First Principles Thinking

The best way to approach the question What is wealth? is through a critical thinking model called first principles thinking. This turn of phrase has gotten a lot of attention lately thanks to the likes of Elon Musk. Despite the recent attention of this phrase, first principles thinking has been around since the days of Aristotle, around 350 BC. Therefore, it is a tried‐and‐true methodology. This critical thinking model requires the breaking down of a concept, idea, or problem into its most fundamental parts. Per Aristotle, first principles thinking is “the first basis from which a thing is known.”² Per Elon Musk, “First principles is a physics way of looking at the world. You boil things down to the most fundamental truths and then reason up from there.”³

From that, we can extrapolate that if we want to understand what wealth is, by definition, then a great place to start is with where the word came from—its etymology. Etymology is the study of the origin of a word, and how the meaning of a word changes over time. In other words, we are looking at the genesis of the word wealth. We can more fully appreciate the word wealth by understanding where the first basis (or instance) of the word was used (first principles). From there, we can explore how the meaning has changed over time, and the reasons for this evolutionary change. First principles thinking allows us to break down wealth into basic, etymological building blocks, to then reassemble it’s meaning from the bottom up, within the context of today's world.

The Etymology of Wealth

Using the Online Etymology Dictionary, let's take a look at the origins of “wealth” as a noun:

Mid 13‐c., “happiness,” also “prosperity in abundance of possessions or riches,” from Middle English wele “well‐being” (see weal (n.1)) on analogy of health.⁴

Given the definition suggests we look at “weal,” let's go ahead and do so here:

“well‐being,” Old English wela “wealth,” in late Old English also “welfare, well‐being,” from West Germanic *welon‐, from PIE root *wel‐ (2) “to wish, will” (see will (v)). Related to well (adv.)⁵

Next, here's what the etymology dictionary provides for the adjective “wealthy.”

Late 14‐c., “happy, prosperous,” from wealth + ‐y (2). Meaning “rich, opulent” is from early 15‐c. Noun meaning “wealthy persons collectively” is from late 14‐c.⁶

Finally, here's a look at the etymology of “commonweal,” given that we just saw a nod to collective wealth:

Mid 14‐c., comen wele, “a commonwealth or its people;” mid‐15c., comune wele, “the public good, the general welfare of a nation or community;” see common (adj.) + weal (n.1).⁷

Now let's string these etymological pearls of insight together. First things first, the word wealth came into our lexicon in the mid‐thirteenth century, compliments of England; wealthy came next, followed by commonwealth. It's fascinating that wealth started out as a noun relating to the individual and then wealthy came into our lexicon as an adjective to describe an individual. Finally, the term expanded conceptual reach to that of the community in the mid‐fifteenth century. Following this logic, we can deduce that wealth related to the individual first, and then to society as a whole second. This logic supports the premise that wealth originally started as an individualistic construct: personal wealth, thereby supporting community wealth.

Furthermore, the word wealth initially took on a more expansive definition in the mid‐thirteenth century. Originally, wealth expanded into the realms of possessions, happiness, health, and well‐being. It embodied a wider array of concepts, covering both the tangible and intangible aspects of wealth—a multidimensional definition; a totality of being. What's interesting is that the fundamental roots of the word related to health and well‐being, more so than anything else. Over time, the definition and concept of wealth narrowed to our current wealth narrative, which suggests that wealth relates to money and material wealth, generally speaking.⁸ This is the antiquated wealth paradigm. This reflects the fact that over time—from the thirteenth century up through today—the relationship between wealth and money evolved, ultimately becoming tightly intertwined, nearly collapsing into one and the same.

This then begs the question: What is money?

“What can be added to the happiness of a man who is in health, out of debt, and has a clear conscience?”

—Adam Smith

Commodity Money

First up is commodity money. Commodity money has intrinsic value independent of its value as money. Take gold, for example. Gold has intrinsic value and also satisfies all the functions and characteristics of money detailed earlier. Therefore, this esteemed metal became an attractive—pun intended—tool for economic exchange. Gold's strong yet malleable nature makes it perfect for coin creation, which is exactly what the Kingdom of Lydia (current day Turkey) decided to do around 600 BCE. Lydia was the first empire to issue regulated coins. These coins were considered regulated because the government authority issued them. You could see that the coins were issued by a government authority because the coins had certified markings on them to signify they were intended as a specific value of exchange.⁹ From 600 BCE onward, gold has maintained its stronghold in societies and economies.

Despite gold maintaining its stronghold, the vulnerabilities of gold as money started to reveal themselves—especially as societies, economies, and greed grew. The biggest example of these vulnerabilities relate to the durability, portability, and counterfeit susceptibility of the metal. Gold has high durability given its high density and noncorrosive properties, but gold coins can still be tampered with. Someone can shave a little gold off a coin or bullion bar—a little off the top and into their pocket. Or someone might dilute the gold with another (less valuable) metal prior to minting. Moving beyond the durability and counterfeit susceptibilities, large amounts of gold are hard to move around. Because of its high density, gold is heavy and not the most conducive for strolling around town with. As societies and economies expanded, gold coins and bars became a less attractive means of exchange. Hence, the next iteration of money.

Representative Money

The next iteration of money is representative money. Just like commodity money, the name representative money is pretty intuitive. Representative money is paper money that represents the valuable commodity (asset) it can be exchanged for, like gold. The paper represents the commodity it's backed by, but the paper in and of itself has no value. One brings the representative, paper money to the bank and redeems it for the commodity it represents. This makes representative money akin to a debt instrument: aka an “I owe you.” For example, checks are considered representative money. When you bring a check to the bank and “cash it in,” you get the money owed in return. These valuable papers were designed to create more trust and practical efficiency in economic trade by way of less counterfeiting lighter pockets. Replacing gold coins for paper money reduced counterfeit susceptibility, and transaction friction. Therefore, paper money increased the efficiency of trade, thereby increasing the sophistication of economies. You're more likely to travel further, geographically, to purchase an expensive item if money is light and portable. Plus, the purchaser is more likely to transact if they can trust the authenticity of the money. Win/win.

At this point in the evolutionary timeline of money, all money was local—meaning the state‐chartered banks issued representative money, readily redeemable for gold (or silver). Therefore, trust in the issuing bank was imperative and regulations helped to establish and maintain this trust. Regulations required that a bank maintain enough gold in their vault to back the representative money issued, and in circulation. Otherwise, you ran the risk of holding representative money that represented nothing. In eighteenth‐ and nineteenth‐century America, there were frequent “runs on the bank,” which meant people would literally run to the bank to redeem their paper money for gold before the (poorly regulated and untrustworthy) bank ran out.¹⁰

Clearly, the primary problem with representative money was ensuring that the state‐chartered banks would maintain convertibility (from paper to the valuable, underlying commodity). If banks issued or loaned more representative money than they could back with intrinsic value, then this would lead to an expanded money supply, which could create debasement or the devaluing of money. And debasement of money can lead to a systemic collapse of the economic infrastructure.

In comes the federal government.

The federal government (in many countries) recognized the need to regulate the local banks issuing representative money to ensure that the money was in fact backed by intrinsic value, or gold. Therefore, the federal government created policy around money—monetary policy. Initially, this policy was colloquially termed the “gold standard.” The gold standard is a monetary system in which a government's paper money is directly linked to gold. In the 1870’s, the gold standard became the international standard for valuing currency.¹¹

The gold standard was golden … until it wasn't. In the United States, President Nixon nixed the gold standard in 1971, ushering in our next category of money, fiat money.¹² This is where things get interesting.

“Gold is money. Everything else is just credit.”

—J.P. Morgan

Fiat Money

The third iteration of money is fiat money. Fiat money, just like commodity and representative money, is pretty literal in its definition when you consider what fiat means. Fiat is defined as “an authoritative or arbitrary order” or “an authoritative determination.”¹³ It follows that fiat money is that which originates by government decree. The money, typically paper money, has no intrinsic value nor does it have representative value. The government that issues the money sets the value of the currency. Fiat money extracts its value from the fact that it is issued and tightly controlled by the government. This is why governments issuing money are hyper focused on two things: making sure the money is not counterfeited and that it is the only standard of money in the economy.

This is a good time to address the relationship between “money” and “currency.” Money is an intangible concept, and currency is a tangible representation of the intangible concept of money. Technically, you can't hold money in your hand, but you can hold currency in your hand, which represents the abstraction of money. For example, fiat money is tangibly represented by fiat currency in the form of paper bills and coins.

A government manages the value of its money by controlling how much is in circulation, which is why it's important that currency not be counterfeited. If a third party were to counterfeit fiat money, adding faux currency into the existing supply, this would have negative implications on the supply/demand dynamics of the economy. The economy would experience a devaluation of money, and on the other side of this coin, higher inflation. Note: inflation can also happen when the government, more specifically the central bank, prints additional money for circulation into the economy. We currently have front row seats to this here in the United States, where we saw trillions of dollars added into the economy during the pandemic, ultimately causing inflation to hit as high as 9% (in June 2022).^14,15

Additionally, a government manages the value of its money by declaring their issued currency legal tender. This decree requires the issued currency be the only acceptable standard of money in use.¹⁶ This means the fiat money issued by the government is the only form of currency recognized for payment of financial obligations, debts, and taxes. Could you imagine if a majority of people decided to use cowry shells to pay for financial obligations instead of legal tender? This would undermine the value of fiat currency because there would be less demand for it. As a result, the supply/demand dynamics would be off‐kilter.

Electronic/Digital Money

Electronic/digital money, too, is exactly what it sounds like—electronic/digital money, which exists in a banking computer system, and is available for transaction through electronic systems.¹⁷ Many people consider electronic and digital money to be one and the same, but it's important that we take the time to parse out the distinction between the two. Electronic money moves through electronic systems, and can be turned in for physical, tangible currency. Whereas digital money also moves through electronic systems, but it cannot be turned into physical, tangible currency. Digital currency never takes physical form; it remains on a computer network.¹⁸ Electronic money has the potential for conversion into tangible currency, while digital currency is, and always remains, intangible. This is the distinction.

The intangible nature of electronic/digital money enhances many of the functional attributes of money, hence it's prolific adoption in our increasingly digital world. As a store of value, electronic/digital money is certainly durable because it doesn't rot, rust, or decay; thereby retaining its value in perpetuity. As a unit of account, electronic/digital money can be broken down into small or large standardized units, because it is electronic/digital in nature, existing in a computer system. Finally, electronic/digital money functions as an efficient medium of exchange, because of its portable, easily transmittable (intangible) nature. It is easy to transmit across electronic systems; all you need is your digital wallet (via computer or smartphone) to access your money at any given time. This is why only 10% of the money supply, worldwide, is in physical form.¹⁹ Our predominately cashless society depends upon a strong, technological infrastructure to support economic activity. We've come a long way since my multicolored, neon wallet days.

Bitcoin

There is no literal interpretation for Bitcoin like there is for commodity money, representative money, fiat money, and electronic/digital money. Although, consistent with the evolutionary timeline of money, Bitcoin is (purely) digital in nature. Bitcoin was first introduced to the world in 2008 through a white paper titled “Bitcoin: A Peer‐to‐Peer Electronic Cash System.”²⁰ The title, in and of itself, tells us that the exchange of bitcoin occurs peer‐to‐peer, which negates the need for an intermediary. The title also tells us that Bitcoin was created for the purpose of being a cash system. Here is the first half of the abstract, which is presented in the white paper:

Abstract. A purely peer‐to‐peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution. Digital signatures provide part of the solution, but the main benefits are lost if a trusted third party is still required to prevent double‐spending. We propose a solution to the double‐spending problem using a peer‐to‐peer network … ²¹

Bitcoin has gone (and continues to go) through an identity crises, because of its novel and unique nature. Bitcoin has been socialized as digital money, digital currency (represented by a lower‐case b, “bitcoin”), a digital asset, and/or specifically, a digital commodity—depending on who and when you ask.

In August 2022, a new Senate bill emerged, stating that Bitcoin is a commodity; therefore, the Commodity Futures Trading Commission should regulate it.²² This bill will be voted on in the Senate, before moving to the House (if it's passed). That said, Bitcoin could shape up to be commodity money—digital, commodity money. In other words, Bitcoin could be a multipronged asset, meaning it's both a digital commodity (without an issuer) and a digital asset that can be used as hard money.

For purposes of this discussion, let's assume Bitcoin is digital money, for two reasons: first, Bitcoin was envisioned as a digital currency when it was first introduced in 2008 and, second, this approach helps us to further crystalize the concept of money. Here are the three primary functions of money (again), plus the use case for Bitcoin as money, in parallel:

1. Store of Value: Money can be saved and used later, because it retains its value over time—in perpetuity. Money retains its value over time because of its durable nature, meaning it doesn't rot, rust, or decay. Money also exists in finite supply (scarcity), preserving the integrity of its value.

   Bitcoin retains its value over time, because of its digital durability. Additionally, there's a finite supply of bitcoin because there will never be more than 21 million bitcoins created. Therefore, it is scarce.

2. Unit of Account: Money must exist in small, standardized units for less valuable exchanges and aggregated together for more valuable exchanges. The units of account must be divisible, fungible, and measurable.

   Bitcoins are standardized units that are divisible, fungible, and measurable. Each bitcoin is divisible into 100 million units, called satoshis.²³

3. Medium of Exchange: Money can be used to buy and sell from one another, facilitating exchange. This is possible when money is portable (easy to transport or transmit), and when the monetary tool is widely accepted by society.

   Bitcoin can be used to buy and sell from one another, facilitating exchange, peer‐to‐peer. This is possible because of the digital, portable nature of bitcoin. In other words, bitcoin is easy to transmit across electronic systems.

Bitcoin even cracked the code on creating digital scarcity, in the land of digital copy and paste. But beyond checking all the “money” boxes, Bitcoin offers one major, plot twist: there's no intermediary involved in its creation or circulation. Bitcoin is not issued by a bank, rather it’s created by computers solving complex math problems (aka bitcoin mining).

With fiat money, trust in payments is established by government regulation of banks. With Bitcoin, trust in payments is established by blockchain, cryptography technology. Therefore, the use of Bitcoin eliminates the need for regulated banks. As a consequence, Bitcoin is geographically unconstrained; it's decentralized because of its geographically agnostic nature. Central banks have taken notice, and perhaps notes, as they explore creating their own Central Bank Digital Currency (“CBDC”).

Central Bank Digital Currency

CBDC is digital currency issued directly by a nation‐state's central bank, which is declared legal tender just like fiat money.²⁴ CBDCs are issued by the central bank, and regulated by the central bank. Currently, 60% of countries are experimenting with CBDC technology.²⁵ This reflects the rise of money digitalization, innovation, and a change in our future economy. Watch this space, with eyes wide open.

We only scratched the surface on digital money transformation, but there are many informative books written on the topic. A couple of suggested favorites include: The Bitcoin Standard by Saifedean Ammous and Layered Money by Nik Bhatia.

My intention for highlighting Bitcoin and CBDCs at the end of our journey through the evolution of money is to highlight the fact that things are changing. And they're changing fast! Our journey started with cowry shells and ended with cryptographic blockchain. We are traversing into the next iteration of money as our concept of money continues evolving and becoming more sophisticated over time. And as a result, our economies are evolving and becoming more sophisticated over time, too, because money enables economies to scale. We’re squarely sitting in the digital economy transformation.

“The two greatest tests of character are wealth and poverty.”

—Charles A. Beard

The Bartering Economy and the Money Economy

The bartering economy came first, and, you guessed it, is based on bartering. The bartering economy is a system where goods and services are produced and exchanged for other goods and services, without the use of money. This economic system is not the most efficient, because it's predicated on a double coincidence of wants. In other words, the two parties engaged in the exchange must both want what the other is offering ‐ at the same time.²⁷ Here's an illustration of this inefficiency. Let's assume I grow potatoes, and you make shoes. We can barter, or exchange, our goods if it so happens that you want potatoes and I want shoes—at the same time. This means bartering is possible when you want to trade something you have (and don't need) for something you need (but don't have). Although the odds of someone wanting more than a few pairs of shoes are slim, unless you're Imelda Marcos (who infamously owned 3,000+ pairs of shoes).

Because of the highly inefficient nature of the bartering economy, the money economy was born. The money economy is a system in which goods and services are produced, sold, and bought with the use of money. This economic system is more efficient because it solves for the double coincidence of wants issue by using money as a medium of exchange. Here's an illustration of this efficiency. Let's assume I grow potatoes that you want, but I don't need any more shoes. So, you pay me in money for the potatoes, and I can use that money to buy the clothes I need or save that money for future purchases. Voila. Problem solved. Money was the tool used to transfer value to me, in exchange for the potatoes you wanted. Everyone's happy.

Adam Smith: The Economy, Money, and Work

Who better to answer the question What is an economy? than the father of economics himself, Adam Smith?²⁸ Smith was an eighteenth‐century Scottish economist, writer, and philosopher who defined economics as “an inquiry into the nature and causes of the wealth of nations.”²⁹ Let's explore this. An economy is created in an ecosystem, which is interconnected by virtue of its financial and cultural activity. This activity includes the production, consumption, and trade of goods and services. Put differently, it's a social ecosystem of interrelated financial transactions and human practices that are influenced by a myriad of factors. Further, these financial transactions use money as a medium of exchange. As Smith put it in his renowned book, The Wealth of Nations, “money became the universal instrument of commerce.”³⁰

Because money is the universal instrument for commerce, by extension, it is also the way in which people move value around society. After all, money is an expression of value. And per the preceding, economies have a lot to do with what people value, or want. Let's assume you buy sneakers because you want them for your new workout routine. You're demanding sneakers, to the exclusion of sunglasses, for example, at a given point in time. The sneakers have a higher utility (or value) to you than the sunglasses right now. These economic decisions inform the free market. Smith refers to this concept as the Invisible Hand, which “is a metaphor for the unseen forces that move the free market economy. Through individual self‐interest and freedom of production and consumption, the best interest of society, as a whole, are fulfilled. The constant interplay of individual pressures on market supply and demand causes the natural movement of prices and the flow of trade.”³¹ In theory, capitalistic, free markets are flexible, responsive, and always seeking equilibrium. People are always voting for what they value and want, and this includes demands for innovation (in goods and services).

In order to buy goods and services, you first have to make money to pay for them. [Note: I'll avoid folding in the concept of buying on credit, for simplicity's sake.] How you decide to make money—by deciding how to spend your time and energy—also informs the market. There are three primary considerations when choosing a profession: your interests, your skills, and what the market will reward you for. How you decide to use your productivity superpowers is specific to you, which means different people will specialize and do different things (for money). Specialization is good, really good, for the economy. Here's why.

In Adam Smith's book The Wealth of Nations, he essentially answers the question of what causes wealth by answering: the division of labor.³² Specialization and the division of labor are interdependent concepts. Let's unpack this. The division of labor starts with the division of a large task into smaller subtasks. From there, the smaller subtasks are assigned to different people who specialize in that specific subtask. This means that a group of individuals come together for sake of completing a large task at hand. The individual(s) specializing in the specific subtask(s) benefit from completing the task, because they are doing what interests them, what they're skilled at, and what the market will reward them for. Further, this is beneficial to the broader, larger task at hand—from an efficiency and productivity standpoint. This translates into cheaper production of the larger task (good or service), which is a win for the consumer. This is a net positive for society.

The division of labor acts as the engine for wealth creation, fueled by specialization within the labor market.³³ Individuals are happy doing what they're interested in and what they're skilled at, while the market benefits by way of increased efficiency and therefore lower priced goods and services. It follows that the more expansive a labor market is, the more expansive the division of labor can be. Smith says, “the division of labor is limited by the extent of the market.”³⁴

Categorically, the evolutionary timeline of economies looks similar to that of money, in that economies are also shifting focus from the tangible to the intangible. Initially, goods and services were exchanged within our neighborhoods when the coincidence of wants struck. We saw this when touching upon the barter economy earlier in this chapter. Money then enabled economies to scale and people to specialize, leading to the division of labor—resulting in increased efficiency and productivity. This unlocked the opportunity for innovation of goods and services, intangibles included. What's obvious and absolutely worth mentioning is the internet was an absolute game‐changer for economic activity. The creation of the internet expanded the reach of specialized talent and therefore the division of labor because it expanded the reach of the market, plus so much more …

The Digital Economy

Our concept of economy changed with the introduction of the internet. The internet alchemized economies. The internet was created in 1983, which means it's technically a millennial generation invention. The World Wide Web, which made the internet available to the public, was created in 1991.³⁵ Also a milennial. The web democratized the internet. The internet is the infrastructure that connects computer networks together and the web organizes the information available through accessing the internet. For perspective, in 2000, 5.8% of the global population was using the internet; in 2022, 67.8% of the global population was using the internet.³⁶

The internet brought financial activity online, scaling economies and profit to unprecedented proportions. The internet innovated the who, what, where, why, and how of production and consumption. Businesses are optimizing the production of their goods and services with less friction thanks to the internet. Production optimization is now easier both at the input stage (creating) and the output stage (selling). People are consuming goods and services through the internet, also known as eCommerce. Buyers and sellers now exchange goods and services over the internet, across the globe. And services now expand into electronic businesses, also known as eBusiness. Plus, businesses, both brick‐and‐mortar and electronic, can keep good records of all financial activity through digital accounting. Another win compliments of the internet.

The evolution of economies also saw a shift from an economy dominated by goods to an economy dominated by services and information—powered by the internet. A shift from tangible to intangible. What's more is the distinction between goods and services is now blurring. Consider how many objects (goods) you own that come bundled with services (i.e., your cell phone). This is a result of technological innovations, expanding networks, increasing utility of information, and the creation of new markets. Needless to say, economies are powerful engines for making money—the excess of which, can be spent, saved, or invested. Which leads us back to the initial question in this chapter: What is wealth?

From the etymological pearls of insight to socioeconomic evolution, we can appreciate the etymology of wealth, plus the ever‐evolving relationship between wealth, money, and the economy. Money scales economies, which in turn scales wealth. The economy is an engine for wealth creation, and money acts as the fuel. Therefore, there's an obvious intertwined relationship between wealth and money, but this does not necessarily mean that lots of money simply translates into the definition of wealth. The antiquated wealth narrative deserves reimaging and redefining, on an individual level first and foremost. What's your wealth? After all, we saw the original, thirteenth‐century definition of wealth focused on the well‐being of the individual. Additionally, we saw the father of economics, Adam Smith, explain how individual interests and skills support the division of labor, which contributes to a flourishing economy (and wealth creation).