In the 80’s, the band Dire Straits released an iconic song, Money For Nothing, a social commentary on how easily money seemed to flow to some people. As confidence returns to the world economy, and stocks keep rising to new highs, one would be forgiven for thinking the song was about investors in cryptocurrencies. In the past year, the appreciation of the ‘cryptos’ has been unparalleled. Annual growth on a percentage points basis has been in the tens of thousands and the internet is full of treatise on what cryptocurrencies are, how they function and which ones will boom next. Last year, the combined market value of the cryptos is over $540 billion. That’s not really the full story though.
It’s unclear at this point whether cryptos are workable, or a positive influence. Titans of the financial world such as Warren Buffett and Jamie Dimon have outright panned the concept of cryptocurrencies, and Joseph Stiglitz, the godfather of modern economic theory, believes cryptos are a serious bubble. Governments (as slow as always) are catching up and have decided that greater regulation will be required, and in the meantime, crypto trading could be (and in certain places is being) made illegal. However, to understand cryptos, we need to understand what has gone before. We need to understand the history of money and trade. Humour me, let’s do a quick and dirty recap of world economics.
To simplify a highly complex evolutionary process, thousands of years ago, trade was primarily conducted through a barter system. If I had a dairy farm, and you had fields of wheat – we could trade by exchanging cheese for bread. Over time, certain commodities began to be perceived as having more value. For a point during the Greek civilisations, this was in the form of salt. For the ancient Romans and Cartheginians, it was olive oil. More recently, in the latter part of the 20th century, crude oil took the mantel. As mining of earth metals continued over the millennia, human magpies naturally gravitated towards gold, silver and bronze. These metals, with no inherent value of their own, except what human civilisations have attributed to them, began to form a system of currency. Instead of someone building you a table in exchange for loaves of bread, you could assign a certain weight in gold, silver, or bronze to the value of that work. So what really happened was that the new found consistency with which value could be attributed to commodities, allowed the barter trade to become a bit more organised. Eventually, many began to realise that there simply wasn’t enough of these rare metals to have in circulation at all times; and so alloys entered circulation. Remember, there is no inherent value of a substance that can be found by sifting through rivers. Value is attributed by our perception.
Somewhere down the line, and I won’t pretend to know when exactly (said to be around the time of the Tang Dynasty in China, c.600-900 CE), credit notes began to enter circulation. In other words, IOUs. The concept, of course, was that you could present this note and be given coinage in exchange. Europe caught on to the practice, of what became paper money, several centuries later. By that point, collective perceptions began to form. With organised financial systems becoming more elaborate, more nuanced transactions became possible. If I had an IOU for 50 ducats issued by Marco from Venice, I could travel to Florence and have 50 ducats paid out to me by another branch of the bank that knew and trusted Marco’s financial fidelity. Think of this as the earliest credit ratings. Traders would foster reputations for being trustworthy and good for the money. As the prevalence of these IOUs increased, so did the belief in their value and convertibility. This is one of the most important traits of the concept of money – that you must be able to convert it into something of real value. For a significant time during the modern era of financial workings – people didn’t lose sight of the fact that the paper in and of itself had no value, it was the promise of what it gave you access to that caused it to have value. As this confidence in the ‘system’ grew, our perceptions changed. Why not just pay for that new acquisition with the ‘cheque’ (for all effects and purposes) that someone else gave you when they bought something off of you? If we believe it, does it matter if it’s true?
States rise and fall, but undeniably, since the Treaty of Westphalia, borders have become more consistent and the concept of statehood has become far better defined. In order to be a state, you must also have control over an exchequer, and be responsible for the balance of trade with one’s neighbouring states. Of course, these concepts have been around for longer than just the last 200 years, but in recent times things have become a bit better defined. There was a time when every dollar, pound, franc, lira, yen, ruble and so on, equated to the level of a state’s stock of gold. This was called the gold standard. In theory, you could literally walk into a bank and exchange your pieces of paper for the gold they represented – a system that lasted over a millennia. Then times changed. After 1945, reflecting the post WW2 power balance, the dollar became an intermediary for the gold standard. The dollar was pegged to gold, and other currencies were pegged to the dollar. This still meant that an indirect gold standard existed. You could calculate how much gold you had a right to by the paper in your pocket, but you as a citizen couldn’t exchange that paper for gold. A lack of faith in the US meant that many states, which could still convert their money into gold, ended up depleting the US gold reserves. Now we’re getting closer to the world you’ll recognise. In 1971, the US dropped the gold standard. The result? Well, paper money suddenly became valuable, because everyone believed in it. You see, the financial world is like Peter Pan’s Neverland, to misquote Tinkerbell – every time you say you don’t believe in the value of money, a banker dies. All the world is made of faith, and trust, and pixie dust.
How does that relate to Bitcoin, Ripple, Ethereum or any number of the cryptos? Very simple. Many of you, dear readers, will already be wondering – what on earth is paper money? In cities like London, you could have easily gotten by for the last 3-5 years without having used any paper money or coins at all. Since the advent of contactless cards, ApplePay and the like, it’s become even easier to never interact with a single piece of paper money. Living almost anywhere in the world, most people with bank accounts can now rely on online or mobile banking rather than receiving bank statements. Take a moment to think about it. Your entire wealth exists in pixels on a screen. It is not linked to anything tangible. You can not convert it into anything other than limited supplies of paper, or pixels in another country. It has no value, except that which society attributes to it. If tomorrow, even a quarter of the populations of the UK, US and Germany decided to try and convert those pixels into paper and coinage, it’s very possible the entire world financial system would collapse. The reality, though, is that we all believe in this system. It’s money for nothing!
The initial boom in crypto trading can clearly be linked to money-laundering. This is more because of the unregulated nature of cryptos and the speed with which transactions can take place on the blockchain. The blockchain technology is certainly of value – it can be used in everything from finance to medicine to track and encrypt events in a decentralised, encrypted, online, public ledger as they take place with little risk of forgery or loss. The public element of this means that one can trace back through the different transactions. So, really, blockchain is not the ideal platform for money launderers. If anything, it’s a great evidence trail. Many a criminal enterprise was taken by surprise when their small time efforts to launder say, a few hundred thousand dollars turned into tens of millions practically overnight…back to thousands, and then back to millions. It’s a rollercoaster, not for the faint of heart. Possibly the best way to invest in cryptos, is to put down a sum you’re willing to lose, close your eyes and ears and then look back in a few years. If you’re lucky, you could become an accidental bitcoin millionaire like the rapper 50 Cent!
Cryptos are simply the natural next step in the journey the world financial systems have taken. In theory, they could lead to a bubble, the likes of which we have never seen, decimating the wealth of millions of ‘true believers’. Every time the price of a ‘coin’ dips, tens of thousands take it as an opportunity to invest more in cryptos – they keep doubling down on the bet. It’s almost an addiction. What it really is, is belief. These people are investing the money that the majority of us believe has value, into what they believe is going to have a similar, if not exponentially greater value in the future. If it all comes crumbling down, it’s going to hurt a lot of people. It’s boom or bust. This boom has been driven by the imagination of the dreamers. The new digitised class of tech geeks and futurists. A systemic widespread failure in the current financial system and the political class’ failure to address the inherent disparities in society have meant that many people globally have lost faith in governments, and their instruments.
All power corrupts, and absolute power corrupts absolutely. What do you do when you don’t trust the currency systems in place? In the uber generation, you take matters into your own hands and create new currencies that people do trust. The problem, of course, with cryptos is their volatility at this point. They are conveying value more like commodities than true currencies. However, if history (and we’ve done a brief run through) has taught us anything, it is that belief is more important than reality. The key will be the day an entity like Starbucks or McDonalds start accepting payment in cryptos (and it’s going to happen sooner rather than later), then, all bets are off. Despite this, inherently, cryptos have no value. Then again, nor does a greenback with a presidential face printed on it. The future is decentralised. Whether it is free or not, that remains to be seen. Can we afford to deny cryptocurrencies of their legitimacy? In doing so, would we not be denying the very legitimacy of the system of money that underpins everything we do anyway? The world is resistant to change, and people are inherently conservative. Most of all, the old white men that run the world finance have become the slowest to react. This week at Davos they hinted at accepting what many of us knew to be inevitable. Cryptocurrencies will take over, they’re here to stay. The reason is simple – we have come way too far down the yellow brick road to turn back now. Money has truly become an imagined concept, so grab on for dear life as we go fully digital. Toto, we’re not in Kansas anymore. Welcome to the Blockchain.