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Part 1: Money, Credit and Trust

A world of greater prosperity is possible when we believe in a better future and have the ideas and financial tools to create it. New financial technology is changing the nature of money and providing grounds for this optimism

Cold, hard cash is tactile and simple… But this simplicity is deceptive. The more one ponders the nature of money, the less straightforward it seems. Cash merges with credit. Coins are replaced by code. ‘Value’ becomes increasingly relative. ‘Money’ is a fluid concept, and today, it’s one that’s on the brink of transformation. Historically, the magic of money creation was achieved through trust in centralized organisational structures, with manual processes carried out by humans. We now have the potential to create trust using software-enabled global peer-to-peer networks, with automated processes carried out by machines.

Yet, before we begin to build a vision for the future, it’s important to establish an understanding of the present, and how we got there.

Money and Credit: Two Sides of the Same Coin

Money is intertwined with the concept of credit, and the two have existed in tandem for millennia. Imagine this prehistoric scene: bored of hunting all day, a shrewd cavewoman (we’ll call her Alice) gives another hungry hunter, Bob, a handful of nuts. They agree that Bob will use the energy derived from the nuts to go hunting and bring back some meat to share. While Bob is off hunting, Alice recruits another caveman, Charlie, to go and fetch fresh water from the river, in exchange for a tasty, proteinous meal later. If all goes to plan, Alice has turned a few spare nuts into a feast, by transforming credit in the form of future meat into ‘money’ to buy fresh water.

So long as Alice’s trust is well-placed (meaning Bob’s hunt is successful) and trust is maintained (which means Bob gives Alice and Charlie their agreed share of the hunt) then all is well and the economy grows.

Creating Trust: Centralized vs. Decentralized Systems

Today’s modern economy is infinitely more complex but the basic idea of money and credit remain at the core. A highly structured credit derivative conjured up by an investment banker is based on the same principle that our prehistoric ancestors may have utilized. Credit is a contract rooted in shared trust in a future state. Now here lies the trick: credit is also money. When I borrow money from a bank, funds are credited to my account which can be used for purchasing. Money has quite literally been created out of thin air.

This is possible because, at its core, money is just an idea. Throughout history, money has manifested in many mediums, from shells and shiny metals to paper and, most recently, electronic databases. The medium is, in many ways, irrelevant. Like credit, money is a matter of trust. Principally, trust that other people imagine money in the same way as you; that a dollar means the same thing to your friend as your foe. Ensuring that this is the case has relied on centralized organisations. Centralization has its merits but it also exposes us to systemic risks and has tended to perpetuate inequalities over time. New and very promising technology is opening up more possibilities.

Decentralized systems such as Bitcoin demonstrate that it’s possible to securely maintain a shared record, enabling peer-to-peer transactions without relying on trust in a centralized record keeper. Platforms such as Ethereum show us that it is possible to create programmatic and autonomous ‘smart contracts’. All the while, the promise of machine learning is increasing rapidly. Humanity’s organisational tool-set has been significantly expanded.

Part 2 will outline what these technologies will make possible, and what this could mean for our future financial system. Follow-me here and on Twitter for updates.

Photo by Christine Roy on Unsplash