Editor’s Note: What is money exactly? In today’s “best of review,” we answer that question by explaining that money is a social protocol, built on a network, and enabled by technology. Ah, but what does that mean? Read on and we’ll explain, hopefully giving you a clearer sense of what the abstract notion of “money” really means. –JCL
Money is a social protocol, built on a network, with technology enabling the network. This goes for all forms of money, even gold. It also applies to all pre-metallic forms of money, and all manner of monetary objects that have existed through the ages.
The concept of money as a networked social protocol is inherently a strange thing. This helps explain why so many people have such a hard time understanding money, in terms of what it really is and how it actually works.
We can demonstrate that money is a social protocol via thought experiments involving gold.
First, imagine an alternate version of reality where nobody had ever heard of gold — where it had never established a global reputation as a store of value and as something to be hoarded and treasured.
If you were transported to this alternate reality — and able to take a chest full of gold with you — the gold would essentially be worthless.
It might have value as a metallic commodity — you could make jewelry out of it — but the value of the gold would not be recognized, because in this alternate world gold has no reputation preceding it. Nobody knows why they are supposed to believe in gold — and so they don’t.
As such, you couldn’t trade the gold for high-value items. You would just be the stranger with a chest full of weird metal.
Then, too, think about how much gold would be worth in a world with no people, or no goods and services to buy. If you had a warehouse full of gold, but nobody to transact with, the gold would similarly be worthless in functional terms.
The thing that gives gold value, even to this day, is the social protocol. Thousands of years ago, the favorable aspects of gold were recognized as a medium of exchange: Doesn’t rust; portable, divisible; scarce within the earth’s crust; and so on.
But those favorable aspects required a sort of long-game, word-of-mouth marketing campaign to impart value to gold on a day-to-day basis.
In order for an ancient spice merchant to take gold as a form of payment, he would need to be socially connected with respect to gold’s inherent message. At some point, the merchant would need to have “heard the word” about gold. Just as importantly, the merchant would need to be confident he can pass the gold on, if need be, to someone else who has heard the word, too.
We take this for granted, but the social aspect is critical. How do you know gold is valuable? Because, at some point along the line, someone told you so. And you decided to believe it.
As another thought experiment, imagine an explorer coming across a technologically advanced Mayan city-state where, by order of the emperor, only silver is acceptable as money, and the use of gold as money is considered blasphemy.
Within that realm, how much would the gold coins in an explorer’s knapsack be worth? Zero, or possibly less than zero — trying to use them might get the explorer killed.
Money is a medium of exchange. The “exchange” part means making useful trades with other people. To do that, a useful form of money needs social buy-in along the lines of “yes, this medium of exchange is worth something.”
When you expand this social buy-in concept across a meaningful number of people, you get a network.
Let’s say an ancient village of 100 people decides to use cattle as money. (This was a regular thing at one time, thousands of years before the first metallic coins were minted.)
With 100 people, you’ve got a small-but-decent network. As such, within the 100-person village community, live cattle could be used as a medium of exchange for meat, grain, tools, weapons, clothing, herbal medicines, and whatever else circulates in terms of local commerce.
If the network then expands to 1,000 people, or 100,000 people, the value of money at the heart of that network rises substantially, by way of a far larger volume of goods and services available (likely with far more choices to boot).
This highlights another interesting thing about the network.
The value of money is not just tied to the size of the social network that accepts said money as a medium of exchange, but also to the available goods and services produced by that network.
Now we are getting closer to modern-day arrangements. A national currency, in a sense, is like a social network for a country. It has value because everyone accepts it as a medium of exchange.
At the same time, the productive output range and technological sophistication of a country — the range and diversity and inherent value of goods and services produced — will help determine the value of the money associated with that network.
So, we’ve hopefully established that money is a social protocol built on a network.
The social part comes from people knowing about the money (medium of exchange), and accepting it, and agreeing to assign value to it.
The network part comes from the fact that, the more individuals and entities who are part of a network, the more useful the network becomes, with money the means of participating.
Technology comes into play in terms of security and accessibility. Before a form of money is accepted and used widely, it has to feel safe. That means making the network secure.
Then, too, you have the accessibility factor. This is also a function of the network — determining how easy the network is to use, and who gets access to it.
At this point, we can go ahead and assert that money has value, even though money is still an abstract concept at the end of the day — a social protocol built on a network, with technology making the network secure and accessible.
But where does money’s value come from? It comes from the implied value of what you can buy within the network.
If you have, say, a pile of dollars in a country that doesn’t accept dollars, the dollars are useless for that particular time and place. When your dollars are outside the boundaries of the U.S. dollar network, they cannot be exchanged for anything valuable (because no one will take them).
But with a pile of dollars in the United States, you can buy a nearly infinite range of things, from goods and services and experiences to stocks and bonds and real estate. Within the dollar network, the dollars have value precisely because you can readily convert them into attractive things that you want.
Outside the United States, meanwhile, dollars have value for the same reason.
The U.S. dollar as a world reserve currency is another form of widely accepted social protocol, with a network that blankets the planet, and security and access to technology that includes everything from international bank accounts to aircraft carriers.
Meanwhile the reason why fiat currencies can lose value, and sometimes do so quite suddenly, is because faith in the social protocol takes a hit.
If a central bank is seen as rapidly expanding the currency supply, or a government is seen as issuing prodigious amounts of debt — or both at the same time — the value of the social network can become psychologically degraded, with holders of dollar-denominated assets feeling less marginally inclined to hold assets priced in that currency.
A currency can also be degraded by way of hidden inflation, which happens when an increased supply of currency enters the network.
If the general supply of money increases, and the money is being lent and spent (as opposed to just sitting in bank vaults), prices can seem to rise mysteriously with no one able to pinpoint why. The hidden reason is because a greater volume of currency is chasing a relatively smaller volume of goods and services, causing prices to naturally rise.
These monetary basics can further help explain why Bitcoin is so powerful. Given the criteria as described, Bitcoin has all the hallmarks of sovereign global money.
We’ve established that money is a social protocol. People have to know about it, have heard about it, and agree it has worth in order to be useful. Bitcoin has that unquestionably.
We’ve established that money, as a social protocol, is built on a technology-enabled network. Bitcoin has that, too.
The Bitcoin network encompasses people and technology, with neither more important than the other. Technology enables the safety and security of the Bitcoin network, while people strengthen the network through active use and ongoing development (adding payment rails, improving security and accessibility, and so on).
In the final twist, the value of Bitcoin keeps increasing as the network expands, because greater adoption means a wider array of goods and services that can technically be purchased with it.
Nor do these purchases have to be a one-to-one exchange — it is more about general accessibility on a worldwide basis.
If you wanted to pay in Bitcoin to purchase a Swiss chalet, for example, and the chalet owner wanted Swiss francs, all you would have to do is exchange Bitcoin for Swiss francs at the point of sale.
The key idea is that the Bitcoin network is robust enough and liquid enough that, if you want a Swiss chalet priced in Swiss francs, there is someone out there happy to trade Swiss francs for Bitcoin on any given day, allowing you to then make the purchase.
Some like to say the value of money is an illusion, that money is not inherently worth anything. This is somewhat true, in a technically correct sense, and yet categorically false at the same time.
The value of money, in a real and tangible way, can be extrapolated from the scope and depth and security of the technology-enabled network that turns a medium of exchange into a social protocol. Fluctuations in the price of money, meanwhile, are tied to units of currency supply relative to the supply of goods and services within the given network.
And by that simple standard, Bitcoin is deeply and inherently valuable at this point. It just is.
The technology-enabled network that supports Bitcoin as a social protocol — which consists of not just hardware and software but people — cannot be replicated or counterfeited.
And as more individuals and institutions opt into the Bitcoin network, and more layers of security and accessibility are added, along with greater levels of recognition worldwide, the Bitcoin value proposition only grows stronger with each passing day.