Bitcoin: Separation of Money and State

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by SatsJoseph

That’s me and my very deep thoughts. Give me a follow if you please.

About this text

I hope you enjoy my book. Please note English is not my first language. Drop me a DM on Twitter if you find any typos, factual errors, or just want to get in touch.

Big thanks to Max Webster for reading the first draft and inspiring the section on pre-Fed business cycles.

Table of Contents

I. Austrian School of Economics, and its Relation to Bitcoin

II. Bitcoin and Time Preference

III. Bitcoin and Monetary History

IV. Bitcoin: Separation of Money and State

V. Why only Bitcoin?



I. Austrian School of Economics, and its Relation to Bitcoin

Why an “Austrian” school?

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Watch out for those pesky terms!

Further authors of Austrian origin later built on Menger’s work: Eugen von Böhm-Bawerk, Ludwig von Mises, Friedrich August von Hayek. The last two emigrated to the United States and England before World War II, and the Austrian school of economics in Austria itself subsequently disappeared, while being further developed mainly in the United States (by institutions such as the Mises Institute and universities such as George Mason. Interestingly, the Austrian school also has a strong background in the post-revolutionary Czech Republic.

It is noteworthy that the marginal theory of value was concurrently developed by three economists: Carl Menger, Léon Walras, and William Jevons. This is a nice example of so-called convergent evolution, where scientists (or forces of nature) independently arrive at the same result when faced with the same inputs. The marginal theory subsequently became the basis of modern economics, while the cost theory of value was generally abandoned as invalid.

i: Methodological Individualism
The Austrian school is characterized by a strong emphasis on individual behavior. It is only individuals, not social institutions, who have preferences and strive to fulfill them. “That there are nations, states, and churches, that there is social cooperation under the division of labor, becomes discernible only in the actions of certain individuals. Nobody ever perceived a nation without perceiving its members,” says Ludwig von Mises in Human Action.

The analysis of all economic phenomena, be it consumer decisions, inflation, or the business cycle, always begins with an examination of the preferences and incentives of individuals (e.g. entrepreneurs or central bank officials).

Economists of the Austrian school argue that social institutions are not sovereign economic entities. Only people at the individual level act. Yes, individuals can be influenced and manipulated by crowds or ideologies — but they are always, in the end, specific individuals who set their bodies in motion and give way to their thoughts. As Mises points out, this holds true even if one acts in the name of the state: “The hangman, not the state, executes a criminal.”

The Essence of the Austrian school

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Bitcoiners like their LTP signaling!

A crucial finding of the Austrian school is also that institutions such as law, ethics, business practices, and language evolve naturally, based on the independent action of thousands of motivated individuals; and state intervention in this evolutionary process usually produces unexpected and pernicious consequences. These are emergent institutions that are impossible to replicate or improve by “rational intervention.” Emergent institutions are the result of human action, but not of human design. Friedrich Hayek illustrates this spontaneous order with the example of crystals: although we know its structure, it is impossible to create a crystal by assembling individual atoms. However, we can create the conditions under which the process that results in the formation of a crystal takes place. That is how a rational economic policy should look like as well: it should create the right conditions (rule of law, protection of private property) and otherwise leave people alone (such a policy is also referred to as laissez-faire).

Prices: a Signal Transfer Network

Austrian Business Cycle Theory

  1. Today’s money is created and injected in the economy through credit; interest rates are essentially prices of the loans given out in the economy.
  2. Central banks generally conduct monetary policy by regulating interest rates.
  3. Interest rate regulation, as a rule, pushes interest below the level that would occur on the free market (without interest rate regulation); if the central bank set interest rates higher than the market rate, then it would not regulate anything (banks would simply borrow from each other and savers at a lower rate than the central bank would target with its operations).
  4. By lowering the interest rate below the rate would prevail on the free market, more investors and companies borrow and start more business plans — thus a credit expansion ignites an economic boom.
  5. The boom is caused by artificial credit expansion, not by higher demand for new projects (e.g. new homes). Completed projects thus face low sales, unfinished projects run into problems as there is often a lack of real capital to complete them, and entrepreneurs drive up input prices. Higher consumer inflation (due to more money circulating in the economy) is forcing the central bank to raise interest rates in the name of fighting inflation. Cheap financial capital was only an illusion; after the boom comes a bust, i.e. a decline in economic activity and a recession.
  6. The central bank often treats the recession by lowering rates again and the whole cycle starts anew (note: now, after decades of this monetary policy, central bank rates are already at zero or below zero, so there is nowhere to cut anymore).

The issue of the business cycle is, of course, much more complex, but the above explanation covers the reasons for the observed continuous cycles. In short, as long as we have central banks, there will be long periods of capital misallocation, followed by cleansing periods. Monetary policy is thus a source of considerable waste of capital.

Don’t forget the economy is about stuff, not money. Monetary stimulus doesn’t equal production.

Private Money

Economics, the Indispensable Framework

II. Bitcoin and Time Preference

What is Time Preference?

“Satisfaction of a want in the nearer future is, other things being equal, preferred to that in the farther distant future. Present goods are more valuable than future goods.”
-Ludwig Von Mises
Ludwig von Mises (1881–1973) was an economist, political philosopher, historian. Author of Human action, an influential treatise on economics. Mises and Hayek are the fathers of the Austrian business cycle theory. Other influential books are Liberalism, Socialism, and Bureaucracy.

The basic aspect of decision-making in the context of time is this: one usually prefers to satisfy one’s needs sooner rather than later. This is especially true under the assumption of “ceteris paribus”, or other things held constant. If I am faced with a choice to have a beer today or tomorrow — and other things are held constant — then I will have my beer today, thank you very much. This statement applies universally, i.e. about all possible consumption. Why is that? Well, everyone is mortal and faces the same relentless passage of time. The satisfaction of needs and preferences takes place in an environment of uncertainty and limited time — and therefore it must necessarily be the case that, ceteris paribus, man always prefers satisfaction sooner rather than later.

The real fun begins when ceteris paribus no longer applies — as circumstances of our decisions change, time preference begins to manifest. A simple example: you get to choose whether you want 100 dollars today or 100 dollars in a year. Under the same circumstances, you will always prefer 100 dollars today. However, if the offer is 100 dollars today or 105 dollars in a year, you may prefer to wait. For some individuals, the 5% interest per annum doesn’t change their decision; but 20% might. The ratio of preference for present goods over future goods is called time preference.

High time preference means that I prefer to satisfy today’s needs and I significantly discount the future (I do not consider it too important).

Low time preference means that today’s consumption doesn’t carry much weight in my decision-making process and I discount the future only slightly.

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Progression of time preference in a productive individual’s life. Only for illustrative purposes, not based on real data.

Time preference evolves throughout a lifetime. Young children do not yet understand the passage of time and do not have much patience — they usually value current consumption the most. With increasing age and wisdom, one already understands the need for savings and planning for the future — time preference decreases. And in the last decades of life, an average Joe experiences a midlife crisis, buys a convertible, and embarrasses his children (while on the other hand, he usually wants to leave them something, so time preference doesn’t return to the childhood levels).

High time preference, its causes, and effects

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2 percent doesn’t sound like much. But over the long term, it compounds a devastating erosion of the purchasing power.

A mere 2% yearly inflation will cut the purchasing power by a quarter in 15 years, and by half in 35 years. Interest rates on bank deposits rarely pay more than a fraction of a percent, so this rate of inflation causes a widespread change in time preference — building up savings in the national currency no longer makes any sense, as it deprives you and your family of purchasing power over the long term. You must either spend now or invest in risky financial instruments.

Low time preference, its causes, and effects

  • Secure property rights — efficient protection against private criminals and a minimum level of taxation (none, ideally)
  • Rule of law — countries with a higher level of contractual security and decentralized common law, as has been the case in England and its colonies for centuries (incl. the United States)
  • The non-inflationary nature of money — in the past, money consisted mainly of gold and silver (did you know that Switzerland abandoned the gold backing of the franc only in 1999?).

Countries in which these three aspects came together have experienced a golden era of prosperity in the past — the American Gilded Age is a fitting historical example.

The nature of money is quite possibly the most relevant factor influencing the societal level of time preference. The inflation tax is one of the least fair taxes. Inflation tax mostly affects the poorest, who are unable to protect themselves against inflation in the financial markets. The inflationary currency also allows for a record level of government debt, as central banks are among the largest holders of government bonds.

In other words: if we want to live in a society of low time preference, we need to deprive the state of its power over our money.

Time preference, gold, and Bitcoin

  • Transferability: due to bitcoin’s intangibility, we can transfer huge sums across the globe, without any third party involvement
  • Verifiability: fake gold is hard to detect by an average Joe; fake bitcoin (e.g. bitcoin cash) is summarily detected; when operating a full node, the operator has the full opportunity to participate in the enforcement of the protocol rules
  • Scalable sovereignty: a single gold coin is easy to keep in your custody — a ton of gold bricks not so much; due to the intangible nature of bitcoin, it is possible to retain sovereignty in scale — nothing changes whether one holds just a few satoshi or thousands of bitcoins
  • Unconfiscatability: when fleeing nazi and communist countries, gold sewn into a coat was often the only way to save family savings — such a method is, however, prone to confiscation; bitcoin is unconfiscatable when its holder uses adequate procedures (multisig schemes, Shamir backups, timelock transactions, etc.)
  • Antifragility: Bitcoin is a fine example of the remarkable phenomenon of antifragility — something that is reinforced by constant attacks, hacks, and internal conflicts; gold, on the other hand, was “only” robust — it served its role satisfactorily for thousands of years, but in the end, it was overtaken by states (read more about Bitcoin’s antifragility in Parker Lewis’s article Bitcoin is Antifragile)
  • Ecology: modern gold mining and processing is a full-fledged ecological catastrophe (I recommend a Baltic Honeybadger talk on this topic); while bitcoin mining consumes only electricity — and increasingly from renewable sources. Moreover, Bitcoin is starting to be used as a battery, smoothing the peaks of renewables.

But to be fair, Bitcoin has one major disadvantage when compared to gold. Bitcoin doesn’t have thousands of years of history behind it. Gold has a much higher acquired Lindy effect. We can’t tell with certainty that Bitcoin won’t encounter a serious problem as the mythical mass adoption arrives — the issue of sovereign management of private keys or the sustainability of mining rewards are aspects that we will reliably know are solved only in the long term. Holding a gold coin in one’s purse is mentally a simple concept; holding satoshi in one’s hardware wallet, not so much (at least for now).

i: Lindy effect
Lindy effect is a rule of thumb popularized by philosopher Nassim Taleb. In short, the rule states that technologies or institutions that have survived for x amount of years are likely to survive another x amount of years. I.e. if Bitcoin has been around for 11 years, it will most likely be around for another 11 years. Gold has a strong Lindy effect and is the main advantage of gold over Bitcoin.

Now the crucial question: how does Bitcoin affect time preference, here and now?

In the long term, Bitcoin is deflationary. From a certain moment, the number of units won’t increase anymore and it probably won’t even stagnate — it will fall due to losses. According to CoinMetrics, an estimated 1.5 million bitcoin is already lost forever due to occasional private key loss, burned bitcoin, and transaction errors. Although the rate of bitcoin loss decreases as bitcoin’s price increases (people are more careful and learn to use solutions such as hardware wallets and Shamir backups), in the long run, the total amount of bitcoin in circulation can only fall.

Such predictable dynamics in the total supply of bitcoin has its effect on reducing the time preference of those who accumulate bitcoin. And I deliberately use the term accumulate — “OG hodlers” who were lucky enough to buy bitcoin years ago for $5 and ever since only hold and gradually sell their sats for fiat can’t be considered low-time preference individuals in the true sense of the term. In the context of savings, time preference determines how large a percentage of income a person saves — and if one doesn’t save in bitcoin and instead only observes the growing value of previously purchased bitcoin, one does not demonstrate low time preference.

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Hodling by itself isn’t a sufficient LTP activity. Ongoing sat stacking is. Low time preference is demonstrated by a permanent change in one’s behavior.

On the other hand, those who regularly save in bitcoin and think about ways to increase their pace of sat stacking can be described as individuals with low time preference, as they consistently choose to postpone their consumption to the future.

Given that bitcoin’s purchasing power can be expected to rise in the future, this has a very positive effect on the level of time preference of those who keep on descending the Bitcoin rabbit hole: existing holders think about meeting their short-term needs without selling their satoshi, and those who are only just discovering Bitcoin look for ways to increase their productivity and reduce the consumption to maximize the accumulation of bitcoin at a time when it is not yet widespread and thus cheaper when compared to expected future price levels.

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Image source: brg444

Bitcoin as salvation from degeneration

III. Bitcoin and Monetary History

Why explore the history of money?

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So let’s get down to business.

From communism to cooperation

Drachma, denarius, solidus — a thousand years of prosperity and decline

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Coin debasement in ancient Rome. Image source: Wikipedia.

An exemplary example of debasement is the antoninianus, which has been debased to almost a zero silver content within a short time frame of 30 years:

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Antoninianus was a silver coin of a very short life — within 30 years, it lost almost all its silver content. What a progressive monetary policy! Image source: Wikipedia.

The precious metal content in Romanian coins is a reflection of the overall health of Rome. In times of prosperity, the ruler did not consider destroying the fundamental anchor of the economy via debasement. But in times of pervasive bureaucracy, empire-building, and overall degeneration, a coin was the first victim, and its debasement subsequently hastened the empire’s decay. As we can see from the graphs above, once debasement was tried, there was no turning back. Financing public expenditures via a secret robbery of the population was too much of a temptation once discovered.

Byzantine Empire: solidus
After the fall of Rome, the center of European power and civilization shifted to the east, where the Byzantine Empire was established. The rulers of the Byzantine Empire continued to mint the solidus, with a gold content of 4.45 grams.

Byzantine solidus became one of the most stable currencies in human history — for 700 years, it was minted with little signs of debasement. Solidus was a coin made of almost pure gold — the coin had a purity of 23 carats, i.e. 96% gold content. The debasement of such a coin must have been a temptation: if the coin had just a slightly lower gold content, nobody would notice! The fact that the solidus has remained stable for so long suggests that the period after the collapse of the Roman Empire was not as dark as sometimes called. On the contrary — when compared to late Rome, it was an age of low time preference. Preserving the gold content of solidus required a consistent long-term outlook and a resistance to the short-sighted lure of cheap money.

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Solidus under Justinian II. from year 705. Gold content 4.44g. Image source:

Nevertheless, solidus also met the fate of debasement. Emperor Michael IV. ascended the throne in 1034 AD and slightly lowered the gold content. There was no way back from this path. Of the original 23 carats, the solidus was devalued to 21 carats in 1042, 18 carats in 1059, 16 carats in 1068, 14 carats in 1071, 8 carats in 1078, and less than 8 carats after 1081. After 700 years of anchoring the world economy, solidus was destroyed in 50 years. Solidus was replaced by a hyperpyron coin (20.5 carats), which remained stable until the crisis of 1204 when it was once again debased; and in the final era of the Byzantine Empire, hyperpyron had zero gold content.

Dollar before 1913

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Pictured: an African immigrant reminisces over the American monetary history.

The Spanish dollar and the constitutional safeguard
During the Revolutionary war, the colonists shot up the paper drug again with devastating consequences: in 1775, the total money supply was $12 million, four years later it was $600 million. “Continentals” (paper notes) were initially defined as 1 Continental = $1 in gold. After four years, they were worth $0.01.

But what was that dollar? Surprisingly, the dollar was not an American invention — it was the then widespread Spanish dollar, defined as 24.443 grams of silver. Spanish dollars were already circulating in the colonies, and in 1785 Thomas Jefferson persuaded members of the Continental Congress to accept the Spanish dollar as an official American currency. Jefferson’s proposal was accepted. The next step was to ensure that silver dollars wouldn’t be debased and that the paper money hydra would never return (everyone still remembered the hyperinflations from the pre-war and war periods).

To mitigate these concerns, Congress defined the dollar as 371.25 grains of silver (roughly 24.05 grams), and the United States Constitution banned the states from issuing money other than gold and silver. And to make things indisputable, the Tenth Amendment stated that the federal government had only such power as explicitly assigned to it by the Constitution.

And such is the end of monetary history, as since then humanity has been blessed with a new solidus in the form of a silver dollar! Well… wait — how come the current dollar is a pure fiat again?

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Jackie Chan is as perplexed as the dear reader.

To answer this question, we need to analyze the strange policy of bimetallism, which started in 1792. As the name indicates, bimetallism is a double monetary standard when both gold and silver are considered money. While the dollar was at first defined as a silver coin, gold also had indisputable monetary qualities. As was the case with the silver dollar, the Founding fathers feared that without a clear definition, gold coins would be debased in the future. So Congress took a step that seemed obvious — it defined the gold dollar similarly to the silver dollar. Eagle (a new gold coin) was thus given a $10 face value. This meant that one Eagle coin had the same value as ten silver dollars. And that is the crux of the problem: gold and silver do not have a mutually stable price. Members of Congress simply took the current market ratio (gold was 15 times more expensive than silver at the time) and defined the precious metal content with that rigid ratio.

This error would be the basis of many headaches in the years to come — the rigid ratio caused silver or gold coins to alternately disappear from circulation, depending on how advantageous it was to hold one metal and spend the other. The market ratio differed from the one set by Congress most of the time. California’s gold rush eventually caused a significant influx of gold into the market, and the gold-to-silver ratio finally changed in the favor of silver. It became advantageous for people to withdraw silver coins from circulation and pay with gold — a practical example of Gresham’s law, which describes people’s tendency to hold on to stronger/undervalued money and to spend the weaker/overvalued money). In 1834 Congress adjusted the ratio to 16: 1 which made the situation worse — silver was heavily undervalued against gold and completely disappeared from circulation. In 1853 silver coins were devalued and in 1873 bimetallism was abandoned for good. Thus the United States adopted the gold standard.

Long story short, the government killed the original silver dollar in less than 100 years.

Subsequently, in 1900, the gold dollar was defined as 23.22 grains (1.5 grams) of gold. This gold dollar was killed even sooner than the silver one — after 33 years.

Business cycles before the Fed: The Panic of 1819
Before we move on to the explanation of how and why the Federal reserve system (Fed) was established, it’s good to answer one frequently asked question: what were the causes of pre-Fed business cycles? As we’ve seen in the first chapter on the Austrian school of economics, it is the central bank that is the cause of ever-present, ever-greater credit expansions, and subsequent contractions. So how come we can observe business cycles even before the central bank was established?

For the answers, we have to consult the great Murray Rothbard and his The Panic of 1819. Reactions and Policies. This book is generally regarded as the best analytical work on the causes and effects of the first banking panic in the newly founded United States. Rothbard points out that even 200 years ago, the American economy was far from the laissez-faire ideal. First of all, the federal government was involved in the War of 1812 (waged between the US and the UK). As Rothbard writes in his book:

“[The war] brought heavy pressure for federal government borrowing. New England, where the banks were more conservative, was opposed to the war and loaned only negligible amounts to the government, and the federal government came to rely on the mushrooming banks in the other states. These banks were primarily note-issuing institutions generally run on loose principles.”

Why were the banks “run on loose principles”, though? Banking was an enterprise requiring state charters, and the states often granted the charters to those who were willing to acquire state bonds. Moreover, the federal government agreed to suspend specie (gold) payment in exchange for banknotes — because it required the loose credit policy to take on higher debt due to war efforts. So while there wasn’t a central bank per se, it was the federal government and individual state governments, who sparked the great credit expansion, which later resulted in the Panic of 1819. Rothbard explains:

“Banks continued to expand in number and note issue, without the obligation of redeeming in specie, and their notes continued to depreciate and fluctuate from bank to bank, and from place to place. The number of banks increased from 208 to 246 during 1815 alone, while the estimated total of bank notes in circulation increased from $46 million to $68 million.”
“Investment in real estate, turnpikes, and farm improvement projects spurted, and prices in these fields rose. Furthermore, the federal government facilitated large-scale speculation in public lands by opening up for sale large tracts in the Southwest and Northwest, and granting liberal credit terms to purchasers. Public land sales, which had averaged $2 million to $4 million per annum in 1815 and 1816, rose to a peak of $13.6 million in 1818.”
It does not seem accidental that the boom period saw the establishment of the first formal indoor stock exchange in the country: the New York Stock Exchange opened in March, 1817. Traders had been buying and selling stocks on the curbs in Wall Street since the eighteenth century, but now they found it necessary to form a definite association and rent indoor quarters.”

To save the day, a special banking institution was chartered — the Second Bank of the United States (a predecessor of sorts to Fed). However, the federal Second Bank also engaged in credit expansion (to help the state-chartered banks) and was faced with quickly diminishing stock of gold. And that is when the Panic ensued:

“Faced with these threatening circumstances, the Bank of the United States was forced to call a halt to its expansion and launch a painful process of contraction. Beginning in the summer of 1818, the Bank precipitated the Panic of 1819 by a series of deflationary moves.”
“The contractionist policy forced the state banks, in debt to the Bank, to contract their loans and notes outstanding at a rapid pace. Total bank notes in circulation were estimated at $45 million in January, 1820, as compared to $68 million in 1816. The severe monetary contraction, lasting through 1820, led to a wave of bankruptcies throughout the country, particularly outside New England. The financial panic led, as did later panics, to a great scramble for a cash position, and an eagerness to sell stocks of goods at even sacrifice rates.”

So as always, the ruler/government/state was the culprit. The foolish and fraudulent credit expansion based on fractional reserve practice was sanctioned and exacerbated by the state and federal actions, and the ensuing bust was the inevitable and necessary correction of the misallocated capital. That said, the Panic of 1819 was actually quite short and painless because nobody had the “brilliant“ idea of quantitative easing, bailouts, or any such modern monetarist voodoo. But more on that later.

The underlying logic of monetary history: the monetary perpetuum mobile

“Power tends to corrupt. Absolute power corrupts absolutely.”
-Lord Acton
John Emerich Edward Dalberg-Acton was a 19th-century historian and a political philosopher. A lifelong advocate of liberty, he is mostly known for his statement about the corruption of power. Lord Acton is oft-quoted by Murray Rothbard in his works.

The power over the definition of money is a huge temptation. Bankers throughout history always faced the temptation to issue more gold & silver receipts (“banknotes”) than they could settle. Manipulating the definition of money was an elegant solution for bankers to finally get away with fractional reserve banking. And convincing politicians to get on board wasn’t such a hard task, as creating more money out of thin air seemingly produced additional prosperity.

After all, money is a magical store of value, isn’t it? He who gains more money will attain more wealth. All this is true, but it comes with a catch. Money is only a relative carrier of wealth: 10% of money controls 10% of the wealth. When government or banks create more money and have 20% of the money at their disposal, they will command 20% of the societal wealth; while everyone else loses 10%. Money doesn’t create wealth, but it can redistribute wealth from one pocket to the other — from the producers to the money creators.

The history of money, all its debasements, its redefinitions of monetary instruments, and its “monetary policy”, can be viewed as an age-old effort to create a perpetuum mobile: a miraculous machine that produces more energy than it consumes. The monetary perpetuum mobile is treacherous and seductive in that it absorbs its energy (in the form of purchasing power) initially invisibly and with dispersion in time and space. If you rob citizens of 1% of their purchasing power, will they notice? If you induce an economic boom, the consequences of which (the depression) will be borne by the country only after 10 years — and perhaps not even then, if you then create an even bigger boom — isn’t such a contract with the devil amazing?

The power to define and create money is simply too tempting and there is no human or man-made institution capable of controlling it. Like the Ring of Power, it must be destroyed; otherwise, it will destroy mankind.

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Bilbo Baggins contemplates keeping the money printer.

The creature of Jekyll Island

  1. Government issues bonds
  2. Bank accepts government bonds in its balance sheet on the assets side
  3. Bank issues a check to the government in the value of the bond
  4. The government deposits the check in another bank, where the check is converted into a deposit
  5. The government can now spend newly created money on its expenditures

This process is a nice example of a monetary perpetuum mobile — so nice that both statesmen and commercial bankers have worked for many years to make it fully legal and sanctified. Once Fed (and other central banks around the world) was established, commercial banks have been operating on this one principle: the money that banks “lend” is not in fact lent — it is a newly created money that arises in banks’ balance sheets as a counterbalance to received assets (government bonds, household mortgages, etc.). It is quite weird that the newly created money gets called a loan because under this system no one lends anything to anyone. The bank simply creates new money; and when the “loan” is repaid, the reverse happens and the money disappears from circulation.

i: When reality sounds more like a conspiracy theory
Some people have a hard time accepting the idea that today’s money is built solely on debt, and that new money is largely created by commercial banks (based on the privilege from the central bank). I was once even accused of spinning conspiracy theories for mentioning this fact. It is quite hilarious that the reality of today’s money is so absurd that people are reluctant to believe it. To avoid further accusations, let me refer to two serious sources that acknowledge the nature of modern money as debt: Bundesbank and the Bank of England.

The formation of the Fed was preceded by a secret meeting of influential bankers on the island of Jekyll Island, which took place in 1910. Among the participants were the most powerful bankers of the time — Morgan, Rockefeller, Rothschild, Kuhn-Loeb, and others. The meeting aimed to create a system that would protect the bankers from “panics” — sudden bouts of demand to withdraw the real money (gold), of which banks have never had enough due to the policy of fractional reserve banking. The ideal development for bankers would be one that would completely remove real money from the equation and establish a monetary system based purely on debt and paper. However this was deemed too extreme to perform in one go — so the first goal was to create the “lender of last resort” that would rescue commercial banks in the event of a panic. And the government, on the other hand, would gain a bottomless source of money without the need to raise taxes significantly.

The legislation submitted to Congress in 1913 spoke of an acute need to stabilize the banking system and prevent recessions. As the world soon witnessed, the Fed could not live up to that promise. On the contrary, the existence of a lender of last resort led to an even greater credit expansion which triggered the apparent economic boom of the 1920s and subsequently led to a contraction known as the Great Depression. Big banks were unharmed though, which was the actual goal. And in 1933 the bankers’ dream came true when President Roosevelt nationalized the American citizens’ gold and allowed the advent of pure fiat.

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Consumer price index in US cities, 1913–2020. Chart source: Fred.

In the 107 years since the Fed’s formation, there have been a total of 20 recessions. Mainstream economists usually praise central banking as an invention that ensures economic stability. The opposite is true: central banking is the very cause of periodic credit expansions and subsequent contractions. This cycle gradually redistributes wealth to those who receive the new money first — the government and the financial sector. This is not a newly created wealth, it is a theft of purchasing power from those who hold cash, save, and are dependent on wages. Inflation is a reverse tax — the poor pay the rich.

i: Cantillon effect
Imagine a champagne tower. Once the glass at the very top is filled it overflows to those below it, and so on. Level after level, the champagne loses its freshness until finally, a weathered, room-temperature plonk reaches the glasses at the very bottom.

The way new money is spreading through the economy today is essentially the same as pouring champagne as described. Those who get the money first enjoy higher purchasing power — they have more money while prices have not risen yet. As new money gets spent (typically in financial markets), information about a higher money supply spreads through the economy and prices rise. Those at the bottom of the money distribution pyramid face higher prices before new money reaches them (e.g. in the form of increased wage).

The effect of the idiosyncratic spread of new money through the economy is called the Cantillon effect. The result of the Cantillon effect is an enrichment of the privileged classes (with access to the money spigot) at the expense of the unprivileged classes.

1933: Executive order 6102

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The executive order, by which FDR nationalized the American citizens’ gold. Image source: Wikipedia.

The nationalization of American gold was made much easier by custodianship: people have become accustomed to comfortable monetary instruments in the form of banknotes, checks, and bank transfers. Most gold coins and bars were no longer in circulation, but rather stored “safely” in bank vaults. Such gold could hardly be concealed as banks kept client records and were asked by the government to share the data.

The main reason for issuing Order 6102 was the fact that the Fed was still obliged to back the outstanding dollar bills with gold. As the very creation of the central bank was very controversial, the transition to a full fiat could not take place at once. Therefore, the federal reserve notes had to be backed with at least 40% gold. Twenty years after the creation of the Fed, this demand was already “too binding” and the nationalization of gold with the subsequent devaluation of the dollar by 75% once again loosened monetary policy. Besides, citizens could no longer create a “panic” because they simply no longer had anything to withdraw from the bank — real money in the form of gold was forbidden and all they could get were federal reserve notes, which could be created at a whim.

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A dollar note from 1928. Notice the text at the bottom: “Will pay to the bearer on demand One dollar”. Dollar notes before 1933 were receipts redeemable for the real money in the form of gold (and previously also silver). Image source: Wikipedia.

1971: the mask comes off

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And what a surprise: the debt after 1971 rises fast. Chart source: Fred.

A fun fact about American gold: according to official figures, the US government holds 261 million ounces of gold (over 8,000 tons) and most of this gold should be stored at Fort Knox. The last transparent audit of Fort Knox took place in 1974, and since then the audits of American gold have been secret and, according to critics, highly dubious.

Bitcoin: the end of monetary history?

  1. we don’t need a central authority to mint and certify the monetary units
  2. there is no monetary policy in the true sense of the word

The first point is an advantage over gold and silver — the central authority required to mint and certify coins will always abuse its position. Point number two is the Achilles heel of the modern financial system. Central planning in the field of money does not work any better than central planning in any other industry.

Bitcoin brings hope that turbulent monetary history has come to an end. It will no longer be possible to awaken an inflationary monster that eats the savings and wages of those who have no way to defend themselves. With Bitcoin, it is again possible to save — not to invest or speculate, but to truly save: hold on to our money and preserve the purchasing power into the future.

However, for Bitcoin to become universally accepted money without succumbing to the risks of previous monetary standards, we need to adhere to two principles:

  1. oversee that the protocol “monetary policy” does not change. We must operate and use as many nodes as possible and create a hard core of monetary sovereignty adherents
  2. hold our bitcoin with complete, exclusive, uncompromising control

While the first rule is critically important in the long run, the second rule is acute here and now. The “risk of 6102” can materialize at any time, as the potential booty of large-scale confiscation is huge.

Bitcoin and risk 6102

  • BitGo: professional custodian services
  • BlockFi: provider of bitcoin “savings accounts” (not really, these bitcoins get rehypothecated and that’s how clients get an interest)
  • Kraken: large bitcoin exchange
  • Bakkt: bitcoin derivatives services and custody
  • Grayscale: one of the first bitcoin funds, holds over 400 thousand bitcoin

Recently even regular US banks won the permission to custody bitcoins for their clients. And all of these institutions have full client details, so even if the clients manage to withdraw bitcoin in time, Uncle Sam will come knocking on their door later.

Indeed in these lines, I do sound like a conspiracy theorist. But the fact is the fiat dollar is slowly nearing its end and it doesn’t really matter whether it lasts another five or twenty years. I believe there may be some intelligent and visionary individuals in the Fed and the government and they may be planning the next step. And the widespread confiscation of millions of bitcoin as a basis of a new financial system simply doesn’t sound so crazy in the context of monetary history. The United States would probably retain its leading position, while the rest of the world would be left with worthless paper and database records. It might start a war or two but, well, they have some experience with those in Washington. And after all, everything could be resolved peacefully: via an agreement to repay the outstanding bonds in bitcoin (with the exchange ratio set by the United States government :-)).

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Pictured: dear reader when she stumbles upon conspiracy theories in an article on monetary history.

But let’s leave the conspiracy theories behind. Whether it is a government, hacker, or an exit-scamming CEO, you should remember:

Not your keys, not your bitcoin.
And if “they” know where to knock, they will come knocking.

No more patches

IV. Bitcoin: Separation of Money and State

Origin and nature of the state

The cause of the genesis of all states is the contrast between peasants and herdsmen, between laborers and robbers, between bottom lands and prairies.
-Franz Oppenheimer
Dr. Franz Oppenheimer (1864–1943) was a medical doctor by education. At the age of 45, he changed his career when he obtained a Ph.D. and began pursuing an economic and sociological career. His most influential book is The State, in which he presents a theory of the emergence of the state as a coercive relationship arising from violent subjugation.

From this initial dynamics, Oppenheimer derives six stages of the creation of the state:

1) Looting: herders raid farmers’ settlements and rob them of food, fur, women, and other items of interest. Raids are accompanied by burning down villages and similar pastimes.

2) Truce: herdsmen eventually realize that farmers are a metaphorical goose laying golden eggs. Instead of one-off looting, it is more advantageous for herdsmen to take only the surplus production and keep farmers alive. However, for farmers to be there during the next harvest, it is necessary to protect them from the competition — other raiders. Herdsmen are thus beginning to protect farmers — not out of love, but to protect their interests.

3) Tribute: confiscating the surplus production is costly for herdsmen, as it requires full monitoring and control of individual farmers. They, therefore, impose a uniform tax or tribute on farmers, a flat-rate protection payment. Such an arrangement is also more advantageous for farmers, as it will allow them to keep more of their production. This motivates farmers to further increase productivity.

4) Occupation: over time, it becomes beneficial for herders to leave their nomadic lifestyle and settle permanently with “their” farmers.

5) Monopoly: the lords (into whom the settled herdsmen transform) appropriate the monopoly right to administer justice on “their” territory. The lords do not like to see mutual disputes and fights between individual villages (it reduces yields), so they resolve the conflicts themselves and establish relative peace in the territory.

6) State: lords invent the genealogic mythology (typically: the family line has the right to rule from God/gods), and establish a hereditary title to the territory and its subjects. Hierarchical structures for better tax collection are devised.

i: Cattle and the capital
Cattle are the primordial capital that was available to mankind. In contrast to a game (targeted by hunters) or crops (farmers), cattle were long-term preservable, self-regenerating, and scalable (one family could have a herd of thousands of heads). The Latin term capitale is derived from “head”, a piece of cattle. The English term cattle originally referred to any property and income and has a common etymological origin with capitale. Cattle were also one of the first forms of money.

We can summarize Oppenheimer’s theory of state origination as follows: in the distant past, stronger nomadic herdsmen subjugated weaker settled farmers. Given that the desire for effortless profit was universal among nomads, this arrangement was eventually mutually advantageous (farmers needed protection from other invaders), and thus the state was created. The origin of the state is violent subjugation, and this is the case on all the continents, wherever historians look.

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A herdsman informs the farmer what’s what. 10,000 BCE, colorized.

Oppenheimer also provides us with a useful distinction of wealth acquisition: according to Oppenheimer, there are economic means and political means. Economic means are cultivation, manufacture, trade — productive activities that require voluntary, mutually beneficial cooperation of people. Political means are robbery, subjugation, extortion, and tax. “The state is an organization of the political means,” points out Oppenheimer.

And it has been as such throughout human history: the political means of earning a living have transformed over time from simply collecting the protective payments to creating industrial and trade monopolies, collecting various forms of taxes and duties, and finally controlling the money and devising a “monetary perpetuum mobile” — central banks and fiat money.

But let’s not confuse the state with some abstract monster (or, on the contrary, a savior). The “state” is simply a designation for a privileged class that thrives on political means and seeks to maintain its position with the help of mythology (from the divine mandate to social contract theory to pseudo-economic theories on public goods) and coercion (per another sociologist Max Weber, the state can be well defined as a monopoly on violence). The state is simply an ingroup of individuals facing an idiosyncratic incentive structure.

i: State vs. Society
A reader may be surprised that we use the terms “state” and “society” as opposites. Indeed, public education and, to a large extent, the media, cultivate in us the long-term impression that the state and society are synonymous. This is not the case.

Society is all people living in a certain territory and/or sharing certain traditions. Society has a common culture and institutions. Society usually extends beyond the state both in time and space (for example, Czech society survived six different state arrangements during the 20th century — nazist and communist states included).

The state is an arrangement under which some members of society find themselves in a privileged position in which they can legally use political means of wealth acquisition (violence, taxation, legislation, and prohibition). With the development of the state into a democracy, the apt quote from the French economist Frédéric Bastiat begins to apply: “The state is a great fiction by which everyone tries to live at the expense of everyone else.”

Incentives and responsibility within the state

Oof, naughty words Tim!

Second, the problem of motivating politicians and bureaucrats. As Ludwig von Mises points out in the book Bureaucracy, politicians and officials are, unsurprisingly, people with subjective motivations. And the nature of the state structures and the services they provide is such that politicians and officials rarely bear the long-term costs of their decisions. However, they can capture short-term returns, whether it is the votes, well-paid seats, or backroom deals in the form of future positions in regulated industries (the infamous “revolving door”).

The fact that the motivations of government officials and employees are not always in line with the public interest is not very controversial anymore or even specific to the “marginal” Austrian school of economics. There is a whole specific branch of mainstream economics that examines incentives within the public sector: a public choice theory and its representatives are the recipients of several economic Nobel Prizes.

Why should we separate institutions from the state?

i: What is an institution, really?
It may seem strange to refer to money as an institution. In common language, we talk about institutions as specific organizations: companies, authorities, think tanks. In the social sciences (history, economics, sociology), however, the institution is a recurring pattern of behavior with a social purpose (wiki). Institutions arise from evolutionary pressures, they are an instance of spontaneous order (F. A. Hayek). The institution of money arose from the need to exchange and preserve produced value. The institution of the school arose from the need to organize the transfer of knowledge and skills. The very fact of the spontaneous establishment of institutions speaks volumes that they are a natural product of society and will exist even without state intervention.

Institutions such as a church, school, or media are potentially a very powerful tool of state propaganda, and it shouldn’t come as a surprise that totalitarian states do not allow any competition and private initiative in these institutions. In democratic countries, the abuse of these institutions for state propaganda may not be so obvious — however, the problem is the very possibility of abusing them sooner or later. State influence on institutions is like a loaded weapon waiting only for the right hand, the owner of which will not be reluctant to pull the trigger.

State control over the institution of money has very specific manifestations. It isn’t used for propaganda, but for the redistribution of wealth — power over the definition and creation of money makes it easy to shift wealth from the productive sector to the masters of money (state and financial sector); thus the control over money is a good example of Oppenheimer’s political means of wealth acquisition.

In short: state influence or direct control of various social institutions weakens the society and strengthens the state. Fortunately, throughout history, we can see a clear trend of gradual separation of institutions from the state.

A short history of institutional separation

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Is she behind me? I know she’s behind me. Sigh. They won’t leave me alone, not even when I ride my beloved Chubby. Image source: Wiki.

The widespread use of the divine mythology throughout history and geography suggests how strong a tool it was. Every human culture in history has had its faith in the supernatural and the divine element; the connection of political power with the supernatural was a logical solution to ensure long-term legitimacy — there is simply no discussion with God, and if God has chosen a pharaoh/king/emperor, who is the ordinary plebeian to ask for justification?

But as a result of the economic laws, this handy trick stopped working. With the gradual growth of economic specialization, the importance of cities grew, in which more and more people were needed. Economic migration emancipated swaths of the population from the clutches of mental and material slavery: the urban workers now had their independent income, community, and ideas. The advent of the Enlightenment, exacerbated by the technological revolution, then turned the age-old mythology on its head: ordinary citizens grew in importance, and the mandate to rule came from the people, not from heaven. Rulers had to reluctantly accept such ideas as they became economically dependent on cities: wealth creation shifted from rural peasants to urban artisans, entrepreneurs, and their employees.

“The industrial city is directly opposed to the state. As the state is the developed political means, so the industrial city is the developed economic means. The great contest filling universal history, nay its very meaning, henceforth takes place between city and state.
-Franz Oppenheimer

The gradual disappearance of the divine mandate has greatly undermined the legitimacy of the state as such. Over the last two centuries, new arguments for the state legitimacy have emerged: national identity, social justice, the provision of public goods. Soon these were are all refuted by an appalling reality: the new purposes of the state bring world wars, concentration camps, gulags, lousy public services, and systematic inequality before the law. Ever since the separation of the church, the state has been going through an identity crisis.

Although education may still seem to be the sovereign domain of the state, this perception has become increasingly distant from reality in recent years. It is true that compulsory schooling still applies in most countries and a large share of secondary and higher education institutions are part of the state school system. However, those who want to maintain their expertise and competitiveness after leaving school seek education with the help of Youtube, Udemy, Khan Academy, etc. This trend is so strong now that some companies are no longer requiring a formal degree — and in its place, they require more real skills.

For 300 fiat bucks and 6 months of your time, you can have a BSc equivalent. Much better deal than formal schooling!

The media are a good example of the technological separation of an institution from the state. With the development of the Internet, a very rapid disruption of existing media houses began. Even in countries where the media were not under direct state control, these could be heavily influenced by the state in the pre-Internet era. An overly critical view of the establishment could mean that journalists from such a media house were not invited to press conferences of government organizations — in the United States, for example, granting access to journalists at White House press conferences has long been problematic. The greater the state power and the greater the barrier to “market entry” in the media, the easier it can be to engage in propaganda.

The Internet and the emerging blogs, social networks, and independent servers such as Zerohedge, Wikileaks and The Intercept largely free the media from the power of the state.

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The decline of media houses is evident from the ad revenue statistics. Facebook and Google disrupted the paper media houses; who will disrupt these giants in return?

Of course, new information gatekeepers like Facebook and Twitter have emerged, and these seem to engage in political manipulation. However, the fundamental difference compared to old media houses is that social networks are far from being in a certain, monolithic position. Rather, the history of Internet services suggests that their market share is quite temporary — because these companies do not enjoy a state-sanctioned monopoly and the entry to the market is very open to new startups. Moreover, there is a very positive trend that the abuse of power itself is being seriously talked about — in earlier times, media critics were simply labeled as conspiracy theorists.

Leaks about the interconnection of technology giants with the state seem scary, but let’s realize one thing: these companies and their form of income through Internet advertising have only been around for 20 years — and they again will be disrupted by entrepreneurial action. One of the possible futures of non-state media is the news and social servers financed by streamed micropayments, which are made possible by the LNP/BP technology stack.

Production and trade
The past 200 years have been nothing short of wonderful and unprecedented in human history. For thousands of years, most people lived in absolute poverty. Then, by 1820, something changed and humanity embarked on a path that had seemed impossible until then: a path of significant population growth combined with a sharply declining poverty levels. By 1800, the global population was around 1 billion people and over 90% of the population faced poverty. Today, there are almost 8 billion people in the world, and below 10% of the population faces poverty. This means that today fewer people are living in poverty than 200 years ago — although the global population increased eight times!

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A fall into prosperity: over the last two hundred years, most of humanity has finally freed itself from extreme poverty.

What happened after 1820? Let’s quote from the book Progress by Johan Norberg: “By then, the Industrial Revolution was taking off in Europe, starting in England, a country where government control of the economy had been scaled back and the élites did not try to resist new technologies like they did in other places. (…) By 1900, extreme poverty in England had already been reduced by three-quarters, to around ten percent. Never before had the human race experienced anything like it.”

So what changed after 1820? Production and trade became a domain of the private sector, not of the state. Why did the separation of production and trade have such an impact? Because people have one amazing tool at their disposal, which has been called an “ultimate resource” by an economist Julian Simon: people have their minds. And the free mind can do miracles: create technologies that “are indistinguishable from magic” (A. C. Clarke). The market, with the help of a price mechanism, can coordinate millions of minds, thanks to which people can solve previously unsolvable problems in a short time. The result is enormous prosperity and, from a historical perspective, almost a paradise on Earth.

And the most beautiful thing is that everyone benefits from the resulting wealth, the poorest being the largest beneficiaries. Norberg again: “Since 1950, India’s GDP per capita has grown five-fold, Japan’s eleven-fold and China’s almost twenty-fold. (…) Almost nine in ten Chinese lived in extreme poverty in 1981. Only one in ten do today.”

Thanks to technology and globalization, poor countries can take advantage of the catching-up effect: they can break out of poverty in a much shorter time than it took Western countries.

India is a good showcase of what happens when the production and trade are separated from the state. In 1991, India was going through a severe crisis caused by decades of state planning. Norberg: “The crisis caused Finance Minister Manmohan Singh to stand up in Parliament and quote the nineteenth-century romantic Victor Hugo: ‘Nothing is more powerful than an idea whose time has come.’ The idea was to dismantle the protectionism and planned economy that had held India in poverty since independence in 1947. License requirements were removed, tariff barriers were reduced and the Indians got more freedom to start businesses and compete with the old monopolies. What used to be known as the ‘Hindu rate of growth’ — a growth rate slower than population growth — is history. Since the reforms, average incomes have increased by 7.5% a year, which means that they double in a decade.”

In some countries, we can from time to time observe a return to a historical standard of state control over production and trade — and the result is always a return to the historical standard of poverty, hunger, and filth. Socialism is a barbaric idea. It doesn’t deliver on its promises in any field or industry.

And socialism doesn’t work in the area of money either. It disrupts price signals, redistributes wealth, and demotivates producers. Central banking and fiat are similarly destructive bodies as the former Soviet Gosplan.

The effects of monetary socialism

  1. the entire system rests on the government monopoly on currency
  2. the system is based on the privilege which permits banks to create loans ex nihilo
  3. the management of the whole system is performed by the central bank, which acts as a true planning agency for the financial system
  4. losses are socialized as much as possible, with the help of bailouts, quantitative and qualitative easing programs, and an almost unlimited provision of liquidity by the central bank
  5. Interventions in the event of a crisis are arbitrary, short-sighted, and usually violate the long-term principles of caution in the name of short-term stabilization

In other words, monetary socialism has the same features as socialism in any other sector. Suppression of market forces and an attempt at central planning produce unsatisfactory results, which are then patched up by more and more interventions. However, while state-produced cars or food are of obviously poor quality, in the case of money, the destructive impact of socialism is less visible.

The main consequence of monetary socialism is the systematic transfer of resources from society to the state and the financial sector. The state thus obtains more resources than it should from simple taxation, and the financial sector becomes rich at the expense of other sectors. This systematic transfer of resources takes place in two main ways.

First, debt-based fiat money provides a permanent and unlimited demand for government bonds. When the money creation isn’t limited by any backing such as gold, the government can be sure that there will always be unlimited demand on the “market” for its debt. This became very clear after 2008 when quantitative easing became a common part of monetary policy.

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Size of individual QE rounds. Source: Unchained Capital.

Quantitative easing is an example of the gradual erosion of definitions and guarantees regarding the quality of money. As the rulers of ancient Rome, today’s central bankers aren’t able to keep the money undebased for a long time. Quantitative easing was supposed to be a $600 billion one-off program. As we can see in the chart above, this promise was immediately broken (the program grew to twice the size) and was followed by more rounds of direct purchases of securities by the central bank. The 2020 round of quantitative easing will probably exceed all previous rounds. The securities purchased by the central bank are mostly government bonds. This applies not only to the US Fed; all the major central banks have programs of government bond purchases. Such purchases are in effect providing the governments with unlimited funds — funds that are newly created and their purchasing power is based on an adequate decrease in the purchasing power of workers and savers.

Second, the policy of inflation targeting is a clever way to redistribute additional purchasing power generated by overall growth in productivity. Productivity growth means we can produce a larger number of products that are of higher quality. In a competitive environment (no regulatory barriers to entry), the inevitable consequence of productivity growth is a fall in the price level. Let’s look at consumer electronics: in the long run, we see devices with more features, of higher quality, and with lower price tags. And best of all: the steadily falling prices do not constitute a problem for the producers, as costs fall even faster than sales prices due to efficiency increases.

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Compared to 1980, the cost of storing 1 GB of data is more than a million times cheaper. Source: AIimpacts.

This effect of productivity growth is nothing specific to electronics; a similar gradual decline in prices due to higher productivity occurs in every sector where investments are made and where the government doesn’t cripple the competitive environment.

i: The double meaning of deflation
Deflation is an oft-quoted boogeyman of central bankers and some economists. Often two different things are mixed up when people talk about “deflation” and a misunderstanding ensues. The two different meanings of deflation are: first, a natural, long-term decline in prices due to rising productivity, and second, a fall in prices of financial instruments that have been previously inflated via the monetary policy’s Cantillon effect.

While the first case of deflation is beneficial to society and brings prosperity (as people wield higher purchasing power and their savings increase in value without the need for risky speculation), the second case of deflation may be harmful to the economy, because it can be accompanied by the financial crisis and cascading bankruptcies. However, harmful deflation is a direct consequence of the attempt to centrally plan the financial system via monetary policy.

The danger of the “fight against deflation” lies in the fact that also the beneficial first type of deflation is stopped and the artificially inflated prices of financial instruments are inflated even further. The permanent inflation of financial instruments can go on until one of the three possible scenarios happens: deflationary collapse (Great depression style), creeping nationalization of the economy (the past two decades in Japan), or hyperinflation (Austria 1920s, Russia 1990s, Venezuela 2016, etc.).

All the major central banks have an inflation target of 2 percent — meaning a standardized basket of goods and services should increase in price by an average of two percent per year. However, let’s say the prices are to fall naturally by 3 percent over the same period. Consumers are then deprived of a total of five percent of purchasing power. Instead of paying 97 dollars for a purchase, they now pay 102 dollars. Instead of saving 3 dollars, people have to pay 2 dollars more. This is a very important aspect of the harmfulness of an artificial inflation target: although nominal inflation around 0% may seem harmless, the real harm is the prevention of the natural fall in prices. Society loses far more than the nominal inflation rate, as it is deprived of natural growth in the purchasing power of wages and savings.

— — —

We have explained how monetary socialism redistributes purchasing power. Now let’s see what this redistribution allows for.

First, the power over money allows the state to obtain far more resources than it would have by simply taxing the populace and selling bonds on the open market (i.e., without the unlimited demand due to unlimited money creation). We can easily illustrate this with the example of the US federal budget:

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Source: Wiki.

Only two pieces of information are relevant to us in this infographic: total revenue and total outlays (expenditures). While revenue is $3.5 trillion, outlays are $4.4 trillion. The difference, or deficit, is 20% — the government has to borrow a fifth of the total spending each year (of the last 50 years, only in 5 years was the US federal budget in surplus). As a side note: let’s not be fooled by the fact that both in this infographic and in the media, state revenues and expenditures are compared to GDP — such a comparison is completely irrelevant. What is relevant are the income and expenses of a given entity — a household in an apartment building also does not relate its expenses to the “product” of the whole building, but rather to the income of the given household.

Monetary socialism thus makes it possible to cover a significant percentage of expenditures without the government having to resort to unpopular tax increases. The government simply issues new bonds, which the commercial and central banks happily buy — or rather accept to their balance sheets. Thus year after year the government debt increases and the purchasing power decreases because the incentives are set this way.

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A humor break.

An oft-neglected effect of monetary socialism is the fact that taxpayers are gradually moving to higher income brackets. As a result of inflation targeting, a person may find himself in a bracket with a higher tax rate, without experiencing any real increase in purchasing power.

But what does the state do with all the money? Sure, it administers and finances many things that can be seen as beneficial: healthcare, education, infrastructure, pensions. Let us now set aside the fact that the quality of state-administered services is often appalling and is gradually being replaced by private initiatives. However, a far worse consequence of rampant government spending is rather on the “services” that would otherwise not exist, as there would be no demand for them in a free society:

  • Wars for “Democracy” — The wars in Vietnam, Afghanistan, and Iraq are just the three best-known cases of many senseless war expeditions the United States has embarked on in the past 50 years, usually escalating the conflict up to complete destruction of the invaded country. Defensive warfare is one thing; a war expedition with vague (or outright fraudulent) justifications is another matter — and such expeditions are largely made possible by almost unlimited resources available to the US government thanks to the US dollar’s exceptional position as a world reserve currency.
  • War on Drugs — A program launched in the United States in 1971 is increasingly recognized as a complete failure to fulfill its original intentions. The United States has the world’s highest incarceration rate — and a large share of the prisoners is deprived of their freedom for drug offenses. Like alcohol prohibition, the prohibition of drugs produces the exact opposite of the intended: the result is an increase in crime and addiction.
  • War on Poverty — According to economist Thomas Sowell, War on Poverty is a major cause of the gradual creation of ghettos in American cities. The welfare state, like the war on drugs, is a program that emerged in the 1970s, following the advent of the pure fiat money system, which allowed for the public expenditures to explode. I recommend the interview with Thomas Sowell on Youtube (especially after the 21st minute), where he explains the devastating effects of the welfare state.

Monetary socialism undermines the responsibility of government officials to taxpayers, significantly inflates the state budget, and allows the financing of dubious programs that serve to satisfy the politician’s ego and win him short-term political points, while imposing long-term devastating effects on society.

And now: do you think something will fundamentally change in the near future? Only in the sense of furthering the current trend. The Modern Monetary Theory (MMT) is fast becoming popular and this theory says that a state equipped with a central bank can stop worrying about the size of the deficit and mounting debt, as it can cover all the expenses via inflation. This is principally a Zimbabwean monetary policy — the difference is that such a policy can actually work for a world reserve currency with no competition among existing currencies. But such is not the case anymore, since Bitcoin is a direct competitor to the US dollar.

An Achilles heel of MMT: the USD shitcoin has competition now.

Gold or Bitcoin?

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Balancing demand and supply for precious metals.

In the case of Bitcoin, however, the mechanism is as follows:

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Balancing demand and supply for Bitcoin.

In the case of precious metals, higher demand leads to an increased supply of new metal to the market. Supply here acts as a regulator of price growth, and gold and silver thus maintain a more or less stable purchasing power (which has been growing slightly in the long run due to a natural fall in prices brought about by productivity growth).

Bitcoin has the maximum number of units in circulation built into the protocol: 2.1 quadrillion satoshi, or 21 million whole bitcoin. Increased demand for money in Bitcoin does not bring any newly mined satoshi to the market; instead, the protocol reacts by adjusting the mining difficulty. The ultimate result is thus higher network security, which is required for securing an increased purchasing power of bitcoin (you can read more on Bitcoin’s security budget here).

i: Is there enough bitcoin?
2.1 quadrillion satoshi is a huge number of units — if 1 satoshi were equivalent to today’s 1 cent, then the total market capitalization of bitcoin would reach $21 trillion, which is twice the market capitalization of gold. If bitcoin were to serve as the global money, then 1 satoshi would be equal to about 5 cents — the “broad money” of the whole world is about $100 trillion (according to Visual Capitalist). In other words, there is plenty of bitcoin — or rather satoshi — to satisfy the role of global money, without encountering the problem of the smallest denomination being too valuable.

Thus, with the gradual separation of money from the state, we can expect the price of satoshi to continue to rise, as this is the only mechanism that balances the demand for money and market supply in Bitcoin (existing holders must be lured by sufficiently high price tag to let go of their sats).

But doesn’t that mean bitcoin is quite as bad a money as fiat, only with the opposite sign? No, because the significantly increasing purchasing power of satoshi is only a temporary phenomenon. It is an effect of something called Gresham’s law. This law, originally describing the behavior of gold and silver in the context of government bimetallism, can be described as follows in the context of bitcoin and fiat:

When one has an income in fiat money (the purchasing power of which can be expected to decline in the future) and the possibility to save in bitcoin (the purchasing power of which can be expected to increase in the future), it is rational to pull bitcoin from circulation as part of long-term savings and use fiat for spending.

Gresham’s law in this context simply states that bitcoin will keep on appreciating against fiat until the time when bitcoin income is a widespread phenomenon. It is likely that by that time fiat money will no longer exist (or will be a curious affair of backward countries) and comparing the purchasing power of sats to fiat will no longer make sense; only the purchasing power concerning various goods and services will matter. The effect of Gresham’s law will thus disappear and the dominant effect will be the long-term growth of purchasing power due to productivity growth (in the magnitude of couple percentage points per year).

The credit market and two phases of monetary separation

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Elon sees the future and says it won’t be gentle to gold bugs.

We must, however, acknowledge that the credit market in the world of bitcoin money is likely to be reduced in size when compared to the present. The smaller the role loans would play, the greater the financing of investment plans with the help of savings — which are worth building in the environment of bitcoin money, as such money isn’t devalued by the policy of inflation targeting. It is also likely that instead of lending to entrepreneurs, investors would demand a share for their satoshi — the precedent being the relatively widespread “Islamic banking”, where equity investing replaces interest-bearing loans.

A burning question in the context of the credit market is: will bitcoin banks emerge? Hal Finney predicted their creation as early as 2010 and recent developments could indeed be viewed as a confirmation of Finney’s vision — platforms such as BlockFi or Coinbase are de facto bitcoin banks, as transactions within their accounts take place outside of the Bitcoin blockchain and we cannot be sure that they do not undertake a policy of fractional reserves (i.e. that they do not sell or lend more bitcoins than they hold).

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Hal Finney predicts the emergence of bitcoin banks. Source: BitcoinTalk.

In Finney’s post, we can witness his worry about the transaction scalability, which was to be solved via bitcoin banks. Fortunately, he was wrong about this, as the researchers Joseph Poon and Thaddeus Dryja came up with the solution in the form of Lightning Network. First proposed in 2016, this solution has developed significantly over the years and is now usable in practice. Therefore, bitcoin banks are not needed to scale payments — and due to the intangible nature of bitcoin, they are also not needed to securely store larger amounts of bitcoin.

Therefore, in the context of fulfilling the role of non-state money, the advantages of bitcoin over gold are twofold:

  • Absolute scarcity and the associated strong Gresham’s law effect in the first phase of separation. The resulting appreciation of bitcoin against fiat currencies makes it very attractive; according to some, the long-term rise of the price tag is its natural marketing. This effect is sometimes (rather ironically) referred to as NGU — Number go up.
  • The intangible nature of bitcoin is a good protection against attempts at state control. Unlike gold, we can use bitcoin for electronic transfers around the world, without the slightest loss of sovereignty.

As we’ve stated before, one major disadvantage of bitcoin over gold is the Lindy effect — bitcoin hasn’t yet been sufficiently verified by history. Gold has been around for thousands of years; bitcoin only for one decade. However, the world is accelerating in many ways, and one more decade may be enough to confirm bitcoin as the best possible money available to mankind.

Bitcoinization: the future of monetary history

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Selected cases of recent bitcoinization. Bitcoinization has its own pace. The CEO of MicroStrategy, who anticipated a quick end to bitcoin in 2013, recently decided to allocate all of the company’s free funds to bitcoin.

For companies that decide to switch to bitcoin with their treasury, the next logical step will be to use bitcoin within their supply chain and for payroll. However, this step may take a long time, as in the first phase of bitcoinization the Gresham’s law is still in effect, which discourages the use of bitcoin for payments (the expected high future value represents a high opportunity cost).

DCA: a savings renaissance

The logical first step of personal bitcoinization is savings. Savings today is a half-forgotten function of sound money: savings should simply mean putting your money “under the mattress”, i.e. preserving the purchasing power without the counterparty risk or a risk of a failed investment. Bank deposits, stocks, bonds, funds, and similar instruments aren’t savings in a true sense, as they always carry an element of risk and speculation. Bank deposits today do not even cover the official inflation target and cash receives a full inflationary penalty, so savings have lost their meaning — instead of conservative planning for the future, they evoke the sad image of an old grandma who, after decades of meager life, discovers that her money is barely worth a tenth of what she saved over her lifetime. Bitcoin brings savings back, especially via the DCA approach.

i: DCA: regular bitcoin savings
Dollar-cost averaging or DCA is a simple and very effective strategy to bitcoinize your long-term savings. The essence of DCA lies in the fact that you save in bitcoin regularly, in small amounts, and regardless of the current price — for example, you buy every month sats for $100. The advantage of DCA is that you don’t have to worry about price volatility at all and you get rid of a short-term speculative mindset. This is an ideal strategy for reducing personal time preference — with DCA you plan for the years ahead. Since no one knows what the legal status of bitcoin hodlers will be in the future, I recommend avoiding exchanges with KYC practices as much as possible and stack sats via P2P exchanges. Check out the various options at noKYConly.

As part of the savings bitcoinization, you need to get rid of the mental block in the form of the “missed train syndrome”. It is pointless to be depressed that you did not buy bitcoin years ago. As crazy as it may sound today, in retrospect, we may yet see that bitcoin was not at all about how many dollars a speculator made on it in the first phase — as the dollars turned out worthless in the end. A patient “stacker” with low time preference may eventually protect and gain much more purchasing power than any boastful “whale” with hundreds of cheap bitcoins (which he will sell at a high fiat price tag). Finally, if bitcoin becomes truly global money, then it will not be “late” in the true sense of the word for anyone who switches to bitcoin. The effect of increasing purchasing power will be lower after the exhaustion of Gresham’s law for sure, but it will still be there due to the effect of productivity growth.

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Hal Finney recommended Bitcoin DCA already in 2011. Source: BitcoinTalk.

An unforeseen separation

Just watch out for the splatter.

In the future, the separation of money and state will be seen as an act of civilized progress comparable to the previous separations of the church, media, education, and business. Bitcoinization is, in the words of Nic Carter, the most peaceful revolution. It does not require crowds in the streets, political campaigning, or armed conflict. For most people, it does not even require a deep understanding of economics, history, or technology — the pressing need for bitcoinization will be understood by most simply through the increasingly visible effect of Gresham’s law. A future society operating on bitcoin will not be a utopia, but it will take another important step from a primitive statist arrangement to a prosperous civilization.

V. Why only Bitcoin?

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The end. Thank you for reading.

Longer answer: keep on reading.

What is the point of blockchain?

  • Liberty Reserve: the project operated between 2006 and 2013 and facilitated a digital transfer of units which we would now call stablecoins (dollar, euro, gold equivalents). Liberty Reserve had about 1 million users at its peak. The system was allegedly widely used to launder money from stolen cards and similar activities. In 2013, the founder was arrested and later sentenced to 20 years in prison. All funds were confiscated. Some users (who used Liberty Reserve as a PayPal alternative — for legal activities) still cannot get their money back from the authorities.
  • e-gold: this project operated from 1996 to 2008, enabling the transfer of digital grams of gold. The underlying gold was held by the company operating the e-gold system. At the top, the company held 4 tons of gold, e-gold’s users conducted $2 billion a year in transactions. In 2008, the project was closed by the US authorities, all the gold was confiscated. The gold was returned to the users only in 2013. The founders were sentenced to light sentences.
  • e-bullion: a project similar to e-gold, also enabling transactions with digital gold. It operated between 2001 and 2008. It had a million users at its peak and held about 1.5 tons of gold. The e-bullion was run by the Fayeds, who quarreled, and the husband had his wife murdered. All the gold was confiscated by the authorities.
  • Liberty dollar: operated from 1998 to 2007, issued mostly gold and silver coins with a dollar denomination (according to the original historical definition of the dollar). Liberty dollars were once very popular in the American libertarian community. A raid was carried out in Liberty Dollar’s offices in 2007 and the founder was charged with counterfeiting the US dollar (yes, “counterfeiting” in the form of much more valuable coins). Although the founder was threatened with decades of imprisonment, he was eventually let go (coins were returned only in 2017).

Satoshi permanently solved the problem of non-state money using a proof-of-work mechanism combined with dynamic difficulty adjustment. Bitcoin was conceived from the beginning as a system without a central point of failure — where servers cannot be shut down, founders cannot be arrested and the monetary units cannot be confiscated.

Thanks to Satoshi’s invention, we now have non-state money at our disposal, with a good long-term outlook. We can expect Bitcoin to work in the years to come due to its design: the decentralized nature of Bitcoin is ensured by the financial incentivization of the miners. We cannot expect miners to expend energy on the proof-of-work out of love for Bitcoin; we must expect that they are only interested in financial gain, that is, that miners are economically rational.

Two demands for non-state money

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Source: Bitcoin wiki.

Altcoins have to adapt to Bitcoin and its uncompromising monetary policy. Unless altcoins have at least comparatively low long-term inflation, people will simply not rationally choose them for long-term holding. Why keep an altcoin with high inflation when I can keep bitcoin? As rhetorical as this question may sound, some altcoins had to answer it in practice. A prime example is Grin — a currency with a high inflation rate. The market duly appreciated its value:

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Shitcoiners call this pattern the “accumulation phase.” I call it the “death phase”. Source:

Rewarding miners through high inflation is simply not a good idea. Transaction fees are required. Let’s see how the biggest cryptocurrencies fare in this area: how much do miners get from transaction fees per day?

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Daily transaction fees on individual networks, in USD. Source:

The only two networks with relevant transaction fees are Bitcoin (~$1 million) and Ethereum (~6 million). All other networks, many of them in the cryptocurrency Top 10, do not generate even $1,000 in transaction fees per day. So how do these networks still survive at all? Because they either gave up on the decentralization aspect in the first place or are living on a temporarily high block reward — which has to decline in the long run (or the network goes down the Grin’s path of death).

Now let’s see how much do the miners get from block reward:

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Daily block reward (newly issued units) on individual networks, in USD. Source:

For the highest explanatory power, we can express the data from the two graphs in proportion, i.e. what is the multiple of the block reward as compared to transaction fees. The higher the figure, the more the network is dependent on the block reward:

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Block reward to transaction fees ratio for individual networks.

The comparison shows that the only networks with any hope of a long-term sustainable miner incentive are Bitcoin and Ethereum. No other network is able to generate transaction fees that could replace block rewards in the long run. In the next decade, most of these networks will disappear or move towards stronger centralization.

And keep in mind this analysis covers most of the cryptocurrency Top 20 in terms of market capitalization. We didn’t cover some assets from the Top 20 such as USDT, LINK, or CRO, because these are just tokens that stand and fall with their parent platform (usually Ethereum).

The problem of Ethereum? It’s shutting down.

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*Sweating Ethereum fan*

Recap: why bitcoin > shitcoin

Please note: “shitcoin” is a technical term.

In non-state money, we need the features of decentralization, long-term miner incentivization, and for this money to actually have an advantage over fiat, we also need a predictable monetary policy. Bitcoin has set the bar in all three areas and for shitcoins (technical term) it seems to be an insurmountable problem to succeed in all three areas at the same time. The “at the same time” is important here. It is nice when a representative of a certain shitcoin talks about low future inflation, and at the same time has the power to change it arbitrarily — for example, under the official policy of “minimum necessary issuance”. We do not need a new central bank; we need full separation of money and the state and an end to monetary socialism.

The classic objection to these arguments is that not all altcoins strive to become non-state money. Well, there are two answers to this: first, another use case — which would last at least a few years — has not yet come to fruition. Where are all those decentralized computers, prediction markets, DAOs, social networks, and revolutions in dentistry? It seems that the only surviving use case is a just a slightly more sophisticated casino, where noobs are constantly being lured by the buzzword marketing. Second, even if such a use case existed — what network would it run on? Is there a network other than Bitcoin that is decentralized, has a working mechanism for long-term miner incentivization, and at the same time has no plans to shut down and switch to new, experimental technology?

Another possible objection is that we cannot predict the future. What if something better than Bitcoin comes in the future? That is indeed possible. However, the later such Bitcoin killer arrives, the harder it will be for it to succeed — because Bitcoin has the advantage of an ever-growing Lindy effect and the penetration into economic activities via the ongoing bitcoinization. Besides, the fact that Bitcoin is generally easy to understand, speaks against all sorts of “innovative cryptocurrencies” — shitcoins tend to differentiate themselves through complexity, by which they try to look sophisticated. All these facts make Bitcoin a natural Shelling point for non-state money.

Schelling point: what we agree on without the need to communicate.

Bitcoin has long been the leader in cryptocurrency “market share” (by market capitalization) and liquidity (market depth). As sexy as a new coin may seem, its main problem will be building a sufficient network effect. Of the more than 7,000 cryptocurrencies, Bitcoin’s “market share” is around 60% (second Ethereum 12%, third Ripple 3%); in terms of liquidity, the situation is even more in favor of Bitcoin:

Top 20 cryptocurrencies (excluding stablecoins) ranked by their liquidity (market depth). The vast majority of shitcoins is completely illiquid — a medium-sized purchase/sale significantly affects the price.

By no means do I want to convey that Bitcoin has no problems of its own. On the contrary! Even Bitcoin, which represents the best hope for non-state money, has several potentially critical obstacles on its way to total world domination. Among the most burning problems are:

  • miner incentive sustainability: so far, we had 3 halvings and the share of transaction fees on the miner rewards is growing. But is the trend sustainable over the long term? Will the transaction fees be sufficiently high? They very well may be — further layers above Bitcoin (such as the LNP/BP protocol stack) increase the so-called transaction density, where one on-chain transaction can potentially settle many economic activities at higher layers (more about the concept of transaction density in Dan Held’s article). However, we will truly know whether the transaction fees are sufficient only after another 2–3 halvings (i.e. 8–12 years).
  • hostile attempts to change the protocol/monetary policy: corporate attempts to change the protocol happened in the past and can happen again. The takeover attempt of 2017 — known as SegWit2x and the New York Agreement — was problematic for two reasons: first, a significantly higher block size limit is a severe threat to decentralization: with larger blocks, the set of potential node operators gets smaller (because the requirements for operating the node — hardware and bandwidth — increase). Secondly, the 2017 event was an attempt by well-capitalized companies to subject Bitcoin to their business needs, which — if successful — would be a very dangerous precedent. The retaliation by the node operators via the UASF/No2X movement prevented the takeover attempt. But will the community be similarly vigilant in the future?
  • compliance layer: according to the growing number of bitcoiners, one of the largest problems today is the gradual adoption of KYC practices — the ubiquitous attempts at identification of bitcoin holders. Due to the transparent nature of the bitcoin blockchain, KYC is very dangerous — the “taint” of a linked real-world ID is difficult to get rid of. The very essence of Bitcoin is financial sovereignty — and the identification of holders and their subsequent monitoring goes directly against this essence. Identified holders face the risk of extortion, taxation, and future confiscation (akin to 1933’s Executive order 6102).

Now back to the questions from the beginning of the chapter.

Don’t we have a diverse, prosperous, dynamic, exciting cryptocurrency industry here? Well, as was once said on the floor of the US Congress: “we have bitcoin, and we have shitcoins.” Shitcoins can be exciting in the short term as they go through hype cycles and offer a lure of getting rich quick while offering feel-good rhetoric of revolutionary technology. However, it is a zero-sum game, where the profit of one is balanced by the corresponding loss of another (often the ones who profit are VCs and the development team, while retail — that is you — are on the losing side).

Should I diversify? Into other asset classes for sure. Shitcoins are not diversification, but rather gambling with valuable satoshi.

Shouldn’t I engage in yield farming? Only if you can explain to yourself where that yield comes from and what the risk is. But essentially it’s the same stuff as ICOs, cloud mining, and master nodes from years ago. If you stay away, you will experience JOMO (joy of missing out).

Bonus: But I’m in the green on shitcoins! Congratulations, especially if you are in the green not only in fiat but also in sats. But if you don’t get dump your shitcoins for bitcoin, in five years you will likely have much fewer sats than today.

Ultimately, it’s about what you expect from Bitcoin. If you’re looking for long-term savings with a good probability of protecting and increasing your purchasing power, Bitcoin is here for you. If you hope to get rich quick, Bitcoin will probably disappoint you. Bitcoin represents the best possible hope for non-state money. I’m not saying that you can’t make money on shitcoins — I’m just saying they don’t make any sense in the long run.

A few final recommendations

Ten Bitcoin Commandments

  1. Thou shalt secure your sats in the hardware wallet
  2. Thou shalt keep only small change in mobile wallet
  3. Thou shalt withdraw from the exchange immediately after buying
  4. Thou shalt prefer dollar cost averaging over timing the market
  5. Thou shalt not stack so much you would face the temptation to sell in big market dips (thou shalt buy the dip instead)
  6. Thou shalt not be tempted by altcoins, for these are the play of the Devil, intended on taking your sats
  7. Thou shalt double-check the recipient address when sending sats, for malware demons lurk around
  8. Thou shalt not boast about the height of your stack stash
  9. Thou shalt prefer hodling over day trading

Written by

@SatsJoseph on Twitter

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