A Guide to Consensus Algorithms on Blockchain Networks Part 3

Short history of money. Fiat currencies.


Cryptocurrency networks do not just remove third parties such as merchant account services and banks from the financial transactions between individuals. Essentially, they are the new money because they remove the official governments from issuing money. While it may seem that having governments be the third party in control of the money can only be beneficial, history shows that putting government in charge of money can also lead to serious problems in the lives of individuals and existence of societies.

This is the reason why conversations about cryptocurrencies and blockchain very often turn into political and philosophical discussions about societal governing systems, philosophy, freedoms of individuals and so on.

This article will not take any political or philosophical sides and will simply discuss the issues with governments being in charge of the financial systems from the factual perspective (for example, no matter what the philosophical stance of a person, the person can’t argue with the statement that all government currencies in the world today are fiat currencies. This is a simple fact that is easy to check and verify).


Brief history of money. Pre-fiat money

Historians disagree about the exact dates and origins of money, but most of them do agree than initially people traded goods directly and used livestock, grains and salt as money. Originally, it was items that had undeniable value that were used as money because everybody could agree that, for instance, cows had value in the form of meat and milk and chicken had value in the form of meat and eggs. As the human society was developing, the labor was diving, the quality of the products and services was going up and people were getting more and more of their needs met. Eventually, this led to the appearance of commodity money. Gold coins and silver coins are examples of commodity money. Commodity money has two tiers of value. First, it has value as money, as a medium of value exchange. Second, it has intrinsic value. For example, gold is scarce in nature, it is one of the best conductors of electricity and it does not lose its form or shape easily. Silver has similar properties, having high conductivity for both heat and electricity. This means that even if you were to visit a society that did not know about the existence of your gold or silver money and had no use for it, your money would most likely still have value because of the properties of metals it has been made of. The society would not be interested in the money aspect of your metal, but would most likely have use for the metals because of their properties and you’d be able to exchange the metal into whatever form of money the society had.

Eventually, people started printing paper money. Some of the first paper bills were circulating in China in the eleventh century. The governing bodies all over the world quickly noticed the advantages of paper money: it was easy to transport and convenient to use. Paper money started to become popular in Europe towards the end of the period of the Middle Ages. For centuries, paper represented commodity money. This means that while a society would be using paper, the paper would only represent value and the governments would store precious metals and potentially other commodities somewhere. Users of the money could always exchange paper for gold or whatever other precious commodity the government was storing as a form of value.


Fiat money

Fiat money is money that does not have any intrinsic value. It is money and people and organizations only use it as money because the participants of the system have agreed that this is money. There is nothing else to it. There is no gold, silver, or anything else backing a fiat currency. Fiat currencies started becoming popular in the twentieth century and eventually all the countries in the world switched to the fiat system. There was simply no incentive for countries with commodity currencies to store the commodities when many other countries were not storing anything and the system worked just fine.

The United States has delinked the United States dollar from gold in 1971, during the administration of Richard Nixon. The last country to switch to being a fiat currency was Switzerland in 2000.


Disadvantages of fiat money

Fiat currencies have a lot of advantages. They protect countries from the booms and busts of the markets of natural commodities and give governments a lot of power and flexibility when it comes to the creation of monetary policy and management of the economy, including supply of credit, setting interest rates and so on.

However, the goal of this series of articles is to explain how cryptocurrencies can become new money and how they function. Cryptocurrencies came into existence because the system of fiat currencies has a lot of problems, which is why the next part of this series of articles will examine the problems with fiat money and point out what problems digital money and cryptocurrencies are trying to solve.