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How Bitcoin works (4)

How Bitcoin works (4)
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1/1/1970

In the last post we saw and understood the most technical part of how Bitcoin works, 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 combined elements made Bitcoin such a strong transmission network of value, and we ended up introducing the concept of sound money; This is what I am going to focus on today, surely the most disruptive concept proposed by Bitcoin.

What makes Bitcoin unique and incredibly revolutionary is that it is probably the most robust form of money we have ever had. As humans who "trade" we need to have money; It is what allows us to transmit value and consequently civilize us. We could even say that money is one of the oldest technologies that we have as a species (it has existed for more than 500,000 years), and it was because of it that the incentive to collaborate and civilize was greater than the fact of being hostile between different tribes. nomads

Characteristics of money

We are used to a state dictating what is and is not money. Moreover, it is fair that we ask ourselves, what makes something become money? Mainly there are three characteristics:

  • Reserve value: Property present in a commodity capable of preserving its value over time. It is linked to the scarcity and the annual increase in the monetary mass of that commodity. Gold, for example, has been used for millennia as a reserve value because, in addition to being scarce, its rate of the annual increase in money supply has always been stable between 1% and 1.5%. No matter how much you invest or how much the incentive to mine goes up (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 commodity to hold value.
  • Medium of exchange: A commodity that can be used for 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 calculating profits and losses.
caracteristicas forma de dinero
Comparison characteristics that are sought in a form of money. (Gold, Fiat, BTC)

Depending on how well it fulfills these characteristics, reserve value being the most important, we can find solid or weak forms of money. The solid ones are usually those that do not depreciate, and that can last for years or even centuries as trusted reserve values. Quite the opposite of 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? Or who was the first to say that gold was from that moment considered money? The answer is nobody. Money does not become money because someone says so, we choose it naturally because it fulfills its function correctly. The strongest currencies will tend to gain prominence and displace the weak ones because they bring more benefits to users and society in general. The imposed currencies -which have not been born in the free market- are usually weak currencies, which do not fulfill their main function of storing value correctly. Talking about the history of money is undoubtedly something interesting, although we will leave this for another post.

What is clear is that we need something to use as money; without it it would be practically impossible to live in civilized societies. Today the most used form of money is the US Dollar, the Euro or the Pound, but they are chosen because they are the least bad option. The purpose of money is to be able to transfer and store value over time. A currency that is devalued annually and controlled by a central entity will never be a sound form of money. But the truth is 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 split. Perhaps there is something, although at the moment it is still an experiment: Bitcoin.

Bitcoin as new money

Bitcoin for the first time brings a type of digital currency, with global reach and unprecedented scarcity. It is the first asset in history to be really limited and that implies a change that we are not yet aware of the strength of. There is an economic treatise published by Julian Simon called “the last resort” where it specifies that there is no way of knowing how much there is of a specific commodity, since never in history have we 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 quantity of something was to compare how long we had to extract it. Bitcoin for the first time has created real scarcity, there are only going to be 21 million Bitcoin. Not one more.

Not only is this digital scarcity (never seen before, since all digital elements are duplicable), but it is also the only truly finite element in the world apart from our time. There has never been a commodity capable of storing value as successfully as Bitcoin. This strength in the currency is not yet perceived by people, especially since we are a few months before the third halving,and therefore, the monetary increase in Bitcoin is 3.8%. As of May-June of this year it will be 1.7% and as of 2024, it will be less than 1%. It will be in 7-8 years when the solidity of this currency will be evident, and the world will begin to wonder if they prefer to maintain its value in a FIAT currency (supposedly with an inflation of 2% per year, which I doubt after the increase in the aggressiveness of inflationary policies to cover 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. Certainly, we underestimate the power of scarcity that Bitcoin has. Remember this the reader: there are more millionaires than Bitcoins in the world, so not everyone will be able to have 1 BTC as much as they want.

The New Keynesian theories (predominant today) think that a small inflation and a currency controlled by the government is the best option. Although it is not difficult to think so when all governments are encouraged to have this opinion. It allows them to obtain resources out of thin air at the expense of reducing the purchasing power of the currency, indirectly impoverishing the entire population. FIAT currencies are a local monopoly, which is imposed on us in a mandatory way, without counting the dependency 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 business monopolies and instead we accept with enthusiasm the biggest and most unfair monopoly of all, the total control of the currency by the Central Banks. Bitcoin is a phenomenon born of the free market, which thanks to its decentralized nature provides monetary freedom to any citizen of the world. Without a doubt, we are looking at the most successful experiment we have seen since the Austrian economy.

Money is a commodity like anything else, just more liquid and used as a medium of exchange, and I don't think we'll ever have true capitalism and a truly free market until money comes from the free market itself, and not monopolized by the government. .

In a way I regret that most people blame capitalism for having created a consumerist and short-term-oriented society. The reality is that a weak currency such as FIAT encourages us to spend and not save, since if you keep your wealth in money, it will lose purchasing power every day. As a result, it makes us individuals more focused on the short term, debt, and senseless consumption. A concept excellently described by Saifadean Ammous in his book “The bitcoin pattern”. He calls it "time preference," that is, how much we value the future over the present. One of the most important psychological aspects of the economy has a direct relationship with the type of currency that predominates in society.

Long-term money outlook

We must start from the idea that money has 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 its value will have increased thanks to 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 borrow and not save. And it is logical since the value of money will be less in the future. If I don't spend the money I have today, I will be able to acquire fewer goods in the future, and if I borrow instead of saving, it will be better, since the value to be returned in the future will be less. And this is transferred only at the economic level, but the influence of currency is also on culture, art, our manners, our relationships, our values... A solid currency can contribute a lot in a society, not just "freedom" monetary.

devaluacion del dolar
Devaluation of the Dollar in the last 100 years
inflacion vs deflacion
Inflation vs deflation concept graphic image

The predominance 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 investment and saving has been broken. Now companies, despite not being competitive, can stay afloat thanks to obtaining financing. We even see unreal 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, the companies in the SP500 index spent an average of 52% of their cash-flow in share repurchases), looking for short-term profits and long-term irresponsibility. Although I suppose it's normal, with a currency that encourages short-term behavior and with a government capable of rescuing companies by creating money out of thin air, it's worth taking the risk... 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 the economy seems to prosper, yes, without having an increase in productivity or even having dropped. This cannot happen with gold or Bitcoin.

Don't worry, we're not done, this topic is for more. We do not see in the next post!

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