Bitcoin Vs Gold Standard Vs Fiat — Bitcoin Fundamentals for an Average Joe
Overview
Bitcoin is a form of digital money that cannot be controlled by central entities like governments or federal banks. Even for all the democratic countries on the planet, money printing (also known as Fiat Currency Minting) is a matter that comes fully under government jurisdiction and people have no say in how much money should be printed. Bitcoin takes back this control from governments and puts it back into the people’s hands. To understand Bitcoin and its rise, it is important to grasp the fundamentals of money.
How does money work?
Demand and Supply Drives Value of Everything
Let’s consider a simple example of the omni-heard rule of “Demand and Supply”. Let’s assume that many farmers produced onions this season. Due to the huge production of onions, if the total onion supply exceeds the consumer demand, prices go down sharply, which makes all farmers sell their onions at cheap prices. Similarly, in a contradicting situation, when onion supply is not enough to meet demands (or even consider a worse situation when onion crops die due to heavy rainfall resulting in reduced supply), in such
cases, shortage of supply shoots the prices high. So, demand and supply play a central role in driving the prices of all goods everywhere.
Fundamentally, balancing the ‘Demand & Supply of Currency’ is an important task for the government and central/federal banks for economic growth.
Inflation is a result of the following 4 combinations.
1. The supply of money/currency goes up. (currency value goes down, goods become expensive)
2. The supply of goods goes down. (shortage of supply causes goods value to go up, goods become expensive)
3. The demand for money goes down. (people lose trust in national currency due to bad economic policies of a government or unstable governance and start trusting other value storages like gold, silver, or stocks to store their money )
4. The demand for goods goes up. (people lose trust in national currency due to bad economic policies of the government or unstable governance and start trusting other value storages like gold, silver, or stocks to store their money)
Inflation and Purchasing Power Correlation
Suppose a person is earning $1000 a month from his job to support the family expenses. There could be various reasons for rising inflation, which affects a person’s purchasing power. For example, if the price of daily vegetables is $100 a week; after a few months, due to rapidly rising inflation or some supply shortage issues, the same amount of vegetables could cost $125 a week. In such cases, since the salary of the person did not change, he/she still needed to purchase the same goods at higher prices, which means now he/she has the “reduced purchasing power”. Because giving out an extra $25 leaves the person with a lesser balance in the account to purchase other things. So inflation is inversely related to purchasing power. As inflation rises, if net income stays constant, purchasing power reduces, and vice versa.
Note — any specific fiat currencies like dollar, rupee, etc are used for example purposes. All fiat currencies went through the same issues over the years.
To understand how bitcoin came into existence, We must go back and build more understanding about the evolution of money and monetary systems.
Bitcoin Vs Gold Standard Vs Fiat Currencies
Following visualizations show the comparison between Bitcoin, Fiat, and Gold Standard.
Above displayed comparisons and visualizations are discussed below in-depth to understand, how these systems evolved and outperformed the former system.
Gold Standard Currency or Gold-backed Fiat Currency
During the early 1900s, for all the countries on the planet, including the USA, fiat currencies(like Dollar, Euro, Yen, Rupee, etc) had no intrinsic value, as gold was the only standard for exchanging the value. For example, if the USA decides to value of 1 gram of gold at $100 while India decides to value the same at INR 50, then a comparison between the US Dollar and INR is merely useless, because, there is no intrinsic value associated with the Dollar or Rupee, instead the value of these currencies are derived from gold.
It can be clearly seen that the exchange rate for a Dollar against a Rupee remained the same. Governments used to print currencies equivalent to their gold reserves. At any point during such times, if any government or country needed to print more currency, they would need an equivalent amount of gold to be deposited to support the currency minting.
Obviously, there were both pros and cons associated with the ‘gold standard’ system. Eventually, in the latter half of the 20th century, the cons did outweigh the pros, and finally, the ‘fiat currency system’ that we use today came into the picture. We will discuss this in detail below.
Why did the Gold standard fade?
To understand why the gold standard system was scrapped it goes back to WWI(1914) as countries involved in world war following things happened
1. To fulfill the huge expenses for military weapons, food supply, and to recover from the destruction caused by the war, countries involved in wars needed a lot of money, so they neglected gold standards and printed more money without considering gold reserves.
2. As the crisis occurred people hoarded gold for safety rather than helping the government that in effect caused a shortage of money.
3. As countries started to implement development programs for a better future required huge funds which were eventually not possible for the gold standard to fulfill.
4. As war occurred imports and exports of gold between countries stopped so it gave birth to the need for a new monetary system that should not be based on a commodity.
5. Countries with less gold due to the geographical location were having limited money as they didn’t have much gold to compete internationally.
6. Governments were not penalized for poor economic policies or bad decisions because money was dependent on gold only, this causes unstable governments to stay for longer periods.
To overcome the above issues came fiat currency in 1972 when Richard Nixon scraped the Gold Standard in the US, which was back then the only country at that time which was on the gold standard.
What is Fiat Currency System and How is it Overcame Gold standard Cons?
Fiat currency which is printed out of thin air has not backed or pegged to any commodity such as gold or any metals. It has value just because governments have issued that value and people using it to exchange believes in that value.
Advantages of Fiat Over Gold Standard
1. Nowadays countries require a lot of money to conduct development activities, space programs, military advancements to fulfill all these need money can be printed as required it helps governments to implement economic policies.
2. In the time of crisis, countries can print money to bring a supply of money in the country or to avoid deflation.
3. The value of a currency is dependent upon supply and demand and credit of country products in international markets.
4. If governments implement poor economic decisions or policies it affects the value of money immediately which forces governments in power to make wise decisions and implement good economical policies.
Despite having the above advantages fiat currency gave rise to a list of problems discussed below, which gave birth to the cryptocurrencies (or Bitcoin in this case).
What are the problems with Fiat Currencies?
- Unlimited Supply
Fiat currencies can be printed as much as governments want, there is no supply limit. Governments with poor economic policies can print hefty amounts which will reduce purchasing power which causes Hyperinflation e.g Zimbabwe printed currencies at a very large scale that people needed to carry bags of money to buy pins. They printed bills of trillion too!
2. Fiat currencies are not accepted worldwide
Most Fiat currencies are not accepted worldwide; they need to be exchanged (based on their value against the US Dollar), and exchange rates are floating and they are not fixed.
3. Fully Centralized and governments have huge control over them
Fiat currency system is fully centralized, governments decide the value of bills, and central banks have the authority to print as much money they need, which can lead to bigger problems. Governments have unnecessary control over our money and financial transactions, for e.g India demonetized their currencies which made their money useless for some period until a new currency was issued and brought inconvenience to peoples.
4. No privacy in financial transactions and Poor management in Banks
Our banks have full details of our funds, where they are invested, and all transactions happening through our account. They have unnecessary control and access to our personal information, which can lead to bigger problems. Banks with poor management invest people’s savings funds into volatile schemes and provide loans to some favored people at fewer interest rates. For e.g When banks go bankrupt, people lose access to their life savings and are not able to withdraw their own money.
5. Governments bail loans of some people and print more money to cover such bad trails
Governments and banks distribute loans to big business at lower interest rates, and if they fail to return they even bail them, and to recover the lost funds they print more money, which causes inflation which in effect reduces the purchasing power of the common man without.
6. Privacy compromise and can sell our data to financial institutions
In the 20th century, the most valuable thing is DATA, central banks, and governments have unnecessary access to our personal and financial data. They can sell our data without even informing us of Finance and insurance companies. Privacy is compromised at a larger scale in fiat systems.
How does Bitcoin solve these problems?
Hence we discussed all the monetary system from start to today, we can conclude that we needed a global electronic currency system which is
1. Decentralized (no centralized entity or organizations should be able to fully control )
2. Having Limited Supply of Currency
3. Private
4. Globally accepted and easy to transport
5. Transparent and incorruptible i.e having auditable database
Bitcoin has all of the above-listed characteristics as described below.
1. Decentralized
Bitcoin is purely decentralized i.e not controlled by any central
authority or government or any single entity. It is basically a computer algorithm (cannot be altered without public consensus) and based on distributed ledger technology i.e Blockchain.
2. A fixed supply of 21 Million coins
Bitcoin has a fixed supply of 21 million coins i.e there will never be more bitcoins in the world than 21 million in the coming future. At the time of writing 18.45 million coins out of 21million are in circulation. To simply say, it is governed and printed digitally by an algorithm that guarantees that supply will never increase like centralized fiat currencies.
3. Transparency
All the transactions are recorded on a public blockchain(distributed
ledger), anyone can see it and it is immutable in nature. You can just see
transactions; it does not share personal details of someone neither sender nor
receiver.
4. Privacy and Anonymity
Bitcoin never collects any personal info about you i.e name, address, identification number, etc. All your funds are collected and stored in a wallet that is encrypted. It is nearly impossible to trace a person’s identity using their
wallet number.
5. Global Acceptance and Transportability
Bitcoin is not pegged to any fiat currency or commodity its value is determined by people using it. You can electronically send bitcoin to anyone across the world, you just need to know their wallet number i.e peer to peer transfer without any intermediary bank or authority. There are no borders in bitcoin
By reading this article, you must have gained a lot of intuition about how money works, and why bitcoin or crpyptocurrencies are a need for future!
