I've introduced a lot of people to bitcoin. Most of those conversations are the same - we get to a point where we discuss the price of bitcoin and then I get asked where bitcoin get it's value from. I often answer that question with a question: "Where does the US dollar get it's value from?" - it's amazing how people still think that the US dollar is backed by gold. The idea that currencies have to be backed by gold or by the US dollar to be valuable is outdated. I'll get into why in a minute but first, lets look at the history of money.
Once upon a time
We used to barter. If you're selling a cow, I can pay for it with 2 goats. 2600 BC Many historians say that it's the Egyptians who discovered Gold at around 2600 BC. Gold was a better currency than 2 goats because, unlike 2 goats:
- Gold was divisible: You could break it down into smaller pieces and use those smaller pieces to buy stuff
- It was durable: Gold doesn't die or lose its shine
- It was fungible: Because it's just as easy to melt a 2gram piece of gold and split it into two 1gram parts as it is to melt two one gram parts and combine them into one 2gram parts, if I lend you a 2gram piece of gold, I don’t really care if you give it back in 1 piece or in 2 pieces. The same way, when I lend you a single $100 bill, I don't care if you give it back as one $100 bill or as two $50 bills.
- Durability - gold is not perishable. Need I say more.
- It was easy to move around. Well at least it was easier to move than 2 goats
- Scarcity: Because I lived in Zimbabwe in 2008, I know very well why scarcity is a property of good money
- It seemed very valuable because it was shiny and looked nice.
~1500BC
Around 1500 BC humans started using gold for international trade
~700 BC
The first gold coins were created. Gold coins were very useful because before them, people had to first check that the thing they are trading was actually gold and then weigh it.
~17th Century
Europeans started using paper money and as we moved towards the 18th Century, paper money started to get more popular but others were still using gold coins and there was no relationship between the two. It was also difficult to know the value of your currency when you exchanged it for another. That's why the gold standard was developed.
The Gold Standard (~ 1875)
A bunch of countries agreed to what's known as the Gold Standard: here they basically agreed that whatever paper money is in circulation has to be backed by gold. So if you have $100, the government will give you $100 worth of gold as and when you need it and if you have $100 worth of gold, you can exchange it for notes. Here nation countries valued their currencies from how many ounces of gold you would get for converting one unit of the currency to gold. This made it easy to exchange currencies because you could now calculate the value. The gold standard became the first standardised means of exchange in history. The gold standard worked great until world war 1 and then word war 2 broke out. All the Allied Powers stared spending more on their military, than they had in gold reserves and it got to a point that they couldn't guarantee all their money with gold. That's how the gold standard failed. Today, no currency is backed by gold.
The Bretton Woods Agreement (1944)
44 countries met in a town called Betton Woods to reach an agreement on a foreign exchange rate system because the gold standard had failed. They reached an agreement that was similar to the Gold Standard except they replaced gold with the US dollar. So they agreed that the US dollar was the only currency that had to backed by gold at a fixed rate of $35 per ounce and all the other currencies had a fixed exchange rate to the US dollar. This made the US dollar the primary reserve currency of the world.
1971
Again gold reserves in the US started depleting rapidly. The then US president, Richard Nixon announces that the US will no longer exchange gold for US dollars so countries were free to choose any exchange agreement , except the price of gold. The Bretton Woods system failed. And until this day, governments have let their currencies float on a global decentralised market called the foreign exchange market. Over 5 trillion dollars is exchanged on this market every day.
References
- [Properties of good money](http://coin4.me/2012/05/properties-of-good-money-bitcoin/)
- [Gold Standard](https://en.wikipedia.org/wiki/Gold_standard)
- [Forex Trading](https://www.udemy.com/forex-trading/)
- [Bretton Woods Agreement](http://www.investopedia.com/terms/b/brettonwoodsagreement.asp)