Ever Since humans figured out getting along with one another is the best thing for survival and co-existence, they started trading goods and services. Primitive people lacked sophisticated market and financial systems and they were simply exchanging things of value among each other. This system is known as barter system and it had few problems.
Problem - Mutual Value
Parties involving in a transaction should have things of value for each other, otherwise the transaction may not happen.
E.g. If I make wrestling cards and you make jumbo jets, you can’t buy wrestling cards from me if I don’t want your jumbo jet.
Problem - Value Matrix
Parties involving in a transactions should figure out relative value of each others goods or services. This creates huge complexity essentially requiring an infinite matrix of all goods and services in the world to facilitate free trade and to add to the complexity you should account for fluctuation in the market on a constant basis.
E.g. If you are selling your jumbo jet in exchange for wresting cards you should know how many packs of wrestling cards the jet is worth. If you are selling for kittens you should know many kittens its worth. If you are selling for corn flakes, you get the point. right.
Problem - Value Matching
In certain scenarios value can’t be split easily.
E.g. If we figure your jet is worth 4000 packs of wresting cards and you want to buy 2000 packs from me, how would we split the jet? Thus no transaction would occur.
Beyond barter system
To solve above problems in barter system merchants figured out it would be easier to have a common commodity that has value to (almost) all parties and trade their goods and services relative to it. Salt and gold were the mostly used two common goods that had value for almost all merchants. Over time salt gradually lost its value due to efficient production but that is another story. So, gold became the commodity against which all other goods and services were valued against.
Gold is harder to carry around and store so there were logistical problems. To work around this people made gold deposits in vaults and traded the receipts instead.
These gold receipts were the first version of modern currency. These receipts were issued by vaults in exchange for gold. These vaults were run by private entities.
As governments gained more power it took over the entire vault system from the hands of private entities and maintained its monopoly over storing of gold and issuance of currency.
In the earlier days currencies were synonymous with gold receipts. For every unit of money in circulation there was equivalent amount of gold in the vault somewhere which the holder of the money can claim anytime.
Gold to Fiat
As governments became the sole authority in issuing money, they started printing out more money than there was gold in the vault for various reasons.
As currency started out as receipt for gold, governments had the obligation to give corresponding gold for the currency if a citizen chooses to claim his or her gold. Since governments has printed disproportionate amount of money than the available gold in treasury, they had to do something about the situation.
Meanwhile governments noticed almost no one redeems gold for the currencies and most people of the newer generation doesn’t really know how the whole monetary system really works, they came up with a plan to entirely move away from the gold backed currency system. The gold standard was successfully abolished by president Nixon in 1971. Since then all money issued were not backed by anything but government promise. This type of currency that is not backed by anything of tangible value is called Fiat currency.
Even though a currency not backed by anything is evil as it gives lot of power to the issuer of currency which in this case is the government. It surprisingly works. It is safe to say almost all the value transactions in the world for the past 50 years were done using fiat currencies.
Fiat currencies demonstrate an interesting phenomenon that we otherwise wouldn’t have discovered. No matter how stupid and evil the underlying mechanics are, the mere act of participating parties believing something has value makes the financial world go round.
Bitcoin the Fiat currency
Bitcoin is an Open Source, decentralized currency that does not require trust in any particular entity. Bitcoin differs from government issued fiat currencies backed by unverifiable government promise by offering more tangible and solid promise backed by math and cryptography that anyone can verify.
Government Fiat vs Bitcoin
Since government issued currencies are backed by nothing of value, anyone can print a same looking currency bill and start circulating it. In such a scenario there is actually no difference between government issued currency and counterfeit currencies except the issuer, since both of them are backed by nothing.
Even though Bitcoin is also not backed by anything of tangible value, It delivers on certain promises that government issued fiat does not. Some of them are:
Impossible to counterfeit
The number of counterfeit Bitcoins in circulation is zero. Thats right. Since, Bitcoin is based on cryptography and every unit has to be verified for each transaction its impossible to have a counterfeit unit of currency in Bitcoin network.
Inflation in simple terms is increasing the total amount of money is circulation. Governments inflate the currency by printing more bills. So why is it important to have inflation under control you ask? Lets say there are only 10000 units of currency in circulation and you have 100 of them. That means you have 1% percent of total money supply and you are uber rich, now you probably realize you are not rich because you have 100 units, its because you have relatively large portion of total money in circulation. Lets say government prints another 10000 units, now you still have the same 100 units with you but now you only own 0.5% of the total 20000 units in circulation. Thus increasing the money in circulation makes you poorer even if the amount money you posses doesn’t change. Therefore inflation is a serious problem that needs to be addressed.
Bitcoin addresses inflation with a set of rules for adding units to total supply and the total number of units in circulation will never exceed 21 million.
Low barrier to entry
Bitcoin is an open protocol upon which anyone can easily build tools and services to improve overall experience for Bitcoin users whereas working with government currencies and financial systems requires lot of paperwork and huge overhead because government fiat is not built upon solid foundation and allowing untrusted parties to participate in the ecosystem will render the system broken.
Fiat of the future
Finance world is working with government issued fiat currencies for well over 5 decades midst all its flaws. Now a clearly superior fiat currency has emerged in the form of Bitcoin. It is inevitable, for a superior solution to replace the inferior one. Thus Bitcoin ( or possibly a better alternative cryptocurrency ) will be the standard fiat currency for a long time.
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