Imagine going on vacation if you had to barter along the way. Imagine taking a 401k distribution in barley. “Money is the most universal and most efficient system of mutual trust ever devised,” writes historian Yuval Noah Harari. “Even people who do not believe in the same god or obey the same king are more than willing to use the same money.” Yet, whether it’s diamonds or gold, euros, yuan, or dollars, none have any inherent value; they can’t be used as food or shelter. As Harari puts it, “Money isn’t a material reality—it is a mental construct.”
Societies need to store and trade value. The units of exchange, institutional supports, and technologies involved have changed over time, but whether Sumerian silas of grain or the Bitcoins accepted in hipster coffee shops, currencies only exist if people believe they have value.
Bitcoin’s volatility underscores the challenge of establishing the trust needed for a widely useful currency, but the proliferation of cryptocurrencies also shows that traditional, government-backed currencies don’t address everyone’s needs. Cryptocurrencies offer money that’s not at the mercy of a central bank, faster and cheaper transactions, electronic money for the unbanked, digital funds protected from identity theft, easier cross-border payments, and reliable means to do a transaction without needing to trust the other party.
Yale Insights talked with William N. Goetzmann, the Edwin J. Beinecke Professor of Finance and Management Studies and director of the International Center for Finance at the Yale School of Management, about how financial history informs our understanding of how cryptocurrencies are reimagining money.
Q: There’s a great deal of hype around cryptocurrencies. Do we know how much impact they will actually have?
Cryptocurrency is a speculative instrument at present. The news that we hear is all about high prices being made or low prices being made, people becoming millionaires, and people losing their Bitcoin code. It’s something that catches a lot of attention but is not fundamental to the economy.
I don’t know whether it’s a good or bad investment. I know it’s very volatile, and there are certainly other risks beyond the fact that it goes up and down a lot. There are cases where cryptocurrency exchanges have been hacked and people just lost all their Bitcoin. Another fundamental risk is that there’s no place you can go to look up the key to your Bitcoin.
Over the long term, who knows whether there’s going to be a permanent demand and value to it? I suspect there is a demand for a way of transferring and storing value outside of the purview of the global banking system, but just how to figure out the fundamental value is quite a challenge.
Q: What makes a currency successful?
There are all sorts of theories, but we don’t quite understand what makes a currency work and what makes it really liquid. You can create all sorts of currencies but getting people to spend them and to accept them almost requires a kind of magic. The United States makes dollar coins and two-dollar bills. Nobody spends them. Why not? There’s really no good explanation. They just don’t have liquidity.
When the government thinks about revising the currency, they’re cautious about disrupting people’s reliance on doing things the way they’ve always done them. There are good reasons to consider getting rid of the penny but doing that would involve risk. When you’re holding a physical penny, you trust that the dollar bill is worth 100 of them. Getting rid of the penny risks interrupting an institution that’s worked really well, particularly for the United States.
Q: Does Bitcoin need to be fully liquid, in the way that dollars are, in order to be useful?
There are a few basic things any currency has to fulfill. It has to be a store value. It has to be a unit of account. It has to be a method of transferring value. With Bitcoin, because it fluctuates so much, it’s not a particularly good store of value. You could put in $100 worth today, and it could be worth $25 dollars two weeks from now. Until it overcomes that particular feature, it’s not a great currency.
“Some ancient money resembled today’s cryptocurrency in that it was based on credits and debits in a ledger. Metal coins broke the reliance on an accounting system. Coins had no history.”
Q: Can financial history help inform our understanding of cryptocurrency?
In ancient times, some of the money actually resembled today’s cryptocurrency in the sense that it was all based on accounts, a ledger. There’s no physical Bitcoin; you can buy, sell, and trade Bitcoin with other people, but it’s really an accounting transaction more than anything else.
Before coins were invented, value was transferred through a system of accounts. If you and I lived in the same city, you’re a baker and I make pottery—a loaf of bread is one shekel of silver; a pot is three shekels—when we would trade with each other, we were not using actual pieces of silver. We were creating credits and debits in a ledger. That’s kind of the way Bitcoin is working now; there’s no physical transfer.
The innovation in ancient times was the creation of metal coins that broke the reliance on an accounting system. Coins had no history. They were completely anonymous. Once I paid you, nobody knows what happened to that coin. You could use it for something completely different. Bitcoin today actually keeps a history in the blockchain, which is a distributed ledger that exists in no single place but is shared across a lot of participants.
In a sense, we’re going back to the time before we had anonymous money, transferrable by physical processes. That is exciting because each method of storing and transferring value solves different kinds of problems.
Q: Are there aspects of cryptocurrencies, besides the technological aspect, that are novel in the history of money?
The thing that seems to distinguish Bitcoin, from other forms of transfer of money across accounts, is this process of verification which depends upon solving a mathematical problem. That was the innovation, I think, with Bitcoin. But the idea of having to solve a problem in order to authenticate a transaction, is related to other kinds of technologies that people have come up with to make sure that the money is good. I’ll give you an example.
Benjamin Franklin was a printer. One of the things that Franklin printed was money. He was constantly having to fight against counterfeiters. So how do you deal with people that are also good printers? How do you design a currency that can’t be replicated? His idea was very clever. He found a way to take leaves from trees and make an impression of them, and then use that impression as a printing device on the money. Now, why was this something that couldn’t be replicated? Because every leaf is unique, and it’s very hard for the human hand to imitate nature’s detail. So that was one of his tricks for preventing the counterfeiting of the currency.
Q: How long has paper money been used?
The invention of paper money can be traced back to China. It was invented by a set of merchants in a city in western China as a workaround to really cumbersome coins made of iron that the government had forced the people in this district to use. Merchants took deposits of the heavy coins then gave people printed certificates that represented their deposits. Eventually, the merchant agreed to honor each other’s deposit bills and trade amongst each other. It became a standardized way of trading in that city.
The problem was that one or more of the merchants decided not to keep all of the coins in reserve, so there was a financial crisis. The government stepped in, said, “From now on, no more private money. We’re going to be the printers of the money.”
Q: You taught a course on cryptocurrency that was cross-listed with the Yale School of Management and the Yale School of Art. What’s the connection between cryptocurrency and art?
Artists are interested in what makes society work. They’re interested in the economic system and the social role of money. There’s a long history of artists engaging with money: trying to understand what it is, using it as a symbol for things, and even helping to create money. There are artists on staff in the U.S. Mint whose entire careers are based upon design of money.
One of my favorite examples comes from Marcel Duchamp, one of the great conceptual artists. He believed that investors were being gulled and tricked by financial propositions. Instead of just writing about it or making a traditional piece of art that offered a critique, he set up a company, printed bonds, and collected money from investors promising to take that money to Monte Carlo and bet it all using a special system that would return 20% on their investment. It was a scheme that was doomed to fail, but by creating a corporation and issuing bonds, he went from being a viewer and commentator to a participant in the financial system.