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[Economy] Barter-Money-Bitcoin: Fungibility, Double coincidence of wants, division


of labour (Part 1)
Posted By On 24/12/2013 @ 9:27 pm In Economy | 105 Comments

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.
There are two ways to get Bitcoins:
#1: Mining

#2: Exchange

Aluminum is hidden inside bauxite ore in


earth.
Similarly, Bitcoins are hidden in data
blocks designed by Satoshi and spread If you dont want to mine bitcoins, then simply find someone who
has already mined bitcoins. then
across the internet.
You can mine Bitcoins by solving those
A. Offer him real money (rupee, dollar, euro) and get bitcoins
datablocks using special computer
in return. Websites that facilitate such transactions are
softwares.
called Bitcoin exchanges. OR
Reward for solving one data block=25
B. Sell him some goods/services, and earn Bitcoins in return.
bitcoins at the moment.
Total number of Bitcoins in the system
=~21 million. Additional bitcoins cannot
be created beyond that.
Once youve have bitcoins (BTC), you can use them to buy goods/service (But very few sellers accept
bitcoins.)
OR you can just wait for the BTC vs.$ exchange rate to rise then sell your bitcoins to a third party.
But what about anonymity and terrorist angle? what about money laundering? what about inflation? isnt this a
ponzi/MLM scheme? Well all those things in detail later on. I gave the overview right now, because for next 5-6
articles, atleast ^this much knowledge of bitcoin topic is required before we start comparing Bitcoin system with
barter system and money system. Now lets start first article.

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

Barter system: advantages


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?

#1: Double coincidence of wants


farmer I want you to cut my hairs just Amir Khan in Dhoom3. Ill give you 5 kilos of rice
But I already have 200 kilos of rice from previous customers. I dont want rice anymore! Ill cut hairs only
barber
if you bring 1 kilo tomatoes as payment.
Another case
Mallya My son wants to get admission in your coaching class. I can give you 500 beer bottles as fees.
Sir
I dont drink at all! Although I do want new table and benches for my classroom.
But I dont know any carpenter in this area, and even if I find one, there is no guarantee hell accept beer
Mallya
bottles as payment for making furniture!
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 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.

What about Bitcoins?


Bitcoin also serves the same purpose but with some caveats
Fiat money

Bitcoins

Fiat money= money issued by the government (or its


central bank) example Rupee, dollar, Yen, Yuan.

Bitcoins are not issued by any


government. Bitcoins are unique pieces of
digital codes that (some) people accept as
digital currency.

It is legally recognized money for settling all payments


and debts within the territory.
If you walk with a 5 rupee coin to a tea-vendor, he must
serve tea, irrespective of your race, religion, color, caste,
age or gender.
If he refuses to serve tea, hell be in legal trouble.

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.

Even better, you can get your rupees exchanged in a


foreign currency and import any commodity from any part
of the world to India. So a fiat money (rupee) removes the
double coincidence of wants for the trade within country
and abroad.

Bitcoin removes the double coincidence


of wants ONLY for the people who
believe in bitcoin system, and not for
everybody everywhere.

Lets make comparison table:


FEATURES
BARTER FIAT MONEY BITCOIN
trade can happen without double coincidence of wants? No
Yes
Yes, if two parties agree.

#2: Division of Labour


In the barter system, buying/selling/trade can only happen, when two parties want each others stuff- the
double coincidence of wants e.g. farmer wants haircut and barber wants rice from that farmer.
But that doesnt always happen, so each household tries to produce all of its daily requirements- from
growing green tea, tomatoes, chilies in their backyard; raising cows and poultry for milk and eggs; even
making pickles, paper and papad for entire year.
So is this good or bad?
Good from Gandhian principle of self-reliance.
Food inflation is kept in check- because everyone is growing vegetables in their backyard.
But overall bad because:
Everyone is wasting their time and energy to become jack of all trades, instead of becoming master of a
single trade -medicine, engineering, construction, accounting, teaching, singing, painting etc.
Thus, a bartering economy is less likely to produce specialists like Alexander Graham Bell (telephone)=> Vin
Serf (Internet)=> Sergey Brin (Google) because everybody busy growing vegetables in their backyard and
trying to become self-reliant-jack-of-all-trades.
And even if there are talented specialists, they wont have the necessary capital or resources to continue
their research. Imagine how many parties with Double coincidence of wants youll need, for assembling the
parts of a Large Hadron Collider or a Param Supercomputer.
Money system also facilitates savings to become investment for the entrepreneurs => more companies,
more job, division of labor, optimal usage of manpower, good for economic growth, R&D and international
trade.
And with the money thus earned, anyone can buy his daily necessities, doesnt need to grow vegetables or
rear cows in the backyard.

What about Bitcoins?


Just like traditional money, Bitcoin also promotes division of labour, but it is limited by the factor that not everyone
accepts Bitcoins- especially the local milk-veggie sellers. So if a software professional decides to live only on
bitcoin, hell 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./$) Bitcoin
trade can happen without double coincidence of wants No
yes
Only if both parties agree.
Promotes division of Labour?
No
Yes
Yes, lot possibilities in future.

#3: Divisibility of Value

Under the barter system


JK Rowling Give me a cup of tea, Ill give you two pages from the latest Harry Potter book.
chai-walla 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 stationarywalla will not accept because such low quantity of alcohol cannot give the kick.
3. To pay for a cup of tea, Picasso cannot cutout 1 mm2 of canvass from his original painting.
Fiat Money system (and Bitcoins) dont suffer from this problem of divisibility, and hence facilitate the trade.
currency
smallest unit
Rupee (Rs.) 1 paisa=0.01 Rupee (that is 10-2)
Bitcoin (BTC) 1 Satoshi= 0.00000001 Bitcoin. (that is 10-8)
You can see it is possible to divide 1 BTC into so many small parts, so even if new bitcoins are not created, it
can continue as mode of payment by lowering the corresponding values of commodities.
e.g. if today MRP of 1 laptop =1 bitcoin then in 2050, MRP of 1 laptop may adjust itself to 0.00165 Bitcoins, if
there is shortage of bitcoins.
And still you can pay 0.00165 BTC to someone by simply typing that specific amount in your keyboard. Same
thing is not possible with rupee or dollars because of the chillar shortage in real life.

#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, interchangeable. 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 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.)

Bitcoin and Fungibility


Bitcoins (BTC) are fungible because
1. Individual units are identical. 1 BTC in Rajas Digital wallet will buy same 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
trade can happen without double
coincidence of wants

barter

Fiat money (Rs./$)

Bitcoin

No

Yes

Yes, if both parties agree.

Promotes division of Labour

Hardly

yes

Not
always
Not
always

Yes but limitation e.g.


Rs.14.199

Yes, but limited @the


moment.
Yes and less limitations than
fiat money

Yes

Yes, for now.

Divisible?
Fungible?

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 etc. parameters. click me

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.

Both A and R correct and R is the correct explanation for A


Both A and R correct but R is not the correct explanation for A
A is correct but R is wrong
A is wrong but R is correct

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.
3. Smallest unit of Bitcoin is called Satoshi.
Choice
A.
B.
C.
D.

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.

Q9. If a Barter economy is transformed into Money economy, what will be the consequences?
1. Increased Economic Efficiency
2. Increased Transaction costs
3. Increased specialization among workers
Choice
A. Only 1 and 2
B. Only 2 and 3
C. Only 1 and 3

D. All of them
For more on Economy, visit Mrunal.org/Economy

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