In the last post we saw and clarified the most technical part in the operation of Bitcoin related to the immutability of the Blockchain, the PoW algorithm, the incentive system and the computational difficulty of the network. We ended up identifying why these elements combined made Bitcoin such a value transmission network, and we ended up introducing the concept of solid money; that’s what I’m going to focus on today, surely the most disruptive concept that Bitcoin proposes.
What makes Bitcoin unique and incredibly revolutionary is that it is probably the strongest form of money we’ve ever had. As humans who “trade”, we need to have money; this fact allows us to transmit value and consequently civilize. We could even say that money is one of the oldest technologies that we have as a specie (it has existed for more than 500,000 years), and it was because of it that the incentive to collaborate and civilize ourselves was superior to being hostile between different nomad tribes.
Characteristics of money
We are used to a State that dictates what is and what is not money, so let me ask: is it fair that we ask ourselves what makes something turn into money? There are three commonly accepted characteristics:
- Reserve value: Property present in a merchandise capable of conserving its value over time. It is linked to scarcity and the annual increase in the supply of this commodity. Gold, for example, has been used for millennia as a reserve value because, in addition to being scarce, its rate of increase in annual money supply has always been stable between 1% and 1.5%. No matter how much anybody invests or how much the incentive to mine rises (the price of gold may have gone up), it is historically proven that no more than 1–1.5% will be found. This makes it a good value-conserving commodity.
- Medium of exchange: A commodity that can be used to trade and that people accept as a means of payment.
- Unit of account: Merchandise that serves to measure the value of goods and services and allows to calculate profits and losses.
Depending on how well it fulfills these characteristics, with reserve value being the most important, we can find weak or solid forms of money. The solid ones are usually those that are not devalued, and that can last for years or centuries as trustworthy securities. Quite the opposite for weak currencies.
It is logical that as a society we choose a solid currency to develop our economic system, although we should ask ourselves, who chooses what form of money is going to be used from now on, and why? Or, who was the first who said that gold was going to be considered money? The answer is nobody. Money does not become money because someone says so, we have historically chosen it naturally and unconsciously until it became adopted, because it fulfilled its function correctly. The strongest currencies will tend to gain prominence and displace the weak ones because they bring more benefits to users and to society in general. The imposed currencies -which are never born in a free market- are usually weak currencies, which do not fulfill their main function of storing value correctly.
What is obvious is that we need something to use as money. Without money it would be practically impossible to live in civilized societies. Today the most used forms of money are the US Dollar, the Euro or the Pound, but they are mostly chosen because they are the least bad option. The objective of money is to be able to transfer and save value over time. A currency that devalues annually and is controlled by a central entity will never be, by definition, a solid form of money. But the truth is also that until now we did not have any other form of money, adaptable to current commerce, that correctly fulfills the functions expected of something used as money. Gold is a great commodity to store value, but it is physical, heavy, and difficult to divide.
Bitcoin as a new money
Bitcoin for the first time brings a type of digital currency, with global reach and with an unprecedented scarcity. It is the first asset in history to be truly limited and that implies a change that we are not yet aware of how powerful it is. There is an economic treatise published by Julian Simon called “the last resort “ where he specifies that there is no way to know how much there is of a specific merchandise, since never in history we have found something that was 100% finite. Even gold, one of the scarcest elements on our planet, continues to increase its money supply between 1% -1.5% annually. According to Simon the only way to measure the amount of something was to compare how long we had to extract it. Bitcoin for the first time has created scarcity, there are only going to be 21 million Bitcoin. Not one more.
This is not only digital scarcity (never seen before since all existing digital elements are duplicatable), but it is also the only truly finite element in the world other than our time. There has never been a commodity capable of storing value as successfully as Bitcoin. This solidity in a currency isn’t yet perceived by people, partly because we are a few months before the third Halving , and therefore, the monetary increase in Bitcoin is 3.8%. From May-June of this year it will be 1.7% and from 2024, it will be less than 1%. It will be in 7–8 years when the solidity of this currency will be evident for everyone, and the world will begin to wonder if they prefer to maintain their value in a FIAT currency (supposedly with an inflation of 2% per year, which is obviously increasing after the aggressiveness of inflationary policies to plug the holes of the 2008 financial crisis or to overcome the challenge of the Coronavirus; this week the American Federal Reserve announced an injection of 700,000 million dollars), or in Bitcoin. We certainly underestimate the power of scarcity, which is something unprecedented. Don’t forget this: there are more millionaires than Bitcoins in the world, so not everyone will be able to have 1 BTC, no matter how much they want it, or how much FIAT money they have.
Neo-Keynesian theories (currently prevailing) think that low inflation and a government-controlled currency is the best option. Although it is not difficult to think this when all governments are economically and powerfully encouraged to have this perspective. It enables them to obtain resources out of thin air at the expense of reducing the purchasing power of the currency, indirectly impoverishing the majority of the population. FIAT currencies are a local monopoly, which is imposed on us in a mandatory way, not counting the dependence that it forces us to have with the financial system, capable of blocking accounts, freezing transactions and not authorizing the withdrawal of YOUR MONEY that you have earned with YOUR TIME and effort. It is paradoxical how we are against corporate monopolies and instead we accept with illusion the biggest and most unjust monopoly of all, the total control of the currency by the Central Banks. Bitcoin is a phenomenon born from the free market, which, thanks to its decentralized nature, gives monetary freedom to any citizen of the world. Without any doubt we are in front of the most successful experiment we have seen from the Austrian economy.
“Money is a product like anything else, just more liquid and used as a medium of exchange, and I don’t think we will ever have a true capitalism and a truly free market until the money comes from the free market itself, and not monopolized by the Government.”
It makes me quite sad that most people blame capitalism for creating a short-term, consumerist society. The reality is that a weak currency such as FIAT encourages us to spend and not save, since keeping your wealth in money, will make you lose purchasing power every day. As a result, individuals become more focused in the short term, in debt and in mindless consumption. A concept excellently described by Saifadean Ammous in his book “The bitcoin pattern.” He calls it “time preference” (which can be low or high): how much we value the future over the present. One of the most important psychological aspects in the economy and that have a direct relationship with the type of currency that predominates in society.
Long-term money outlooks
We must start from the idea that money has an abysmal importance in society, it is the pillar of civilizations and depending on its characteristics, human behavior will tend to be one way or another. If we have a finite currency that tends to effectively increase/retain its value because it cannot be manipulated, we tend to value the future more; precisely because with the money we have today we will be able to buy more things in the future, since it’s value will tend to increase because of its scarcity. If instead, we have an infinite form of money that tends to lose its value over time, we tend to look more short-term. To spend today and not tomorrow. To go into debt and not save. It is what is logical since the value of money will be lower in the future. If I do not spend the money I have today, I will be able to acquire fewer assets in the future, and it will be better if I go into debt instead of saving, because the true value to be returned in the future will be less. And all these implications only talking about the economic level, but the influence of the currency also goes to culture, art, manners, relationships, values … A solid currency can contribute a lot to a society, and on the same time, can create monetary “freedom” for everybody.
The prevalence of a controlled and weak form of money in our society has deteriorated and generated great changes in the economy. A clear example is that the relationship between investing and saving has been broken. Companies, despite not being competitive, can stay afloat thanks to obtaining financing. We can even see unrealistic growth in the stock markets arising from “financial engineering” where the companies themselves spend 80% of their cash-flow on buying back shares (from 2010 to 2019, companies in the SP500 index spent an average of 52% of their cash-flow in share buy-backs), seeking short-term benefits and long-term irresponsibility. Although I suppose it is logical, in a world where all currencies encourage short-term behavior, and where governments are capable of rescuing companies by creating money out of thin air. The worst thing is that there are even companies that have used borrowed money to buy back shares. This is because large companies with capital are the first to have access to the “new money” and can buy back shares with it. Consequently, the total value of the company rises and, in the charts, the economy seems to be prospering, but the reality is it happened without any increase in productivity or sales. This could never happen with gold or Bitcoin.
That’s all for this post, but don’t worry, we’re not done, there’s still a lot of things we need to talk on this topic. See you in the next post!