In early human history money did not rely on trusted entities, but this pattern changed when more efficient fiduciary systems emerged. Bitcoin, thanks to its electronic nature, could bring back trustless money to the masses.

Money, together with writing, is probably one the biggest invention in human history. While writing improved the transmission of information to the next generations, resulting more effective than oral language and more efficient than genetics, money helps to keep track of favours over time, making trade possible also when the exchange of goods is not instantaneous.

Having an intermediate commodity or a collectible that acts as money is what makes human cooperation on large scale possible, even between groups that don’t trust each other. Indeed, money happens to be far more scalable than barter. If there are n goods to be traded, barter requires n²-n prices to have a functioning market, while with money you only need n-1, which makes a huge difference in a complex market. Such very efficient linear scaling is possible only if there is just one form of money, multiple competing monies would indeed reduce the utility of money itself.

In absence of state influence, the higher utility coin will replace competitors creating a consolidation towards the better money. This phenomenon, known as Thiers’ Law, has been observed numerous times in recent years with the dollarization of weak economies such as Ukraine and other East European countries in the ’90. As our world becomes more and more interconnected, we should expect something similar to happen on a global scale. With the intensification of economic interactions between individuals and entities with different local currencies, the need for a common currency will grow, and with Thiers’ law in place a consolidation is likely to happen.

Kids exploring non-monetary applications of the German mark, 1923

But how can we define better money? Historically money is supposed to fulfil three functions: (i) unit of account, (ii) medium of exchange and (iii) store of value. While the success of the first depends on the latter two, the ability to hold and efficiently exchange value is what drives the adoption of a currency. In particular, the store of value is usually the key feature needed to be established as a reliable form of money, currencies that were not able to hold value due to hyperinflation always quickly ceased to be used, with some notable examples to be found in the Weimar Republic and more recently in Zimbabwe.

The best possible form of money is often considered something not subject to inflation, as suggested by Nobel laureates (FWIW) such as John Nash and Friedrich Hayek, and this is probably the reason why gold has been so successful for most of human history.

The transaction cost

A good medium of exchange is supposed to be able to facilitate trading by reducing friction while exchanging value. In particular, we can identify two cost drivers that characterize the efficiency of a certain medium of exchange: (i) costs of storage/carrying and (ii) validation costs.

The storage and carrying costs are mostly linked to two factors: the value to weight ratio and the durability of the asset. While gold is often considered good at condensing value, there are some other materials that largely outperform it, such as LSD crystals, priced at about $3000 per gram, and anti-matter, costing over $60 trillion per gram. In both cases, however, the preservation over time and transportation can be an issue, making them unusable for monetary applications. Gold and cash are definitely much better as they don’t deteriorate easily, but they are still limited by their physical nature, which is why today most financial assets are digitalized and transactions happen electronically, with extremely low costs.

Price per gram in USD of various goods in logarithmic scale. Some of them are highly illiquid assets, so the approximated price may be unreliable

On the other hand, the cost of verifying the correctness of received payment has been one of the main issues traders had with gold and silver for most human history. Checking the purity of metals required appropriate measurement tools or heating them enough to make them glow in a distinctive manner, either way not suitable for quick instant trades. With the invention of coinage, transactions became smoother as a creditor could easily accept a coin stamped or cast by a reputable mint as he could trust that the quantity of precious metal contained in the coin was correct.

On the left an Roman denarium with ~97% silver from the Augustan age, on the right a 3rd century Antoninianus with only ~30% silver

Fungible coins were great for commerce and spread very quickly, but since they were a fiduciary solution, they had their weakness in the third party everybody had to trust. So as a Caesar minted reputable high purity coins, the next Caesar was often quite tempted to debase the coins reducing the quantity of contained silver while still trying to put them in circulation at the same nominal value. Coinage proved thousands of years ago that centralised solutions are very efficient but not very robust under a game theory perspective.

A Jiaozi credit note, the world first paper money, Song Dynasty (960–1279 CE)

Coinage was a good attempt to reduce the validation cost of transactions using precious metals, but it did not help to reduce storage and transportation expenses. Therefore, while in Europe alchemists were doing their best trying to turn base metal into gold, in China corporations managed to turn paper into money with the invention of credit notes. Those early banknotes were originally introduced due to shortage of metal coins, but soon traders realised that, compared to metal, they were also much more convenient to carry around. Such notes quickly became very popular in the booming economy of the Sichuan region in the 11th century and the concept was so good that it was soon adopted by the central Chinese government as well. On the contrary, Europeans happened to be more sceptic with the idea that paper could be used as money and it took a few centuries after Marco Polo’s reports about Chinese credit notes to see something similar in the western world.

While paper money was a useful innovation, the key to improve the efficiency of the system was, once again, trusted third parties. Differently from coinage, a significant counterparty risk emerged with paper money, as an issuer could indeed abuse its power to print more money than what was actually contained in its reserves (which happened very often). Nevertheless, history teaches us that the convenience of low transaction costs are enough for people to expose themselves to some counterparty risks towards the trusted minter, meaning that sacrificing security for efficiency is a behaviour we should expect.

Trust in scarcity

In order to be successful, money has to be in the right quantity, scarce enough to be able to hold value over time but also abundant enough to sustain trading in the economy of the system. Having the right scarcity level is definitely the one most important features defining the success of a currency. It can be the natural scarcity of shells and precious metals, the artificial scarcity of Bitcoin and other digital assets backed by frozen energy, or the fiduciary scarcity of fiat currency, where citizens simply trust the central bank not to abuse its printing power.

An interesting case that shows how an object without any kind of fundamental value or backing by an authority, but with the right level of scarcity and some network effect, can still be used as money, is the Swiss Iraqi dinar. After the Gulf War in 1990, due to economic sanctions, the Iraqi government could not import any more the Swiss printed notes it was using, so it started printing new notes on its own. However, these new notes happened to be traded at discount, so Saddam decided to disown the old Swiss dinar. Nevertheless, in the autonomous Kurdish regions of Northern Iraq the Swiss notes kept circulating as main currency even without government backing and, of course, without any other fundamental value. The Swiss dinar not only was still used until the U.S. took control of the country, but it also appreciated significantly compared to the new over inflated Saddam dinar, going from the initial 1:1 rate up to 300:1 thanks to the fact that nobody owned the plates to stamp more Swiss dinars and the scarcity of the currency was guaranteed.

On the left the Swiss Iraqi dinar, on the right a pre civil-war Somali shilling

A similar situation happened in Somalia more or less in the same period. Indeed, after the early 90' Civil War and the shut down of the Somali Central Bank, the old Somali shilling stayed in circulation for over two decades without the backing from any central bank, but in this case the old currency lost most of its value due to seigniorage coming from the private sector.

The absence of risk of oversupply seems to be one of the main factors that determines the success of an asset as a currency, and in the foreseeable future Bitcoin is definitely the asset that can provide the best guarantees in such direction. Its supply does not indeed depend on trust in a central bank nor on the difficulty of extraction of a natural resource at the current technological level, but on a strong system of economical incentives.

Future of currency: fiduciary vs trustless

Money is just a tool to exchange and store value, all it matters for its users is the utility it can bring. Fiduciary fiat currency theoretically can be the perfect form of money as a central bank makes sure the supply is always well calibrated to sustain the trading in the system while holding its value, and the central government enforce adoption guaranteeing a strong network effect. However, there are two obvious problems: there is a need to trust the central bank to continue to operate correctly, which in the long term is unrealistic, and the benefits of the government backed monopoly end where the government influence ends (usually coinciding with national borders).

Naturally scarce and non-fiduciary forms of money, such as precious metals, have lost their dominance position due to their high transaction costs, which were mitigated by the introduction of credit notes that later evolved in modern fiat currencies. Fortunately in 2009, with the launch of Bitcoin, the world had, for the first time, a non-fiduciary digital money that could have competitive transaction costs due to its electronic nature.

King Mansa Musa (1280–1337) , the wealthiest man ever lived, carrying about 100 tons of gold while travelling to Mecca. Due to his spending attitudes, he caused a decade long hyperinflation in Egypt.

The costs of storing and carrying wealth with Bitcoin is extremely low: you can easily carry billions of USD in value just by memorizing your private key. When in 1324 King Mansa Musa, the wealthiest man in human history, had to bring over 100 metric tons of gold to cover his expenses during the pilgrimage to Mecca, he needed over 60000 men and 80 camels to transport its wealth. Needless to say that with Bitcoin it would have been much easier.

On the other hand, the problems caused by validation costs are still present in electronic trustless currencies. While in gold the transaction validation cost grows linearly with the amount transfered (i.e. more gold to check), with Bitcoin the cost is inelastic to the amounts but grows linearly with the number of transaction occurring on the network, due to the blockchain architecture securing the system. This causes scalability problems in all cryptocurrencies, but solutions to reduce blockchain usage and increase transaction throughput are already being deployed (e.g. Lightning Network), it is therefore realistic to expect that, with technological progress, trustless currencies will reach a level of efficiency similar to that of fiduciary ones.

At comparable efficiency levels, trustless currencies have some clear advantages over fiduciary ones since, as the name suggests, they don’t require trust in any authority. Once established, trust is great to cut costs of interaction, but it is very expensive to build, it does not easily extend geographically and it is hard to maintain over time. On the other hand, Bitcoin is based on more universal principles such as mathematical laws and the human greed powering the economic incentives. The fiduciary nature not only increases the risk of a catastrophic failure of a currency, for example with hyperinflation phenomena, but causes also exposure to the Triffin dilemma, (i.e. the conflict of interests between short-term domestic and long-term international objectives, arising in a country whose currency serves as global reserve currency), making fiat money not ideal outside of its native country.

Bitcoin path to world domination

A trustless currency like Bitcoin has some obvious advantages on today dominating fiat currencies and, if it can reach similar levels of efficiency, it should become the obvious choice for anyone. However, there is a missing key feature in Bitcoin: the network effect. If very few people use it for transactions, it has limited utility as a currency, reducing the incentive to use it. Still, there are two different scenarios to analyse in which Bitcoin could gain substantial traction the become the main global currency: a catastrophic failure of fiat currencies and a stable macroeconomic environment for the coming decades.

Due to its decentralized approach to money issuing and transaction validation, Bitcoin has its greatest advantage in the lack of exposure to the systematic risks fiat currencies suffer. In case of a global financial crisis (the probability of which is hard to estimate and out of the scope of this article), the trust in governments to pay off their debts and the ability of central banks to control the stability of their currency may be jeopardized. In such a scenario, it is to be expected that people will look at Bitcoin as the safe heaven to preserve their wealth, driving up adoption and its use for financial transactions.

In the opposite scenario, where no major disruptive event happens, there still are some forces that will drive Bitcoin global adoption. First, differently from fiduciary currencies,Bitcoin has a very high degree of socially scalability, which is defined by Nick Szabo in one of his posts as follows:

Social scalability is the ability of an institution to overcome shortcomings in human minds and in the motivating or constraining aspects of said institution that limit who or how many can successfully participate.

Bitcoin is socially scalable because it does not need to buy trust in the security and reliability of the system. Trust is extremely expensive, since it requires humans to process a lot of information with limited and not expandable brain capabilities and it has to be bought again with every new generation. So over time, fiduciary systems have to keep investing resources in buying the trust of every new person on the planet, while Bitcoin, thanks to its trustless nature, does not need to buy trust, thereby obtaining a significant advantage.

American Union Bank losing the trust of its customers. New York, 1929

Moreover, a trustless currency has one huge main advantage over fiduciary ones as a medium of exchange: the censorship-resistance nature. This is indeed the key feature that guarantees financial inclusion to all those that have enough resources the participate in the network, meaning that for at least a niche Bitcoin is the only option to have access to payments and other financial services. With this assumption, it is possible to imagine a scenario where there is a majority of the world population that can either use a fiduciary currency or a trustless one without any particular preference, because in both cases they can obtain the utility they are aiming for, and there is a minority that has a strong preference for a trustless currency because they need the censorship-resistance feature. Before the described minority becomes large enough to be relevant, more awareness and culture about how bitcoin works is required by the general public. So, due to the limitation of the human mind to process new information and acquire knowledge, the adoption phase may be longer that many expect in the industry. However, once the minority gains enough traction, we should expect merchants and service providers (but also regular users wishing to access services only payable in Bitcoin) to start prioritising support for Bitcoin, in order to be able to trade with both the indifferent majority and the intolerant minority. An intolerant minority that imposes its preferences to the indifferent majority is nothing new, as pointed out by Nassim Taleb, it is indeed a frequent phenomenon in our society.

It is also important to notice that the censorship-resistance can enable other interesting features that are technically possible in fiduciary currency too, but almost never supported for multiple reasons. An example is a strong privacy setting (not yet present on Bitcoin, but potentially supportable), that could be implemented also in centralised solutions like PayPal but, due to government regulation or business goals of the companies (e.g. collect users data), are never enabled. Similar extra features can further increase the size of the intolerant minority that will drive global adoption of the digital trustless currency.

Digital gold and digital silver

Since the very early days of Bitcoin, people started to compare it to the historically most successful trustless intermediate commodity, calling it digital gold. The question comes spontaneous, if there is such a thing as digital gold, where is digital silver? Litecoin promoters (and other altcoiners) tried for a long time to market their coin as digital silver, intended to be used for smaller transactions like silver in the old days. While the comparison may be appealing and definitely is a good marketing strategy, one should first ask himself whether there is any need for a digital silver.

One ounce of gold and its approximate value in silver (at current prices you would actually need at least another silver bar).

Silver gained success due to its ability to overcome what is simultaneously a flaw and a feature of gold: having an excessive value to mass ratio. The ability to hold a lot of wealth in small quantities is great for high value transactions and store of value, but makes it impractical for more common smaller transactions, as measuring fractions of a gram of gold is very hard, bringing the validation costs often over the transaction value. Silver happened to be perfect for daily usage, still scarce enough to be a reliable store of value but abundant enough to be easy for humans to use it also in small transactions.

Is there a need for an equivalent of silver in the digital world? For sure handling satoshis is not any more difficult than handling bitcoins, but the high price that the Bitcoin network is paying for the security of the transaction validation may be considered excessive for use cases where small amounts are transacted. A second network with different security-performances trade-off seems a reasonable solution, for thousands of years we used different medium of exchange for different transaction types, so it may make sense to do it again.

Differently from gold, Bitcoin happens to be programmable money, so it is possible to solve some of its limitation with a different approach. Thanks to its smart contract capabilities it is indeed possible to build new layers on top of Bitcoin with a different security-performances trade-off to accommodate different use cases and transaction types. This is why it is more likely to have something like the Lightning Network to become the digital silver rather than a new altcoin with a different unit and another transaction history to audit.

Conclusions

Trustless currencies bring much less systematic risks than fiduciary ones, but due to the greater efficiency of the latter, fiat currencies gained a dominant market share over the last century. With the introduction of digital and programmable trustless money, a paradigm shift is to be expected and depending on future macro-economic events the mass adoption may require years or decades, but the incentives are already in place.

Since a currency maximises its utility when there is only one in a system, it is unlikely that some clones of Bitcoin will see any long term success, just like not all precious minerals had the same success of gold throughout human history. Bitcoin is showing that, even when you have a huge technological advantage on the systems you are trying to replace, it is very difficult to gain substantial traction, making quite hard to believe that just changing some trade-off levels will be enough to take the place of Bitcoin. Many people around the world need trustless digital money to move and store value, but since we are talking about currencies, one is enough.