning Network not only infinitely increases Bitcoin's capability as a medium of exchange but also allows for innovations such as paying for online streaming by the millisecond.

Scaling Bitcoin. The Lightning Network, introduced in 2016, addresses Bitcoin's scalability issues and expands its functionality:

• Enables instant, low-cost transactions
• Increases Bitcoin's transaction capacity to millions per second
• Allows for micropayments and new use cases

Smart contracts, programmable agreements on the blockchain, further enhance Bitcoin's capabilities by enabling:

• Complex financial instruments
• Automated, trustless transactions
• New forms of decentralized applications

These technological advancements have positioned Bitcoin as a more versatile and powerful monetary system, capable of supporting a wide range of financial activities.

7. Central banks are developing their own digital currencies in response to crypto

When fully implemented, DCEP carries the potential to be the largest financial surveillance operation in the world, especially if it forces its major trading partners into using DCEP to transact with Chinese entities.

The CBDC race. Central Bank Digital Currencies (CBDCs) are being explored by monetary authorities worldwide:

• China's Digital Currency Electronic Payment (DCEP) system is already in testing
• The European Central Bank is actively researching a digital euro
• The Federal Reserve is cautiously evaluating a potential "Fedcoin"

CBDCs aim to:

• Modernize payment systems
• Enhance monetary policy tools
• Counter the rise of private cryptocurrencies

However, CBDCs also raise concerns about privacy, financial surveillance, and the potential displacement of traditional banking services.

8. Bitcoin may become the new global reserve currency and unit of account

Bitcoin is antifragile because it thrives off global monetary disorder within the dollar pyramid and is resilient to the threats, slander, and legislation from dismissive bureaucratic entities.

A new monetary order. As Bitcoin continues to gain adoption and legitimacy, it may eventually challenge the US dollar's position as the global reserve currency:

• Bitcoin's fixed supply and decentralized nature make it resistant to inflation and political manipulation
• Increasing institutional adoption and investment in Bitcoin lend credibility to its long-term prospects
• Technological innovations like atomic swaps could enable seamless exchanges between Bitcoin and other digital currencies

The potential implications of Bitcoin as a global reserve currency include:

• Reduced government control over monetary policy
• Increased financial privacy and autonomy for individuals
• A more stable and predictable global monetary system

While this scenario remains speculative, the growing influence of Bitcoin and other cryptocurrencies suggests that the future of money will likely be very different from its past.

Last updated: August 17, 2024