Value Exchange

Human civilization has come a long way to be well-organized and operate seamlessly in the society. One of the most challenging problem for humans, was to exchange the value with one another. People bartered before they began using money which was inconvenient to do. Money is a concept which made them easy to trade their products and services. Money is one of the most advanced tools engineered by humans to carry out value exchange for thousands of years. The oldest known coin minting site was in China which began using coins around 640 BC. Since then, humans have been constantly improving and changing the shape and system of money. The new form of digital money is being built and accepted as the new form of money for value exchange as you’re reading this.

Before inventing money, humans did bartering as an act of exchanging or trading goods and services. It is thought of as the oldest form of commerce besides the written credit system written on a clay tablet used by the ancient Babylonia 4000 years ago. They exchanged commodities or services for other commodities and services. Carpenter built fences for farmer and farmer paid the carpenter with crops and foodstuffs worth of his service. Apple farmer sold his apples for bananas. Men with chicken exchanged it with those breeding cows. But this barter system had its flaws. It was hard to measure the worth of goods and services with other goods and services. They carried out barter based on personal agreement on the estimate of equivalent goods and services. Two individuals  negotiate to determine the relative value of their goods and services and offer them to another in an exchange.

There are still come countries where some people use barter exchange. In some way, it’s convenient because it’s far from the intervention from third party. In a small group of family and friends, barter system can be very useful and often recorded verbally and one can trust the other party. For example one can ask his brother or sister for helping their mother with dishes or their father in mowing a lawn or polish their father’s shoes substituting for next day’s work. They don’t record this transaction on paper or computer. They can trust each other and he/she can substitute for their next day chore or even do favor to their family or friends. But as community becomes larger and larger, there is a problem of trust and the medium of exchange comes in handy because of which no stranger has to trust each other verbally. People trade their product, service, time, value or knowledge for this medium of exchange.

Metals were used heavily as a form of money and exchange. Even barter system used both common and precious metals. Use of bartering and metal exchange paved the way of the modern day monetary system. The Romans used bronze as their money to exchange goods and services. They usually paid the workers in metal. There have been different kind of money in different parts of the world. Metal coin is the most commonly used form of money. Gold, silver and bronze are common metals used in coins around the world.

Besides the metal coin, there were many other forms of money such as salt, sea-shell, glass beads used in Sub-Saharan Africa and Rai Stones used in Yap island. Glass beads were used as a form of money in Africa. It was considered rare because African didn’t have the accessible technology to create them. But when European came to Africa and knew about the glass beads used as money, they created unlimited amount of them and reduced the value of glass beads across the continent.

Rai stones on the Yap island was also used as symbol of wealth and riches and even money itself. The people of the island had the verbal consensus about who was the owner of the particular Rai stone. Those Rai stones were gigantic and heavy stones, so nobody could carry it with them. People announced who the owner of the stone was and everybody followed the consensus. If there was to be a big transaction like land or house, they would announce the transfer of ownership in-front of all the islanders and that was the official transfer and exchange of the value.

These kinds of value exchange has been carried out throughout our civilization and there has always been some inconvenience, fraud, demonetization and unjust in the process. So humans have always been improving the flaws of the method of value exchange and money. We have come a long way from barter exchange to stones, to metal coins to paper money, to plastic cards(credit cards), to digits and numbers on a database and now on the verge of transferring to completely digital native currency. You can check out this new digital currency at The Bitcoin Standard.

The invention of value exchange medium was a long and is an ongoing process. Humans are always improving and striving for the better version of everything. The way of exchanging value is no different. We have been constantly searching for much better form of medium of exchange and been inventing various kinds of it. This is a long process of experimentation in the real world. It takes decades and centuries to change the human behavior and its impact on money and economy.

Along the process, there has been good and bad form of money. The concept of money itself is one of the greatest invention of our civilization as it makes us easy to exchange value and services so that we can all work towards the better version of our society. But there has always been and will always be some bad actors who tries to rig the tool, be it the emperor who reduce the amount of gold in a gold coin or central bank printing unlimited amount of money. This kind of fraudulent action results in the decrease in the value of that medium which leads to the decrease in trust of the money creating authority. You can check out my article on Money.

Money was standardized into the paper money as economies became more complex. Paper money helped in reducing transaction cost by making easier to measure and compare the value to exchange. Current monetary standard is close enough to just a digital record on a database. Throughout the history, humans are following certain properties of money to use it as the medium of value exchange. Below are its important properties as a value exchange tool.

1. Fungibility

This is the most important property of money as one unit of money should be exactly equal to and have same value to another unit of same money. For example, one 1,000 Japanese Yen note should have same value as another 1,000 Yen paper note else the Japanese Yen as a monetary unit would not be fungible. As per commodity money like gold coin, two coins are equal in and only if the weight and purity of both coins are completely same.

2. Divisibility

Money should be divisible so that the exchange in value can be easily carried out regardless of the size and value of the product or service. For example, we can buy a chocolate for ¥10, bread for ¥100, a meal for ¥1000, shoe for ¥10,000 and a computer for ¥300,000.

3. Portability

Money should be portable so that one carry it with him easily. He can use it whenever he has to exchange value with others. For example, it would be hard to carry his cow with him through out the day and exchange his cow to the bicycle he wish to buy. Paper money is much more easy to carry in a wallet compared to a cow and use it for the exchange to the new bicycle. Gold lacked this property as it is hard and unsafe to carry huge amount of gold. There are chances of theft and also the cost of carrying gold to far distant places is very high and it increases with the increase in amount of gold.

4. Durability

In barter economy, people exchanged bananas for apples. Both bananas and apples were used as value exchange medium but both of them are poor in durability. Both apples and bananas will rot in couple of days and won’t have any value if it’s not used or eaten. Gold has been trusted for thousands of years because its durability is one of its strong properties. It almost last forever. It can be melted and changed to other shape but its weight won’t change and its value remain the same.

5. Store of Value/Wealth

Money should hold its value across both time and space. Gold has the same value in every country of the world and also keeps the value across time. The value of 1 oz of gold in 1930 UK was £4.25 and it’s £1,522 today. GBP has lost over 99% of its value compared to gold. Similarly in 1971, 1 oz of gold would cost US $35, and its $1,800 today. History shows that centrally created and controlled currency has always failed compared to the hard money like gold and there will never be any exception.

6. Recognizability

The authenticity of money should be readily apparent to users so that they can easily recognize it and agree to the terms of an exchange. Every country of the world recognize the value of gold but may not except currency of other countries.

7. Unit of Account / Medium of exchange

Current monetary system around the world uses fiat currency in every country. They have their own unit of account. For example, Japan uses Japanese yen as the unit of account and can be used across the country but US dollar cant be used as a unit of account. So this is the huge friction for economy of the world as a whole, as a globally connected internet based economy. If there was single unit of account, this would not be any problem. Humans will overcome this inconvenience too. There already is contender for new monetary system having this property.

8. Stable Supply/ Scarcity

This property is also one of the most important properties of value exchange as we are witnessing the devaluation of the money through the constant printing of money in recent years. The supply of the money should be relatively constant over time to prevent fluctuation in value. The overflow of the money in an economy causes the decline in its value as it dilutes the value of existing supply. The scarce property of commodity is what gives them value over other non-scarce asset. For example, Gold has more value than silver because it is scarcer than silver. But silver was used as better money for smaller transaction because it was appropriate for the exchange of cheaper goods which humans could not do with gold.

Stock-to-flow ratio

The stability or scarcity of money is one of the most important properties but balance is the key. Money as a medium of exchange is the most salable good available in society. It should be the good that every people want and realize that they can trade any products or services for it. This is why liquidity of a money matters. The overly scarce money is not a good medium of exchange if it does not have the required liquidity. For example certain atomic element like Rhodium is rarer that Gold but barely anyone has it so the liquidity is extremely low which makes it useless as a medium of exchange.  Another example is meteorites which is very rare on earth but it cannot  be used as money because of the lack of its liquidity.

This is where the concept of stock-to-flow ratio can be used as a great measure of supply of any commodity. It is basically the measure of how much supply there currently exists in the world (stock), divided by how much new supply can be produced in a year (flow).

Approximately 187,000 metric tonnes of gold have been mined in history, which is the stock of gold. It’s almost impossible to destroy gold, so all that are mined are still around. Annually, around 3,000 tonnes of gold is mined each year on average. It is very hard to mine gold which is one of the reason why it’s so desirable and valuable commodity across the world. Gold has a stock-to-flow ratio of about 187,000/3,000 = 63 on average, which is the highest stock-to-flow ratio of any commodity. This basically means, the world collectively owns 63 years’ worth of average annual production, based on estimates by the World Gold Council. The second most valuable metal, Silver currently has the stock-to-flow ratio of 22 and that of Platinum is approximately 1. So it takes about a year for current platinum production to double the current platinum inventory and it takes 22 years for silver to achieve this.

Compared to 63~70 years for gold, these metals are not in level of gold. This is the reason why gold is the most valuable commodity today. But the advancement in technology can make humans able to carry out deep-sea mining to retrieve gold from the ocean floor. There has even been proposal recently of possible asteroid mining where the required materials like gold can be extracted from the asteroids and other minor planets, including near Earth objects. If it is to succeed in the near future, the stock-to-flow ratio of gold will dramatically decrease and people might not want to possess the yellow metal, and care less about its value whatsoever.

We have seen recent rise in the price of gold compared to the fiat currencies of almost every country. The reason is these countries are massively increasing its money supply which is reducing its purchasing power. And as gold is considered the hardest money today as it cannot be easily produced, it is of no surprise that its value is increasing with demand. But gold has failed for thousands of years in its one property. It is very difficult to transfer gold through space. Specially, if the amount of gold is bigger, it is heavy and there’s lot of friction to transfer. It requires lot of energy to transfer gold to distant places which includes but not limited to the super-high cost of transfer and security from theft and robbery. Countries spend enormous amount of their military power whilst transferring gold to other nations, just for security.

Let’s look at the stock-to-flow ratio of Bitcoin. The total supply of Bitcoin is capped at 21 million coins, of which around 19.5 million have already been mined. Miners are currently rewarded 6.25 BTC per block. With a block mined every 10 minutes on average, this translates to the annual flow of around 328,500 BTC. We can calculate the stock-to-flow ratio of Bitcoin as 19,500,000/328,500 = 59 (appx). As subsidy of BTC rewards is halved every 4 years and the next halving is scheduled on April of 2024, its stock-to-flow ratio will double from that point in time. This will make its ratio to around 118, which is almost twice as high as that of gold. The higher the ratio, the scarcer the commodity. This trend will continue as the miner subsidy get cut in half every 4 years. How valuable will Bitcoin be and will it be the new medium of value exchange? Only time will tell. I’ll be writing about Bitcoin supply and halving on future articles.

Humans have been continuously improving and innovating the way we exchange value for thousands of years, and it’s hard to think we’ll stop innovate from here.

You can read about The Bitcoin Standard if you are interested in this new contender for value exchange medium.

Hope you enjoyed this. See you on next one.😉