If we want to understand why blockchain will disrupt and uproot our current monetary and financial system, we need to understand the following: the history of currency; what is a currency; why currency exists; and the relationship between currency and wealth. Then we look at three key aspects (money form, money issuance, and the flow of money as Influence Observation Factors, IOF for short)  of our monetary and financial system where the blockchain technology may have a significant impact. We believe blockchain will eventually bring about the best form of “freedom” that is most desirable of any monetary and financial system.

Currency and money form

Historically, humans needed to exchange commodities. The earliest form of exchange was barter. Barter trade is completed if only the two sides have complementary needs, or both parties need to trade the third commodity. As the frequency of exchange increased rapidly, that the third commodity, being a medium of exchange, which everyone wanted to possess became crucial. This “general purpose” commodity which is particularly handy for exchange activities then became what we now call the “currency”. In theory, if the commodity is treated as a medium of exchange, it can function as a currency. The commodity with attributes like scarcity, limited supply, and physical stability eventually turned up as the winner. There were once shell, silver, gold, stone, bronze, among others. As time passed and through what we may call natural selection of currency form, gold then became the most accepted form of currency around the world. It is extremely important that the currency as a form of wealth be kept stable for wealth inheritance. Historically, it was very difficult to refine aluminum, and so its price exceeded that of gold soon after its discovery. So aluminum was once a form of wealth. However, after the mass adoption of electrolytic production, the price of aluminum declined drastically. So, as a generally adopted currency and as a form of wealth, the currency form is of uppermost importance.

Money issuance

Using heavy metal as a form of currency, for example, gold had led to several important considerations in practice.

(1) Standardization. The authority normalized and unified the weight and measurement of gold, which was required for money flow, thus the exchange of commodity. Naturally, the power of supervision was vested in the authority.

(2) Non-equivalent exchange. The authority used less gold than what is needed in a fair deal or even other heavy metals in lieu of the gold. This way, by using less valuable currency in exchange for commodities, the authority stole value from us and gained their benefit stealthily. The authority could do that, perhaps illegally, because they control the currency issuance to a certain extent.

(3) Gold standard. For easy circulation, a handier form of currency such as paper was introduced, which is backed by fixed amounts of gold. Since the paper was much easier for exchange and to carry, it accelerated trade. This was a very drastic change. We needed to trust the institutions issuing the paper currency in terms of their worth as measured in gold.

With the development of international trade, gold became the most recognized heavy metal currency around the world. Also needed was a method to measure money and wealth that would be accepted by all. In 1867, the first monetary conference was held in Paris where participating countries agreed to a single gold standard, for the very first time [2]. Currency systems built around that gold standard prevailed. After WWII (or in 1944 to be exact), a world monetary system was built based on US dollars, which in turn was, as claimed, backed by the gold standard under Bretton Woods Agreements. Many countries then fixed their exchange rate relative to the US dollar, thus making all currencies pegged to gold at a fixed rate indirectly. This was the so-called Bretton Woods System. In 1971 with “Nixon shock”, US President Richard Nixon abolished the international convertibility of the US dollar to gold [1]. In March 1973, the fixed exchange rate system was abandoned. “By 1973, the Bretton Woods system was replaced de facto by the current regime based on freely floating fiat currencies”, which let the free market determine the US dollar exchange rates for other countries’ currencies. This marked the beginning of the collapse of the Bretton Woods System. Gradually, the whole world converged to the “national credit standard” where currency issuance was backed by national credit.

Flow of money

Traditionally, exchanging gold for the commodity is completed simultaneously in terms of ownership. Over time, we added more concepts to financialize our service: credit, mortgage, mismatch, leverage, futures, etc. Then the concepts of “payment, settlement, clearance” were introduced to describe the whole cycle of transacting. With more financial derivatives, we added substantially to the complexity of our financial system logic and its implementation. Consider any of today’s banking systems, it is virtually impossible to rebuild it with so many legacy data and subsystems. For cross border service among financial institutions, we are still using the arguably low-efficiency SWIFT protocol, which was first adopted in Brussels in 1973 as “a network that enables financial institutions worldwide to send and receive information about financial transactions in a secure, standardized and reliable environment.” [3] Because of all these complex systems and protocols, the bank charges us when we make payments, exchange foreign currency, and when we do remittance of any kind. They charge us for even the pettiest flow of money, and by that, they reap huge profits for their inherent low-efficiency services. Moreover, the poor suffered the most from these charges, who became slaves of the currency financial system. In the new blockchain system, both sides trade directly without a third party involved, and thus the trade could finish spontaneously. The concept of payment-settlement-clearance becomes redundant in the blockchain system, leading to a much-simplified money flow cycle. The cost of payment, trade, remittance, and even foreign exchange is nearly 0.

Blockchain and cryptocurrency

In 2008, Satoshi Nakamoto invented bitcoin, a peer-to-peer electronic cash system [4] and described blockchain the underpinning technology. Since then, bitcoin and blockchain have taken the world by storm and is hailed to be the answer for a perfect currency and financial system in the future. The issuance of bitcoins is by POW, a proof of work algorithm first proposed in 1993. By the algorithm, the issuance is reduced to the task of mining. This is an entirely new way of currency issuance. Gold mining is measured by human labor, whereas bitcoin mining is measured by computation power. The emergence of bitcoin and blockchain thus marked the beginning of the transition from a carbon-based civilization to a silicon-based civilization. A person tries to maximize their profit and wealth that is generally proportional to human labor. With currency being the main carrier of wealth can lead to different perceptions of money and wealth by the method of issuance of currency. Adopting the bitcoin method shifts our focus to computation power, for which there is still plenty of room for further advancement and innovation. The big open question here is that can we create a new world currency that can benefit (in terms of much-improved features and services) human as a whole in the long run? What currency issue rules should we adopt? Besides the traditional gold standard and then the current national credit standard, bitcoin and blockchain represent the third generation of currency issuance. Bitcoin is a kind of cryptocurrency, of which the ownership depends on a private key. Without the correct private key, there is no way to move bitcoins around, even if it is by means of law. This brings to us the notion of “absolutely private property”, for the first time in human history! Bitcoin is innovative in all IOF factors. Use IOF, For Facebook's Libra, it is creative in money form and flow of money, leaving money issuance unchanged. Blockchain has the potential to provide us with much better solution in terms of IOF.

With blockchain, we put an end to the monopoly of government-issued currency as suggested by the title of Hayek’s book – “denationalization of money”. Blockchain will simplify the set of concepts revolving around financial services and the complexity of the IT system. With blockchain, we have cryptocurrency that is more stable and safer than any currency that has ever existed before. This is “monetary and financial freedom”!

To learn what else Bitcoin and blockchain can bring to humanity, stay tuned for the next article in the “Blockchain in Human History” series.

About the Authors:

Kun Hu

CEO of Blockchain.News

Professor Francis Lau

Associate Dean of Engineering, The University of Hong Kong

Sources:
[1] Nixon's Economic Policies Return to Haunt the G. O. P., New York Times
[2] HKEX museum
[3] SWIFT
[4] Bitcoin Whitepaper
[5]  Dwork, Cynthia; Naor, Moni (1993). "Pricing via Processing, Or, Combatting Junk Mail Advances in Cryptology"