A Brief History of Money: From Favors to Bitcoin and Beyond
For most people, the word “money” brings to mind banknotes and coins. Yet, we all know that a banknote is just a piece of paper, and a coin is merely a piece of metal. So, what exactly is money? Money is nothing more than embodied trust! To truly grasp this concept, it helps to take a quick journey through the history of money.
Around 2.5 million years ago, our ancestors lived in small, tight-knit communities where cooperation was essential. They gathered food, hunted, and shared tasks collectively, creating a system that ensured security for everyone. For instance, if someone returned from a hunt or gathering empty-handed, others in the group would share their resources. The principle was simple: today, I share some of my fruit with you, and tomorrow, you’ll return the favor.
Even without money, these communities operated on what we might call an “economy of favors.” The primary purpose of forming such communities was to establish and sustain this mutual support system. This exchange is as old as humanity itself and can even be observed in some animal species.
However, this “economy of favors” had its limitations. Without formal record-keeping, it relied entirely on personal relationships, which are naturally constrained. Studies have shown that humans can maintain meaningful relationships with roughly 150 people — a concept known as Dunbar’s number. This limit defined the size of such communities and set a boundary for how far the “economy of favors” could extend.
Transactions outside the community were only possible through barter. Unlike the “economy of favors,” which allowed exchanges to be deferred over time (e.g., “you saved my life, and years later I’ll save yours”), barter transactions were immediate and final. Once the exchange was completed, there were no further obligations or interactions between the participants.
Barter eliminated the need for personal relationships or the mental tracking of favors, as it didn’t rely on maintaining a “cognitive ledger.” In essence, barter required no trust at all!
Barter has its limitations — it requires both parties to have matching needs at the same time and place for an exchange to work. For example, I might have plenty of apples to trade and want fur, but if no one with fur needs apples, I’m out of luck. To overcome this issue, commodity money emerged as the earliest form of money.
Commodity money consisted of goods that were universally valued and could be exchanged for anything at any time because they were always in demand. The first known example of this was Sumerian barley money, which appeared around 3000 BC in Sumer. Barley money was simply barley measured in sila, with one sila being approximately one liter. Barley was universally accepted as payment for goods and services, much like how we use modern banknotes in stores today.
Barley, while practical in some ways, was far from convenient as a currency — imagine lugging around massive sacks of it just to go shopping! Over time, humans experimented with various forms of commodity money, but precious metals eventually emerged as the most effective. Initially, like barley, precious metals were traded by weight. However, coins, as we know them, didn’t appear until around the 7th century BC.
The oldest surviving coins date back to the reign of Croesus, the king of Lydia. Coins offered a major advantage: they didn’t need to be weighed because their precious metal content was guaranteed by the king’s authority. This royal guarantee added immense trust to the system. Counterfeiting coins, therefore, was not just fraud — it was considered a direct attack on the king himself, punishable by death.
The banking system developed alongside the evolution of money. As early as 2000 BC in Ancient Mesopotamia, institutions existed to manage deposits of gold, silver, and grain, while also providing loans to support economic activities.
The first paper money emerged in China during the Tang and Song dynasties in the 7th century. Paper money made transactions much more convenient compared to the heavy and cumbersome use of coins.
In Europe, by the 12th century, bills of exchange and letters of credit began to gain popularity as payment methods. These documents, issued by banks, could be exchanged for coins at any time, effectively functioning as a form of money.
The concept of central banking began in 1668 when the Swedish government established the first central bank. The central bank introduced the bill of exchange as a standardized form of currency, which we now recognize as the banknote — the official currency of a nation and what most people associate with money today.
Until the mid-1900s, banknotes were backed by gold, meaning they could be exchanged for gold at any time, with the bank guaranteeing this equivalence. However, in 1944, the U.S. dollar took over gold’s role as the global standard. Initially, the dollar itself was backed by gold, but by the mid-1970s, even this gold backing was removed. This marked the birth of fiat money — currency that is no longer tied to precious metals but derives its value from the trust in the issuing country.
This shift is worth reflecting on, as it marks the point where trust became the foundation of money rather than its physical form. In a way, we’ve returned to the principles of 2.5 million years ago, where trust was central to the “economy of favors.” However, there’s a critical difference: this trust is no longer personal. Instead of relying on trust in individuals within a community, we now place our trust in central banks and governments, believing they will maintain the value of our money. The modern economy is still trust-based, but the decentralized, personal trust of the past has been replaced by centralized institutional trust.
There’s an important twist in the modern banking system: in most countries, it operates on a two-tier structure. This means there are both central banks and commercial banks. While the central bank has the exclusive right to issue banknotes, commercial banks — private companies that offer banking services — play a crucial role in creating money.
Since individuals cannot open accounts with the central bank, we rely on commercial banks for our banking needs. Our salaries are deposited into accounts at these banks, and we spend money from these accounts when using credit cards or making transfers. However, the $1,000 you see in your account is not actual cash sitting in a vault — it’s simply a promise from the bank. This means the bank owes you $1,000 and will provide it in the form of banknotes if you request it.
In reality, banks only keep a small fraction of the money deposited by their customers, as the required reserve ratio is typically less than 10%. This works because most people rarely withdraw large amounts of cash. When you transfer money or make payments, no physical cash moves; instead, the bank simply updates numbers in its database to reflect the transaction.
When we take out a loan from a bank, the process is surprisingly simple. The bank evaluates our creditworthiness and, if approved, credits the loan amount directly to our account. For example, if we take out a $10,000 loan, an additional $10,000 appears in our account, ready to be spent. The bank essentially creates this money out of thin air.
By taking the loan, we owe the bank $10,000, and in return, the bank gives us $10,000 in our account to use as we wish — for example, to shop at a store. However, this $10,000 isn’t physical cash; it’s still just a promise from the bank.
So why do we rely on banks? Why can’t we just pay with our own promises? The answer is simple: trust. The store clerk trusts the bank’s promise because it guarantees the value of the money, but they have no reason to trust our personal promise. Money created by the bank holds value because it comes with institutional backing, while money we create on our own does not.
Banks are often criticized for “creating money out of thin air,” which can seem puzzling at first — almost as if the money has no backing. However, this perception isn’t accurate. Banks operate under strict regulations and are supported by the authority of the state and the legal system. This framework ensures that when a bank owes us money, we can trust it will fulfill its obligations.
For instance, when someone takes out a loan to buy a house, the house itself serves as collateral. If the borrower fails to repay the loan, the bank has the legal right to repossess and sell the property. Additionally, bank deposits are typically insured up to a certain amount, so even if a bank goes bankrupt, depositors are protected and their money is returned by the insurer.
This makes banks reliable debtors. The money they “create out of thin air” holds value because it is backed by trust — not just in the bank itself but also in the systems that regulate and support it.
The banking system is undoubtedly a clever and well-designed structure. Perfectly reliable, right? Not quite. The 2008 global financial crisis exposed the system’s flaws, showing that while it may work perfectly in theory, it is highly vulnerable in practice. It took significant — and still controversial — government interventions to prevent an even greater catastrophe.
In response to these systemic failures, the cyberpunk community introduced its own alternative in 2009: Bitcoin.
Bitcoin is a decentralized database maintained collectively by its community. This database functions similarly to a bank’s ledger, recording the balances of individual accounts and the transactions between them. However, unlike traditional systems, the total number of bitcoins is capped at 21 million. New coins are gradually introduced into circulation, with a small number distributed approximately every 10 minutes.
The distribution process operates like a decentralized lottery. Participants, known as miners, increase their chances of winning by dedicating more computing power and energy — essentially putting their hardware to work. This process, called mining, mirrors traditional gold mining: miners invest effort, and with some luck, they’re rewarded with Bitcoin. The more computational work they contribute, the higher their chances of success.
Bitcoin’s design draws heavily from the principles of old gold-based currencies, which is why it’s often referred to as “digital gold.” But this raises an important question: what exactly gives Bitcoin its value?
Let’s break down what happens during Bitcoin mining. Energy is consumed, and in return, the number in a database increases. But what gives that number its value? Unlike traditional currencies, there’s no state guarantee, no deposit insurance, and no promise that Bitcoin can be exchanged for banknotes. Yet, as of October 2024, one Bitcoin is valued at $64,000.
Bitcoin’s value is rooted entirely in trust — not in a government or central bank, but in the Bitcoin system itself. People who buy Bitcoin trust that they’ll be able to exchange it for money or goods whenever they choose. There’s no formal guarantee behind Bitcoin’s value, and yet, it continues to function successfully. This trust alone sustains its worth.
Bitcoin represents the first digital currency founded entirely on trust. Its core philosophy challenges the idea that the state or banking system can truly guarantee the value of money, suggesting the need for an alternative. The Bitcoin algorithm offers just one guarantee: the scarcity of coins, akin to the finite nature of gold. This scarcity is the foundation of its value — and the only aspect we can trust. As the saying goes, “In code we trust!”
Bitcoin, while groundbreaking, is not without its flaws. Its mining process consumes vast amounts of energy, leading to substantial CO2 emissions that harm the environment. Moreover, its speculative nature and gold-like operating principles make it unsuitable as a direct replacement for modern currency. However, Bitcoin has provided something invaluable: the introduction of blockchain technology!
Blockchain technology has enabled the creation of decentralized databases and systems where trust among participants is no longer required. As long as the majority of nodes follow the established rules, we can be confident that the entire network will operate as intended. This foundation allows us to build other trust-based currencies, leveraging the same principles of decentralized trust.
The future remains uncertain, and while many alternative blockchain-based currencies exist, they often grapple with the same challenges as Bitcoin. I believe the most promising path forward lies in returning to the roots: building systems where trust is as decentralized as possible. Instead of relying on banks, we can embrace solutions like DAOs and personal trust networks. Initiatives such as Circles, and my own concept, Karma Money, strive to bring this vision to life. But that’s a story for another time…
If you’re interested in my concept of Karma money, you can read about it here:
UPDATE: The second part of this article is published.