The Evolution of Money - Bitcoin Foundations

Money is often taken for granted as a part of our daily lives, but it is important to remember that it did not always exist in its current form. The journey from a simple collectible item to a widely accepted unit of account is a complex one. Before a good can be adopted as money, it goes through several stages of evolution.¹ In this article, we will explore the steps that a monetary good must go through in order to become adopted as money.

Stages of Evolution

The transition from a market good to money is a gradual process, involving four key stages.

1. Collectible
2. Store of Value
3. Medium of Exchange
4. Unit of account

Collectible

Money, in its earliest form, starts as a collectible. This means that people begin to value a particular market good, not just for its utility or practical use, but for its unique characteristics. It could be something as simple as the weight, feel or look of a sea shell or particular metal.¹ As more people begin to see the value in these items, they start to accumulate them. As a collectible, these items are not yet widely accepted as a means of payment, but they have begun to gain value and recognition in their own right. As they gain value over time, it transitions into the next stage.^1,2 There was a time Bitcoin also underwent this stage. In its earliest days it had no value to purchase other goods or services. It had perked the interest of a handful of computer nerds for its rare digital properties and was used for nothing more.²

Store of Value

A store of value is something that holds its value over time. As people begin to trust and accept a market good as a collectible, they also start to see it as a valuable asset to hold on to. This simultaneously increases demand and reduces supply, resulting in volatile growth of the good (higher purchasing power over time).^1,2 Things like gold or other precious metals have historically been used as a store of value. Other examples of stores of value used today include land, property, and stocks. As the market good gains acceptance as a store of value, it becomes more widely accepted as a means of preserving wealth.² Once the market approaches saturation, the volatility of its value will diminish. This phenomenon occurs because as an asset grows, the liquidity of the market for that asset increases, and so takes more to move the market up or down.² You can think of it like the difference between a puddle, a lake and an ocean, each having progressively more “liquidity”. To make the water level rise and fall, it takes the force of a kid for the puddle. For the lake, it’ll take at least a large boulder. For the ocean, it’ll take the moon. As an asset matures, it takes more capital to move the price up or down and so reduces volatility. This is also the stage in which you can benefit the most, seeing the greatest return in value of any stage. This is the stage which Bitcoin is currently in. Once the opportunity cost of significant price rises begin to diminish, people will be more willing to part ways with it to exchange for other goods and services. This further increases supply, eventually stabilising the value by arriving at an equilibrium, where it can transition into its next stage.²

Medium of Exchange

A medium of exchange is a good that is acquired for the purpose of acquiring other goods (the example of Bob and Alice in our previous article would be best to explain this). Once the volatility of a desired money diminishes, it can be better used as a medium of exchange. If you were expecting gold to rise 400% in the year, you would be less willing to part ways with it to buy something like a pizza. If it was only expected to move 1% in the year, it would be easier to convince you to give it up for other things.² After a reasonable history of price stability and use as a medium of exchange is established, the asset can proceed to the next and final stage of its evolution.

Unit of Account

Once a monetary good has established itself as a medium of exchange, it is used widely enough to become the good that all other goods and services are measured against. A unit of account is a standard measure of value that is used to price goods and services, and to record debts and credits. It also allows for the comparison of relative value. Throughout history, different societies have used various forms of units of account, such as grain, gold, silver, and paper money.² It is important to remember that these transitions aren’t absolute. They often occur in tandem with a lot of overlap. For instance a money can be used as a collectible, store of value, medium of exchange and unit of account at the same time by different individuals. The change between stages best reflects the change in how most people are using the monetary good at any given time.

Volatility, is it bad?

The question of whether volatility is a good thing or a bad thing really depends on which stage of the evolution we are talking about.

During the collectible stage, the monetary good has no purchasing power and so by default, there can be no volatility. Although it may have value to an individual, it will not have value for trade with someone else.

During the store of value phase, volatility to the upside is often seen as a good thing. This is where you can gain the greatest purchasing power of any given monetary good.

During the medium of exchange phase, volatility is considered a bad thing. In Argentina, the currency is so volatile that menus in some restaurants are no longer printed. They have QR codes that display a digital menu with up-to-date prices minute to minute. If you were to accept Argentinean pesos in the morning, you take a real risk of a significant reduction of value by the afternoon.

During the unit of account phase volatility is neither good nor bad. If the currency is a true unit of account, liquidity would have reached its absolute maximum and price fluctuations should be accurate representations of what the collective free market is doing. Accuracy is the most important feature when money is utilised as a unit of account. If there is volatility, this is a reflection of the volatility of the goods in that economy. Just like degrees celsius and centimetres are units used to measure temperature and length, a monetary unit of account measures value.

Note that this is only true if the unit of account is reliable. If your local currency is doubled in supply, it would be reasonable to expect the average price of goods and services also to increase. It’s akin to having a stretchy rubber ruler to try and measure a table. At some point, you are better off using the table to measure the “ruler”. These days many countries actually do this and have adopted a separate number called the CPI (Consumer Price Index). This number is used to measure the degree of error of their “unit of account” against other goods and services.

Bitcoin fixes this and we will discuss the phenomenon of inflation further in the Austrian Economics Series.

Money Trends to One

We discussed in our previous article why money is simply the most saleable good in an economy. The key here is most, which means, naturally, there can only be one.³

Money may differ in different places if there are enough barriers. One society may use sea shells while another may use gold simply because the two economies are separated far enough by distance to never interact. These days we live in a very connected global economy, and the barriers in modern times are different. Sovereign nations may impose physical borders, capital controls, and legal tender laws in order to monopolise the local currency.⁴

When a local currency collapses and such barriers can no longer be imposed, it often reverts back to a free market natural selection of money. This happened with the hyperinflation of Weimar Germany in the 1920s. People used foreign currency, such as the US dollar, as a more stable form of money. It also occurred in Argentina in the early 2000s. The Argentinean peso experienced severe devaluation and people used the US dollar as a more stable form.⁵

The Internet revolution also brought a dramatic reduction of barriers to the global economy. As encryption technology improves, information and communication become increasingly harder to control. Will a single global unit of account form over time? It’s hard to predict, but these factors make that scenario increasingly more likely.

In the next article, we’ll go into the common properties of a monetary good that increases its chance of being freely adopted as money. We’ll also discuss what occurred historically when these properties were violated.

References

Szabo N. Shelling Out: The Origins of Money. Nakamoto Institute. 2002. Available from: https://nakamotoinstitute.org/shelling-out/ [accessed 25 November 2022]
Boyapati V. The Bullish Case for Bitcoin. Medium. 2018 Available from: https://vijayboyapati.medium.com/the-bullish-case-for-bitcoin-6ecc8bdecc1
Menger, C. (1892). On the Origin of Money. Economic Journal, 2, 239-255.
Murphy R. Cooperation, Enterprise, and Human Action. 1st ed. Independent Institute; 2015.
Eichengreen B. When Currencies Collapse. Foreign Affairs. 2012 Jan-Feb. Available from: https://www.foreignaffairs.com/world/when-currencies-collapse

These articles were designed to make these concepts more palatable. If you’re interested in reading a more in-depth perspective on the concept of money, consider the following:

Robert Breedlove, “Money, Bitcoin and Time“ Saifedean Ammous, “The Bitcoin Standard: A Decentralised Alternative to Central Banking”. Wiley, 2018
Vijay Boyapati, “The Bullish Case for Bitcoin”
Robert Breedlove, “Masters and Slaves of Money“
Nick Szabo, “Shelling Out: The Origins of Money“

Ruki is a passionate Bitcoin educator who firmly believes in the principles of the Austrian School of Economics. As a sound money advocate he recognises its benefits to individuals and society as a whole. He is dedicated to empowering those without financial access to take control and build a more secure future.