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- Mrunal - http://mrunal.org -
1. Prologue
2. Bitcoins overview
3. Barter system
1. #1: Double coincidence of wants
2. #2: Division of Labour
3. #3: Divisibility of Value
4. #4: Fungibility
4. Bitcoin and Fungibility
5. Mock Questions
Prologue
Original plan was to write on Bitcoins. But for Bitcoin related MCQs, group
discussion (GD) and interview questions, one must know the basics of money
itself. Only then you can see how Bitcoin is better or worse than the money we
use today- rupees, dollars or Euros. Hence a long series of articles.
1. In the first few of articles (total 3), well see why did people start using
traditional money (Rupee, dollar), how is it better than bartering system.
And how is bitcoin better or worse, on those parameters?
2. In the second batch of articles, well see evolution of money system: from
commodity money, metallic coins, fiduciary money, gold backed paper
currency, fiat money, bank money etc.-what were their advantages and
limitations. And how is bitcoin better or worse on those parameters.
3. And in the final articles, well see what is bitcoin exactly? from where does it
come? How does it operate? Advantages, limitations, future applications
and regulatory issues etc.
Bitcoins overview
Bitcoin is a digital code. (Some) people use it as currency.
Started in 2009 by Satoshi Nakomoto. He could be a man or a woman or a
group of people- real identity unknown.
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#2: Exchange
Barter system
People have been trading with each other even before the advent of money,
coin, cash, currency, rupee, dollar, euro or Yuan.
They simply exchanged goods and services with each other through barter
system- 1 kg rice for a 200 gms tomatoes, 1 kg tomatoes for 50 gm
almonds and so on
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1. Simplest form of exchange. Had all nations did foreign trade on barter
system, there will be no headache of foreign exchange rates and
associated problems. Today if Dollar strengthens by some action of US
federal reserves (=American RBI), then it automatically becomes expensive
for India to import oil from Saudi=>everything else transported through
petrol/diesel becomes expensive= inflation.
2. Less chances of overproduction, hoarding, profiteering etc. =less chances
of inflation. Although itll be wrong to say there will be no inflation in barter
system- because war, famine and natural disasters can create mismatch in
supply and demand even in a barter system => lead to inflation.
3. Difficult to concentrate wealth= Less inequality of income, and all the social
problems associated with it.
4. Barter system ensures need based production. In money system, firms
create products to create demand e.g. so many softdrinks and plastic
bottles+ the subsequent harm to health and environment.
5. Barter system promotes personal contact among individuals, social
harmony, and healthy community life, joint families etc.
But Bartering system had many limitations, thats why people shifted to the
money system. So,
What are the limitations of Barter System?
Another case
My son wants to get admission in your coaching class. I can give you
500 beer bottles as fees.
I dont drink at all! Although I do want new table and benches for my
Sir
classroom.
But I dont know any carpenter in this area, and even if I find one,
Mallya there is no guarantee hell accept beer bottles as payment for making
furniture!
Mallya
Thus, under barter system, the wants of two parties must coincide with
each other, otherwise they cannot trade with each other. This increases the
transaction cost as everyone will have to waste time and energy to find
another party with double coincidence of wants.
Money system solves this problem. Farmer can sell his rice for money, use
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that money to get a haircut, and barber can use the same payment to buy
tomatoes from another farmer.
Money thus facilitates the exchange of goods and services, lessens the
time and effort required to carry on trade.
Bitcoins
An IT professional in
Banglore may accept
bitcoin payment for
creating software for
some American
businessman.
But if the same techie
offers to pay house rent
in bitcoins, the landlord
is legally free to refuse
this payment and can
even order him to vacate
the property.
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FEATURES
trade can happen without double
coincidence of wants?
BARTER FIAT
BITCOIN
MONEY
Yes, if two
No
Yes
parties agree.
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have to start growing vegetables and wheat in the backyard of his house,
arrange a goat/cow for milk, and so on, we are back to square one- everyone
trying to become jack of all trades like in Barter system.
However, in future, Bitcoin may promote Division of labour to a whole new level
(when and if Bitcoin is accepted by a large population):
Imagine a laptop manufacturing company- owned and operated by an AI
(or robot) that accepts bitcoin payment, robots make and pack the laptops
into parcel, and drones deliver them at your door step.
AI uses these bitcoins for paying the cost of raw material, warehouse rent,
electricity bill etc. to humans (or other AIs).
And whatever bitcoins left (=profit), are reinvested in buying more drones,
bigger servers and so on.
This is not possible in the present money system because legally- an AI or Robot
doesnt meet the KYC norms for opening a bank account = impossible for
them to pay electricity bills through netbanking or creditcard!
Anyways, lets update the table:
Features
barter
fiat money
(Rs./$)
No
yes
No
Yes
Bitcoin
Only if both parties
agree.
Yes, lot
possibilities in
future.
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barter-system-divisibility
Give me a cup of tea, Ill give you two pages from the latest Harry
Potter book.
I dont want just two pages, I want the whole book for my son!
Even if chai-walla continues serving tea to Ms. Rowling for 300-400 days,
gets all the pages of Harry Potter book and staples them together => still
that stapled book will not sell at the original value of a brand new Harry
potter book (which is say worth 30 kilos of rice).
Meaning:
You cannot always divide the value
You cannot always re-unite the divided values.
Other scenarios:
1. Jeweler wants a matchstick box. But its not possible to divide gold to such
a micro-micro-micro quantity where gold becomes proportional to the value
of a matchbox.
2. Mallya wants to buy a pencil box for his son, offers 1 table-spoon of liquor
for 1 pencil box but stationary-walla will not accept because such low
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smallest unit
1 paisa=0.01 Rupee (that is 10-2)
#4: Fungibility
Even if items are divisible, their fungibility is a problem under barter system.
Fungible items = those items whose individual units have same uniform value and
mutually exchangeable, inter-changeable. For example:
1. The value of first five pages of harry potter book= Not same as the value of
last five pages of the same book. Because in the last pages you get the
climax so theyre more precious= not fungible.
2. Value of one diamond of 100 carat = not equal to ten smaller diamonds of
10 carat each. In this case, bigger the size, more precious. Even those 10
carat diamonds are not mutually interchangeable because their individual
value may vary depending on cut,color and clarity.= not fungible.
3. If Picassos painting was cut into nine equal square parts, then Central
Square will be more precious than others. So you cannot interchange
them. And if you glue these torn parts together= its total value will be far
less than the original painting=not fungible.
4. Exception: Precious metal. Value of 1 kilo gold bar= Value of 100 gold
coins of 10 grams each. You can melt to reunite them, you can melt again
to divide them. And those 100 gold coins will be interchangeable because
their individual value will be same.= fungible.
But by and large, goods are not fungible and this creates obstacle in barter
trade, when two commodities are not available in their standard weight/size. For
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example, Suppose the ongoing barter rate is 5 kilo salt = one live hen weighing
500gms.
A poultry farm owner wants to buy 2.5 kilo salt. He gives the whole live hen
to shopkeeper.
Common sense suggest that shopkeeper should give 2.5 kilo salt and cut
half of the hen and return it.
But which half? In non-veg cooking, the legs of chicken are considered
more valuable than its head and neck upper part. = dispute between
customer and shopkeeper.
Overall, the customers in a barter-trade will end up buying more than what
they really need. (e.g. 5 kilo salt even if he needs only 2.5 kilo.)=
considerable wastage and sub-optimal use of resources.
Money system solves this via fungibility.
Rs.1000 note= can be exchanged for 20 notes of Rs.50 each. And each of
those 50 rupee notes have equal purchasing power. A 50 rupee note in
your pocket will buy as many ballpens, as the 50 rupee note in my pocket.
(as long as ballpens are of same brand-model.)
Similarly ten notes of Rs.100 can be exchange for a single note of Rs.1000
and so on.
But there is an exception: Someone might offer 1000 rupees for a single 10
rupee note that has unique serial number like ABCD-123456789. but
ignoring such exception, currency notes are fungible.
So, if you give Rs.100 note to shopkeeper to purchase a ten rupee worth
ballpen=> hell give you 10 rupee pen + one note of 50 Rs. + four notes of
10Rs.
Still Money system too has limitations:
You cannot pay Rs.149.75 through notes and coins because 25 paisa is
out of circulation. (Although possible if you pay via credit card, debit card
or internet banking)
Persistent shortage of chillar coins. And if you cut a ten rupee note into ten
parts using a scissors, itll not become ten 1Rs. notes.
Persistent looting by Shopping malls. Items priced @Rs.99, 499 or 999
often, cashier wont give you one rupee coin back but instead gives a
chocolate. (He is making additional profit because for him cost price of 1
chocolate is less than 1 rupee.)
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amount of goods & services as 1 BTC from Kalmadis digital wallet. (Even if
their unique digital codes are different.)
2. Mutual substitution possible. it doesnt increase or decrease the value. e.g.
100 centibitcoins (cBTC)= 1 bitcoin (BTC).
As such chillar/change problem doesnt arise in Bitcoin because you can pay
exact amount to the seller. E.g. if a pen valued at 0.4 BTC. you can type 0.4 in
keyboard and eletronically transfer that amount to seller. Its not like you have to
give him 1 Bitcoin(BTC) and he gives 1 pen + 0.6 BTC in return. This is a digital
transaction after all.
But there is trouble brewing:
You may have read in newspapers that Bitcoin transactions are anonymous
and hence can be used by terrorists, druglords and tax evaders.
Therefore, some experts have came up with the idea of coin validation.
Well see about that in a separate article later, but for the moment the gist
is:- Through coin validation software, you can separate GOOD BITCOINS
(those earned through honest work) vs BAD BITCOINS (those earned
through hacking & other illegal activities) via analyzing their transaction
history and origin.
This coin validation will destroy the fungibility of bitcoins. How?
Because then most users will refuse to accept bad bitcoins.
Some American users might even refuse to accept bitcoins originating from
people of Cuba, Pakistan, Afghanistan, North Korea or Iran-for the fear that
later US authorities may persecute/harass them while hunting for Bad
Bitcoins/Al-Qaeda/Terrorists.
Anyways lets update the table:
features
barter
No
Fiat money
(Rs./$)
Bitcoin
In the next article, well see more on Barter vs Money vs Bitcoin, with reference
to storing wealth, account keeping, deferred payment, circular flow of income
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Mock Questions
Assertion reasoning instructions: Each of the following questions contain a
set of Assertion (A) and Reasoning (R) statements. Answer codes are as
following
A.
B.
C.
D.
Questions:
1. (A) Money brings down the cost of transaction in trade, compared to barter
system. (R) Money promotes division of labour.
2. (A) A trader is free to refuse payment in Bitcoins. (R) Bitcoin is not a fiat
currency.
3. (A) A Barter economy is less likely to have to food inflation. (R) In Barter
system, trade can happen without double coincidence of wants.
MCQs
4. Correct Statement(s) about Bitcoins?
a. It is a digital fiat currency without fungibility.
b. It is not a fiat currency but has all the properties of a fiat currency.
c. Both A and B
d. Neither A nor B.
5. Find Incorrect Statement(s)
a. One fiat currency can be exchanged with other fiat currency.
b. Bitcoin cannot exchanged with fiat currency.
c. Both A and B
d. Neither A nor B
6. Correct set of fungible pairs?
a. One i-phone of 64 GB capacity vs Four Nexus phones of 16GB
capacity each
b. 1 Bitcoin vs 108 Satoshis
c. 1 Rupee vs 100 cents
d. None of Above
Q7. Which of the following statement(s) is/are incorrect?
1. Bitcoin algorithm is designed to generate 21 million coins every year.
2. There are two types of Bitcoins: mined bitcoins and exchanged bitcoins,
theyre not fungible among themselves.
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Only 1 and 2
Only 2 and 3
Only 1 and 3
All of them.
Q8. Which of the following is/are the benefit(s) of barter system over
money system?
1. Trade is possible without double coincidence of wants.
2. It promotes division of labour
3. Bartered commodities are always fungible.
Choice
A.
B.
C.
D.
Only 1 and 2
Only 2 and 3
Only 1 and 3
None of Them.
Only 1 and 2
Only 2 and 3
Only 1 and 3
All of them
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