Introduction

There is no doubt that currency is an important cornerstone of modern civilization. For thousands of years, it has always been a language of value, effectively promoting trade between people and supporting them to accumulate the fruits of their labor.

Broadly speaking, currency is defined as a widely recognized method of payment for goods and services. Many social groups around the world have given rise to many different types of currencies. There are so many that it is difficult for us to systematically sort out all currencies.  

In this article, we will introduce the differences between commodity currency, substitute currency and fiat currency.

Before the advent of money: bartering

Bartering is the exchange of goods and services for Other goods and services. Interestingly, this behavior occurs in many different situations in life. Many species in the animal and plant kingdoms have reached a tacit agreement - a symbiotic relationship, in which both parties benefit from each other and help each other. For example, the Acacia angustifolia tree provides food and shelter for ants, protecting themselves from parasites. Zebras and rhinos allow woodpeckers to clean insects from their skins, and the birds are fed food.

Of course, humans have a more complex way of exchanging value than the above species. Before the advent of money as we know it, barter was common practice.

The following is a simple example. Suppose you have a coat and your neighbor has apples. She's cold and you're hungry. So, you exchange the coat for twenty apples. Both parties exchange what they have and what they have in exchange for what they need.

However, this is just a simple transaction case. After a while, you want more apples, but your neighbor's new coat will last you for many years. When offered again to trade coats for apples, she may not need the deal. At this time, the neighbor needs to go refuel, but the gas station owner is allergic to apples and will not allow her to exchange apples for gasoline.

This phenomenon is called Conformity of Demand in economics. When you have something the other party wants, it is easy for both parties to make a deal, and vice versa. If the needs of both parties do not match, it will naturally be difficult to establish a transaction.

Commodity Currency

Commodities are raw materials that exist in a certain way (i.e. they haveintrinsic value). This definition covers a wide range of commodities - from metals such as gold, silver and copper to consumables such as wheat, coffee and rice.

Therefore, commodity currency uses commodities as currency. You're unlikely to consume oil in your local store, but throughout history there have been countless examples of utilitarian raw materials being used as currency.

For example, in the 17th century, tobacco was officially recognized as legal tender in Virginia. As Nick Szabo described in his influential paper "Shelling Out: The Origins of Money," American Indian tribes used wampum (beads made from clam shells) ) with shells as a means of payment. Like Virginia tobacco, the commodity circulated as legal tender for decades.

On the surface, commodity trading does not seem to be much different from bartering. After all, if you have a book and are willing to trade it for rice, this is clearly the same trading behavior discussed above.

Functionally speaking, this is indeed the case. Commodity currency acts as a medium of exchange. At this point, you want rice to become widely used as a method of payment for goods or services. Therefore, unlike the barter economy where goods and services are exchanged, rice will become an attractive medium of exchange for many transactions.

Thus, you may be more inclined to calculate the value of the book based on the purchasing power of rice. When you accept payment for rice, you don't necessarily have to actually eat that much rice, but you can exchange the rice for a variety of goods. If the good in question is so prolific, it can also become a unit of measurement upon which other goods are priced. In such cases, the amount you pay for coffee is likely to be expressed in kilograms of rice.

Commodity currency can eliminate the problem of demand consistency in barter scenarios. You can take the commodity currency away and conduct other transactions.

Precious metals such as gold and silver are perhaps the most famous commodity currencies. Gold has always been active in civilized society, both as currency and as an industrial metal. To this day, gold coins and bars remain the poster child for value investing. Investors convert wealth into precious metals for future use. There are many reasons for advocating gold. We have discussed in "Is Bitcoin a Value Savings Tool?" 》The article discusses its monetary function.

Commodities are still active in the market. However, as monetary instruments, they have long since been replaced by other forms of money.

Substitute currency

Commodity currency is an upgrade of the barter system. Its own shortcomings cannot be ignored and it is convenient. Sex is even more widely criticized. While you could tuck a few gold and silver coins in your pocket and conduct small transactions, this approach wouldn't scale.

Nowadays, using coins to buy expensive goods is obviously unrealistic. Assuming that Bitcoin is bought at a unit price of 8,000 euros, the weight of the required coins can reach about 60 kilograms.

After the advent of commodity currency, substitute currency emerged, becoming a more portable alternative supported by commodities. Alternative currencies have been active at different times and have emerged around the world. Essentially, it involves a central issuer whose certificates can be redeemed for a certain amount of goods.

You can bring proof of ownership without having to carry pounds of gold and silver. At any time, you can exchange the materials for real money through the issuer. Alternatively, you can transfer the materials as payment to someone else, who can redeem them through the issuer. The above mechanism follows the same basic principles as stablecoins.

Private companies issue substitute currencies from time to time, but the issuance scale of the central bank is larger. You're probably very familiar with the gold standard, which was the monetary policy adopted by many governments whose currencies were backed by gold. This may seem a far cry from the current system, but less than a century ago you could take banknotes to a bank and exchange them for precious metals.

From an economic perspective, this also has some substantial advantages. The gold standard is of great significance and is still synonymous with substitute currencies. The first major advantage is that despite increased government intervention, it is difficult for inflation to devalue the currency. Governments cannot issue more banknotes than they can hold, at least in theory. Unfortunately, it is easy for banks to implement fractional reserve policies (which are extremely attractive) because they print more money than they store gold.

The gold standard system supports people to use gold transactions without having to carry a large number of gold coins or divide gold into small change for consumption.

Another major advantage of this monetary system is inseparable from gold's long-term recognition by the international community. If the domestic economy is centered on gold, countries that adopt the gold standard can conduct global resource trade smoothly and unhindered.

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Fiat currency

Today, alternative currencies are no longer mainstream. The demise of the gold standard gave rise to a new type of currency that could be promoted globally, one that was completely detached from commodities.  

In short, fiat currency is currency issued by the government (the term fiat currency is derived from the Latin word meaning by decree). The US dollars, Mexican pesos, Japanese yen, and Indian rupees we use today are all typical fiat currencies.

The value of legal tender is closely tied to the decisions of governments and central banks. At its core, fiat currency is a paper note with value, the value of which is backed by a government agency.

It is important to note that while currency is occasionally viewed as a new invention, fiat banknotes date back to 11th-century China. After that, experiments were carried out for hundreds of years in Europe and America in the 17th century.

Unlike the types of currency we discussed above, fiat currency has no scarcity. Unlike agricultural products or refined precious metals that have to wait for a good harvest, printing banknotes is simple using readily available materials. Freed from these constraints, entities like the Federal Reserve can print new money out of thin air.

The issuance of legal currency is regulated by the authorities, which is its greatest advantage and also its greatest disadvantage. Supporters of the fiat currency system believe that increasing the money supply will help the government flexibly respond to financial crises or carry out macro-control. By controlling money markets and interest rates, the government also has complete control over the country's financial markets.

Interestingly, opponents of fiat currencies make the same point, albeit in reverse. One reason why government monetary policy is criticized is that inflation eats away at the wealth of fiat currency holders. If not properly managed, it can trigger severe inflation (hyperinflation), leading to complete currency devaluation and causing huge economic and social turmoil.

Where do cryptocurrencies come from?

Bitcoin is recognized as digital cash and digital gold. On the one hand, it imitates many of the attributes of money in commodities (i.e., homogeneity, divisibility, and portability), making it an ideal medium of exchange.

On the other hand, the stored-value attribute makes Bitcoin more and more popular. Proponents of Bitcoin as digital gold argue that its deflationary (more specifically “anti-inflationary”) supply policy helps maintain purchasing power over the long term. This is in contrast to inflating currencies such as the U.S. dollar, which can depreciate at the discretion of the Federal Reserve system.

On the surface, cryptocurrencies appear to be commodity currencies. Although they have no other use outside of the protocol, they are not currencies issued and backed by government entities. In the case of digital currencies, the value of the currency is derived from free market valuations.

Summary

As we have seen, money comes in many forms. Most people are used to thinking of value in terms of their national fiat currency, but these are a relatively new creation. The payment apps we use today are the result of thousands of years of currency development and evolution.

Cryptocurrency is a remarkable experiment as currency development opens a new chapter. If Bitcoin or other cryptocurrencies become widely adopted, it will undoubtedly become the first real example of digital commodities. Can cryptocurrencies break the global dominance of fiat currencies? We'll see!