About this text
Individual chapters were originally published in Czech on the Alza.cz (central European e-retailer) website. You can download the text as an e-book in following formats:
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?
Bitcoin. It has been around for more than 11 years now. Most people have heard of it, some own it, few get it. Many people believed the naive interpretation that Bitcoin is only something like a better PayPal — a global uncensored payment system. This confusion is partly due to the widespread term “cryptocurrency” — currency is meant to be paid with! Most of Bitcoin’s criticism revolves around this misunderstanding: Bitcoin is criticized for low transaction capacity, for price volatility, for low merchant adoption. Some of the original proponents of Bitcoin even went to establish their own cryptocurrencies in the spirit of this delusion, with higher transactional capacity (to the surprise of their creators, however, these cryptocurrencies are used even less for payments than Bitcoin).
Bitcoin is not a cryptocurrency. Bitcoin is money. If we start to understand Bitcoin through this lens, everything fits together. The long-term rise in its price (or rather: purchasing power), the tendency to hold it rather than spend it, its “boring” monetary policy.
What’s more: Bitcoin is non-state money. It is a brazen attempt to set a new monetary standard without anyone asking the state for permission. The state and money are seemingly inseparable. However, the church, production and trade, education, or the media were similarly inseparable from the state. And while it may not seem like it in recent years, in the long run, the state loses its power over institutions.
January 3rd, 2009 will be referred to in the future as the turning point in the monetary history of mankind. The state, that “great fiction by which everyone seeks to live at the expense of everyone else,” loses its most valuable instrument of power. And society is getting it back.
The text is divided into five parts. The first part is an introduction to the Austrian school of economics, which is rightly popular among Bitcoin supporters — as one of the few schools of economics, it does not maintain any sacred statist cows; most economic treatises on non-state money come from supporters of the Austrian School of Economics. The second part explains the term time preference and its relationship to the nature of money. In the third part, I acquaint the reader with the monetary history of mankind and the age-old tendency of rulers to devalue and redefine money for their own interest, culminating in the establishment of a global standard of pure fiat money. The fourth part deals with the nature of the state, the separation of various institutions from the state, and the impact of monetary separation. Finally, in the fifth part, I address the question of why only Bitcoin has any hope of success unlike the thousands of other “cryptocurrencies.”
In the last section, I include basic recommendations for dealing with bitcoin and links with references for further study.
This is the darkest hour before dawn and we should never underestimate monetary authorities’ ability to deal with the adversity.
-Gideon Gono, former governor of the Reserve Bank of Zimbabwe
There are terms in this text that may be unfamiliar to a newcomer to Bitcoin. For better orientation, we will explain them here.
Hodl — a slang term for long-term bitcoin possession. The origin is a typo in the title of the legendary comment on the BitcoinTalk forum. “Hodler” is a person who has been holding bitcoin for a long time.
satoshi (shortly sats) — the smallest unit of bitcoin. 1 bitcoin is 100,000,000 satoshi, 1 satoshi is 0.00000001 bitcoin.
Bitcoin/bitcoin — Bitcoin with a capital B is a designation for technology/protocol; bitcoin with a small b is a designation for a monetary unit. Example: “I recently discovered Bitcoin and now my goal is to accumulate at least one bitcoin.”
DCA — Dollar cost averaging, or the strategy of regular bitcoin purchases regardless of the current price.
Stacking sats — A slang synonym for DCA; stacking sats means adding more and more small units of bitcoin to your wallet. Unlike DCA, stacking does not have to be regular (you can stack sats well in the case of price drops — then you’re buying the dip), nor does it have to constitute of purchases (you can stack sats by being paid in bitcoin).
Fiat —money the value of which arises from a decree. From Latin fiat = let there be. Most often used as a term for paper money (not backed by precious metals).
Citadel — originally a joke from 2013 from the Reddit forum. In the post, the “traveler from the future” predicted that in 2025, hodlers would live in guarded gated communities while the rest of the world economy was in ruins. The term was initially taken only as a meme (joke), in recent years the term begins to take on the meaning of dissent — gradual separation from fiat and coercive society and organization of one’s own life around the principles of voluntarism and long-term outlook (also called low time preference).
I. Austrian School of Economics, and its Relation to Bitcoin
The Austrian school is an often-cited term among Bitcoin fans. The foremost Bitcoin advocates such as Saifedean Ammous or Stephan Livera are proud “Austrians” themselves. What are the main ideas of the Austrian school and what does it have to do with Bitcoin?
Why an “Austrian” school?
Paradoxically, the Austrian school of economics has nothing to do with today’s Austria. The beginnings of this school of economics date back to the second half of the nineteenth century, when Carl Menger published his Principles of Economics. Menger’s book and the ideas contained in it were revolutionary, literally — it stood at the beginning of the marginal revolution. However, this revolution wasn’t a revolution of Molotov cocktails and uprisings; marginal revolution was a fundamental change in the economic analysis of human action. Earlier economists explained the value of goods and services with their production costs. Within this cost theory of value, economists considered goods in the context of aggregate classes, not individual goods. However, this approach produced obvious paradoxes: how come diamonds are more valuable than water, even though water is much more useful? How is it that a rough gold nugget (with zero production costs) can buy a happy finder a whole laboriously built house?
Enter Carl Menger who explains that people evaluate goods not by the costs incurred, but by how well they meet their subjective needs. Moreover, we shouldn’t analyze goods as an aggregate class, but the marginal increments of goods. In other words, one does not compare water and diamonds as a class, but rather compares, for example, an additional liter of water with an additional carat of diamond. Water as a class is very useful — but it is not very rare and the need to quell thirst is usually easy to satisfy. Diamonds as a class are not as useful compared to water — however, as marginal units, they are very rare and in high demand to meet the needs of aesthetics, investments, and industrial uses.
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
For this text, the Austrian school of economics can be characterized as a set of findings about the nature of human action and the nature of the world in which action takes place.
First of all, human action is the purposeful behavior of an individual aiming to satisfy subjective preferences. In contrast to animal action, human action is characterized by its purposefulness — man acts with a conscious goal, while animals act based on instincts and the direct satisfaction of physical (or emotional) needs. However, let us not confuse actions with “rationality” — the subjective needs of a certain individual and actions to satisfy them can be “irrational” for others; however, this does not mean that the individual does not act.
The acting individual must constantly face factors of scarcity. In this world the resources, space, and time are scarce. Economic activity is, in essence, a permanent effort to satisfy the most urgent needs using as few resources, space, and time as possible.
The market is a system for mutual coordination of all economic agents (consumers, producers, investors, traders). One of the side effects of the market is that factors of scarcity are allocated efficiently (satisfying the most urgent needs with the least possible waste), due to the existence of profits and losses.
Government intervention in the market usually throws this coordination mechanism off, produces inefficiencies, and wastes factors of scarcity. The government’s management of the economy — or socialism — has a consistent problem in the form of an impossibility of economic calculation. The socialist calculation problem lies in the fact that without freely created prices and signals in the form of profit and loss it is not possible to effectively allocate the factors of scarcity, the result of which is the “groping in the dark” (Mises) and the gradual descent of society into poverty, while consuming previously accumulated capital.
The factor of time gives rise to time preference. If a person prefers the satisfaction of needs as soon as possible, we are talking about high time preference. If, on the other hand, one is willing to postpone the satisfaction of needs to the future, we are talking about low time preference. Time preference is one of the reasons why the natural interest rate is positive — the creditor has to postpone the satisfaction of his needs, and for this, he demands compensation from the debtor in the form of interest. Today’s world of zero and negative interest rates is quite absurd in this context, and unsustainable in the long term.
Bitcoiners like to talk about low time preference, often in connection with minimizing current consumption, saving in bitcoin, and waiting for the future rise in their purchasing power.
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
One of the groundbreaking texts of the Austrian economist Friedrich Hayek is The Use of Knowledge in Society. The article deals with the problem of information transfer in a complex, dynamic, decentralized system — in other words, human society. The efforts to aggregate information into a central point, which would then develop plans based on such aggregate information, necessarily fail.
According to Hayek, every economy faces the question “how to secure the best use of resources known to any of the members of society, for ends whose relative importance only these individuals know. Or, to put it briefly, it is a problem of the utilization of knowledge which is not given to anyone in its totality.”
The price system is the coordination mechanism that solves this problem. Due to the interaction of relative prices, producers, investors, traders, and consumers can coordinate their actions to satisfy needs most efficiently. If a certain resource needs to be conserved due to its relative scarcity or a more valuable use elsewhere, all that is needed to transmit this information is to raise its price. If the needs to be satisfied have changed, the price system will transmit this information across traders, investors, manufacturers, and other relevant agents. Entrepreneurs listen to the price mechanism to make a profit; consumers listen to meet as many of their needs as possible. No central coordination or coercion is necessary. Through intervention, this coordination mechanism is only disrupted and rendered ineffective.
Wikipedia founder Jimmy Wales cites The Use of Knowledge in Society as the main inspiration behind the idea of an emergent encyclopedia.
Austrian Business Cycle Theory
One of the best-known contributions of Austrian economists (especially Hayek and Mises) is the so-called Austrian Business Cycle Theory. It is a theory that combines the above-mentioned findings (time, scarcity, subjective preferences, price mechanism). Given the complexity of this theory, let’s break it down to individual propositions:
- 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.
- Central banks generally conduct monetary policy by regulating interest rates.
- 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).
- 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.
- 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.
- 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.
Unsurprisingly, Austrian economists aren’t exactly fans of the state money monopoly. Both Mises and Hayek experienced Weimar hyperinflation and correctly identified its origins in the central bank’s boundless printing of money. In 1976, Hayek published The Denationalization of Money, where he advocated for the establishment of competitively issued private money.
Noteworthy is also Murray Rothbard’s publication What Has Government Done to Our Money? (1963), where Rothbard analyzes the history of the US monetary system since the creation of the Federal reserve system (1913) up to the establishment of the “paper dollar” without any gold backing (1971). Rothbard, like most Austrian economists, considered gold to be the only real money in the history of mankind. Nevertheless, the arguments of Hayek and Rothbard are very well applicable to Bitcoin as well.
Economics, the Indispensable Framework
Unlike mainstream economics (which could be characterized as a mix of Keynesianism, the neoclassical school, and the Chicago monetarist school), the Austrian school does not rely on mathematical formalization or a large number of assumptions (often unrealistic) and it doesn’t flatten all economic phenomena into aggregate macroeconomic indicators.
Owing to its idiosyncratic methodology, the Austrian school of economics is an analytical framework that brings a lot of valuable insights. By analyzing individual actions and incentives, the Austrian school can explain why central planning always leads to failure — whether the planner is trying to manage the labor market, urban development, or the money itself.
An uncompromising approach to the analysis of human behavior can lead an economist to findings that are controversial or even heretical. If the government intervention always leads to harmful results, what do we need the state for? However, the answer to this question is no longer provided by economists, but by political philosophers — and it’s no surprise that Mises, Hayek, Rothbard, and other “Austrians” devoted themselves not only to economics but also to the philosophy of classical liberalism and libertarianism. Their works such as Liberalism (Mises), The Road to Serfdom (Hayek), and For a New Liberty (Rothbard) thus combine both economic insights and advocacy for individual freedom and human rights.
The Austrian School of Economics is thus, in addition to being a solid analytical framework, an important argumentative apparatus for all the enemies of state encroachment. It shows that good intentions such as the welfare programs are just a cover, under which usually lie the interests of the state and its employees.
For the past 150 years, economists of the Austrian school of economics have been proving that a free market economy is the only conceivable arrangement compatible with prosperity and civilization. Intervention to market forces always and everywhere fails and leads to poverty, hunger, and war. For a truly free market to function properly, an emergent, non-state money is needed. Bitcoin is a serious contender in this regard, and a new generation of Austrian economists, including the author of these lines, is beginning to see Bitcoin as the key to unlocking the full potential of humanity.
II. Bitcoin and Time Preference
Why do some people have a short decision horizon? How does inflationary and deflationary money affect societal time preference? Time preference is one of the most interesting aspects of human action. And it’s also very useful on our voyage to understand the true value of Bitcoin.
What is Time Preference?
Man lives in a world of scarcity, and every action has to deal with the fact of scarcity. This axiom of scarcity applies even to those with unlimited money and material wealth — even the rich face the scarcity of space (man cannot be in more than one place at a time) and time (all of us have only 24 hours a day and we all die in the end). In this chapter, we will discuss the factor of time and its effect on human behavior.
“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.
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
You crawl across the desert, slowly dying of thirst. Suddenly a lemonade stand appears, but the price is steep: one glass for 10 million satoshi. Will you buy it? Of course, you will, because at that very moment you have a high preference to satisfy your thirst in the shortest time possible.
High time preference is characterized by precisely such a preference for satisfying the current needs over the costs of satisfying that need. Apart from acute physical needs, the usual cause of high time preference is mental weakness towards temptations: alcoholism, drug use, or infidelity are typical examples of high time preference behavior. Such activities can bring intense short-term pleasure for steep long-term costs (such as ruined health or broken family).
While mental weakness can ruin individuals, at the societal level it is not the leading cause of high time preference. At the societal level, it is uncertainty about the future, especially in terms of property rights, currency strength, and the legal environment. As Hoppe remarks in Democracy: the God that failed, it’s not a private crime (thieves, mafia) that we should be most afraid of — much more devastating is a systematic violation of property rights by the state. According to Hoppe, taxation, inflation, and ever-changing legislation are the leading causes of the rise in time preference in society as a whole.
Since this text has no ambition to focus on political philosophy, let’s address only the problem of inflation. Most of the world’s central banks today operate with inflation targets — yearly targets for what the consumer price inflation should be (i.e. a year-on-year increase in the price of a typical consumer basket). The prevailing inflation target today is 2% per year. What will such inflation do to the purchasing power of money?
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
Hoppe likens low time preference to a civilizing process: lower time preference and the associated savings lead to investments in production processes, long-term planning, cooperation, and peace. Conflict increases the level of uncertainty in the future — and people with lower time preferences try to reduce this uncertainty, as they place great emphasis on their prosperity in the future.
Low time preference manifests itself as a propensity to delay the satisfaction of our needs if we get either more goods or goods of higher quality in the future as a reward. As production capacity grows and investments increase, so do real wages and real wealth — people have better health care, better food, better environment (while high time preference communist countries have notorious pollution problems).
Now for an attentive reader, it won’t be a surprise which factors lower the time preference:
- 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
Economists of the Austrian school have been advocating for the return to sound money for decades. Rothbard’s What has Government done to our Money? or later de Soto’s Money, Bank Credit, and Economic Cycles call for a return to gold as a historically established money that greatly limit the power of the state.
The primary advantage of non-state money is an avoidance of the devastating cycle of credit expansions and subsequent recessions that are a direct result of official monetary policy. These cycles cause a massive waste of capital and incentivize the society to shorten their decision-making horizons — business cycles increase time preference. On the contrary, monetary policy outside the reach of the state is in line with lower time preference.
In other words, we need money with a predictable monetary policy. For thousands of years, gold was such money. But even gold underwent several supply shocks throughout history (usually through the discovery of large deposits that have eroded purchasing power). Bitcoin, on the other hand, has its monetary policy predetermined and practically unchangeable.
In addition to better monetary policy, Bitcoin has other considerable advantages over gold:
- 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.
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.
Bitcoin as salvation from degeneration
Time preference may seem like a nice theory that doesn’t translate into any impact in real life. But such an impression would be far from the truth. In real life, it sometimes helps to step away from everyday matters and undergo a self-reflection: why do I act the way I do? And is it in my best interest — today and in the coming years?
People and communities with a longer decision horizon often achieve much higher prosperity than those with a short-term outlook. Education, health care, financial literacy: all this requires today’s moderation in the interests of tomorrow’s prosperity. And we are very lucky to be able to participate in the development of an ecosystem that defies the general trend of living on debt and disregard for the future. Bitcoin is tomorrow’s money in which we can save today.
Time preference is one of the most important economic concepts, while also being very practical in daily life. The way you approach your health, finances, family, and friends is often a direct result of your time preference. The level of time preference and level of civilization are two sides of the same coin. Inflationary state money must be considered a tool of civilizational degeneration. Bitcoin, on the other hand, has the potential to usher in a new golden age, with a high degree of future-oriented society.
III. Bitcoin and Monetary History
The history of money gives us a clear lesson: do not entrust the power over money to a central authority. Such power is too tempting. Bitcoin is an exit from the history of monetary redefinitions and debasements — but we have to stay vigilant, as the risk of 6102 lurks around.
Why explore the history of money?
Monetary history sounds like something that bored you at school. Just by reading the term, your eyelids are already closing slightly and you wonder whether to make yourself another coffee or close the book right away, giving it another try tomorrow (you won’t). But try to persevere and I promise you will be well rewarded. History of money is an incredible story comparable to John Wick’s rampage. The history of money is full of hope and betrayal, of fabulous enrichment and crushing poverty, of truth and lies. When you understand the underlying logic of monetary history, you also understand the logic of current events. Money is a critical aspect of all human action. Fundamental understanding of money provides you with a huge advantage when one monetary era ends and another begins.
From communism to cooperation
Throughout history, man has used various stuff as money — shells, worked stone wheels (Rai stones), cattle, salt, tobacco. However, precious metals — especially gold and silver — have always had a special place in the history of money. The reason for that is these metals best fulfilled the essence of money.
But what is money?
Money is an institution that emerges out of cooperation. As soon as the division of labor takes hold, a need arises to divide the fruits of labor among members of the community. One way to do it is communism: “to each according to his needs“. This only works in a narrow setting — typically within the family, relatives, and long-term trustworthy friends. Even within such in-groups, however, communism is limited by the Dunbar’s number — the human brain is unable to keep track of more than 150 strong relationships. Larger communities need the concept of money because of its neutrality — the distribution of fruits of labor in the monetary economy does not depend on subjective emotions and affection, but rather on one’s productivity and the usefulness and scarcity of the produced goods.
Money performs the following critical functions.
Money is a store of value: let’s say Bob is a capable blacksmith and makes the best horseshoes and swords in the county. He has a pantry full of food, plenty of quality clothing, and overall he’s doing just fine. To keep his standard of living, he only needs to work an hour a day — this way he produces enough to buy himself food and occasional change of clothes. He doesn’t need any more food and clothes as those would only be eaten by mice. However, the surrounding community needs Bob’s horseshoes and swords (the community has to arm itself against the invasions of the barbarian tribe of Fiatmen). So the community has two options on how to get Bob producing all day long: enslave or motivate. The problems of enslavement (i.e. forced communism) are discussed in detail in Mises’s Socialism — we can simply state that motivation is a better long-term strategy. So Bob receives something magical in exchange for his products. He receives money, which allows him to obtain food, clothing, and anything else he wishes for at any time in the future. Money is a tremendous store of value because, unlike food or clothes, it won’t get eaten by mice. Money has a property we call durability.
Money serves as a unit of account that allows for both divisibility and density. For Bob’s money to truly preserve value into the future, other people must recognize and accept it. This does not necessarily mean that Bob’s money has to be the only accounting unit or that its purchasing power has to stay stable over time. In a free market environment (where the state doesn’t manipulate the value of currency via regulations, monetary policy, etc.), purchasing power is taken care of by economic laws. For the needs of Bob and his community, the money must be divisible and able to concentrate enough value in small quantities. In short, the money has to be able to mediate the trade of a single nail, but also the whole wagon of swords. Silver coins and gold bars have served this purpose very well throughout history.
Money is fungible and easily verifiable: serving its purpose best when people aren’t required to estimate the purchasing power of a particular unit (e.g. a coin). Fungibility is a problem in instruments that are not homogeneous — for example, individual cows are quite different in terms of age and health, thus they may come with hidden defects such as illness. Gold and silver coins are quite fungible, but with one major catch: individual coins need to be minted and certified by a trusted third party. Such a trusted third party was usually the ruler, who thus received an almost unlimited power (we will explain the nature of this power later).
It is no coincidence that ancient Greece and Rome have become the most advanced civilizations in the world. At their peak, they used money that met the above requirements very well, allowing for prosperity not only to be created but also to be stored and shared through trade.
Drachma, denarius, solidus — a thousand years of prosperity and decline
Greek drachma is one of the first coins in human history (6th century BC). Drachma was a coin containing 4.3 grams of silver. Besides drachma, there were also smaller coins (the smallest Hemitartemorion with 0.09 grams of silver) and large medals (decadrachm with 43 grams of silver). Greek silver coins have been in circulation for hundreds of years, not only in the Mediterranean but also in distant India. According to historical research, a craftsman in Athens in the fifth century BC earned 1 drachma a day which provided him with food for 16 days.
Not much is known about the debasement of coins in ancient Greece — the drachma was a relatively stable monetary unit for hundreds of years. The reason for this stability is quite possibly the competitive nature of city-states as no Greek state had a long-term monopoly on the creation of money.
Rome: denarius and aureus
The denarius was the primary coin of Rome. Denarius was in circulation for over 400 years, from the third century BC to the third century AD. The denarius initially had a content of 4.5 grams of silver, and this silver content was held stable for two hundred years. Around 1 AD, however, Emperor Augustus succumbed to the lure of coin debasement — melting the coins and their re-minting with lower silver content. Since it was the emperor who defined the face value, he could get away with it — the face value on the coins remained the same, while the silver content decreased. However, the emperor’s newfound wealth did not come out of thin air, it was simply a redistribution of purchasing power. As soon as merchants noticed a lower silver content in the new coins, they increased prices to receive the same amount of real money for their goods (real money being the silver). And these higher prices had to be paid mainly by workers receiving wages that did not increase.
The second popular Romanian coin was Aureus, a coin made of gold. Minted from the first century BC to the fourth century AD, it was originally defined as 25 denarii — and that was a problem. With the gradual debasement of the denarius, there were also gradual “adjustments” in the definition of the aureus. Julius Caesar minted an aureus containing 8 grams of gold, Nero debased that to 7.3 grams. After the reign of Marcus Aurelius (otherwise a great philosopher of Stoicism), the gold content of the coin fell to 6.5 grams. Subsequently, the aureus was renamed to solidus and the gold content was further reduced to 5.5 grams. In 337 AD, the content was yet again reduced to 4.5 grams — but the solidus was still a relatively “solid” coin as it was now worth 275,000 denarii! The reason is denarius had almost no silver content anymore, and therefore almost no monetary value.
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:
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.
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
In this chapter, we have so far inquired into the role of money and the sad history of monetary debasements. As we’ve seen, the gold and silver coins weren’t immune from manipulation as the rulers who should have been the guardians of the coin’s purity were instead its greatest threat.
Let’s now move a bit forward in history. The world today is on the de facto dollar standard, so in the remainder of this chapter, we will explore the turbulent history of the United States dollar.
The colonial paper experience
The first historical occurrence of paper money comes from 11th century China. The second instance of paper money takes us to the American colonies.
In 1690, the English colony of Massachusetts embarked on a raid against the French colony of Quebec. The Massachusetts soldiers were promised a share of the booty, but the expedition failed and the company escaped with bare life. The colony’s administrators had no way to pay the soldiers and were afraid of the revolt, so they decided to resolve the situation by printing vouchers promising a future redeemability for real money (gold or silver). This promise was not kept. On the contrary in the following years, the colony increased the circulation of paper vouchers sixfold.
The curious invention of paper money quickly gained popularity across the colonies and was even vehemently advocated by Benjamin Franklin at one time. Let us now quote from the book The Creature from Jekyll Island on the consequences:
“By the late 1750s, Connecticut had price inflated by 800%. The Carolinas had inflated 900%. Massachusetts 1000%. Rhode Island 2300%. Naturally, these inflations all had to come to an end and, when they did, they turned into equally massive deflations and depressions.”
In a stroke of irony, it was England that definitively ended the colonial inflationary period. The Bank of England ordered the colonists that the only paper money allowed was that printed in England. Resistance to English rule was already growing at this stage though, so the idea to use English banknotes did not take hold, and in the following decades, it was gold, silver, and tobacco that circulated as money.
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?
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
Let’s pause our walk through history for a moment and explore the underlying logic of monetary history. Why does the power over money inevitably lead to debasement and the gradual abandonment of all the original definitions and guarantees?
As we saw in the example with blacksmith Bob, money is a tool for preserving the fruits of production for the future. This definition is crucial as those who hold money without being productive beforehand usually have a very unhealthy attitude towards money. Lottery winners are known for their notorious inability to hold on to their new-found wealth. Undeserved wealth often destroys lives instead of making it better. Cheap money is a killer.
Still, money by itself is neutral — even if undeserved, it can bring great power to its holders. Money means command over scarce resources. Gaining as many resources as possible and fulfilling one’s dreams is the goal of most people. Such dreams do not have to be of the variety of “eternal vacation in the Caribbean” — historically the most pernicious dreams are to do good. Nero, who was the first to debase the aureus gold coin, did so to raise funds for repairs after the devastating fire of Rome.
“Power tends to corrupt. Absolute power corrupts absolutely.”
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.
The creature of Jekyll Island
Let’s now return to our excursion through monetary history.
In 1913, the Federal Reserve System (Fed) was established. It was the culmination of a hundred and twenty-year effort by bankers and cheap money advocates to create a US central bank. Fed was preceded by two unsuccessful attempts:
First Bank of the United States operated from 1791 to 1811 and was the child of Alexander Hamilton, a great supporter of the centralization of power.
Second Bank of the United States existed from 1816 to 1836.
What was the motivation to establish a central bank? To gain the ability to create money and redistribute wealth. Bankers and their allies in Congress came up with an ingenious way to circumvent the restrictions in the Constitution: Congress was never forbidden by the Constitution or the Amendments to borrow. The motivation for the establishment of a central bank was therefore to create money out of debt. And this is exactly what happened after the Fed was established. In short, the accounting trick of converting debt into money works like this:
- Government issues bonds
- Bank accepts government bonds in its balance sheet on the assets side
- Bank issues a check to the government in the value of the bond
- The government deposits the check in another bank, where the check is converted into a deposit
- 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.
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
On April 5th, 1933 president Franklin D. Roosevelt issued Executive Order 6102 “forbidding the hoarding of gold coin, gold bullion, and gold certificates.” The president has instructed all citizens to hand over almost all of their gold by May 1st. The government paid $20.67 for an ounce. Failure to comply with the order resulted in a fine of $10,000 (approximately $200,000 today) and/or 10 years in prison. Citizens were allowed to keep coins of a total weight of 5 ounces (~$100). After citizens handed over their gold (or were imprisoned for disobedience), the government changed the official valuation to $35 an ounce. Of course, the government was aware of this planned revaluation — the official definition of the dollar no longer corresponded to reality after the significant credit expansion of the previous twenty years. The government simply robbed its citizens of almost 50% of the value of gold, as it bought gold at an artificially low price. The government subsequently prohibited American citizens from owning gold until 1974.
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.
1971: the mask comes off
Near the end of World War II, the American town of Bretton Woods hosted a peculiar conference chaired by a famous economist John Maynard Keynes. The conference aimed to create a new global financial order based on a dollar standard.
The Bretton Woods conference fulfilled this goal perfectly: following millennia of gold and silver, the dollar became the new global money. Dollars were still exchangeable for the underlying gold — but only for the foreign central banks, not the citizens. However, the dollar money spigot was still flowing (the financial perpetuum mobile is too tempting to shut down) thus the dollar kept on losing its value. As the dollar was artificially overvalued against gold, there was a gradual outflow of gold from the United States. The US government sought to prevent the outflow of gold by all possible means — friendly (not always) persuasion, manipulation of the market price of gold (via the so-called London gold pool in 1961–1968), unilateral amendments to the original Bretton Woods Agreement. All in vain, the United States was still “losing” its gold due to the growing difference between official valuation and the market price of gold. Does that remind you of anything? It should: this is the same problem that the rulers of ancient Rome experienced. It is a problem of debased money, whose face value no longer corresponds to the actual content of the precious metal.
In 1971 US President Nixon stopped pretending the dollar is backed by gold and “closed the gold window”. Dollars ceased to be convertible into the underlying gold even for central banks.
We are currently living in the world of pure fiat — unbacked by gold, “backed” by ever-increasing debt. However permanent this state of affairs may seem, it has only been this way for the last 50 years.
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?
Fifty years of experimenting with pure fiat won’t be particularly interesting in the course of monetary history. Similarly to denarius, solidus, or the original silver dollar, the “debt dollar” will not be here forever and will be soon forgotten once it implodes. The dismantling of the original monetary guarantees and definitions is already unstoppable — already in the early months of the 2020 crisis, the Fed cut interest rates to zero and began buying corporate bonds. Distinguishing between the monetary policies of the United States and Zimbabwe is harder by the day. Perhaps the only difference is the fact that US dollars, unlike Zimbabwean dollars, are still in high demand all over the world and form the central banks’ monetary reserves. I don’t know what the disintegration of the global financial order will look like in detail — but I dare say that it will not survive for another fifty years.
Bitcoin can be understood as a restorative technology. We have a tool here that has the potential to give economies a much-needed anchor in the form of solid sound money. For the first time in history we have money at our disposal for which:
- we don’t need a central authority to mint and certify the monetary units
- 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:
- 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
- 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
The most acute risk in terms of large-scale bitcoin confiscation are the exchanges and institutional custodians — and most of these are located in the US. According to research from January 2020, Coinbase holds about 1 million bitcoin. Coinbase’s CEO is Brian Armstrong, who had no problem hiring former Hacking Team employees. As a reminder: Hacking Team is a company that supplies spyware and hacking tools to various governments and police forces. Armstrong also has a good relationship with the US government: Coinbase recently sold blockchain analysis software to the government. Long story short: if Brian Armstrong was offered a highly prestigious office like the secretary of the treasury — in return for the keys to a million bitcoin — he’d probably ask where to sign. The events of 1913 and 1933 show that something like this can happen quite orderly and legally.
Coinbase is not the only point of interest for large-scale bitcoin confiscation. Other large custodians based in the US are:
- 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 :-)).
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
While studying monetary history one notices the ever-repeating theme: meddling with money always causes problems that are “solved” by further meddling. The history of money is the history of patching up the previously made holes.
The debasement of coins led to inflation which led to further debasement, redefinition of the monetary unit, and the legal tender laws. Bimetallism and the gold standard with economically illiterate parameters led to an outflow of metals from circulation. Government-sanctioned fractional reserve banking led to the creation of a legal banking cartel. Credit expansion causes wild economic cycles, and the depression phase of these cycles is pushing central bankers to give up on the previous promises of conservative monetary policy and to find new ways of pumping the money into the economy.
The global monetary history culminates in an irresponsible experiment of pure fiat. Money is no longer the anchor of the economy, it is a token in the financial market casino — where even the stock of bankrupt companies can rise. You can try your luck and place your bets — or you can start saving in real money.
We do not know what other patches bankers, politicians, and officials will pull out of their sleeves. Helicopter money? Direct stock purchases? A populist attempt to return to the gold standard?
Whatever the next patch on a broken financial system, we don’t just have to sit and wait for the next decision of our dear rulers. We have the opportunity to keep our savings in money that cannot be debased. We have the opportunity to step out of the historical carousel of monetary double-crosses and take the money into our own hands. We have the option to choose Bitcoin.
IV. Bitcoin: Separation of Money and State
Fiat money is the last major tool of the statist control over society. However, history is unforgiving to the state and its power over the institutions: over the centuries, the state loses control over the church, media, education, and the economy.
Origin and nature of the state
In previous chapters, we looked at human action, time preference, and money from a “longer and higher” perspective. With the help of the analytical apparatus of the Austrian school of economics (the “higher” perspective) and history (the “longer” perspective), we begin to understand why Bitcoin matters: it represents the potential to finally disband the statist power over money. And to understand the importance of the separation of money and state, we again need to look at the state itself from a higher and longer perspective.
In that task, we will be helped by Franz Oppenheimer, a German sociologist who in 1908 published The State: Its history and development viewed sociologically. According to Oppenheimer, romantic theories about the origin of the state as an institution for better political coordination are in stark contrast to historical reality. The origin of the state lies in the simple dynamics between the three basic groups that established themselves with the rise of humanity after the Neolithic revolution (~10,000 years before Christ): hunters, herdsmen, and farmers. Hunters and herdsmen were nomads by nature, farmers led sedentary lives. Hunters were mostly neutral towards the other groups (they didn’t have much to gain from the others and themselves were not an interesting target), while the herders were a natural predator to farmers. Herdsmen are mobile and accustomed to frequent fighting (both against other herdsmen and natural predators attacking their herds), and farmers are an easy target — living on the same land and devoting maximum energy to the cultivation of the land.
“The cause of the genesis of all states is the contrast between peasants and herdsmen, between laborers and robbers, between bottom lands and prairies.”
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.
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
Let’s explore the mentioned incentive structures for a bit. If the state has a certain sector of the economy under its control, this presents a double problem.
First, the problem of economic calculation. As we mentioned in the chapter on the Austrian school of economics, state control means the absence of market prices, ie. valuable information signals. Sectors under state control face the problem of “groping in the dark” — politicians and bureaucrats simply have no way of determining which allocation of factors of scarcity is the optimal one. That is why communist countries and state-controlled industries are notoriously backward.
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?
Let’s turn to the question of why we should strive to separate the various social institutions (including money) from the state. In addition to the reasons already mentioned — the problem of economic calculation and the distorted incentives of the state agents — there is also the fact that various institutions have been used throughout history to strengthen the state mythology and further the population control.
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
Even though the state does have better surveillance tools due to new technologies, we can be optimistic: in the long run, the state loses its power. Money is the last major institution utilized to control the population and economies — and as we will see below, the era of state money is coming to an end due to its inertia.
But first, let’s take a look at the most impactful institutional separations. We will see that humanity (especially Western society) has come a long way in emancipating itself from the state.
As part of the Enlightenment (17th-18th century), all the civilized countries underwent the separation of the church from the state. The importance of this separation cannot be overstated. As we noted at the beginning of this chapter, the lords gradually built a mythology that helped them maintain their privileged position — and this mythology was usually based on a “divine mandate”.
We can observe the usage of the divine mandate myth in every major empire in history — from the Egyptian pharaohs, through the Chinese dynasties, the Japanese emperors, the Inca rulers, to the European kings: the rulers everywhere explained their right to rule as a gift from gods.
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.”
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.
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.
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!
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.”
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
“The organization of the banking system is much closer to a socialist economy than to a market economy.” — this is how Jesús Huerta de Soto, the author of Money, Bank Credit, and Economic Cycles, characterizes today’s banking system. The reasons for such a description are as follows, and are valid in all the centrally-banked countries of the world:
- the entire system rests on the government monopoly on currency
- the system is based on the privilege which permits banks to create loans ex nihilo
- the management of the whole system is performed by the central bank, which acts as a true planning agency for the financial system
- 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
- 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.
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.
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:
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.
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.
Gold or Bitcoin?
Libertarians and Austrian economists have been calling for the end of monetary socialism for decades. Most of us always thought the return to sound money would involve gold. Gold has been money for most of human history — and has almost perfect monetary properties.
However, in 2009, Satoshi discovered something unexpected: money with even better features than gold. Compared to gold, bitcoin has two unique properties: absolute scarcity and intangibility. These features make it a very interesting candidate for the future money of mankind; especially if non-state money is indeed to remain free of any state influence.
Absolute scarcity means that higher demand does not lead to an increase in supply. For precious metals (which do not have absolute scarcity), the following mechanism of balancing supply and demand can be observed:
In the case of Bitcoin, however, the mechanism is as follows:
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
Economists sometimes object that bitcoin cannot perform the full scale of monetary functions because its credit market won’t work. The alleged problem is that no one will want to take on debt — borrowing 10 million sats if bitcoin is appreciating by 20% a year is pure madness. Thus, the bitcoin money economy is claimed to be the economy of a permanent recession — no credit, no investments, high unemployment, and a privileged layer of ultra-rich hodlers laughing from their Citadels.
Such a caricature arises from a misunderstanding of the different phases of the monetary separation. The separation of money from the state will come in two distinct phases. The rapid and unpredictable rate of appreciation is a matter of the first phase in which Gresham’s law applies. Just as it is irrational at this stage to spend satoshi on daily consumption, it is also irrational to undertake debt in satoshi. The first phase of the separation of money and state can be characterized as a phase of discovery and rebalancing: humanity gradually comes to the understanding that there is a new form of money with better properties than fiat money and precious metals, and then rebalances its savings into new money. Understandably, this phase takes a long time — bitcoin is initially seen as a new, experimental technology with unknown risks. Only with increasing years do we get a better awareness of how to deal with this technology, what its real risks are, and to what extent can we trust the immutability of monetary policy in the long run.
It is only in the second phase that bitcoin can begin to serve other monetary functions, such as facilitating credit. At this stage, the behavior of bitcoin will not be very different from the behavior of precious metals. The only difference is that for precious metals, the growth of purchasing power due to productivity growth is partially reduced by flexible supply, which can also cause significant shocks: an example is high silver inflation in 16th century Spain or the California gold rush.
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).
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
The advent of bitcoin as mankind’s new form of money is sometimes described by the term hyperbitcoinization. This term is derived from hyperinflation: one of the final stages of state monetary policy. However, there doesn’t need to be anything “hyper” about bitcoinization, just as the decline of the fiat does not have to be accompanied by a devastating rise in consumer prices (as we have seen, the alternatives to hyperinflation are deflationary collapse or gradual nationalization of the economy).
When we look at the monetary arrangements in the twentieth century, we can observe a predecessor to bitcoinization in the form of dollarization. Dollarization is a process of adopting the US dollar as a currency in a foreign country. It can be official (e.g. Panama) or unofficial (Belarus, Venezuela, Argentina, and other countries suffering from high inflation, where ordinary people start saving and accounting in dollars). However, the dollar has a double problem that is becoming ever more acute: it is subject to capital controls and in the world of fiat it is only the one-eyed king among the blind. It is likely that with the growing awareness of bitcoin and the declining quality of the dollar, dollarization will gradually be replaced by bitcoinization. In addition to protecting purchasing power, bitcoinization also has one major advantage for people in developing countries: it allows cashless payments. The unofficially dollarized countries have a notorious problem with digital payments, as they are usually dollarized only in cash. Bitcoin, on the other hand, allows for digital payments by default.
Bitcoinization in the next decade will take a form of pervading bitcoin into various economic activities, though savings will naturally come first. There is no need at all for bitcoinization to be officially sanctified in any way — on the contrary, the separation of an institution from the state always happens in a bottom-up fashion. Whether a bitcoinization happens will be decided by the people and their businesses. There will be a natural flow to bitcoinization — various people and institutions will adopt bitcoin as soon as they understand the essence of bitcoin as the new money, learn to work safely with it, and accept that short-term volatility is an acceptable price for the long-term positive effect of Gresham’s law and other characteristics (e.g. uncensorable global payments).
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.
An unforeseen separation
Every institutional separation in history must have been unimaginable and completely heretical beforehand. On the eve of the separation, many certainly pointed to the fact that the institution has been associated with the state since the dawn of time, and only state benevolence and expert leadership allow the institution to exist at all and protect society from collapse into the chaos of anarchy. Such is the narrative with money today. No one expects the separation of money and the state, although in retrospect it will be quite obvious and inevitable.
Bitcoin may be blamed for the fall of the dollar and hodlers may be demonized similarly to 1930s gold “hoarders“. However, bitcoin cannot cause the dollar to fall — if the dollar indeed does collapse, it’s due to the very nature of fiat money. Let us not forget that pure fiat without a gold backing has only been a matter of the last fifty years, during which the monetary policy has become increasingly extreme and out of line with any existing economic policy recommendation (on the contrary, new theories such as MMT must be hastily invented). Thus, in the event of the dollar demise, Bitcoin will only fill the resulting vacuum.
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?
In the previous chapters, we discussed the pressing need for non-state money, the effects of monetary socialism, the history and temptation of debasement, how and why a bitcoinization will happen. However, one question remained unanswered. Why only Bitcoin?
Don’t we have a diverse, prosperous, dynamic, exciting cryptocurrency industry here? Shouldn’t I also buy ETH, XMR, LTC, LINK, YFI next to my first satoshi? Shouldn’t I engage in yield farming (whatever that is) or buy some NFTs? Shouldn’t I diversify into altcoins?
Short answer: no. Adopt a strategy of regular, ongoing bitcoin purchases (DCA strategy), live long, and prosper.
Longer answer: keep on reading.
What is the point of blockchain?
“Blockchain” is pretty much an empty buzzword, and rightly so — a blockchain without a tradable token (e.g. bitcoin) makes no sense. In Bitcoin, a blockchain comes into existence only as a by-product of transaction settlement. Its main purpose is the possibility of independent verification of the current UTXO set (database of unspent transaction outputs — i.e. who owns what). Bitcoin full node allows everyone in the world to recreate their copy of the blockchain, through the process of validating all the bitcoin transactions from the initial genesis block up to the current UTXO set. Blockchain thus gives everyone the certainty that received bitcoins are genuine (and not a fake bitcoin, like bcash, for example). At the same time, the operation of the own node gives the recipient assurance that the received transactions comply with the rules of the bitcoin protocol.
In short, the purpose of blockchain is to make the existence of non-state money possible, without any dependence on a trusted third party.
The independence from a trusted third party is not an empty paranoia. Bitcoin was preceded by several centralized attempts that did not end well for the founders and holders of the currencies:
- 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
This brings us closer to answering the question of “why only Bitcoin”.
Non-state money must meet two requirements:
2) Long-term miner incentives
If non-state money does not meet one of the points, sooner or later it will fail. Insufficient decentralization may be caused by high demands on the operation of full nodes or from the granting of privileges to certain actors (e.g. the DPOS system for the EOS cryptocurrency leads to mining cartels and censorship; similarly with Tron). High dependence on one provider of “cloud full nodes” is also very problematic: within Ethereum, about 70% of all nodes are running in the cloud. The dominant provider of these services is Infura (a subsidiary of Consenys) — a prime central point of failure. Insufficient long-term incentives of miners then lead to squeezing the system through 51% attacks, as in the Ethereum Classic network.
If the cryptocurrency network is not decentralized by design, there really is no point to it. If the centralized network becomes successful in circumventing capital controls and other features of the state monetary monopoly, the network will be stopped or regulated similarly as the Bitcoin’s predecessors were. Most of Bitcoin’s competitors make this fundamental mistake: they sacrifice decentralization in favor of greater functionality and faster development.
But let’s look in particular at the second problem: sufficient long-term miner incentives. In Bitcoin, the incentive to mine is twofold: newly issued bitcoin (so-called block reward) and transaction fees. Block reward is designed to go down over time — every four years comes the halving, which slashes the block reward in half. As block reward tends to zero over the long term, it is the transaction fees that are crucial for long-term sustainability.
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:
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?
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:
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:
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.
Ethereum is thus the only real challenger to the role of non-state money and the promoters of Ethereum have already begun to talk about Ethereum as money. I described Ethereum’s specific approach to “moneyness” in the article The Moneyness of Bitcoin and Ethereum.
Vitalik Buterin and Joe Lubin (i.e. the Ethereum founder and the Consensys/Infura founder) said in 2019 that the current Ethereum is only the initial phase of an experiment and the time to shut down this initial phase has come. Yes, you read that right — Ethereum is shutting down. The reason is the long-planned migration to the so-called Ethereum 2.0.
However, this migration is very unprecedented. In the past, most of the changes in Ethereum were made via hard forks: backward-incompatible change in rules. Fun fact: the very ease of implementing hard forks and even an official role of “hard fork coordinator” employed by the Ethereum foundation speak volumes about Ethereum’s centralization. However, the transition to Ethereum 2.0 will not be just another hard fork; it’s an introduction of a completely new platform and a gradual shutdown of the old one.
And Ethereum 2.0 is based on completely new principles, massively deviating from the current Ethereum. Instead of proof-of-work, it will run on proof-of-stake. Instead of a globally shared blockchain, it will be based on the so-called sharding (comprising of 64 separate chains, which are compatible only to a limited extent). No one today can say how the migration of existing contracts and applications, such as the very popular DeFi, will happen in practice. Existing holders of an “old” ETH will be entitled to an adequate amount of a “new” ETH, but that’s about it in terms of network similarities. All the Lindy effect that Ethereum has accumulated over the years will be lost and the new network will have to prove its safety and viability from scratch.
The transition to Ethereum 2.0 will take multiple years and has already been delayed for years. By the time Ethereum 2.0 is up and running in full, Bitcoin will already have around 15 years of operation behind it, accompanied by an ever-larger network effect and an increasing pace of global bitcoinization. And the question is whether Ethereum 2.0 will be the final version, or Ethereum 3.0 will come next.
Recap: why bitcoin > shitcoin
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.
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:
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
If the dear reader finds the ideas in the book persuasive and is contemplating to start stacking sats, it is important to follow a few basic recommendations. Bitcoin is unique in that it offers the possibility of real sovereignty: if you hold bitcoin, securing it is your sole responsibility.
The basic rule is to hold bitcoin yourself — not in an online wallet or an exchange account. Anyone in the Bitcoin space will sooner or later encounter a sad story of lost or stolen bitcoin from a service where the user wasn’t the sole owner of the private keys. Always avoid online or web wallet services. For larger amounts, get a hardware wallet (ideally with the possibility of Shamir Backup — a good product in my experience is Trezor Model T). For smaller amounts, use Green (iOS and Android) or Samourai (Android only) mobile wallets. When setting up your wallets, it is critical to write down the seed to offline storage, such as on a plain paper (which you have to keep in a safe, dry place).
After the wallet setup and writing down the seed, wipe and restore the wallet, i.e. simulate the loss of a device (mobile or hardware wallet). Believe me that you do not want to experience the stress of recovering from seed for real as your first time; you will have a much better sleep when you try it with an empty wallet first.
Always carefully check the addresses to which you’re going to send your satoshi. Internet is full of malware that is trying to steal your sats by swapping addresses in your clipboard (i.e. the memory after you press ctrl + c).
Never trust any people, services, and ads that promise to multiply your bitcoin. This is always a scam.
Never exchange your valuable sats for altcoins. They are not “Bitcoin 2.0”, they didn’t solve the scaling, and banks or corporations won’t adopt them. It is all lies of the altcoin founders and shillers who do not understand the essence and value of Bitcoin.
Learn about stacking sats without having to go through the KYC exchanges. Such options include in-person purchases, bitcoin ATMs and P2P exchanges: Bisq or Hodl Hodl.
In short: if you are faithful to the Ten Bitcoin Commandments, you will sleep well.
Ten Bitcoin Commandments
- Thou shalt hold your own keys (and the seed)
- Thou shalt secure your sats in the hardware wallet
- Thou shalt keep only small change in mobile wallet
- Thou shalt withdraw from the exchange immediately after buying
- Thou shalt prefer dollar cost averaging over timing the market
- Thou shalt not stack so much you would face the temptation to sell in big market dips (thou shalt buy the dip instead)
- Thou shalt not be tempted by altcoins, for these are the play of the Devil, intended on taking your sats
- Thou shalt double-check the recipient address when sending sats, for malware demons lurk around
- Thou shalt not boast about the height of your stack stash
- Thou shalt prefer hodling over day trading
Resources for further study
Sorted from introductory to advanced.
- Vijay Boyapati: The Bullish Case for Bitcoin
- Jameson Lopp: Bitcoin information and resources
- F. A. Hayek: The Use of Knowledge in Society
- Johan Norberg: Progress: Ten Reasons to Look Forward to the Future
- Bitcoin Twitter megathread
- Parker Lewis: Gradually, then suddenly blog series
- Nic Carter Medium
- Robert Breedlove Medium
- Max Webster: The Solar-Bitcoin Convergence
- Saifedean Ammous: The Bitcoin Standard
- Yan Pritzker: Inventing Bitcoin: The Technology Behind The First Truly Scarce and Decentralized Money Explained
- Murray Rothbard: What has Government done to our Money?
- F. A. Hayek: Denationalisation of Money: The Argument Refined
- Frédéric Bastiat: That Which is Seen, and That Which is Not Seen
- Ludwig von Mises: Bureaucracy
- Hans-Hermann Hoppe: Democracy: The god that failed
- Ludwig von Mises: Economic Calculation in the Socialist Commonwealth
- Robert F. Mulligan: Property Rights and Time Preference
- Arkadiusz Sieroń: Money, Inflation and Business Cycles. The Cantillon Effect and the Economy
- Jesús Huerta de Soto: Money, Bank Credit and Economic Cycles
- Franz Oppenheimer: The State. Its history and development viewed sociologically
- G. Edward Griffin: The Creature from Jekyll Island: A Second Look at the Federal Reserve
- Murray Rothbard: Man, Economy, and State, with Power and Market
- Ludwig von Mises: Human Action