Crypto Currencies Research Paper
Literature Review – Cryptocurrencies
Everyday is a bank account, and time is our currency. No one is rich, no one is poor, we’ve got 24 hours each. – Christopher Rice
The following literature review gives an overview of the history, the development and the current situation of cryptocurrencies. While this is a rather young topic (first conceptualized in 2008), due to the evolving importance and prevalence of cryptocurrencies and especially bitcoins, researchers have been increasingly looking at this topic, particularly in the last two years.
Before analyzing the system and the function of cryptocurrencies, a detailed view into the system of money and its history in generally are necessary in order to understand how cryptocurrencies are different from the traditional means of payment and money.
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History of cryptocurrencies in the global context of money and currency development
While there is some debate whether cryptocurrencies are really currencies, commodities or something else entirely, they are definitely a means of payment and their development can at least therefore be regarded as an extension of means of payment and trade.
People have always traded. A woodsman would trade his wood for a bread or milk from a farmer. Everybody focuses on his specialty, making it necessary to exchange goods and services. Already around 12.000 BC, humans realized that it would be much more efficient if they could trade through a central, general and easy to handle instrument to avoid situations where one would like the goods from another who needs something that the first one does not have. Money (in this case coins) as we know today was not introduced until approximately 1000 years BC (Weatherford, 2009), but livestock (9000 – 6000 BC) and raw materials such as silver, copper or gold were used instead, later being developed into the mentioned coin system, similar to what we still use today. It was necessary because barter (direct exchange of goods or services) was not appropriate anymore. Timing and the different needs of people required a new intermediary tool to be designed.
About 1200 years later, the coin system was further developed: The first banknote was introduced in China as coins were getting too difficult to transport in large amounts. This development created several problems as it was not centralized and such a banknote could only be traded in at certain banks. Therefore, the issuing of banknotes from several different banks came to end in the 17th century, when Western governments took over this responsibility and only allowed one central federal bank to issue banknotes which were backed up by the promise that this piece of paper could also be exchanged for gold. Such currency is called commodity money as it is bound to at least one universally accepted good.
The interplay of USD and gold was ended by US president Nixon in 1971 when he gave the executive order to stabilize the dollar by separating the value of banknotes from gold. This later became known as the ‘Nixon Shock’ since it had great impact not only on the US Dollar but also on various other currencies around the globe. The cutting of the bond between the US Dollar and gold was the last step towards what is called a ‘fiat currency’; coming from the latin “Let it be done” (referencing to the central authority that can declare the currency a legal form of payment and backing mainly through its authority). Since then, the value of banknotes relies largely on the acceptance of all users and the acceptance and confidence in the central backing authority. It is a form of money that is not related to any goods but only relies on the declaration of the government and will fail once the acceptance from users decreases. Both the Euro and the USD are fiat currencies.
Since a government has (almost) full control of their currency, they may control the supply and demand through the central bank and use this leverage to fight financial crisis and hold inflation on an acceptable level. This was greatly used to counter the financial crisis when the federal reserve in the US put large amounts of liquidity in the markets. The power of such central banks is shown exemplary when one sentence by Draghi, head of the European Central Bank in 2012 impacted economies throughout the world, believing him when he stated that the “ECB will do whatever it takes to preserve the Euro, and believe me, it will be enough.” (Bloomberg, 2012) While this may have had a positive impact on the Euro-Debt crisis, it also showed clearly how statements from governments can steer or even manipulate currencies. With the rise of the internet, certain groups wished for a non-regulated, independent form of exchange. They were and still are opposing governmental regulations and therefore wanted a currency that is not controlled by any government and cannot be used for political purposes. At first this seemed impossible to achieve since somebody would be needed to give out such money and, even more importantly it would need to gain the trust and acceptance from the users.