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For most people, currency is synonymous with the cash in your wallet; nothing is further from the truth. The money evolution has been facilitated by the need to exchange goods. This important human invention has undergone a long process of historical evolution.

Beginning with the period where goods were exchanged directly, the inconveniences and drawbacks of barter trade led to the introduction of a medium of exchange. Study human history, and you will realize that all sorts of commodities have been used as a medium of exchange.  From seashells, pearls, precious stones, tea, tobacco, cow, leather, cloth, salt, wine, etc. have been used as a medium of exchange (i.e., money). This was called commodity money.

The inadequacy of commodity money led to the evolution of metallic money – gold and silver. However, there was a problem with the uniformity of the weight and purity of these precious metals leading to private and public coinage. The state finally took over the process as one of its essential features and commodities, giving way to paper money called currency notes. The use of paper money is almost universal, along with copper, bronze, and nickel coins.  

The evolution of money to a better medium of exchange continues. The increase in transaction volumes made even paper money inconvenient. This is because counting takes time, and you needed lots of space to keep it safe. What followed next is Bank money or credit money that came in the form of checks, credit cards, bills of exchange, etc. Plastic money is now popular because it’s a convenient form of money for large payments besides being durable and eliminating risks of carrying paper money.

Not as Stable as You Think

Fiat currency or paper money has become the standard medium of exchange today. Grab anyone anywhere in the world today, and the chances are that you will find some paper money in their wallet. This could be in dollars, pounds, euros, shillings, or just about anything else. This system is recognized globally, and people have complete faith in it. However, this 19th-century creation is not as stable as you think.

How Paper Money Works

Fiat currency refers to any money that a government calls legal tender. Fiat money was first used in China in 1000 A.D, and many countries have since adopted it. Apart from being used as a medium of exchange, fiat currency is also used as a medium for repaying debt. The value of fiat doesn’t derive from the material it’s made from but simply on the relation between supply and demand.  Paper money keeps its value as long as the government maintains that value. The value of paper money fluctuates along with a country’s economic condition. 

The Danger of Paper Money

The greatest challenge facing paper money is that while the entire world believes in it, it can easily collapse when circumstances are not right. Fiat money is used globally, and, as a result, when governments produce a huge supply of paper money, the result is hyperinflation. Once the economy deteriorates, it leads to the devaluation of paper money, and people begin losing faith in it. 

The best case study on what can go wrong with fiat currencies is Venezuela. The government had questionable economic policies that pushed the Bolivar into a downward spiral, and prices went haywire. At its worst, the Bolivar shed off 96% of its value.  Since its central banks that issue fiat currency, governments can control the value of their currency. Former Venezuela President Hugo Chavez printed millions of Bolivars to pay the country’s debts; the increased bolivar supplies caused a plunge in value.

By the end of 2018, the annual inflation rate in Venezuela was 80,000%. There was hyperinflation since 2016, and because the prices of commodities increased so rapidly, Venezuelans went back to bartering for a while before turning to bitcoin out of necessity. Thousands of Venezuelans went into Bitcoin and Ethereum mining to get an alternative means of exchange.  

Is It Time for the Next Stage of Money Evolution?

While fiat currency is effective, problems arise when governments mismanage them. We have to lay our trust in the central bank and hope that it will work independently from the government. However, in cases like Venezuela and Zimbabwe, corrupt leaders influenced the central bank to print more money. This practice makes the government richer at the expense of the people.

Problems with the monetary and fiscal policy can also be used to manipulate aggregate demand. Critics argue that such moves cause economic volatility. During an economic downturn, governments print more money and spend it as a way of boosting economic growth. This encourages spending and inflates the economy until it creates a bubble. As soon as the government stops printing money, liquidity dries up, and the bubble bursts, leading to the crashing of the economy.  Bad management of monetary and fiscal policy by central banks brings suffering to the population. 

Political moves and trade wars also influence the value of fiat currencies. The latest U.S China trade wars have negatively affected the Chines Yuan; the result has been Chinese looking for an alternative in Bitcoin to preserve the value of their money. When political tensions make fiat currencies volatile, again, it’s the common man who suffers because he will be forced to bear higher costs when currencies drop in value.

Alternatives to Fiat Currencies

Before the advent of fiat currencies, the value of currencies was tied to the value of gold. People saw gold as a store of value because it was a rare commodity, and supply was limited. No one could deliberately and unilaterally influence the value of gold. When gold was king, inflation was controlled, and cases of super inflation were unheard of. The reason gold stopped being standard was lack of liquidity, the cost of security for keeping gold, and difficulty in transporting it. 

Enter Digital Currencies

Digital currencies operate almost like the gold standard. However, they don’t have the logistical issues associated with gold. Since the supply of digital currencies is controlled, they keep inflation stable. Like we already saw in the case of Venezuela and China, people have been quick to consider cryptocurrencies as an option when fiat currency fails. Cryptocurrencies such as bitcoin and based on a protocol and are decentralized. No single person or institution can control the value of cryptocurrency, and everyone can access the currency.  

With cryptocurrencies, users can make cross-border transactions and are not subject to any form of exchange rates. This means that users can spend them without being affected by the action of governments. When Venezuelans started mining Bitcoin and Ethereum, they were able to purchase goods from overseas for import.

Central Bank Digital Currencies

With the growth of the knowledge and adoption of cryptocurrencies, central banks, the world over has begun studying and issuing their digital currencies. The People’s Bank of China, The Bank of Thailand, and the Bank of Korea are at different stages, creating digital currencies. The point of departure with cryptocurrencies like bitcoin is what they call the lack of monetary control. It appears like the governments are not yet willing to let go of their control on the money. The BRICS countries (Brazil, Russia, India, China, and South Africa) have discussed the possibilities of creating a shared digital currency to ditch the U.S. Dollar in international transactions.

Privacy Concerns over CBDCs

The reason Bitcoin is more popular than all other cryptocurrencies is the privacy it allows users. Governments are all over the place, cracking down on the use of cash, especially following the spread of Covid-19. People have had to start using electronic payments and receipt platforms. This enables governments to pry their eyes on the transactions and its participants.

People today are arguing that anonymity and privacy are their right to economic freedom. While central banks are trying to adopt digital currencies, the issue of privacy will continue to be a thorn in the flesh because people don’t want governments to trace the value of their transactions. With the issuance of CBDCs, the governments and central banks will continue to retain their powers.

The issuance of Central Bank Digital Currencies will not resolve the greatest problem with fiat currencies. This will only replace paper money with digital currencies that central banks will still control. The simple reason is that while we’re in the 21st-century, we’re still using financial systems developed in the 20th-century that based on a 19th-century understanding of trade and finances.

Final Thoughts

At a time when we all believe that the fiat currency system has its challenges, it’s a fact that fiat currencies backed by CBDCs will deliver the world. The problem is that any currency which gives central banks a huge amount of power leaves us right where we are. When so much power is left in the hands of an institution, it can be abused at the cost of the common people. There is no doubt that currencies are going digital; the issue of power and privacy cannot be resolved if people are forced to use CBDCs. Decentralized cryptocurrencies like Bitcoin and Ethereum offer users privacy and control since no one can control or manipulate them. 

It appears like the unfolding economic crisis is setting the stage for a tug-of-war between centralized digital currencies, the central bank-issued digital currencies, and decentralized digital currencies. The coming war between digital currencies is inevitable, and the crisis brought about by Covid-19 will only speed up the labor pangs.