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How money and banking work, and why they're broken today.

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There are over 160 currencies in the world today, and the money supply from most of them

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increases rapidly, which persistently and invisibly dilutes people's savings and wages,

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and siphons that value away towards others. Money can be printed or lent into existence

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for corporate interests, bankers, or corrupt officials, and this purchasing power is taken

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away from the public in ways that are purposely more subtle and harder to detect than taxation.

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And as people try to reach outside of their regions for better money elsewhere,

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capital controls and other points of friction are often used to keep them in.

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Even in wealthy countries, all is not well. While inflation may not be as high,

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the money concentrates toward a smaller and smaller number of hands over time,

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and more and more debt is piled up on the government ledger.

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Political polarization grows, as nobody can agree on who is causing it or why it's happening.

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Improving technology should make things cheaper over time, but central banks' inflation mandates

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are to ensure that prices continually increase instead by continually expanding the amount of

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money in the system. Money affects us all. It's how we make contracts, how we coordinate economic

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activity, and how we store our purchasing power for the future. And while the world has improved in

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many ways, money itself continues to be broken for most people worldwide.

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I'm Lin Alden, and this is a problem I have invested countless hours into understanding.

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I grew up in poverty, which from a young age gave me a strong interest in saving and investing.

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In my adult life, my husband and I split our time each year between the United States and Egypt,

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since our shared roots, families, and friends are in both places. So, I see firsthand the troubles

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that broken money can cause, both subtly in a developed country and more overtly in a developing one.

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I currently analyze and invest in the global financial system as a profession. But before that,

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I was an engineer building, taking apart, and understanding complex systems. I view money as another system

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I must take apart to understand. This video aims to distill the knowledge I've gathered on this topic.

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For a deeper dive, refer to my book, Broken Money, Why Our Financial System Is Failing Us,

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and How We Can Make It Better. For us to understand our monetary system from the top down,

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we must start at the bottom and work our way up. Let's rip away the complexities and pose a fundamental

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question. What is money? Trading goods on the spot is a challenge, as there are more ways a trade can

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fail than succeed. If you have extra spears, but lack furs, and I have extra furs, but lack spears,

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that's a relatively rare scenario where our needs align. When this barter system scales to an economy

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that produces five different products, it results in 10 unique trading pairs. With 20 different products,

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there are 190 trading pairs. And with 100 different products, that number of trading pairs grows to

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4,950. Clearly, a more efficient trading method is needed. One way to address this is by making the

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timing of a transaction more flexible. Suppose you have extra spears and are short on furs,

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while I have extra spears and furs, but I don't need anything from you. If you ask me for furs,

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I could give you some in exchange for an unspecified favor at a later date. This is called flexible

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social credit. In settings with family and friends, gifts are exchanged as a form of social credit

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with no specific expectation of repayment. And outside of close relations, people keep track of

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who is helpful and who is a burden. When a well-laid community member needs help, others are more

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generous with their offerings because of the social history attached to the person in need.

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In larger settings, credit systems adhere to a more formal type of credit. In these systems,

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a person can borrow some value in the present, but they must promise to repay it later. And there's

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often some local authority that sets the rules regarding how credit is handled. Suppose a baker needs

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meat from a butcher, but the butcher already has bread. The baker can create, quote, bread credits,

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where each credit is a promise that could be exchanged for bread in the future.

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If the butcher trusts these bread credits will hold that promise, they make a transaction. Still,

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the butcher takes on some risks. In this case, trusting that the baker will remain in business.

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Another solution is to use a commodity as money. Rather than finding a person who has what you

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specifically need and where you also have what they specifically need, people can use a portable,

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divisible, durable, scarce, and widely desired universal good as one side of every transaction.

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Among hunter-gatherers, shell jewelry beads served as a common form of money. They were small,

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long-lasting, wearable, hard to make, and widely desirable. People frequently found use in acquiring

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more shell jewelry than they currently possessed due to its size, wearability, aesthetic appeal,

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and the value it holds over time. So, if you find yourself short on spears, and I have no immediate

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need for your goods, I might request shell jewelry in exchange, even if it's not an immediate necessity

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for me. I can wear the jewelry, and later, when I come across something I desire, I can offer the

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jewelry for trade. As commodity money evolved, gold and silver coins gained popularity across numerous

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empires. These slender disks adhere to standardized shapes, weights, and fineness, simplifying their

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ability to be verified by anyone using them, which in turn enhance the efficiency of transactions.

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Coins established dominance over all other forms of commodity money for three primary reasons. First,

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gold and silver are harder to increase the supply of relative to other commodities due to their unique

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properties. Second, coinage with guaranteed size and purity makes gold and silver easier to use in

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transactions than raw bits of metal. Third, the acceptance and liquidity of coins issued domestically

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would generally be higher than that of foreign coins, which would ensure widespread acceptance of a

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standardized unit within that region. Ultimately, the answer to the question of what is money is that

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money is a ledger for payments and savings. Ancient monetary systems usually consisted of a blend of

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commodity money and credit. Commodity money represents a ledger whose attributes and constraints are

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governed by the laws of nature, and was useful for determining a society's standard unit that

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transactions would be denominated in. Holding commodity money in one's own possession also served as a

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way to store value independently, without relying on anyone else's ongoing memory or liability. Meanwhile,

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various credit agreements represent a shared ledger governed by humans, either orally or in writing,

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and were used to make transactions more efficient, either between known entities or the backing of a

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shared authority. And this is what led to the rise of banking.

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In medieval times, a popular paper-based financial instrument in the Middle East and North Africa

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was the Suftaja, playing a pivotal role in the development of a system known as Hawala.

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Under this arrangement, a Hawala-Dar money-changer operated in one city while their business partner

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worked in another. To transfer money between cities, an individual could deposit gold with

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their local Hawala-Dar and either they or their recipient could redeem the same amount of gold from

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a Hawala-Dar in another city. This system relied on a network of trust and credit among Hawala-Dars,

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enhancing the efficiency and safety of long-distance money transfers. Hawala-Dars with established

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relationships conducted regular credit-based transactions on behalf of their clients, while

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settling with each other less frequently, but under more secure conditions. Without this system,

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merchants would have had to transport bulky and unsafe quantities of gold between cities more

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frequently. This idea of a paper-based credit system eventually made its way into Europe through

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trade and warfare interactions between Christians and Muslims. With the advent of the Renaissance in

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Europe, the development of double-entry bookkeeping facilitated increasingly intricate credit

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arrangements and the emergence of well-known financial institutions. The invention of the

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printing press further enabled the creation of more complex financial paper instruments based

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around increasing levels of negotiability. In financial jargon, negotiability means that a

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financial instrument can be transferred to another party, which makes it more broadly applicable and

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liquid. In the initial stage, a simplistic, non-negotiable paper instrument can only be redeemed by the

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specific party as specified in its original creation. In the second stage, a paper instrument is issued to

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a specific party and is intended for their redemption, yet it possesses negotiability, allowing it to be signed

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over to another party who can then redeem it instead. This involves a more intricate and trusted financial

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network connecting a larger number of counterparties. In the third stage, a paper instrument such as a banknote is an

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asset that is owned by whoever possesses it, enabling it to be freely exchanged between parties with no need

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for ownership transfer beyond physical possession. This third form relies on the existence of large and

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widely recognized institutions. Otherwise, merchants would not accept these banknotes. The foundational issue

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with banking lies in the necessity for customers to trust banks to effectively manage their reserves. In the gold-based

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banking systems of past centuries, customers expected that their deposits and banknotes could be redeemed on

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demand. However, bankers frequently betrayed that trust as they recognized that most individuals did not

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redeem all their gold at once, which allowed bankers to lend out some of their gold while maintaining only a

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fraction for customer redemptions. One way around this problem is with full reserve banking. In this approach,

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all demand deposits which can be redeemed by depositors at any time must be fully backed by liquid reserves,

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and any loans that a bank makes must instead be funded by time deposits with an equal or longer

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duration. So, if a bank offers a two-year loan, it should be supported by certificates of deposit

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with at least two years of duration. This practice of matching durations leads to a more stable system

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because it avoids making commitments about liquidity that cannot always be fulfilled. Much of history has

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decided against full reserve banking in favor of fractional reserve banking, where demand deposits can be

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redeemed at any time even though only a fraction of them are kept in reserves for immediate redemption. This

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approach hinges on the assumption that not many people will redeem or withdraw their money at the same

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time. However, during crises they often do. When money is borrowed from a bank, it leads to the

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creation of additional fractionally reserved deposits. These deposits can then be placed in another bank,

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where they are once again subject to fractional reserve practices, and can be let out immediately, repeating the

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process. This cycle results in the double counting, triple counting, quadruple counting, and so on for base money,

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causing the system to be burdened with many times more gold claims than there is actual gold. While this system

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functions well most of the time, it occasionally experiences catastrophic failures.

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Central banks were established to mitigate the impact of fractional reserve banking crises and to provide

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financial support to governments during times of conflict. In the absence of a central bank, a system is

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typically referred to as free banking. Under a free banking arrangement, banks safeguard their own gold,

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issue deposits, and distribute banknotes redeemable for gold, although they still normally have to

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follow regulations placed on them by the government. In contrast, when a central bank is established and

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granted monopoly status by the government, all banks are required to deposit their reserves with the

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central bank, which holds the gold on their behalf. This setup involves fractional reserve practices even

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within the central bank that manages the reserves. When a fractional reserve bank faces a run on its reserves,

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it can borrow from other banks using its loan assets as collateral. But during financial crises,

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mutual distrust among banks can lead to system failures due to excessive claims on money compared

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to available reserves. To counter this, central banks often resort to printing more currency, causing

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currency devaluation, breaking gold picks, and inflation. Eventually, many central banks and governments

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abandon gold-backed currency altogether to create a new type of global financial system.

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The rails that move money and credit are highly intricate, and their structure evolves over time

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due to technological advancements and shifts in geopolitical dynamics. At its core, the global

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financial system facilitates international trade settlement and external financing between different

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countries. In a system where each country maintained its own separate central bank currency ledger,

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often with mutual distrust regarding the soundness of each other's currency. A global reserve asset

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becomes essential to unify various currencies for international trade. Since 1871, this system has

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undergone three structural transformations. After the first transformation, the modern financial era began

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with the international gold standard, which spanned from 1871 until the early 20th century. By the 1860s,

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the telegraph revolutionized communication with the completion of the first cross-Atlantic cable,

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enabling instant communication across continents, a feat previously unimaginable. The end of the

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Franco-Prussian War in 1871 marked the onset of a period of European peace and the widespread adoption of the

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international gold standard. At the same time, the United States centralized its banking system during the

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civil war and joined Europe in adopting the gold standard. While the telegraph created new possibilities,

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it also introduced a challenge. Transactions could now occur at the speed of light across countries and

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continents, but physical settlements of money were constrained by the limitations of physical matter.

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This mismatch created arbitrage opportunities, which banks and central banks capitalized on. They held a

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monopoly over fast, long-distance value transfers, utilizing paper and telegraph communication to

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update each other's ledgers with minimal need to ever physically send and verify actual gold.

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In 1875, William Stanley Jevons published a book titled Money and the Mechanism of Exchange.

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Similar to my 2023 book, Broken Money, Jevons explored the history of money and the technological

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advancements surrounding it. He highlighted that thanks to the telegraph and other rapid communication

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methods, transactions could frequently occur with minimal reliance on physical metal. The global

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financial system was gravitating towards centralization, particularly around London, where bankers could

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efficiently transact through a centralized clearinghouse. Jevons also recognized the substantial risks

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accompanying this growing efficiency. He emphasized that there are approximately 20 times more

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claims for gold than actual gold reserves. He cautioned that bankers should never forget that these

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fractionally reserved claims essentially represented promises for gold, even though they were rarely

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redeemed as such. Even if just 5% of people simultaneously demanded their gold, the system would crumble.

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Fast forward four decades, and this scenario unfolded during World War I. The era of European peace came to an

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end, leading to money printing for wartime purposes and widespread defaults on gold redemption within a heavily

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leveraged financial system. Taxing for wars is unpopular and can lead to revolts and revolutions by the people.

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So, governments often turned to currency dilution and other less transparent methods to pay for them.

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In earlier centuries, when governments aimed to debase their currency for war financing,

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the process unfolded slowly. There is no swift method to diminish the value of coins held by people.

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Instead, it required taxation, melting, reminting, and reintroducing lower quality coins into the economy.

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However, in a scenario where individuals predominantly hold deposits and paper claims

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backed by gold stored in central bank vaults, the ability to sever gold redemption becomes a matter of a

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stroke of a pen, allowing for the rapid printing of vast amounts of money. Governments were no longer

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restricted by the quantity of gold in their reserves. They could continue fighting until they depleted the

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liquid savings of their entire citizenry. The second period of the modern financial era unfolded

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after World War II and extended until 1971. During the war years, gold pegs collapsed worldwide,

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with some nations even outlawing gold ownership for their citizens. Following the war, most countries,

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except the United States, faced severe devastation. So, the United States, representing over 40 percent

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of the global economy, assumed a central role in a new international financial system. In 1944, as the

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Allied forces neared victory, representatives from 44 countries convened in Bretton Woods, New Hampshire,

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to design the future global financial system. Britain advocated for a system centered around a

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neutral reserve asset called a banker, while the United States pushed for pegging all currencies to

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the dollar, with the dollar itself tied to gold. The U.S. proposal prevailed, leading to the establishment

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of what we now recognize as the Bretton Woods system. Under this system, it remained illegal for Americans to own

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gold, and they couldn't redeem dollars for gold, but foreign central banks had that privilege.

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The creation of the World Bank and International Monetary Fund followed the Bretton Woods Conference,

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serving as the key components for enticing, enforcing, and regulating the system.

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Once again, the Achilles heel was fractional reserve banking. Between 1950 and 1970, the number of dollars in

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circulation tripled due to bank lending and government deficits, even as U.S. gold reserves

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diminished through foreign redemptions. Offshore dollars further multiplied, essentially forming one

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fractional reserve system on top of another. By the late 1960s, it became evident that the system was

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destined to fail, prompting President Nixon to terminate gold redeemability in 1971.

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The third and current era of the modern financial system commenced in the 1970s, following the collapse

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of the Bretton Woods system. After 1971, the world found itself in an entirely unbacked monetary system,

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marking a significant departure from previous eras. While governments could compel their citizens to

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use currency for domestic transactions, the challenge lay in trusting other governments' unbacked ledgers

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for global trade. During this period, the United States still held the world's largest economy,

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military power, and global dollar network effects from the Bretton Woods era. In 1974, the Nixon

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administration struck a deal with the Kingdom of Saudi Arabia, requiring that Saudi Arabia would

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exclusively sell its oil in dollars, accumulate dollar surpluses, and invest those surpluses in U.S.

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government bonds as reserves. In return, the U.S. would offer lucrative arms deals and military

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protection. This practice extended to other OPEC countries, giving rise to the petrodollar system,

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and for a substantial period, almost all global energy trade was denominated in dollars.

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Throughout these three eras, the gold standard, where nations supported their currencies with gold

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reserves, the Bretton Woods system, characterized by the United States' substantial gold holdings and other

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countries pecking their currencies to the dollar, and the petrodollar system, where the U.S. dollar and

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U.S. government bonds serve as the pillars of global trade, one can see a gradual shift toward two

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defining features, centralization and abstraction. Since the invention and deployment of the telegraph

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in the latter half of the 19th century, the global financial system has witnessed a consolidation of power

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and a separation from reality. The ability for transactions to occur globally at the speed of light,

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while physical monetary settlements can only happen at the pace of material transfer, requires a level of

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credit abstraction to work. This shift granted banks and central banks significant power, as they

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effectively monopolized fast, long-distance value transfers. Eventually, they could just drop material

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transfer from the system altogether and to find money entirely around central bank ledgers. Central

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banks took on the role of managing the ledgers for their respective countries, and notably the Bank of

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England in the past and the U.S. Federal Reserve in the present have also served as the global ledgers

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that bound international trade together. As a result, there are approximately 160 different currencies

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worldwide, each holding a local monopoly within its own jurisdiction, with limited or no acceptance

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beyond its borders. Currencies of wealthy nations tend to lose value slowly, while most currencies lose

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value quickly. The anchor of this global financial architecture between all these currencies is the U.S.

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dollar. Countries maintain dollar-denominated assets in reserves, denominate significant portions of

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international trade contracts in dollars, and access dollar-denominated financing from foreign creditors.

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This greatly benefits the United States geopolitically, even though it doesn't

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necessarily benefit all Americans. For instance, the United States can devalue the dollar through

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softer monetary policies, thereby diminishing the purchasing power of currency reserves held by creditor

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nations. Or, the United States can strengthen the dollar through tighter monetary policies, increasing the

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value of liabilities owed by debtor nations, and sending them into financial crises.

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The failure rate for currencies around the world is very high. In the 1990s, Brazil, at the time the fifth

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most populous country in the world, experienced severe hyperinflation. Since the 1980s or later,

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hyperinflation has impacted other nations such as Argentina, Yugoslavia, Zimbabwe, Venezuela, Poland, Kazakhstan,

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Peru, Bulgaria, Ukraine, Lebanon, and several others. Additionally, countries like Israel, Mexico,

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Vietnam, Ecuador, Costa Rica, and Turkey grappled with triple-digit inflation during this period,

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which is on the brink of hyperinflation. Many other countries experienced recurring periods of double-digit

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inflation. Nigeria, with a population of over 200 million people, has witnessed an annualized price

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inflation rate of 13% over the past decade. Turkey and Argentina, both esteemed members of the G20

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nations with a combined population exceeding 130 million people, have struggled with runaway inflation

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for years. In 2016, Egypt, home to over 100 million people, drastically devalued its currency by half relative

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to the dollar and repeated this devaluation again in 2022. Both actions taken at the bidding of the

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International Monetary Fund. When such devaluations occur, not only do people see their savings lose value,

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but their ongoing wages, denominated in local currency units, also suffer. Over the past 50 years, very few

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developing countries have attained developed status. The absence of currency stability forces them to rely on

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external currency financing, which ironically contributes significantly to their currency instability,

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creating a destructive and nearly inescapable cycle. Even in wealthy countries, money often

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doesn't make sense. From 2016 to 2021, Europe and Japan grappled with negative-yielding bonds

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valued at over $18 trillion. Instead of earning interest for lending to governments and major corporations,

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individuals had to pay for this privilege. This upheaval in the financial system

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inverted incentives. And a global inflation surge in the ensuing years greatly eroded the purchasing

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power for those bondholders. Between 2020 and 2022, the United States increased its public debt by

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over $8 trillion, a significant portion of which was effectively printed by the country's central bank.

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This equates to more than $60,000 per American household. However, the average American family has not

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received anywhere near this amount of stimulus. With more than 160 currency jurisdictions worldwide,

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these governments, including the United States, possess substantial authority to erode the value of

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people's savings and wages, often channeling this value opaquely to various parties situated closer to

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the source of money creation. As money is continually diluted with ever-growing supply, sometimes value is

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funneled to corrupt government officials. Other times it is funneled toward financiers with privileged

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access to credit and bailouts. The details vary by country, and although there is plenty of blame to

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go around, the important point is that the incentives themselves are corrupt. The heart of the problem does

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not lie with specific individuals taking advantage of the system or even those maintaining the system.

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The problem is that the system itself is simply broken and outdated. Perhaps what is needed is an entirely new

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system. One that cannot be changed at the flip of a switch. One that is decentralized. One that is

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permissionless. One that is open source. Since the development of the internet, cryptographers have

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sought methods for creating decentralized digital currency. In 1982, David Chaum published a research

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paper on how mutually distrustful groups could use cryptography to maintain a shared database or ledger.

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During the 1990s and early 2000s, figures like Adam Back, Nick Szabo, and Hal Finney explored ways to

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create digital tokens supported by electricity and processing power, a concept known as proof of work.

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In 2008, an anonymous programmer using the name Satoshi Nakamoto published the Bitcoin white paper,

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which expanded on these earlier ideas. It outlined a method for creating a decentralized digital currency

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using a distributed network of nodes and transaction timestamping through cryptography and proof of

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work. In 2009, Nakamoto released the open source application to implement his design, and thus the

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Bitcoin time chain was born. What makes Bitcoin remarkable is its ability to enable bearer asset final

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settlements at the speed of light. It effectively closes the speed gap between transactions and settlements

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that has persisted since the late 19th century. In other words, it's the first workable way to

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quickly send money long distances without relying on centralized intermediaries and credit. And it comes

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with its own finite unit of account that cannot be diluted. For the past 15 years, Bitcoin has been

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refined in various ways, tested to see how robust it is to attacks, and copied by competitors to see if there's

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any way to do it better. So far, it has continuously remained the largest, most liquid, most decentralized,

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and most secure cryptocurrency. Although it has been volatile, Bitcoin has reached higher highs and

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higher lows of market value and adoption, cycle after cycle. Bitcoin works because anyone can run an open

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source node on a simple device such as a laptop, and these nodes all store the full history of the ledger.

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Users possess private keys, enabling them to sign transactions and pay fees to move coins or fractional

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coins between addresses. Miners contribute electricity and processing power to add new transaction blocks to

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the ledger in exchange for receiving transaction fees and new coins that are generated in each new block

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during the early years of the network. No individual entity, including the network's creator, can change the

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rules, dilute people's coins, or censor transactions. The network can, however, be updated over time in a

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backwards compatible way by a revolving set of contributing open source developers whenever

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there is enough consensus by the node operators and the miners to do so. While additional layers can

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enhance Bitcoin's speed, transaction throughput, or programmability, the base layer remains simple and

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robust with an eventual fixed supply of 21 million Bitcoins generated by miners over time in a pre-programmed

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deflationary pattern since inception. Value can be sent to anyone with an internet connection or brought

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with anyone globally. Bitcoin is decentralized digital money, offering a viable alternative to

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inflationary centralized banking ledgers. This technology is helping to pierce the 160 different

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fiat currency bubbles that people are trapped in. Cash and gold can be blocked in airports and bank

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transfers are tightly controlled, but people can send Bitcoins directly to others across borders or bring

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their Bitcoins with them as they move around the world just by writing down or memorizing 12 words

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representing their private key. People can protect themselves against monetary dilution and financial

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censorship. In a world where half of the population lives under varying shades of authoritarianism and

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billions of people live with persistently high inflation, the ability to fracture these 160

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currency silos and connect them together should not be underestimated. However, this technology has

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also catalyzed the development of more centralized digital currencies. Private stable coins, for instance,

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enable collateralized dollar tokens to trade on multiple blockchains, providing people in numerous

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highly inflationary countries easier access to US dollars for savings. Additionally, governments have

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explored and sometimes launched central bank digital currencies, which are digitally native, even more

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centralized versions of fiat currencies. This era marks a fork in the road, offering two distinct paths

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going forward. Over the past century and a half, within the telecommunication age, the global financial

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system has gravitated toward increased centralization, abstraction, and inflation, driven by the gap in speed

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between transactions and settlements, and relying on ever-expanding credit to bridge this gap. Most

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technologies in the past that made money more efficient have come at the cost of making it more centralized

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and controlled. On one path going forward, central bank digital currencies can continue the prior trend of

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ever more centralized systems that enable precise control and authority and dilution by nation states over their

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citizens. On the other path, the emergence of bitcoin and other open source cryptographic technologies,

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facilitating rapid digital settlements without the need for credit in a peer-to-peer manner, charts a course

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that diverges from this trend, leading toward a more decentralized, streamlined, and deflationary monetary

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system. Money is a shared ledger, prompting the central question of who governs this ledger. Early credit

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systems were governed by local communities, commodity money abided by natural laws, fiat

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currencies came under the jurisdiction of banks and nation states, and open source decentralized money like

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bitcoin is governed by its users and selected by market forces. In modern times, our money has been broken

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because it has been centralized, closed, and corrupted in 160 different ways. If we're going to fix it in the digital age,

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a powerful method would be to make it more decentralized, open, and transparent so that it can

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strengthen people as individuals while at the same time shattering the financial silos that separate

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us. With open source money, anyone can hold it, anyone can send it, anyone can bring it with them, anyone can

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build new technologies that make it better, and everyone across borders can be connected by it. If you enjoyed

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this video, share it with a friend. If you want to learn more about these topics, check out my book,

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broken money, why our financial system is failing us, and how we can make it better.