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Hard Currency & Digital Currency

Peter Katevatis - Aug 08, 2019
Money, we know it can’t buy happiness, but it sure can make sadness much more comfortable.  Money has been the foundation of joy and conflict since the beginning of human existence. 

Money, we know it can’t buy happiness, but it sure can make sadness much more comfortable.  Money has been the foundation of joy and conflict since the beginning of human existence.  Money has taken the form of goods exchanged for services or a gold coin with value that is agreed upon by both people to complete a transaction.  Money has definitely evolved over time.

 

 

The value of money took on a whole new meaning when fiat currencies became backed by a government’s promise instead of a pile of gold.  This started with the United States in 1971 when they decoupled the US Dollar from the price of gold.  One USD was still the same piece of paper but the US Government which declared it legal tender no longer had to keep gold in Fort Knox to backstop the value.

 

It seems like this action would be very reckless but with the power of hindsight it has allowed for an amazing economic expansion around the world for both rich & poor countries.  It allowed money supply to expand much faster than historic levels and allowed for more government spending & prosperity.  If used properly, this expanded money supply improved the quality of life for a population, but if it reached inflationary extremes it could have devastating effects.  We have seen several examples of inflationary spirals in Argentina, Zimbabwe, and recently Venezuela.

 

If people become fearful of the government’s ability to support their currency, investors rush to convert it to gold or another “hard asset”.  Interestingly, copper has often been used as the hard asset of choice in China since it has more physical uses than gold, especially in that country.

In 2008, after the global financial crisis, Satoshi Nakamoto (a possible fictional character), published a paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System” which added digital or cryptocurrency to our lexicon.  The idea behind it was to create a network of computers that were not controlled by any governments so investors could trust the value of the virtual coin.  The network of computers (labelled miners) verifying the network and being rewarded with coins for doing so, and thus Bitcoins were created.  In order to create validation with the public, the network had to grow big enough so that it could be trusted. Bitcoin has now become the digital equivalent to gold.

 

In application, there are functional problems with the Bitcoin network that make it unattractive to replace fiat currency - it’s slow.  Nobody wants to stand at a checkout counter for 30 minutes while your bitcoin is verified.  This led to another network of computers which began in November 2013 by Vitalik Buterin. The network called Ethereum, was more of a backbone than a system itself and was designed to allow others to write programs on it so it has much more utility.  I equate Ethereum to the digital equivalent of copper.

 

If the investing world loses faith in fiat currencies or is concerned about a particular government’s ability to repay its debts, the money will flow to gold/bitcoin or copper/ethereum as safety becomes the primary goal. 

 

During the Great Recession of 2007 the biggest fear for investors was the return OF money not the return ON money.  History does not always repeat itself, but it often rhymes.