BITCOIN AND BLOCKCHAIN FUNDAMENTALS

L1 – An unconventional history of money

a.a. 2019-2020
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DISCLAIMER

This is not a monetary economics lesson!!!

You don’t have to agree with the (often controversial) views

we will share with you, but we are convinced that you have to
know the philosophical/political and economical reasons behind
Bitcoin to deeply understand its nature.

Do not try this at home.

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Why do men exchange at all?

Definition: A voluntary exchange is an agreement between A and B to transfer the goods or services of one man for the goods or
services of the other.

The exchange is made only because each party valued the two products in different order!

I want
I love
some
bananas!
meat..
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Why is exchange important?

Exchange enables specialization.

Specialization permits each man to Specialization allows each region to

develop his best skills. Every man has develop its own particular resources.
its own unique features.

Exchange is the lifeblood of

our society itself!
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How can human beings exchange?

Direct Exchange: Barter

Example: John has two apples, Steve has two pears. They could exchange one banana for one pear.

What if.. John hires some laborers to build a house, with what will he pay them? With parts of the house or with
building materials they could not use?

It is necessary for a person who wishes to trade his good or service to find some other
Lack of
person who is not only willing to buy his good or service, but also possesses that good
coincidence of wants
which the former wants.

It is difficult to fix exchange rates for certain goods which are indivisible. Such indivisible
Indivisibility
goods pose a real problem, under barter
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How can human beings exchange?

Indirect Exchange
Example: You sell your product not for a good which you need directly but for another good which you then, in turn, sell for
the good you want

John is a farmer, wants to buy shoes made by Adam. Adam does not want eggs, rather he wants butter.

John then exchanges his eggs for Alice’s butters and sells the butter to Adam for shoes.

The superiority of butter is its greater demand, i.e. its greater marketability.

! !
If one good is more marketable than other, then it will used as a medium of exchange.
In every society, the most marketable goods will be gradually selected as the media for
exchange. Moreover, as they are more and more selected as media, the demand for
them increases even more marketable. The result is a reinforcing spiral.
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How can money be established?

The cumulative development of a medium of exchange on the free market is the only way money can become
established. Money cannot originate in any other way!

- Neither by everyone suddenly deciding to create money out of useless material

- Nor by government calling bits of paper “money”

Thus, government is powerless to create money for the economy;

it can only be developed by the processes of the free market.
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Why is gold valuable to humans?

All of the gold ever mined by humans is still more or less owned by
Gold is chemically stable and it’s virtually people/entities around the world. The existing stockpile of gold held by people
1 impossible to destroy. is the product of thousands of years of gold production and is orders of
magnitude larger than new annual production.

The only one way to increase the supply of golf is by mining gold from each
Gold is impossible to synthesize from other
2 materials
which is an expensive, toxic and uncertain processes in which humans have
been engaged for thousands o year with ever-diminishing returns.

It remains practically impossible for goldminers to mine quantities of gold large

3 Gold is very scarce. enough to depress the price significantly.

The existing supply of gold is the product of thousands of years of pruduction,

Gold has the lowest price elasticity of
4 supply
and X% increase in price may cause an increase in new mining production,
but that increase will be trivial compared to existing stockpiles.
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What is Money?
• A most important truth is that money is a commodity.
- It is not an abstract unit of account divorceable from a concrete good
- It is not a useless token only good for exchange
- It is not a “claim on society”
- It is not a guarantee of a fixed price level
• As a commodity it has an:
- existing stock,
- it faces demands by people to buy and hold it,
- its price is fluctuating and is the total demand by people to buy and hold it.
• It differs from other commodities in being demanded mainly as a medium of exchange.

The Monetary Unit
• Most tangible physical goods are
traded in terms of weight. Gold (or
silver) is no exception and like other
commodities is traded in units of
weight.
• It is obvious that the size of the
common unit chosen in trading makes
no difference to the economist:
- It could be grains or ounces;
- All units of weight are convertible
into each other.
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Some Examples
• The British «pound sterling» originally signified a pound
weight of silver.
• The dollar began as the generally applied name of an
ounce weight of silver coined by a Bohemian Count named
Schlick in the sixteenth century.
> • The dollar was defined as the name for 1/20 of an ounce of
gold.
• The Pound sterling was defined as the name for ¼ of a
gold ounce.
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Private Coinage
Private coinage seems so strange that it is worth examining carefully. How would it work?

In the same way as any other business

• Each minter would produce whatever size or shape of coin is most pleasing to his customers.

• The price would be set by the free competition of the market.

>
What are some cons?

It would be much trouble to weigh or assay bits of
gold at every transactions. But what is there to
prevent private minters from stamping the coin and
guaranteeing its weight and fineness? People
would just use the coins of those minters with the
best reputation for good quality of product.
Fraud would run rampant. Government could be
trusted to prevent or punish fraud. At the end,
prevention and punishment of fraud, theft or other
crimes is a core goal for government.

The supply of money (1/2)
The perennial question is: How much money «do we need» ?
Definition: the total stock or supply, of money in society at any
one time, is the total weight of the existing money-stuff.
• Changes in the total stuck will be governed by the same
causes as changes in other goods.
• Increases will stem from greater production from mine
• Decreases from being used up in different ways
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But what should be the supply of money be? Maybe..
• Money should move in accordance with population
> • Money should move in accordance with «volume of trade»
• Money should move in accordance with the «amounts of
goods produced» à so as to keep the «price level»
constant

The supply of money (2/2)
The perennial question is: How much money «do we need» ?
In general, we could say that when the supply of any good
increases, this increase confers a social benefit
• More consumer goods mean a higher standard of living
for the public
• More capital goods mean sustained and increased living
standards in the future
• The discovery of new, fertile land or natural resources also
promises to add to living standards, present and future
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But, does an addition to the money supply also benefit the
public at large?
> • Consumer goods and capital goods are used by consumers.
Money is not used up. It acts as a medium of exchange,
and its exchanges are all made in terms of money prices.
The price of money is the purchasing power of the
monetary unit and it tells how much money a good is worth.
• What determines the price of money? The same forces that
determine all prices on the market: supply and demand.
• If the supply increases, the price will decrease. If you
increase the money supply you’re just diluting its own
purchasing power.
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Benefits of Money

No indivisibility or «Coincidence of wants»

- Jones can hire laborers and pay them in...money
Gold
- Smith can sell his plow in exchange for units of…money
• a general medium

Prices are just the exchange ratios where the money- • it is most marketable
commodity serves as a common denominator all the • it can be stored to serve as medium in the
prices > future as well as the present,

• all prices are expressed in its terms.

Money can serve as: • gold is a commodity medium for all
- Measure of values exchanges, it can serve as an account for
- Store of value present, and expected future, prices.
- Unit of account
- Medium of exchange
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Coexisting Moneys
Gold and minter have been used together for decades:

- Bot minted by a competitive private firms circulating by weight. Prices fluctuating freely on the market in response to consumer
demands and supplies of productive resources.
- Gold: money in one area, for example it may be used for larger transactions.
- Silver: money in other areas, for example for smaller transactions. Silver remained in circulation precisely because it was
convenient and not because a government was maintaining it.

It should be clear that the exchange rate and the purchasing

The relative supply and demand for the two
metals will determine the exchange rate
between the two, and this rate, like any other
price, will continually fluctuate in response
to these changing forces. At one time, for
example, silver and gold ounces might
exchange at 16:1 , another time at 15:1.
powers of the units of the two metals will always tend to be
proportional. If prices of goods are fifteen times as much in
silver as they are in gold, then the exchange rate will tend to be
> set at 15:1.
The free market, in short, is eminently orderly not only when
money is free but even when there is more than one money
circulating
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Gold Standard: Pros and Cons

Pro Cons

• Gold retains a value that has been recognized across the globe • The value of gold fluctuates widely and would not provide the price
throughout history stability necessary for a healthy economy

• A gold standard puts limits on government power by restricting its • Gold standards create periodic deflations and economic contractions
ability to print money at will which destabalize the economy

• Returning to a gold standard would lower inflation rates and slow the • Returning to a gold standard would limit government’s ability to
rise in consumer prices address unemployment.

• A gold standard self-regulates to match the supply of money to the • A gold standard would increase the environmental and cultural harms
need for it created by gold mining

• A gold standard would prevent government from overprinting money • A gold standard makes the supply of money vulnerable to the ups and
to bail out financial corporations. downs of gold production
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Summary
• All money has originated in a useful commodity chosen by the free market as a medium of exchange.

• The unit of money is simply a unit of weight of the monetary commodity – usually a metal such as gold or silver

• The coinage is just as legitimate and worthwhile as any business activity

• The price of money is its purchasing power in terms of all goods in the economy and this is determined by its supply, and
by every individuals’ demand for money.

• If people find it more convenient to use more than one metal as money, the exchange rate between them on the market will
be determined by the relative demands and supplies.

• Once there is enough supply of a metal to permit the market to chose it as money, no increase in supply can improve its
monetary function.
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History of money
Commodity Money
Many cultures tried then to fix the value of goods exchanged through barter or
gifts in a more stable way. Commodity money was born: objects that had value in
themselves started to be recognized as standard value units.

One of the most famous examples is the ancient Egyptian financial system,
heavily based on the exchange of wheat. The use of grain was made practical by
the (relatively) dependable harvest in the Nile valley, that also contributed in
reducing the frequency of severe inflationary cycles.

Ancient China, Africa, and India used cowry shells. Differently from wheat,
cowries had few practical uses outside of ornamentation. However, their
attractivity, rarity and resistance to counterfeit transformed them into one of the
first form of practical currency and a staple of trade for so long that the Chinese
pictograph for money is shaped after them.

In central Africa it was still possible to pay taxes in cowries in the early 1900s and
to purchase small items at market well into the 1950s.
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History of money
Minted Money
Compared to cowries, precious metals had some additional interesting properties:
they are durable, portable, and easily divisible. Already in 1000 BC, Chinese
had started producing replicas of cowries with bronze. The first “modern” coin as
we intend it today (disk-shaped, made of gold, silver, or other precious metals,
and with both sides bearing an image) was minted in the ancient kingdom of
Lydia in Asia Minor somewhere around 600 BC, and spread throughout
Greece, India and China before 500 BC.

Despite representing a very effective way to exchanging value – enough to be still

commonly used today - minted coins were plagued by two major issues:
transportability in large quantities and debasement. The practice of
debasement consists in lowering of the quantity of precious metals contained
in a minted coin. Especially after the fall of the Roman Empire and in the Middle
Ages, debasement was often performed for the financial gain of the sovereign at
the expense of citizens. During the Renaissance, the golden florin of the
Republic of Florence was one of the few minted coins stable and diffused enough
to play a significant role in large commercial exchanges all over Europe.
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History of money
Printed Money
For travelling merchants, transporting heavy bulks of minted coins for large
commercial operations represented a burden in terms of both insecurity and
impracticality.

Around 1000 BC, Chinese merchant started exchanging among them receipts of
deposit instead of coins: the first form of paper money had arrived. Soon
enough, the government issued a monopoly on the issuance of such
certificates.

In the 13th century, paper money became known in Europe through the accounts
of travellers such as Marco Polo, that entitled one of the chapters of his book Il
Milione "How the Great Kaan Causeth the Bark of Trees, Made into
Something Like Paper, to Pass for Money All Over his Country."
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History of money
Printed Money
The richest merchants in Europe, especially in Italy and Flanders, copied the
concept, and started soon trading using promissory notes instead of coins.
The issuance and the practical use of paper money thus remained in the hands of
traders for a long time.

In 1660, the Stockholms Banco, Sweden’s first bank, was the first to start
issuing deposit certificates that resembled modern banknotes. However,
since banks issued notes far in excess of the gold and silver they kept on deposit,
public confidence was low, and only the notes issued by the largest, most
creditworthy banks were widely accepted.

To reverse this trend was the Bank of England, that in 1816 for the first time tied
the value of its banknotes directly to gold. In the United States, the Gold
Standard Act was officially enacted in 1900.
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History of money
Fiat money
During the 20th century, banknotes issued by private banks were gradually
replaced by banknotes issued by the national central banks.

The Bank of England was granted sole rights to issue banknotes in England
after 1694. In the United States, the Federal Reserve Bank was granted similar
rights after its establishment in 1913.

Due to the debt contracted to finance the war in Vietnam, in 1971 the Nixon
temporarily cancelled the direct convertibility of the dollar into gold, with the
purpose of revaluating the currency. The measure became official and permanent
during 1976.

From this moment onwards, the international monetary system was made of fiat
money: a currency without intrinsic value established as money by
government regulation.
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History of money
Digital money
In 1946 John Biggins, a banker in Brooklyn, introduced the “Charg-It”: the first
modern credit card. Four years later the Diners Club released its own card, that
allowed to pay in more than 20 restaurants in New York without the need for cash.
By the end of the 1960s, American Express had become the first credit card
accepted worldwide.

The evolution of digital payments has since made a considerable number of steps
forward, among which we must mention the invention of PayPal, whose reliability
in ensuring the success of Internet payments lead to proliferation of web-based
businesses, and the first payment systems via smartphones, such as Samsung
Pay and Apple Pay.

As we have seen, during the course of history man has made many compromises
in order to obtain a stable and largely accepted currency. We started from
exchanging intrinsically valuable assets and ended up exchanging entries on
digital databases, whose ownership is legally entrusted to central entities
such as banks and national governments. Money as we know it evolved
converging on centralized entities.
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History of money: the case of Yap Island

450 km
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History of money: the case of Yap Island

• «Easily» storable and retrievable
• Everyone agreed on their value

• Useful to keep track of credits/debts and to

represent the price of goods/services

• Facilitated trading
• Easily divisible/transportable?

Value is not determined by the possession of the physical

good, but by the fact that everyone knows who is the owner
of a stone. In other words, the Rai stone acts as a ledger
containing the financial balance of each individual
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History of money: the case of Yap Island

450 km
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Bitcoin as the digital Rai Stone

Why Rai Stones are the most similar thing to Bitcoin in the whole history of money?
We will see it in the next lesson!