This series covers my first draft of the various chapters for my upcoming book. These articles have not been through fact checks or editing and will not be the final version.
Bartering — The first kind of money
What is money, why does it exist and when did it come to be? To start answering these questions, we need to look back to when we lived in small groups, tribes or villages.
This is the first time we see the most basic form of money — Not the kind we see today, or even the types of money we read about in history books, like shells, beads or salt — the first kind of money is simply anything of value, that is exchangeable.
Exchanging forms the foundation of human life, without exchanges, we would have essentially no society. From a young age we start inventing forms of money by placing value on our possessions, and offering them to the markets we have access to. Even before kindergarten, you will likely have experienced some form of exchange, whether it was trading marbles, action figures or collectible cards, within your school an economy around every kids possessions was formed. Some kids participated and some didn’t, but it was there.
This economy however, is limited, and is dependent on everyone owning something of value to participate. But how is value determined? The value assigned by the owner is not always the value assigned by the market, so when I want to trade my blue marbles for red ones, I might decide that one blue marble is worth two red ones. My classmate however, might view blue and red marbles equally, so he might counter my offer and if we then agree that they are of equal value, we set the price for an exchange of blue and red marbles. In another scenario, my classmate may have too many red marbles, and too few blue ones, making red marbles more valuable than blue ones to me, and blue marbles more valuable to him.
In both examples, the exchange between us is voluntary, and the only reason that the trade happens is because we both expect to benefit from it. We both benefit from it because we both perceive what we give up to be less valuable than what we get back. Since I have an excess of blue marbles, and my classmate an excess of red, we value the marbles we already have lower than the ones we need because our supply exceeds our requirements.
A common misconception is that when an exchange takes place, it’s a record of the value of the items exchanged, but this simply isn’t the case. If I exchange a cup of coffee for a 1 carat diamond, it doesn’t mean that diamonds are worth less after that exchange, nor does it make coffee worth more. All that an exchange measures is the value of the items relative to those making the exchange. (This is something we’ll come back to when we discuss Bitcoin later)
Exchanging goods and services was and is the absolute foundation of society, this is because every person, their circumstances and skills differ. An egg farmer values fish more than eggs since he can obtain eggs with ease, but not fish.
The limitations of barter
Even though the exchange of goods is so fundamentally important to our survival as individuals and as a species, it would be impossible to scale because this type of direct exchange isn’t much more efficient than living off the grid and being able to self-sustain. Take our egg farmer for example; she wants to build a new coop, and in a world without money, she offers to pay with what she has — eggs.
The first problem we face is that not everyone needs or wants eggs, so the people she hires to build her coop may not all accept eggs as payment. The second issue is that the items you exchange are not always easily divisible. While eggs are a reasonably small item and individual eggs are relatively inexpensive, so can be used to buy more expensive items, a shoemaker could hardly separate a pair of shoes to pay for something because a $100 pair of shoes is worth very little to nothing if you only have one of them.
This also doesn’t mean that items that can be easily divisible are easier to transact with, because you then run into the first problem, where you may not be able to exchange what you have for what you need. This creates a scenario where you may have to jump through various sets of goods to buy the item that you actually want. Say our egg farmer wants shoes, but our shoemaker doesn’t want eggs, he wants cheese, and our cheesemaker wants milk, and our dairy farmer wants eggs. The Egg farmer has to sell their eggs for milk, then sell the milk for cheese, and the cheese for shoes, and then she finally gets the shoes she needed. Other than the huge effort that she has to go through to get the shoes, it also costs more to make multiple exchanges due to indivisibility, transport costs, and might even lose a little bit of value each time she makes an exchange on her journey to new shoes.
Being the efficiency loving beings that we are, humans figured out how to scale economies by indirect exchange. Indirect exchange is the process of the egg farmer buying and selling into one or more other products in order to buy what she actually needs, based on the needs of the seller of the item she wants to buy.
This is still an inefficient means of exchange, but indirect exchange lead us to discover (or invent — whichever you prefer) the mechanism of a medium of exchange.
Let’s consider again our egg farmer. This time she needs to buy some tools for her farm. The Blacksmith doesn’t need eggs, but he does need salt, so our farmer buys salt and sells the salt for the tools she needs. On the other side of the village, the baker sells his bread for salt because he needs it for making bread, and also uses the salt to buy flour from the mill.
In this scenario salt becomes incredibly marketable because everyone is confident that they will be able to sell salt to get the goods that they need. This in turn makes salt more valuable because it starts being used as a medium of exchange.