This is the first article of a series of articles to understand Bitcoin and money. Here you can find a brief summary of the project.

Introduction

It is difficult to understand the true essence of Bitcoin because it is a multidisciplinary object. It requires different competences in several fields, which usually does not intersect in such a tight way. It touches economic and monetary theory in which draws inspiration, jurisprudence where it takes the concept of property to another level, cryptography and computer science which are the bricks that make up the code, network and data transmission for distributed systems and game theory to push the mechanism to work. Furthermore, it requires to some degree a detached vision, say, philosophical, to understand the main reasons and beliefs that allowed its creation. Indeed, how money is created is a philosophical and legal matter, which should answer three questions. Who has the right to issue money? Who has the right to decide who can participate or not to the economy? And who decides how should be managed properties? That is how they are separated between people.

It turns out that money requires the correct mechanism and the right rules to work, as much as it is involved with the abstract idea of value and the protection of the purchasing power of its consumers through time. Moreover, one of the fundamental characteristics that money should fulfill to obtain a general consensus, is that it should be trusted, otherwise it would hardly have any value in the long term. Indeed, trusting that a currency is genuine and secure is an important prerequisite for conducting a transaction. This was true in ancient societies during the Gold age and even more today, in the digital age of information, where the money is a string of bits on a remote server connected to bank accounts.

Nevertheless, even if through history a lot of innovations concerning financial institutions and method of payments were made, this system has led to the centralization of the source of money, needed to prevent disputes for managing credits/debts and liquidity between various actors of the economy. The centrality of the system brought with it several orders of problems, such as moral hazard, typical of monopolies and hacker attacks to banks, resulting in a net loss of efficiency of the whole machinery and preventing the discovery of better methods of satisfying a need for which a monopolist has no incentive. This means that one must use their product even if it is unsatisfactory.

However, in 2008, a person under the pseudonym under of Satoshi Nakamoto proposed a new protocol, posting on the web the White Paper of Bitcoin [2]. Here, he described a new kind of decentralized money, suitable for the internet and fueled through sophisticated engineering techniques of synergic economic incentives, built to maintain autonomously the network without a central authority. Satoshi proposed the distribution on all nodes of the ledger of all the history of transactions, collected in blocks and recorded sequentially through timestamps - the Blockchain -, which defines the network of Bitcoin as a whole. Every node could download, share and store forever a change in the system, hence the blockchain is needed to maintain a unique version of the transaction history. To work, the protocol allows for the creation of a defined schedule of a newly issued currency designed to be fixed in number - bitcoin - which is used as an economic incentive to maintain the network cryptographically secure and inviolable.

Therefore one of the greatest merits of Bitcoin is that does not exist anything else in the digital world that is transferable but not duplicable.

However, this solution required to choose between several trade-offs, such as the speed of transactions, the safety of the network, and the size of the blocks needed to maintain decentralization. As we will see more in detail, the main protocol's trade-offs are chosen in such a way to answer to the questions raised above: the issuing of money is decided a-priori and delegated to the protocol, where the seigniorage is shared between contributors; the protocol is inclusive as long as it is founded on open-source software and anyone could improve it or take advantage of the financial service; and lastly the separation of property is administrated by cryptography and by the responsibility of the user, which is the owner of the keys.

The idea is that, if every user is able to manage its properties, everyone could be thought of as a small bank; other things being equal, the more banks there are, and the thinner their size, the harder and better the monetary system will be.

So, even though the Bitcoin's protocol answers partially to these questions, it poses the basis to raise new unexplored questions, that potentially could have no answer. Part of Bitcoin complexity is derived by this premise, indeed, to understand Bitcoin and future challenges, one should start at the question of what is money and what role it fulfills in the society.

Money and society

I would start by observing that money, and more in general the economy, begins from the collective thought of human beings, which depends upon the history, ethics, and culture. These elements are inevitably connected with human consciousness, emotions and physiological needs, which shape ideologies over time and are the basic drivers of societies.
It is not a trivial task to define money because rather than seeing it as a "singular entity" it should be seen as "a range of objects of varying degrees of acceptability, which imperceptibly shade at the lower end into objects that are clearly not money".

At its roots, money is a social agreement between people, which tent to standardize a symbol, material or immaterial, that is widely accepted to foster the number and the quality of trades while reducing transaction costs.

Money can be seen as a brilliant technological group innovation that has allowed to magnify relationships between communities and make huge progress in the society, allowing capitalism to flourish and the specialization of labor. Specialization permits each man to develop his best skill, and allows each region to develop its own particular resources. This has been possible thanks to the increasing connections between people, which started to exchange things to gain well-being.

"If no one could exchange, if every man were forced to be completely self-sufficient, it is obvious that most of us would starve to death, and the rest would barely remain alive. Exchange is the lifeblood, not only of our economy, but of civilization itself. [...] Without exchanges, there would be no real economy and, practically, no society. Clearly, a voluntary exchange occurs because both parties expect to benefit. An exchange is an agreement between A and B to transfer the goods or services of one man for the goods and services of the other. Obviously, both benefit because each values what he receives in exchange more than what he gives up. [...] Why should exchanges be so universal among mankind? Fundamentally, because of the great variety in nature: the variety in man, and the diversity of location of natural resources. Every man has a different set of skills and aptitudes, and every plot of ground has its own unique features, its own distinctive resources" [1, pag.7]

Basically, there are only three ways in which someone can entertain an exchange within the society: pure market exchange, gift-giving and sharing [3].

In these respects, money can be thought as the lubricant of these exchanges, or put differently, as the tool that makes transactions easier. The pure market exchange is the best expression of a capitalist economy where calculation and rationality establish the general rules according to criteria of efficiency and effectiveness, where every rational actor wish to maximize his/her utility through impersonal trades. Every commodity is the result of the matching of supply and demand, which are constantly searching for an equilibrium expressed through price.

On the opposite side of the spectrum, there is the act of gift-giving, connected with the basic human need to relate with other people, characterized by a personal sphere and symbolic value, which cannot be evaluated. Unlike a modern money transaction, which is closed and leaves no obligation, a gift transaction is open-ended, creating an ongoing tie between the participants; when we give a gift, we give something of ourselves. "This is the opposite of a modern commodity transaction, in which goods sold are mere property, separate from the one who sells them [4]". Both these two modalities of exchange are represented by the separation of property, but only in the first case money can be used as a tool to express prices in nominal value, unless one can't give a price to emotional value. This is because gifts are related to the uniqueness of the meaning that they incorporate.

Sharing instead comprehends some characteristics of both types, but in this case, there are not terms of separation between parts, which makes not clear the terms of property. It could be personal or impersonal depending on the nature and the level of confidence of the shared item; for instance, we could think of personal sharing as objects shared within family and friends - sharing in, while impersonal sharing could be associated to the sharing economy - sharing out, that spread into the economy in the last decades. Nevertheless, sharing is a broader concept because relies not only upon economic activity, but also with cooperation and network effects. It helps to amplify the efficacy of the tools used, like for example sharing a language, a set of rules and in particular money, which gains utility and value if other people use it as money as well.

These three ways of exchanging goods and services are deeply interconnected to each other and, as a result, give the structure of society and institutions like money. We are all born in a gift economy where parental care and basic goods are shared without any expectation of reciprocity, but in exchange of love, kindness and confidence.  As the relationship circle is enlarged, this mutual trust weakens, but people still maintain the need to cooperate with each other, and thus the need for a market exchange economy and money arises [5].
However, impersonal trades make it difficult to trust unknown people, increasing transaction costs and thus decreasing trades, due to informative asymmetries and the problem of moral hazard. For these reasons, through time, people started converging to some standardized protocols, that have helped decrease uncertainty between parts and have helped to respond to the well-known environmental issue of the "tragedy of the commons", where individual users, acting independently according to their own self-interest, behave contrary to the common good damaging others.

All these kinds of exchange shape the way money works and the realization of these distinctions leads to one of the paradoxes of the economy, where economic actors try to give price to every good while the perception of utility is merely subjective. The act of evaluating goods and services relies on personal experiences and depends on the scarcity of the object and the environment. As an example, a bottle of water and an ounce of gold have a substantial difference in value, which however could be perceived differently if the choice is made in a desert landscape. The concept of scarcity is defined as a situation where something is difficult to find or to get through time, hence, it is directly related with value. 

"In a more economic sense, of course, money should be a rare good, as only rare goods have a positive value [6]". However, as Hayek noted:

"Strictly speaking, in a scientific sense, there is no such thing as a perfectly stable value of money, or of anything else. Value is a relationship, a rate of equivalence or in other words an indirect mode of expressing a ratio, which can be stated only by naming the quantity of one object that is valued equally with the 'equivalent' quantity of another object. Two objects may keep a constant relative value in terms of each other , but unless we specify the other, the statement that the value of something is unchanged has no definite meaning. [...] When we apply the term  'value' to money itself what is meant is the price of most commodities will not tend to change predominantly in one direction, or will change only little, over short periods" [1, pag.69]

Money is a special good and treating this class as a measurable quantity, in the popular striving of pseudo-exactness, could be very misleading. The confusion that arose, for a long time, made people believe that "an exchange record some sort of equality value, - that if one barrel of fish is exchanged for ten logs, there is some sort of underlying equality between them. Actually, the exchange is made only because each party valued the two products in different order [1]". So because goods are evaluated subjectively and money is the expression of this value, their prices are inevitably interdependent, even if they have to be separated to allow calculations. Calculation is also necessary to have stability.
We may wonder what would happen if, overnight, some entity doubles all money in pockets, vaults and bank accounts. Would we be twice as rich? Obviously not. "What makes us rich is an abundance of goods and services, and what limits that abundance is a scarcity of resources: namely land, labor and capital. Multiplying coin will not whisk these resources into being [1]".

Money is a long process of evaluation by people that use it to exchange their abilities with others, and because exchanges are essential, money is essential. Therefore, to understand what are the reasons that have allowed the creation of money and the processes of abstraction of value, we should dive into the history of money and search for its origins.

Index:

• Cryptocurrencies for friends who don't care about cryptocurrencies
• Bitcoin and money  
• The history of money
• Characteristics of money
• Economic thought
• Technological development before Bitcoin
• The white paper
• Building blocks of the blockchain
• The Nakamoto consensus
• Some crypto-economics

References:

[1] - M. Rothbard. What has government done to our money? 

[2] - S. Nakamoto. The Bitcoin White paper.

[3] - R.Belk. Sharing.

[4] - C. Eisenstein. Sacred Economies. Money, gift and society in the age of transition.

[5] - F. Ametrano. Bitcoin, blockchain and distributed ledgers: between hype and reality.

[6] - European Central Bank. Why price stability.

[7] - F.V.Hayek. Denationalization of money.