This is the third installment of Bitcoiner Giacomo Zucco’s series “Discovering Bitcoin: A Brief Overview From Cavemen to the Lightning Network.” Read the Introduction to his series, Discovering Bitcoin Part 1: About Time and Discovering Bitcoin Part 2: About People.
In this installment of the “Discovering Bitcoin” series, we will build on the previously acquired strategies of exchanging wealth, specializing production and focusing on goods with good physical “hardness,” “scaleness” and “darkness” to explore concepts of scarcity, liquidity and social “hardness.”
From Barter … to Liquidity Maximization …
This third step along our “Plan A” for money will focus on the topic of scarcity and on the question “What?”
In Part 2, you invented and popularized practices such exchange and specialization, enabling an unprecedented level of wealth and cooperation. Good job! There is still a problem, though. In the context of barter, which is what you and your fellow cavepeople are practicing now, utility grows with the number of people exchanging, but the friction to match demand and supply for every good versus any other grows as well, since the number of all the possible combinations increases quickly!
This problem has two sides: one concerns how to calculate, communicate and keep track of all of the combinations of trading couples (each caveman must declare how much of everything he would accept in exchange for everything else). The other concerns liquidity within different pairs (in many scenarios the exchange simply cannot happen, because of what economists call “non-coincidence of wants”: Alice has something Bob wants, but not the other way around, or at least not in that moment). The former side can be mitigated with advancements in information technologies (such as the invention of writing, to keep track of different combinations), while the latter can be mitigated by delaying the actual delivery of one of the two exchanged goods (basically the invention of credit, which is very useful where the wants do not coincide if considered in real time, but would instead coincide in different time-frames). But the problem still exists, slowing down the specialization process.
… to Convergence!
In order for commerce to keep growing, your little cave-economy must converge toward some specific kind of good, namely the one with the best combination of monetary attributes, which will always represent one side of every trade, in order to simplify calculation and bridge liquidity with respect to every other good. This practice is known as indirect exchange: Alice trades what she offers for this “bridge-good,” which she will later trade again for something she wants.
The great news is that you don’t have to try to convince your cave-friends one by one. This switch naturally happens due to so-called “network effects”: The value of a network increases more than linearly with the number of participants, creating a kind of gravitational black-hole effect. The goods that fare better in hardness, scaleness and darkness will compete, and the first one to reach a critical mass will start swallowing the others, as far as monetary uses are concerned.
Cave-ladies and cave-gentlemen … introducing Money! It serves three functions. The first is “store of value,” which was actually already served by our stored goods within the context of pre-convergence barter economies. The others are “unit of account” and “medium of exchange,” which are the answers to the problems of pricing and liquidity, respectively.
This is an important step in human evolution, so much so that from now on I will stop addressing you and all of your friends, as “cave-somethings.” With the level of prosperity that money-based economies give you over barter-based ones, you can all get out of those smelly caves and enjoy stone houses and castles!
How to Get Good Money
So, you just entered the magical world of so-called “commodity money”! Historical examples are seashells, beads, spices, squirrel pelts, dolphin teeth, tea bricks, salt (the word “salary” comes from that) and sheep (the word “pecuniary” from that).
But now you have to face another challenge, once again related to the problem of salability across time (thus back to the “When?” question)!
Imagine you’ve convinced your tribe to use smoked fish as money. This created more demand than the one granted by food consumption alone: Not only do people want to eat it, but they now also want to use it as money. Its price shows what is called a “monetary premium.” This incentivizes you to restructure your enterprise in order to produce more of it — but then you increase the global smoked-fish supply. And the price is a result of demand and supply: If the latter keeps increasing, while the former doesn’t, the price will start falling.
So, even if smoked fish remains as…