Transforming the Future of Finance: The Importance of Sound Money and the Potential of Decentralized Payment Systems

At masternode we believe in the equitable distribution of both wealth and welfare. In order to achieve a world where money is not monopolized and regulated by a select few, sound money is a vital component. This article will tell you all about it.

Introduction

Buying goods and services, saving for the future, and investing in our goals and dreams – money and our financial systems are such a normal and essential part of modern society that it is easy to take them for granted. However, without a well functioning financial system, many societies would look completely different. Yet, not many stop to think about the importance of sound money. Sound money refers to a monetary system that is stable, reliable, and resistant to inflationary pressures. In other words: money that is not subject to sudden changes in value, such as depreciation or appreciation, and that is not vulnerable to manipulation or fraud.

In many traditional financial systems around the world, governments and central banks manipulate interest rates in an attempt to control inflation and boost economic growth. The emergence of decentralized economies and their associated financial technologies has led to a growing body of critique from experts in this field. Advocates of decentralized finance argue that central banks’ control of interest rates creates systemic risks, undermines market efficiency, and perpetuates economic inequality. In short: it does not meet the standards of sound money. 

In this article, we will explore the importance of sound money, its main characteristics, and whether our current financial system meets these criteria. We will also examine the role of decentralized payment systems as a potential solution for sound money, and how they could transform the way we think about money and finance.

As we delve into these topics, we will see that the issue of sound money goes far beyond economics and finance. It touches on issues of social justice, political power, and the very foundations of our monetary system. Understanding what makes money sound is therefore essential for anyone who wants to navigate the complex world of modern finance and contribute to building a more equitable and sustainable future.

What is money?

Before we dive into the definition of sound money, it is important to have a clear idea of what money actually is. Money refers to any object or instrument that functions as a commonly accepted medium of exchange in a given society or economic system. It is a mechanism by which individuals can exchange goods, services, and debts with one another, thus facilitating the allocation of resources and the coordination of economic activity. Money can take on a variety of forms, including physical objects like coins and banknotes. These days, money can also take the form of digital representations such as cryptocurrencies and electronic payment systems.

A (very) brief history of money

Before money

Before the invention of money, people relied on a barter economy, which involved the direct exchange of goods and services. In this system, individuals would trade goods or services they had in surplus for other goods or services they needed. For example, a farmer might trade a bushel of wheat for a cow from a rancher. This system was simple and intuitive, but it had several limitations.

One significant challenge was that bartering required a “double coincidence of wants.” In other words, both parties in a trade had to have something the other person wanted at the same time. This made it difficult to conduct large-scale trades or to exchange goods across long distances. It also meant that some goods, such as precious metals, seashells, or livestock, became de facto currencies because they were universally recognized and valued.

Another limitation of the barter system was that it made it challenging to save or accumulate wealth. Without a universally accepted medium of exchange, individuals had to rely on storing goods or exchanging them for other goods they might need in the future. This made it difficult to conduct complex economic transactions, such as investments or long-term loans.

Despite these challenges, the barter economy was the dominant economic system for most of human history, and it is still used in some parts of the world today. The invention of money, which solved many of the problems associated with bartering, was a critical development that enabled the growth of modern economies and facilitated the exchange of goods and services across vast distances and diverse populations.

Early forms of money

The emergence of early forms of money resolved some of the problems past societies encountered in a barter economy. Early forms of money were typically objects or commodities that had practical value in addition to being used as a medium of exchange. Some examples of early forms of money include:

• Shells: Cowries shells were widely used in ancient China, India, and parts of Africa as a medium of exchange due to their scarcity in regions far from sea, and because of their unique appearance.
• Precious Metals: Metals like gold and silver were used as early forms of money in many ancient civilizations, including ancient Egypt, Greece, and Rome. These metals were durable, divisible, and universally recognized as having value.
• Cattle: In many pastoral societies, livestock, particularly cattle, were used as a form of money because they were both valuable and portable.
• Salt: In ancient times, salt was highly valued as a preservative for food and a seasoning. It was used as a form of currency in many cultures, including ancient Rome, where soldiers were paid in salt.
• Feathers: Feathers from exotic birds were highly valued in some societies, such as the Aztecs, who used them as a form of currency.
• Beads: In many parts of the world, beads made from shells, stones, or other materials were used as a form of money due to their portability and durability.

These forms of money offered several benefits over the barter system, including greater convenience, portability, and divisibility. However, they also had several limitations. Some early forms of money, such as livestock or seashells, were not perfectly fungible, meaning that each unit of the currency had different qualities or values. This made it challenging to conduct precise economic transactions and led to disagreements and disputes over the value of goods. 

Furthermore, storing early forms of money was often challenging and posed risks from theft, damage, or natural disasters. This made it difficult to accumulate wealth or conduct large transactions without significant risk.

An early example of inflation

Finally, some of these early forms of money were easy to create or find outside of the regions in which they were used, which made them susceptible to sudden inflation. For example, imagine a landlocked country in which seashells are the main form of money. Because this country is far away from sea, where seashells are usually found, shells are relatively rare, which provides them with a certain notion of value. However, one day, the country is visited by people from another, more technically advanced society. They discover that the people of our imaginary country use seashells as money. With their more modern modes of transport, such as ships and draft animals, they start importing large amounts of shells to the imaginary country to be able to buy anything they want. As you can imagine, this large influx of money drastically increases the prices, leading to massive inflation rates. Eventually, the economy might even collapse. 

This example perfectly illustrates the dangers of money that is not sound money.

What is sound money?

What is sound money?

Now that we have clarified what money is, let’s talk about sound money. Sound money is a term used to describe a monetary system that is stable, reliable, and resistant to inflationary pressures. Sound money is typically characterized by a stable and predictable currency, limited or controlled supply of money, and transparency in monetary policy. The goal of sound money is to provide a trustworthy medium of exchange that retains its purchasing power over time, allowing individuals and businesses to conduct economic transactions with confidence.

In the case of our seashell economy, the seashells no longer functioned as sound money, because they lost all their purchasing power due to the inflation resulting from the large influx of shells from outside. This prompts the following question: what is an example of sound money?

Gold as sound money

Throughout history, gold has been the best example of a form of sound money. For centuries, gold has been widely recognized as a store of value and a reliable medium of exchange due to its durability, scarcity, and resistance to inflation. Gold has historically been used as a standard against which the value of other currencies is measured. Under the gold standard, a country’s currency was directly convertible into a fixed amount of gold, which helped to ensure stability and prevent inflation. While the gold standard is no longer used by most countries today, gold remains a popular choice for investors and central banks as a form of sound money due to its long-term value and stability.

Key characteristics of sound money

With gold as an example, we will highlight some of the key characteristics of sound money.

Scarcity

Gold is a finite resource that is relatively scarce compared to other materials, making it valuable since not everyone can easily acquire gold. When a currency is scarce, it is difficult to obtain, which makes it more valuable and creates a natural limit on its supply. This scarcity helps to maintain the value of the currency over time and prevent excessive inflation, which can erode its purchasing power.

In a sound monetary system, scarcity is achieved through various mechanisms, such as limiting the supply of currency or using commodities with limited supply, such as gold, as a standard against which the currency is measured.

Stability: high stock-flow ratio

Another crucial characteristic of sound money is stability; in particular it being resistant to inflation. This is especially important when using a form of money as a store of value, since money that is resistant to inflation keeps its value over time. 

Gold is resistant to inflation because of its high stock-flow ratio. The stock-to-flow (SF) ratio is a metric that is used to measure the abundance of a commodity or asset relative to the rate at which new units of that commodity or asset are produced. It is calculated by dividing the current total stock of the commodity or asset by the annual production (or flow) rate. The higher the SF ratio, the scarcer the commodity or asset is considered to be, because very little new units are added to the total. 

Gold has a high stock flow ratio, because the process of mining gold is difficult and expensive, resulting in very low new quantities of gold being added to the total amount of gold in circulation.

Now that we know what sound money is, let’s move on to its importance.

The importance of sound money

Why is sound money important?

Sound money is crucial for the long term functioning of a financial system and, hence, for the societies that depend on this system. Sound money provides a reliable medium of exchange, which is critical to the functioning of economies. Having a stable method of payment of which the value will remain more or less stable throughout time, encourages people to engage in economic transactions, including investments in projects and innovations that boost welfare and economy further. Sound money also encourages saving and the accumulation of wealth, allowing people to plan for the future and achieve their financial goals.

However, the role of sound money is not limited to economy alone.

Sound money and political power

The concept of sound money is often closely tied to issues of political power and control. In many cases, governments and central banks have significant influence over the monetary system and can manipulate the money supply or interest rates to achieve political objectives or address economic challenges. This can create tension between the interests of those in power and the broader interests of society, particularly when the manipulation of the monetary system leads to inflation or other economic distortions.

When money is sound and stable, individuals and businesses have greater freedom and autonomy to make their own economic decisions and pursue their own interests.

At the same time, the question of what constitutes sound money is in itself a political issue, as different groups have different views on the best way to achieve a stable and reliable monetary system. Some argue for a return to the gold standard or other commodity-based currencies, while others advocate for alternative currencies or decentralized financial systems. As a result, the question of sound money is closely tied to broader debates about the role of government in the economy, the nature of money and value, and the balance between individual freedom and social responsibility.

Sound money and social injustice

In addition to having ties with economy and politics, sound money, or lack thereof, is also often linked to issues of social injustice. One way is through the potential impact of monetary policy on wealth inequality. When central banks or governments manipulate the money supply or interest rates, it can have a significant impact on the distribution of wealth and income in society. For example, policies that lead to inflation can disproportionately harm low-income earners who may not have the same ability to keep up with rising prices or invest in inflation-resistant assets. Conversely, policies that favor deflation or a stable currency can disproportionately benefit those who hold significant amounts of wealth or assets.

Another way that sound money is tied to social injustice is through the potential for corruption or abuse in the monetary system. When monetary policy is subject to political influence or manipulation, it can create opportunities for corruption or abuse of power. This can lead to social injustice by diverting resources away from public goods and services, concentrating wealth and power in the hands of a few, or undermining democratic institutions and processes.

It is evident that sound money is a crucial aspect of a world in which wealth, welfare and freedom are distributed equally. This brings us to the next section of this article: Does our current financial system fulfill the role of sound money?

Sound money in modern day financial systems

Before being able to analyze whether current financial systems are based on sound money, it is important to know what type of money is often used in our modern day economies. 

Money in our current financial system: fiat currency

By far most modern economies today use fiat currency as their money. The use of fiat currency has become widespread since the 20th century, when many countries abandoned the gold standard and other commodity-based currencies in favor of more flexible monetary systems. These fiat currencies are not backed by a physical commodity and their value is determined by supply and demand in the marketplace, as well as by the decisions and policies of the issuing authority.

Are fiat currencies sound money?

Let us preface this paragraph by noting that it is difficult to answer this question with a simple yes or no. 

Fiat currencies are created by central banks and governments, and their value is derived from the confidence and trust that people have in the issuing authority. While fiat currencies can be stable and reliable when managed responsibly, they are also subject to the risk of inflation and other economic distortions when the money supply is expanded too rapidly or when monetary policy is used for political purposes. 

Additionally, many would argue that fiat currencies are not truly sound money, as they are not backed by a physical commodity like gold or silver. Furthermore, by manipulating interest rates and consequently inflation, central banks and governments interfere with the stability of money, which is an important characteristic of sound money. 

Fiat currencies and political power

While sound money can promote a more equitable world, unsound money has the potential to create imbalances in political power, exacerbate economic inequality, and constrain individual freedom. If we analyze fiat currencies through this lens, it does not score very well.

Firstly, the power to create and manage a fiat currency lies with the central bank and government, giving them significant control over the monetary system. This control can be used to pursue political objectives, such as stimulating economic growth or controlling inflation, but can also be abused if monetary policy is used for political gain rather than for the benefit of the broader economy. 

Secondly, the power to issue fiat currency also confers significant political influence and authority. The stability and value of the currency is often seen as a reflection of the strength and stability of the issuing authority, giving them greater credibility and influence on the global stage. Conversely, economic instability or currency devaluation can undermine the credibility and influence of the issuing authority, potentially leading to social unrest or geopolitical tensions.

Furthermore, by manipulating interest rates, central banks and governments control the value that the money of their subjects has. When central banks induce inflation, money loses its value, prompting people to spend it now rather than save it for later. This is often done in an attempt to boost economic activity, but it takes away a part of how much power people have over their own money. 

In conclusion, while fiat currencies have become the dominant form of currency, their lack of physical backing and potential for political manipulation raise questions about their status as sound money.

The role of decentralized currencies as sound money

Bitcoin as a possible solution

If fiat currencies do not end high in the sound money scorebook, what alternatives might there be for our financial systems? Do we have to start carrying stacks of gold around everywhere? 

There might be a more practical solution; professionals from the field of crypto believe that decentralized currencies are the answer. This point of view originates from the fact that currencies such as bitcoin are not managed by a central entity, which reduces the risk of fraud, censorship and manipulation. 

Furthermore, bitcoin is designed in such a way that it has an internal limiting mechanism: the bitcoin halvings that occur roughly every four years and that reduce the supply of new bitcoin, thus ensuring a high stock-flow ratio. Since the amount of bitcoin in circulation is limited and will continue to be limited in the future, it also fulfills the requirement of scarcity, which adds a certain value to it. 

Finally, while cryptocurrencies have been subject to significant volatility in the past, some argue that their decentralized nature and limited supply make them more resistant to inflation and other economic distortions over the long term. Once cryptocurrencies acquire a more stable price development, they would also meet the sound money criterion of stability. However, this is not yet the case for most decentralized currencies, including bitcoin. 

Crypto: not all the same

In addition to the volatility that many crypto currencies are still being plagued by today, it is also important to note that not all crypto currencies tick the box of being fully decentralized; some are being managed or controlled by a central entity, whether that be a single person, a company or a select group of people or organizations. 

Another critical remark that has to be made, is that there are many relatively small decentralized currencies out there as well. While these smaller currencies operate on a decentralized basis, they might be vulnerable to manipulation or fraud as they are less resistant against an attack, such as a 51%-attack, due to the small size of their network. 

So overall, decentralized currencies have great potential as sound money, especially the larger and more developed ones such as bitcoin, due to their decentralized network and limited supply. However, there are still significant obstacles to be addressed, such as its volatility and market fluctuations.

Conclusion

In this article, we discussed the importance of sound money. We started with a brief history of money, which led us to some of the key characteristics of sound money: scarcity and stability. Our example of a sea shell economy also showed us why sound money is important, and that its influence extends much further than economy alone; it also impacts matters of political power and social injustice. 

We can conclude that sound money is essential for the proper functioning of a financial system and society at large. Despite this, our current fiat currencies, which lack physical backing and are subject to manipulation, raise questions about their status as sound money. Decentralized payment systems like bitcoin offer a potential solution due to their decentralized network and limited supply, even though there are still significant obstacles to be addressed, such as its volatility and market fluctuations. As the use and adoption of bitcoin continues to evolve, it will be interesting to see whether bitcoin will grow more into the role of sound money or whether the obstacles on its path prove too difficult to overcome.