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The history of money and bitcoin.

Bitcoin reached $12,581.74 as of December 6, 2017. The incredible and sudden rise in its exchange value has made a lot of people wanting to own one. Before we put in our savings into this, we need to have a clear understanding of what it is and what is its purpose. Investing requires prudence, and its basic rules is summarized as 'do not put your money in something that you do not understand.' With this perspective, let us understand what is bitcoin.

Bitcoin is a currency that was created in 2009. It was the first of what is now known as a cryptocurrency or digital currency. Unlike national currencies like our peso, cryptocurrencies have no backing of a central bank and there are no physical representations like paper bills and coins. They are created by using high-powered and high-performance computers working together to validate and secure the system allowing for transactions.

But why were cryptocurrencies invented? It would be good to look back at the history and purposes of money which is exactly what cryptocurrencies want to be. Consider this, without money, we will be reduced to a barter or exchange economy. For example, a barber who wants to eat at a burger joint needs to find a burger-joint owner who wants a haircut. What if he cannot find one and vice versa? This is why we have markets where we can buy or sell goods and services using a common medium of exchange called money. Initially, money was represented by perishable items, such as pepper corn and rice. However, since they are perishable, their supply is unstable and makes it difficult to use them to store value for future purchases. Likewise, it is difficult to standardized their unit of measurement. A kilo of rice may be equivalent to one pair of shoes but of what size? These difficulties were solved by the introduction of what is known as precious metals represented by gold and silver, among others. They serve all three needs for money, i.e., a convenient medium of exchange, store of value and stable unit of measurement. However, their weight made it inconvenient to carry and use them. Eventually, the metals were deposited in banks and people buy and sell using a note issued by the bank with claims on the precious metal deposits. People can just get them using the notes issued by the bank. Fast forward, the link to precious metals in deposits were later removed giving rise to what is known as fiat money.

Fiat money, or the money we have today, has no material value. The value of the Philippine peso today is what we as a nation believe its value to be. It is invented mainly for efficiency or to remove the costs involved in inconveniences. With fiat money, we can do two things with it-we can use it for transactions and we can use it for precautions or saving for future use. Since different people have different needs for money in different times, there needs to be a coordinated mechanism that is managed centrally. This gave rise to the central bank. The central bank determines how much fiat money to print. Unlike precious metals which have a finite amount to be mined, fiat money in circulation is determined by the central bank. It prints more if it perceives there is need for more money in the system or holds printing if not. Too much money in the system could lead to inflation or high prices. In our recent history, the interconnectivity of global financial markets has led to a number of banking crises due to over or undervaluation of fiat money.

Bitcoin came out in 2009, just after the 2008 global financial crisis. It appears to serve as an alternative to the existing financial system. It satisfies the requirement for money, i.e., store of value, unit of measurement and medium of exchange (although not yet at full level). At present, it is limited with its transactional use, but heavy in its precautionary use. It is designed to be like precious metals, i.e., having limited availability over time. This way, its value is not based on what central banks decide to print but intrinsically. Bitcoins are mined electronically similar to gold and silver. The total number of bitcoins will be about 21 million by the year 2040, today it is about 13 million. This seems to be the driver of its current exchange value-people anticipate that since its availability is capped in the future, it is anticipated to increase over time.

This basic comparison with money gives us a perspective of what bitcoin is. It's complicated and technology-dependent process requires more understanding as to its future acceptability. For it to function as money, all people must believe that it is one.
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Publication:Business Mirror (Makati City, Philippines)
Date:Dec 7, 2017
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