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2018-03-19T12:00:00+00:00

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Moneon

What are our money and cryptocurrency backed by?

Money โ€” it's just a piece of paper... Or is it? Letโ€™s study this complicated issue together.

A man has been using money for thousands of years, their embodiment has changed with the course of history. Weโ€™ve already covered the nature of money in one of our articles. But what is behind money, and is there actually anything behind it โ€” let's take a closer look.

How can money be backed?

Let us recall one of the money classifications: money can be real and fiat. Real money is a kind that has a nominal value that coincides with the value of the precious metal it is made of, i.e. with the real value. This kind of money is always backed (with the value of the metal itself). It can also be said that real money is a certificate of value.

Old coins

In turn, fiat money is only a symbol of value. Fiat, or fiduciary money, is a currency that is accepted by the state as a legal tender. Yes, these are just pieces of paper that can be traded for goods in a particular country. They are not backed by any material values and, in fact, are based solely on people's confidence in its ability to buy something. But it is at the same time wrong to state that fiat money is not backed by anything at all. There are certain intangible assets standing behind them: the authority of the country, the GDP and the economy as a whole. For example, the powerful US economy is behind the dollar. Should the economy grow weaker, the dollar will also be falling, and vice versa. The main disadvantage of money, backed by the authority and economy, is their dependence on political decisions and an overall situation; the decisions of the central bank can both bring down the currency and exalt it above others. Sometimes the latter can even cause high inflation, as mentioned in one of our previous articles. Fiat money is not crisis-proof.

To date, the real money has sunk into oblivion. All the money that we tend to use can be classified as fiat. It is worth consulting the history in order to understand why we ended up where we are now and why real-life backing is no longer required.

Money backing throughout history

From the very beginning, money has always been backed by something. For example, for ancient Sumerians cattle figurines played the role of money. They could, therefore, have been exchanged for cows and sheeps. But this is only one of the special cases, that later developed into a system.

A gold standard became the first significant system to regulate the provision of money. The former is a monetary system, under which currency can be freely converted into gold. In other words, under a gold standard money was backed by the value of gold. This system got traction in the 19th century. One of its apparent advantages was the simplification of international economic relations, which derived from a universally known value of gold. However, dependence on gold reserves and the possibility of their replenishment exerted pressure on the national states.

In 1944, the gold standard was replaced by the Bretton Woods system. This year, at the Bretton Woods conference, a fixed price for gold was set โ€” at $35 per troy ounce. It was designed to balance the supply and demand of major currencies through the process of money exchange. But in the end, this noble intention led to the excessive distribution of the USD and, as a result, the appearance of the Dollar standard. Gold was forced to take the back seat. And it wasnโ€™t to everyoneโ€™s liking. France, led by President Charles de Gaulle, entered into a confrontation with the United States, releasing a new franc worth 100 old ones. As a result, France witnessed a period of rapid economic development. Soon the country was among the worldโ€™s three most powerful economies. It is when the day of reckoning has come. France wanted all of its gold back, handing the dollars back to the United States. This sudden strike performed by France created a precedent, and soon Germany followed.

Dollar as an exampleโ€‹ of modern money

Bitter experience is also experience: it became clear that binding the global monetary system to one country is not an option. The Bretton Woods system was replaced with the Jamaican one in 1976. In accordance with the Jamaican currency system, currency exchange rates are set by the market, not the state. Money is backed by the economic importance of countries, their authority. Exchange rates fluctuate following current events. And money is not backed by gold. This particular system is still in action. Through the lens of the global financial crisis of 2008โ€“2009, the need for a new financial system has been proclaimed more than once.

Backing of cryptocurrencies

Although we tend to trust our modern paper money to the extent that there is no difference what they are backed by, with cryptocurrencies it is not that simple. Or quite the contrary, extremely simple. Crypto is not backed by anything! This state of affairs is alarming, but there are also pluses to it. The political independence of the cryptocurrency, limited supply, available output and, finally, a hope for a brighter future โ€” all this, in fact,โ€‹ stands behind bitcoin. It is up to you whether you want to believe it, or not. But if the cryptocurrency has nothing behind it, money is just a piece of paper, then how do you save money for your retirement? We advise you to read our article on investing (link), probably, it will prompt a thought.

About author
I write texts. Once I get a task, I do the following: I find every significant book on the topic, I read 'em all and then I synthesize something, that my readers can actually read and understand. Works like a charm.
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