bitcoin standard by Saifedean Ammous summary

September 08, 2022

take-aways

money was first used as a medium of exchange
gold became the basis for sound money
european governments devalued their currencies to fund their war efforts
gold-backed money was replaced by government-backed money after the first world-war
sound money is the basis for a functioning economy
unsound money leads to recessions and debt
bitcoin is unique in its scarcity
bitcoin could emerge as a new standard, though it faces challenges

Money served as an exchange medium at first

Without money, how does an economy function? By exchanging goods. We call this barter. If you have two pigs and your neighbor needs a cow, or vice versa, you could trade them for a haircut.
Unfortunately, these things don’t always align. No goods to offer your potential trading partner? Sorry – you won’t get what you want either! You’ll need money for that. It will be useful for any transaction since everyone wants it. This is called indirect exchange. However, early money wasn’t at all like what we keep in our wallets today.
Salability:
- A good’s salability across time refers to its ability to hold value into the future, allowing the holder to store wealth in it, which is the second function of money: store of value. For a good to be salable across time it has to be immune to rot, corrosion, and other types of deterioration.
- Similarly, with money, it was inevitable that one, or a few, goods would emerge as the main medium of exchange, because the property of being exchanged easily matters the most. A medium of exchange, as mentioned before, is not acquired for its own properties, but for its salability.
- Monetary status is a spontaneously emergent product of human action, not a rational product of human design.
Rai Stones:
- The owner of the stone could use it as a payment method without it having to move: all that would happen is that the owner would announce to all townsfolk that the stone’s ownership has now moved to the recipient. The whole town would recognise the ownership of the stone and the recipient could then use it to make a payment whenever he so pleased. There was effectively no way of stealing the stone because its ownership was known by everybody.
- The stones’ salability across time was assured for centuries by the difficulty and high cost of acquiring new stones, because they didn’t exist in Yap and quarrying and shipping them from Palau was not easy.
- The very high cost of procuring new stones to Yap meant that the existing supply of stones was always far larger than whatever new supply could be produced at a given period of time, making it prudent to accept them as a form of payment. In other words, Rai stones had a very high stock-to-flow ratio, and no matter how desirable they were, it was not easy for anyone to inflate the supply of stones by bringing in new rocks.
- The Yap Island chiefs who refused O’Keefe’s cheap Rai stones understood what most modern economists fail to grasp: a money that money is easy to produce is no money at all, and easy money does not make a society richer; on the contrary, it makes it poorer by placing all its hard-earned wealth for sale in exchange for something easy to produce.
- Why don’t the Islanders use Rai stones today, if they worked so well? However, they did not retain their value, or their salability, over time. It wasn’t an issue at first.
- The supply of stones was limited and their value remained stable due to the difficulty of mining and moving them.
- With the arrival of David O’Keefe, an Irish-American captain shipwrecked on the island in the late nineteenth century, that changed. O’Keefe began importing Rai stones in large numbers in exchange for coconuts, using modern technology.
- Eventually, they were so commonplace that they could no longer serve as money – they had become mere stones again!

Gold was used as the basis for sound money

Early pre-Christian civilizations made money resembling the change in your pocket using a revolutionary technology, metallurgy, the art of melting metals. As a result of this technology, highly salable coins could be made that were both small and light enough to be carried far and wide.
With regard to coinage, gold stood out from the rest. But why? It has some unique characteristics.
To begin with, it is nearly impossible to destroy, and it cannot be synthesized using other materials. As for gold, you’ll need a shovel if you want it, because the only place to find it is underground.
Furthermore, the more gold you mine, the deeper you have to dig to find more gold, so gold supply still grows slowly and predictably even as gold-mining technologies improve.
All of these properties make for a material that’s incredibly effective as a store of value, making it salable through time. That became obvious fairly quickly. Gold coins were commissioned by King Croesus over 2,500 years ago!
Although gold has existed for ages, the love affair between money and gold blossomed only in the eighteenth, nineteenth, and twentieth centuries. This is the era of sound money in history. Let’s provide some context before we define this term.
Rapid advancements in communication and transportation shaped these centuries. Trains and the telegraph made it easier than ever to transport goods and people from place to place.
Thus, ultraconvenient, nonphysical forms of payment like checks, paper receipts, and bills became more widespread. What can you do to convince merchants and consumers that the pieces of paper they’re using to buy and sell are worth something?
Governments around the world came up with the solution of issuing paper money backed by precious metals, which they stored in vaults. One of the most popular metals in Europe was gold. Among the first to introduce the gold standard was Isaac Newton, who was the Warden of the Royal Mint at the time.
By 1900, over 50 other countries were following suit and adopting the same standard. With more and more nations issuing paper currency backed by gold reserves, gold became increasingly marketable – and therefore more valuable.
Money now had gold backing, as gold had been freely chosen by the markets as the best store of value.
The Gold Standard:
- Different currencies were simply different weights of physical gold, and the exchange rate between one nation’s currency and the other was the simple conversion between different weight units, as straightforward as converting inches to centimeters.
- In the same way metric and imperial units are just a way to measure the underlying length, national currencies were just a way to measure economic value as represented in the universal store of value, gold. Some countries’ gold coins were fairly salable in other countries, as they were just gold. Each country’s money supply was not a metric to be determined by central planning committees stocked with Ph.D. holders, but the natural working of the market system.
- While gold was very hard money, the instruments used for settlements of payments between central banks, although nominally redeemable in gold, ended up in practice being easier to produce than gold.
- These two flaws meant that the gold standard was always vulnerable to a run on gold in any country where circumstances might lead a large enough percentage of the population to demand redemption of their paper money in gold.
- The fatal flaw of the gold standard at the heart of these two problems was that settlement in physical gold is cumbersome, expensive, and insecure, which meant it had to rely on centralising physical gold reserves in a few locations-banks and central banks-leaving them vulnerable to being taken over by governments.
- As the number of payments and settlements conducted in physical gold became an infinitely smaller fraction of all payments, the banks and central banks holding the gold could create money unbacked by physical gold and use it for settlement.

To finance their war efforts, European countries devalued their currencies

Emperor Julius Caesar issued an eight-gram gold coin called the “aureus” in the first century CE. This coin was used throughout the Roman Empire for payment. As growth in the Empire slowed, rulers began “coin clipping,” which involved removing part of the precious metal contained in coins in order to enhance the government’s spending power. Sounds easy, doesn’t it? Perhaps, but it eventually led to inflation and economic crises that ultimately led to the downfall of the once-mighty Roman Empire.
The gold standard, however, had one major flaw: the gold had to be stored in a few bank vaults. As a result, paper money was exchanged for gold, but it also created a highly centralized system in which governments controlled the value of paper money.
It is always possible to increase the amount of money without correspondingly increasing the amount of gold. The salability of paper money rests entirely with them.
Nearly all of the major European powers took advantage of this opportunity in 1914. They were in need of cash to fund their war efforts. Instead of raising taxes, they simply printed new money in the manner of the Romans.
The new money wasn’t backed by gold, and the banks didn’t replenish their gold vaults while new notes and bills were printed.
Within weeks, the countries fighting the First World War had suspended paper money’s convertibility into gold. This was the end of the gold standard.
Two things happened as a result. First, this source of ready cash allowed governments to continue funding their war efforts for four more bloodied years. The second result of this money-printing spree was to seriously undermine the price of existing currencies.
Due to Switzerland’s neutrality and refusal to participate in the war, the Austro-Hungarian krone fell by 68.9 percent against the Swiss franc. In postwar Europe, both of these factors played a major role in shaping the economy.
There are three fundamental reasons that drive the relationship between unsound money and war.
- First, unsound money is itself a barrier to trade between countries. because it distorts value between the countries and makes trade flows a political issue, creating animosity and enmity between governments and populations.
- Second, government having access to a printing press allows it to continue fighting until it completely destroys the value of its currency, and not just until it runs out of money. With sound money, the government’s war effort was limited by the taxes it could collect. With unsound money, it is restrained by how much money it can create before the currency is destroyed, making it able to appropriate wealth far more easily.
- Third, individuals dealing with sound money develop a lower time preference, allowing them to think more of cooperation rather than conflict,

After the First World War, gold-backed money gave way to government-backed money

As the First World War came to an end in 1918, the European powers involved in the conflict were faced with the thorny task of revaluing their currencies.
The obvious solution was to return to the gold standard, but a fair revaluation would have meant admitting how little currencies are worth today.
There was no way to return to the old exchange rates, either, as this would have overvalued paper currencies. Citizens would have demanded gold for their paper receipts, gold they could have sold abroad for a profit.
The governments chose to use fiat money instead of gold as a reserve currency. With the advent of fiat money, governments began to intervene in the economy in an attempt to stabilize their currencies, creating an era of unsound money.
After the Second World War ended in 1944, the victorious nations began planning the postwar economic order. The Bretton Woods system was named after the small village in New Hampshire where they signed their agreement.
It was envisioned that all of the world’s currencies would be pegged to the US dollar at a fixed rate of exchange. In turn, the dollar would be linked to the value of gold at a fixed exchange rate.
These exchange rates would be managed by the newly created International Monetary Fund – IMF. The whole system required the transfer of all gold reserves from participating countries to the United States!
Bretton Woods was theoretically similar to the pre-1914 gold standard in that all currencies were ostensibly exchangeable for gold. However, this was not exactly the case.
To fund economic expansion, the United States bent the rules and inflated its own currency compared to gold, while other nations inflated their currencies compared to the dollar.
Gold was completely abandoned as a standard once the pretense was dropped. It simply wasn’t possible to keep a rapidly inflating currency tied to gold.
According to President Nixon, dollars will no longer be convertible into gold as of August 15, 1971. Now, the value of currencies will be determined by the interaction between the world’s major fiat currencies.
As we will see in the following insight, the results would be disastrous.
The problems with moving from the Gold Standard:
- The automatic adjustment mechanisms of the gold standard had always provided a constant measuring rod against which all economic activity was measured, but the floating currencies gave the world economy imbalances.
- The International Monetary Fund’s role was to perform an impossible balancing act between all the world’s governments to attempt to find some form of stability or “equilibrium” in this mess, keeping exchange rates within some arbitrary range of predetermined values while trade and capital flows were moving and altering them. But without a stable unit of account for the global economy, this was a task as hopeless as attempting to build a house with an elastic measuring tape whose own length varied every time it was used.
- Only governments could redeem their dollars in gold from the United States, but that was to prove far more complicated than expected. Today, each ounce of gold for which foreign central banks received $35 is worth in excess of $1,200.
- With its currency distributed all over the world, and central banks having to hold it as a reserve to trade with one another, the U.S. government could accrue significant seniorage from expanding the supply of dollars, and also had no reason to worry about running a balance of payment deficit. French economist Jacques Reuff coined the phrase “deficit without tears’” to describe the new economic reality that the United States inhabited, where it could purchase whatever it wanted from the world and finance it through debt monetised by inflating the currency that the entire world
- This move by President Nixon completed the process begun with World War I, transforming the world economy from a global gold standard to a standard based on several government-issued currencies. For a world that was growing increasingly globalised along with advancements in transportation and telecommunications, freely fluctuating exchange rates constituted what Hoppe termed “a system of partial bartering” things from people who lived on the other side of imaginary lines in the sand now required utilizing more than one medium of exchange and reignited the age-old problem of lack of coincidence of wants.
- The seller does not want the currency held by the buyer, and so the buyer must purchase another currency first, and incur conversion costs. As advances in transportation and telecommunications continue to increase global economic integration, the cost of these inefficiencies just keeps getting bigger. The market for foreign exchange, at $5 trillion of daily volume, exists purely as a result of this inefficiency of the absence of a single global homogeneous international currency.
The Return to Gold:
- Although gold was supposedly demonetized fully in 1971, central banks continued to hold significant gold reserves, and only disposed of them slowly, before returning to buying gold in the last decade. Even as central banks repeatedly declared the end of gold’s monetary role, their actions in maintaining their gold reserves ring truer. From a monetary competition perspective, keeping gold reserves is a perfectly rational decision. Keeping reserves in foreign governments’
- easy money only will cause the value of the country’s currency to devalue along with the reserve currencies, while the seniorage accrues to the issuer of the reserve currency, not the nation’s central bank,
- Contrary to the most egregiously erroneous and central tenet of the state theory of money, it was not government that decreed gold as money; rather, it is only by holding gold that governments could get their money to be accepted at all.

A functioning economy depends on sound money

The nineteenth century was the heyday of sound money. The free market adopted gold as a store of value because of its qualities that made it such an effective store of value. As a result, a period of prosperity ensued. Let’s examine how that happened.
The first benefit of sound money is that it encourages people to save and invest – the perfect recipe for sustainable, long-term growth. How?
The human brain is wired for instant gratification over future gratification: we prefer the former to the latter. It is sound money that encourages us to consider the future.
Since we might reasonably expect our money’s value to rise over time, it makes sense to consider what we can do right now to maximize our income in the future.
That is what investing is all about – delaying gratification today for a greater reward tomorrow. This leads to capital accumulation. The money is invested into capital goods, commodities that will be used to create other goods and revenue streams in the future. There is a greater likelihood of long-term, stable economic growth when there is more capital accumulation.
Money that is unsound distorts capital accumulation. Here’s why. The government’s manipulation of the money supply, for example by manipulating interest rates, also affects prices.
It’s a problem because prices provide investors with the information they need to make wise decisions without having to study every little detail about global affairs.
Malaysian businesswoman who decides not to expand her offices due to escalating copper wiring costs doesn’t need to know the price spike is the result of the recent earthquake in Chile. She knows by looking at the price.
Government intervention, however, has meant that prices do not reflect market movements. The lack of information distorts capital accumulation, as investors do not have the information they need.
The Problem with Socialism:
- In a socialist system, government owns and controls the means of production, making it at once the sole buyer and seller of all capital goods in the economy. That centralization stifles the functioning of an actual market, making sound decisions based on prices impossible.
- Without a market for capital where independent actors can bid for capital, there can be no price for capital overall or for individual capital goods. Without prices of capital goods reflecting their relative supply and demand, there is no rational way of determining the most productive uses of capital, nor is there a rational way of determining how much to produce of each capital good. In a world in which the government owns the steel factory, as well as all the factories that will utilize steel in the production of various consumer and capital goods, there can be no price emerging for steel, or for the goods it is used to produce, and hence, no possible way of knowing which uses of steel are the most important and valuable.
Resources and production:
- The only limited resource is human time. Each human has a limited time on earth, and that is the only scarcity we deal with as individuals. As a society, our only scarcity is in the total amount of time available to members of a society to produce different goods and services. More of any good can always be produced if human time goes toward it. The real cost of a good, then, is always its opportunity cost in terms of goods forgone to produce it.
- The limit on how much we can produce of each of those metals, however, remains the opportunity cost of their production relative to one another, and not their absolute quantity. There is no better evidence for this than the fact that the rarest metal in the crust of the earth, gold, has been mined for thousands of years and continues to be mined in increasing quantities as technology advances over time.
- It is a misnomer to call raw materials resources, because humans are not passive consumers of manna from heaven. Raw materials are always the product of human labor and ingenuity and thus humans are the ultimate resource, because human time, effort, and ingenuity can always be used to produce more output.
- The eternal dilemma humans face with their time concerns how to store the value they produce with their time through the future. While human time is finite, everything else is practically infinite, and more of it can be produced if more human time is directed at it. Whatever object humans chose as a store of value, its value would rise, and because more of the object can always be made, others would produce more of the object to acquire the value stored in it.
Government intervention and Money:
- Government is immune to the concept of opportunity costs, and rarely are the negative results of government intervention in economic activity even considered, and if they are, it is only to justify even more government intervention.
- With no standard of value to allow an international price mechanism to exist, and with governments increasingly captured by statist and isolationist impulses, currency manipulation emerged as a tool of trade policy, with countries seeking to devalue their currencies in order to give their exporters an advantage.
- More trade barriers were erected, and economic nationalism became the ethos of that era, with predictably disastrous consequences. The nations that had prospered together 40 years earlier, trading under one universal gold standard, now had large monetary and trade barriers between them, loud populist leaders who blamed all their failures on other nations, and a rising tide of hateful nationalism.
- When money was nationalized, it was placed under the command of politicians who operate over short time-horizons of a few years, trying their best to get reelected. It was only natural that such a process would lead to short-term decision making where politicians abuse the currency to fund their reelection campaigns at the expense of future generations. As H. L. Mencken put it: “Every election is an advanced auction on stolen goods.”
- This brings us to the current state of affairs in the global economy, where most governments attempt to devalue their currencies in order to boost their exports, and all complain about one anothers “unfair” manipulation of their currencies. Effectively, each country is impoverishing its citizens in order to boost its exporters and raise GDP numbers, and complaining when other countries do the same.
- The economic ignorance is only matched by the mendacious hypocrisy of the politicians and economists parroting these lines. International economic summits are convened where world leaders try to negotiate each others acceptable currency devaluation, making the value of the currency an issue of geopolitical importance.
Keynesian fallacies:
- Thanks to the popularity of the most dangerous and absurd of all Keynesian fallacies, the notion that government spending on military effort would aid economic recovery.
- All spending is spending, in the naive economics of Keynesians, and so it matters not if that spending comes from individuals feeding their families or governments murdering foreigners: it all counts in aggregate demand and it all reduces unemployment! As an increasing number of people went hungry during the depression, all major governments spent generously on arming themselves, and the result was a return to the senseless destruction of three decades earlier.
- For Keynesian economists, the war was what caused economic recovery, and if one looked at life merely through the lens of statistical aggregates collected by government bureaucrats, such a ridiculous notion is tenable.
Consumption is key:
- The twentieth century’s binge on conspicuous consumption cannot be understood separately from the destruction of sound money and the outbreak of Keynesian high-time-preference thinking, in vilifying savings and deifying consumption as the key to economic prosperity.
- The reduced incentive to save is mirrored with an increased incentive to spend, and with interest rates regularly manipulated downwards and banks able to issue more credit than ever, lending stopped being restricted to investment, but has moved on to consumption. Credit cards and consumer loans allow individuals to borrow for the sake of consumption without even the pretense of performing investment in the future.
Time preferences of Money:
- The reduction in the purchasing power of money is similar to a form of taxation or expropriation, reducing the real value of one’s money even while the nominal value is constant. In modern economies government-issued money is inextricably linked to artificially lower interest rates, which is a desirable goal for modern economists because it promotes borrowing and investing. But the effect of this manipulation of the price of capital is to artificially reduce the interest rate that accrues to savers and investors, as well as the one paid by borrowers. The natural implication of this process is to reduce savings and increase borrowing.
- At the margin, individuals will consume more of their income and borrow more against the future. This will not just have implications on their time preference in financial decisions; it will likely reflect on everything in their lives.
- The move from money that holds its value or appreciates to money that loses its value is very significant in the long run: society saves less, accumulates less capital, and possibly begins to consume capital; worker productivity stays constant or declines, resulting in the stagnation of real wages, even if nominal wages can be made to increase its through the magical power of printing ever more depreciating pie of paper money. As people start spending more and saving less, ue become more present-oriented in all their decision making, resulting in moral failings and a likelihood to engage in conflict and destructive and self-destructive behavior.
Interest rates and misallocation of capital:
- Whenever a government has started on the path of inflating the money supply, there is no escaping the negative consequences. If the central bank stops the inflation, interest rates rise, and a recession follows as many of the projects that were started are exposed as unprofitable and have to be abandoned, exposing the misallocation of resources and capital that took place.
- If the central bank were to continue its inflationary process indefinitely, it would just increase the scale of misallocations in the economy, wasting even more capital and making the inevitable recession even more painful. There is no escape from paying a hefty bill for the supposed free lunch that Keynesian cranks foisted upon us.

Unsound money results in recessions and debt

During the First World War, European governments implemented unsound-money policies that created all kinds of problems. Among them were recessions and an endless accumulation of debt. Find out why in this insight.
Let’s start by talking about recessions. Central planning is one form of government interference in the market. But there’s a catch.
An economy can never be understood by a single person, agency, or department as a result of all the preferences, choices, costs, and resources that go into it.
In the absence of this information, you will likely make bad decisions, and this is precisely what governments do when they manipulate the money supply. Markets are distorted by their interventions, especially capital markets, creating a “boom and bust” cycle.
When prices are artificially inflated during the upcycle, investors think they can buy more capital than they can afford. As a result, the economy goes into recession after the boom bursts.
Debt is another issue. Let’s take a look at how unsound money caused the Great Depression in the 1930s to become indebted. Keynesian policies were increasingly adopted by governments during that time. Keynes’ followers, the “Keynesians,” believe recessions occur when total spending is too low in an economy. Spending increases are the best response to recessions, they argued.
What are your methods for doing that? You could lower taxes, but people usually don’t spend their extra cash. Another option would be for the government to provide the cash.
Tax increases are difficult during a recession, so governments increase the money supply instead. People then spend more money as a result of this.
Do you remember the previous insight on time preferences? People tend to focus on the present when there is so much money flowing around.
As savings become less appealing, opportunistic investments become more prevalent. People soon find themselves deep in debt.
The result is an endless crisis. Keynesianism makes things worse when the government intervenes. However, there is an alternative. A return to sound money would be beneficial. The new technology of Bitcoin might just make it possible.
Credit Creation:
- Credit creation by central banks causes unsustainable booms by allowing the financing of unprofitable projects and allowing them to continue consuming resources on unproductive activities.
- In a sound monetary system, any business that survives does so by offering value to society, by receiving a higher revenue for its products than the costs it incurs for its inputs. The business is productive because it transforms inputs of a certain market price into outputs with a higher market price. Any firm that produces outputs valued at less than its inputs would go out of business, its resources freed up to be used by other, more productive firms, in what economist Joseph Schumpeter termed creative destruction.
- The test of the free market is suspended as central bank direction of credit can overrule the economic reality of profit and loss.

The scarcity of Bitcoin makes it unique

After decades of reckless spending and debt accumulation, it’s time for governments to return to sound-money policies. That’s where Bitcoin comes into play.
How exactly can the world’s first digital currency help put economies back on track, stabilize and grow?
Think of the gold standard. Gold is a top choice for storing value for two reasons: it’s scarce and predictable, which means the supply can’t increase enough to significantly deflate its value. Bitcoin has similar characteristics. In fact, its supply cannot increase. It is impossible to have more than 21,000,000 individual bitcoins, no matter what else happens. Once 21,000,000 bitcoins are in circulation, no more will be created.
Creating bitcoins in this way also leads to stability since the currency’s supply continues to decrease constantly. To see how that works, read on.
A bitcoin is created by mining it. Bitcoin network computers pool their processing power to solve complex algorithms to access new coins.
As a reward for solving these puzzles, the “miners” – the computers that helped solve the puzzle – receive bitcoins. Satoshi Nakamoto, the creator of Bitcoin, built in a failsafe – the number of bitcoins issued is halved every four years in order to prevent online gold rushes.
And what’s the cherry on top? The algorithmic problems become increasingly challenging as the number of computers working on them rises, ensuring a steady and reliable supply, much like the increasing difficulty of mining gold keeps gold supply steady and reliable.
Until 2140, bitcoin will continue to be minted in ever-smaller amounts, after which no more coins will be minted.
Bitcoins are unique because of that. The only good that is characterized by absolute scarcity is Bitcoins.
Contrast that with conventional commodities like oil. It’s true that they are scarce, but by investing the necessary resources we might be able to find new sources.
Despite our ever-increasing oil consumption, proven oil reserves globally are increasing! Bitcoin is a radically different concept.
The algorithmically programmed supply of coins cannot be exceeded by the amount of time or resources available. The result is that bitcoin cannot be devalued by manipulating its supply, making it a perfect store of value.

Bitcoin is unique because of its security

It’s not just the scarcity of the unit in which its value is stored that makes sound money. Security is also important. You’re likely to turn to an alternative if you’re not absolutely convinced that bitcoins are safe. Bitcoins are extremely secure.
That’s because Bitcoin relies on a new technology called the public blockchain. What is the public blockchain? An algorithmic puzzle is cracked when a mining computer creates a block. Blocks are essentially records of recent transactions and mining activity. Adding each new block to the Bitcoin blockchain creates a chain.
Every Bitcoin transaction is recorded on this chain. What’s more, all that information is available to everyone on the network. A bitcoin’s ownership can only be established once it’s registered on the blockchain, which is only possible if a majority of network users approve it.
Consequently, Bitcoin is entirely self-contained; transaction oversight is not required by a central authority. Additionally, it makes it easier to verify transactions, which gives greater security.
Fraudsters must invest significant processing power into creating a fraudulent block – and Nakamoto’s difficulty adjustment will make it even more difficult as bitcoin becomes more popular.
Verifying new blocks, however, takes almost no energy. Most nodes can simply refuse a suspect block without affecting their processing power.
Stacking the odds against cheating makes it a very effective fail-safe. In the end, a user would gain very little even if they spent vast amounts of energy and managed to hack a majority of all network nodes.
Breaking bitcoin’s security would undermine trust in the network, leading to a drop in demand and value. Talk about severing your nose from your face!

Bitcoin could become the new standard, despite its challenges

Bitcoin is both scarce and secure, but is that enough to make it anything more than a passing fad? I think the answer depends on how well it can master a few major challenges.
Consider price volatility. A bitcoin was worth $0.000994 US dollars when it was first used to complete a transaction in May 2010.
In October 2017, it had risen to $4,200, an increase of 422,520,000 percent! That’s just the long-term volatility. Bitcoin’s value jumped from $750 to $20,000 in 2017 alone. This is a result of fluctuating demand.
The supply of bitcoins is fixed, so the currency responds to interest only through price increases. The demand for bitcoins is wildly variable due to its newness.
As a result, the currency has lost its status as an effective store of value. Will the situation improve? As the market grows, these fluctuations should even out, according to the author.
We now come to the second challenge Bitcoin faces. To become a standard, the currency must grow; however, growth, even for Bitcoin, would ultimately depend upon an increasing reliance on large, centralized institutions. If a currency’s aim is to provide people with an exchange system without relying on government-approved third parties, such as banks, then that’s a problem.
Unfortunately, there isn’t a way to square this circle. Bitcoin currently has a limit of 500,000 transactions per day. Although the daily cap could be increased, there is no way to avoid the fact that there will be a daily cap. Cost is another issue. With more transactions taking place, there will be more nodes required.
By doing so, the Bitcoin ledger needs to be updated more frequently, which increases fees and processing power required to process them.
Taking bitcoin trade off the blockchain – in other words, trading in bitcoin-backed currencies – is a pretty compelling case.
A new standard would be created, but it would also require the creation of centralized institutions to manage it.
With Bitcoin, it may be possible to establish a modern sound-money policy. Nevertheless, one question looms over its future: can it evade the fate of the gold standard? It remains to be seen.
The motivation of Bitcoin is a “purely peer-to-peer form of electronic cash” that doesn’t require trust in third parties and whose supply can’t be altered. Satoshi Nakamoto, the pseudonymous creator of Bitcoin, achieved this goal through four key technologies: a distributed peer-to-peer network, hashing, digital signatures and proof of work.
The Growth of Altcoins:
- The growth of these altcoins cannot be understood outside the context of easy government money looking for easy investment, forming large bubbles in massive malinvestments.
- This is why virtually all altcoins have a team in charge; they began the project, marketed it, designed the marketing material, and plugged press releases into the press as if they were news items, while also having the advantage of mining a large number of coins early before anybody had heard of the coins.
- These teams are publicly known individuals, and no matter how hard they might try, they cannot demonstrate credibly that they bave no control over the direction of the currency, which undermines any claims other currencies might have to being a form of digital cash that cannot be edited or controlled by any third party.
Bitcoin as a reserve currency:
- As Bitcoin continues to evolve in the direction of having a higher market value with higher transaction fees, it starts to look more and more like a reserve currency than a currency for everyday trading and transactions.
- Bitcoin is scaling through an increase in the value of on-chain transactions, not through a rise of their number. More and more transactions are being carried out off-chain, settled on exchanges or websites that handle Bitcoin, turning Bitcoin into more of a settlement network than a direct payment network.
- If this analysis is correct, and Bitcoin continues to grow in value and off-chain transactions while on-chain transactions do not grow as much, Bitcoin would be better understood as cash in the old meaning of the term, similar to gold cash reserves, rather than the modern term for cash as paper money for small transactions.
- Bitcoin can be seen as the new emerging reserve currency for online transactions, where the online equivalent of banks will issue Bitcoin-backed tokens to users while keeping their hoard of Bitcoins in cold storage, with each individual being able to audit in real time the holdings of the intermediary, and with online verification and reputation systems able to verify that no inflation is taking place. This would allow an infinite number of transactions to be carried out online without having to pay the high transaction fees for on-chain transactions.
- Based on the foregoing analysis, the real advantage of Bitcoin lies in it being a reliable long-term store of value, and a sovereign form of money that allows individuals to conduct permissionless transactions. Bitcoin’s main uses in the foreseeable future will follow from these competitive advantages, and not from its ability to offer ubiquitous or cheap transactions.
Verification > Trust:
- Bitcoin can thus be understood as a technology that converts electricity to truthful records through the expenditure of processing power.
- Those who expend this electricity are rewarded with the bitcoin currency, and so they have a strong incentive to maintain its integrity. As a result of attaching a strong economic incentive for honesty, Bitcoin’s ledger has been practically incorruptible for the period of its operation so far, with no example of a successful double-spend attack on a confirmed transaction.
- This integrity of the bitcoin ledger of transactions is achieved without having to rely on any single party being honest. By relying entirely on verification, Bitcoin dooms fraudulent transactions to failure and obviates the need for trust in anyone for transactions to be completed.
- In other words, Bitcoin is a system built entirely on cumbersome and expensive verification so it can eliminate the need for any trust or accountability between all parties: it is 100% verification and 0% trust.
key benefits
- store of value
  - “Bitcoin’s immutable monetary supply makes it the best medium to store value produced from the limited human time, thus making it arguably the best store of value humanity has ever created.”
  - No matter how many users adopt it, no matter the price, and no matter the technological innovation, there will always only be 21 million Bitcoin. The only way to address growing demand is therefore via price appreciation.
  - “Bitcoin serves as a monetary lifeboat for people forced to transact in monetary media constantly debased by governments.”
- Individual Sovereignty
  - Any holder of Bitcoin can send value without asking for the permission of anyone. Through a distributed peer-to-peer network, there is no central coordinator.
  - Unlike gold, Bitcoin cannot be destroyed or confiscated by political or criminal interests
- international & online settlement
  - Bitcoin offers a new way of carrying out international settlement that has no reliance on intermediaries and operates outside the regular financial infrastructure.
  - Gold, on the other hand, is difficult to move around the world, for risk of confiscation or theft. With Bitcoin, there is also no counterparty risk. It is separated from any individual country’s economy.
- global unit of account
  - For now, it is likely to remain a volatile, rapidly appreciating asset. But it should it become an established prime choice for payment, should it stabilise, its technological and monetary characteristics suggest it is a serious rival to globally established fiat currencies.
  - Bitcoin meets all the salability criteria of sound money. Through its divisible characteristics, it is highly salable across scales. Through its digital characteristics, it is highly salable across space. And through its monetary characteristics, it is highly salable across time. With widespread adoption, it may have the potential to become the chosen global unit of account.

Quotes

“Bitcoin’s immutable monetary supply makes it the best medium to store value produced from the limited human time, thus making it arguably the best store of value humanity has ever created.”

“Bitcoin serves as a monetary lifeboat for people forced to transact in monetary media constantly debased by governments.”

Civilization is not about more capital accumulation per se; rather, it is about what capital accumulation allows humans to achieve, the flourishing and freedom to seek higher meaning in life when their base needs are met and most pressing dangers averted.

Bitcoin can be best understood as distributed software that allows for transfer of value using a currency protected from unexpected inflation without relying on trusted third parties. In other words, Bitcoin automates the functions of a modern central bank and makes them predictable and virtually immutable by programming them into code decentralized among thousands of network members, none of whom can alter the code without the consent of the rest.

Sound money allows people to think about the long-term and to save and invest more for the future. Saving and investing for the long run are the key to capital accumulation and the advance of human civilization.

The larger the market, the more the opportunities for specialization and exchange, but also the bigger the problem of coincidence of wants—what you want to acquire is produced by someone who doesn’t want what you have to sell.

the key property that leads to a good being adopted freely as money on the market, and that is salability—the ease with which a good can be sold on the market whenever its holder desires, with the least loss in its price.

easy money trap: anything used as a store of value will have its supply increased, and anything whose supply can be easily increased will destroy the wealth of those who used it as a store of value. Note: As more people store value in a form of money there is an incentive to increase the flow/supply which makes it a worse store of value

A one‐time collapse in the value of a monetary medium is tragic, but at least it is over quickly and its holders can begin trading, saving, and calculating with a new one. But a slow drain of its monetary value over time will slowly transfer the wealth of its holders to those who can produce the medium at a low cost. This is a lesson worth remembering when we turn to the discussion of the soundness of government money in the later parts of the book.

Coin clipping reduced the aureus’s real value, increasing the money supply, allowing the emperor to continue imprudent overspending, but eventually resulting in inflation and economic crises, which the misguided emperors would attempt to ameliorate via further coin clipping. Ferdinand Lips summarizes this process with a lesson to modern readers: It should be of interest to modern Keynesian economists, as well as to the present generation of investors, that although the emperors of Rome frantically tried to “manage” their economies, they only succeeded in making matters worse. Price and wage controls and legal tender laws were passed, but it was like trying to hold back the tides. Rioting, corruption, lawlessness and a mindless mania for speculation and gambling engulfed the empire like a plague. With money so unreliable and debased, speculation in commodities became far more attractive than producing them.

The fatal flaw of the gold standard at the heart of these two problems was that settlement in physical gold is cumbersome, expensive, and insecure, which meant it had to rely on centralizing physical gold reserves in a few locations—banks and central banks—leaving them vulnerable to being taken over by governments.

With the simple suspension of gold redeemability, governments’ war efforts were no longer limited to the money that they had in their own treasuries, but extended virtually to the entire wealth of the population

The U.S. Fed’s inflationary policy ended by the end of 1928, at which point the U.S. economy was ripe for the inevitable collapse that follows from the suspension of inflationism.

state of the economy is determined by the lever of aggregate spending, and any rise in unemployment or slowdown in production had no underlying causes in the structure of production or in the distortion of markets by central planners; rather it was all a shortage of spending, and the remedy is the debauching of the currency and the increase of government spending. Saving reduces spending and because spending is all that matters, government must do all it can to deter its citizens from saving. Imports drive workers out of work, so spending increases must go on domestic goods.

the importance of sound money can be explained for three broad reasons: first, it protects value across time, which gives people a bigger incentive to think of their future, and lowers their time preference. The lowering of the time preference is what initiates the process of human civilization and allows for humans to cooperate, prosper, and live in peace. Second, sound money allows for trade to be based on a stable unit of measurement, facilitating ever‐larger markets, free from government control and coercion, and with free trade comes peace and prosperity. Further, a unit of account is essential for all forms of economic calculation and planning, and unsound money makes economic calculation unreliable and is the root cause of economic recessions and crises.

delay his gratification to engage in risky production over a longer period of time is that these longer processes will generate more output and superior goods. In other words, investment raises the productivity of the producer.

increases in the money supply effectively mean low interest rates, the incentive to save and invest is diminished while the incentive to borrow increases.

In a free market economic system, prices are knowledge, and the signals that communicate information.

Scarcity is the fundamental starting point of all economics, and its most important implication is the notion that everything has an opportunity cost. In the capital market, the opportunity cost of capital is forgone consumption, and the opportunity cost of consumption is forgone capital investment.

In a free market for money, individuals would choose the currencies they want to use, and the result would be that they would choose the currency with the reliably lowest stock‐to‐flow ratio. This currency would oscillate the least with changes in demand and supply, and it would become a globally sought medium of exchange, allowing all economic calculation to be carried out with it, becoming a common unit of measure across time and space.

In a society of sound money, there are no liquidity concerns over the failure of a bank, as all banks hold all their deposits on hand, and have investments of matched maturity. In other words, there is no distinction between illiquidity and insolvency, and there is no systemic risk that could make any bank “too big to fail.” A bank that fails is the problem of its shareholders and lenders, and nobody else.

The security of Bitcoin lies in the asymmetry between the cost of solving the proof‐of‐work necessary to commit a transaction to the ledger and the cost of verifying its validity. It costs ever‐increasing quantities of electricity and processing power to record transactions, but the cost of verifying the validity of the transactions is close to zero and will remain at that level no matter how much Bitcoin grows. To try to commit fraudulent transactions to the Bitcoin ledger is to deliberately waste resources on solving the proof‐of‐work only to watch nodes reject it at almost no cost, thereby withholding the block reward from the miner.

It is perhaps one of the most remarkable achievements of the Internet that an online economy that spontaneously and voluntarily emerged around a network designed by an anonymous programmer has grown, in nine years, to hold more value than is held in the money supply of most nation‐states and national currencies.

the fundamental driver of human progress is not raw materials, but technological solutions to problems. Technology is by its nature both a non‐excludable good (meaning that once one person invents something, all others can copy it and benefit from it) and a non‐rival good (meaning that a person benefiting from an invention does not reduce the utility that accrues to others who use it).

the Bitcoin coders face a strong incentive to abide by consensus rules if they are to have their code adopted. The miners have to abide by the network consensus rules to receive compensation for the resources they spend on proof‐of‐work. The network members face a strong incentive to remain on the consensus rules to ensure they can clear their transactions on the network.

The coordination problem of organizing a simultaneous shift among people with adversarial interests, many of whom are strongly vested in the notion of immutability for its own sake, is likely intractable barring any pressing reason for people to move away from current implementations.