Sound Money: A Primer to Bitcoin

Prepared by Alex Harvey, Joseph Kendzicky, and Pietro Moran

Money is central to our lives; whether it’s buying food or saving for a house or college, it is the process of earning, spending, and saving money that allows us to interact with one another in a market system. As a means of engaging in economic activity, money is profoundly important to society, yet many have difficulty describing and understanding it. Some widespread misconceptions pertaining to money pervade common thinking. It is widely believed that money exists due to government sponsorship and acceptance, and that it is backed by gold. Such fallacies result from a system where monetary manipulation is possible, tricking users to believe that the paper in their wallets is a secure form of value. Through explication and analysis of past and current monetary regimes, the logic of these widespread fallacies is debunked in exchange for sounder theory. The resulting findings introduce the need for an alternative that better allows the average citizen control over their money; this innovation is found in the form of cryptocurrency, which has the potential to store value for users and facilitate exchange in the digital world.[1]

Money: A Brief History

Money at its most primitive is to allow for individuals with subjective and ordinal utility functions to assign their preferences to other goods in the market. Conveying that information to other market participants is what allows for trade. The end state of affairs is people exchanging for goods and services that they individually assign separate values to. Money is analogous to language; words are used to express feelings and ideas while money is used as a common language to express how we value goods, services, and anything else the human mind can fathom. Sound money is the best tool we have at signaling consumer preference. By having a targeted and efficient means of relaying consumer demand, producers can concentrate efforts towards goods and services consumers value the most, resulting in effective production, cooperation, capital accumulation, and trade. More significantly, sound money is a powerful hedge against counterparty risk, as the ability of a coercive state to create money can give it undue power over its subjects, power which by its very nature will attract unscrupulous actors.[2]

Gold’s widespread adoption and practically universal acceptance as a global medium largely stem from unique qualities that make it suitable as sound money. The transportability of gold allows it to be moved across vast stretches of land with limited strain. Its durability and uniqueness as one of the purest elements on the planet makes it difficult to counterfeit, while its divisibility allows us to assign various units of account and deterministically measure value. Gold is also fungible, meaning that denominations of equivalent weight hold consistency in value and purchasing power. Gold benefits from a uniquely high stock to flow ratio, defined as a measurement of the outstanding supply against the cost of production in a given timeframe. Gold having the highest, and most optimal stock to flow ratio has made it an irreplaceable measure of value.[3] Historically gold offers the most secure and predictable means of storing value though current price fluctuations may represent the contrary. While public sentiment pertaining to gold may have changed, its intrinsic properties remain a constant.

Optimal stock to flow ratio allows for limited inflation, which ensures value won’t be eroded as a result of over-supply. When a currency is pegged to an underlying asset with high stock to flow such as gold, there is no temptation to print more of it because production can only increase relative to the amount of gold being mined. Gold has been the de-facto reserve asset in modern history because it has had no equal, but it is not immune to competition. As technology increases the scope of the economic community, some of gold’s characteristic qualities no longer give it an edge. For example, there are already problems with gold’s transferability, divisibility and custody. In this digital age, sending gold to someone halfway across the country is quite difficult. Sending a digital payment on the other hand is frictionless. Division of gold into subunits is also challenging. Coins which were once innovative now hold little value in commerce as we tend to conduct more business online and use digital wallets more than physical ones. Custody too is a difficulty; if you have a fortune in gold, keeping it safe in the physical world may prove harder than securing it as lines of code, illustrating gold’s potential replaceability by a digital medium. The evolution of money however didn’t wait for digital innovations to provide a solution, and economies shifted from gold to the paper money predominantly used around the globe.

Countries started using redeemable paper notes as a substitute for carrying large amounts of gold in order to streamline daily commerce. Britain was the first to adopt a modern gold standard in 1717 under the direction of physicist Isaac Newton and would remain on it until 1914. During this time, the economic supremacy of Britain was intrinsically linked to its currency’s peg to a superior monetary standard. Many nations followed suit, collaterally backing their fiat currency; the more nations began to adopt, the stronger gold’s network effect grew. La Belle Epoque ensued, as major European powers rested on the same monetary standard, the result was a period of prosperity and flourishing the world had never before seen. The soundness of the money was reflected in liberalized trade across the world, as different currencies were simply different weights of physical gold, and most importantly, savings rates were increasing across most advanced societies. This allowed for capital appreciation to finance urbanization, industrialization, and vast technological improvements.[4]

By 1914 however, every European country except for Sweden and Switzerland would remove themselves from the Gold Standard. Two catalyzing factors led to this unwinding. First, the temptation for debasement was too strong. Governments with the power over national treasuries could fractionalize their gold reserves, since bullion was centralized and few checks and balances existed to maintain fiscal accountability. Second, most countries held other nation’s currencies on their books, not simply gold. This only further incentivized debasement, as the burden of value loss could be distributed across foreign holders of sovereign currency. As World War I broke out, centralization and lack of transparency surrounding gold reserves allowed governments to drastically expand their credit balances, reducing the value of the outstanding fiat currency.

In order to finance the costs of war, many countries deviated from a hard money standard to a fiat system. The ease with which a government could extract wealth through inflation was more effective and subversive than through coercive taxation. Due to wartime uncertainty and chaos, gold redemptions were suspended. This diversion from policy that ensured currency redemption set the tone for the non-collateralized systems implemented in the late 20th century. In doing so, governments made the fateful choice to move from sound money which had hard asset backing and redeem-ability to unsound money, which could be printed at will. The inflation process was gradual and often lacked transparency, leading to a cognitive disconnect where the public recognized paper money as fixed value. Common people who interfaced with fiat on a daily basis began incorrectly assuming the representative asset as the underlying one, since it still performed the function of exchange for goods and services. This widespread ignorance to the slow value erosion due to inflation allows governments to continue printing more fiat to finance short term objectives, ultimately at the future expense of those denominating their wealth inside the system.[5]

The Great Depression and Monetary Nationalism

Before the eruption of World War II, however, the United States faced one of the most difficult periods of economic turmoil in history, The Great Depression. For various reasons, following World War I, governmental policies ushered in a gross expansion of the money supply and credit, followed by a short economic boom, and a consequential bust. None of these depressions prior to 1929 lasted more than four years, and most were over in two. The Great Depression however, lasted for a dozen years because the government exacerbated its monetary errors with a series of harmful interventions.

The late Murray Rothbard meticulously compiled documents and accounts of the Fed’s inflationary monetary actions prior to 1929 in his America’s Great Depression, Rothbard estimated that the Federal Reserve expanded the money supply by more than 60 percent from mid-1921 to mid-1929. This flood of easy money drove interest rates down, pushed the stock market to new heights, and brought on the “Roaring Twenties”. But by 1929, the Fed choked back the money supply, and raised interest rates. Consequentially, for the next three years, the money supply shrank by 30 percent, wrenching the economy out of its euphoric spending spree, and into a colossal bust. By the time the masses realized the change in Fed policy, it was too late, as a sell stampede led to an impending stock market crash known as “Black Thursday”. Nevertheless, the stock market crash was merely a symptom of the larger problem, for the market rose and fell in near synchronization with Fed policy. [6]

As unemployment grew, and economic turmoil continued, then President Herbert Hoover enacted the Smoot Hawley Tariff, passed in June 1930. The most protectionist legislation in US history, the tariff virtually closed the borders to foreign goods and ignited a vicious international trade war. Citing a foolish belief that increased tariffs will force Americans to buy goods and stimulate the economy, Congress supported the tariff. Foreign counterparts and their workers were obliterated by these protectionist policies and were forced to enact their own domestic trade barriers in response. Foreign nations stopped purchasing American goods, with the agricultural industry being hit particularly hard. Hoover also dramatically boosted government spending for subsidy and relief efforts, increasing the federal governments share of the GNP by one-third between 1930 and 1931. While pouring millions of dollars into the Agricultural sector to artificially stimulate growth, and impeding foreign trade with absurdist tariffs, Hoover also passed the Revenue Act of 1932, in essence, doubling the income tax.[7]

As if ridiculous tariffs and excessive government spending weren’t enough, Hoover’s Revenue Act severely crippled the American taxpayer, with increased estate taxes, gas, and auto taxes. Yet, many historians fallaciously cite Hoover as a laissez faire, non-interventionist. No serious scholar can observe the Hoover administration’s massive economic intervention, and with a straight face, blame free markets as the leading cause of the Great Depression. Nevertheless, many of these obvious economic factors leading to the depression, seem to have been airbrushed from the history books, as FDR’s New Deal and American involvement in World War II are heralded as the saviors of the American economy. The reality stands that FDR’s New Deal only further perpetuated the economic turmoil that already gripped the heart of the nation.

Upon winning the 1932 presidential election in a landslide, Roosevelt passed the New Deal, which in its first year, proposed spending $10 billion, while revenues were only $3 billion. Thus, between 1933 and 1936, government expenditures soared by more than 83 percent as federal debt rose by 73 percent. Two of the most economically dubious elements of FDR’s New Deal are the Agricultural Adjustment Act (AAA), and the National Industrial Recover Act (NIRA). The AAA levied a new tax on agricultural processors and used the revenue to supervise the massive destruction of valuable crops and cattle. Federal agents ensured that entire fields of cotton, wheat, and corn, would be plowed under, and healthy cattle, sheep, and pigs were slaughtered by the millions with hopes of curtailing the supplies and thus raising prices. Furthermore, the NIRA, passed in June 1933, established the National Recovery Administration (NRA) and forced most American manufacturing industries into government mandated cartels. The Act brought on codes that regulated prices and terms of sale, briefly transforming the American economy into a fascist-style regime. Some economists estimate that the NRA increased the cost of doing business by an average of 40 percent, this was certainly not the best remedy for an economy in recovery. [8]

The number of trivial government expenditures during this era would shock even the most unlearned economist. From paying researchers to study the history of the safety pin, to hiring actors to give free shows, and even paying men with government money to chase tumbleweeds on windy days, the incongruity of government intervention knew no bounds. Roosevelt’s next blunder was the passage of the Wagner Act, known as organized labor’s “Magna Carta”. The act took labor disputes out of federal courts and into the hands of a bureaucratic agency, the National Labor Relations Board, who acted as judge, jury and executioner for all cases related to business and labor unions. Along with the Wagner Act, Roosevelt threw constant barrages of insults at business and businessmen, claiming they were obstacles on the road to American recovery. Roosevelt’s relentless attack on business and free enterprise ensured that the free cash need to jumpstart the economy was either taxed away or forced into hiding. [9]

As America sat on the verge of WWII, ten million Americans were still jobless, even though Roosevelt had pledged to end the crisis two presidential terms and countless interventionist policies earlier. While World War II brought destruction and horrors, it also revitalized international trade between allies. This renewed trade aided the struggling American economy, even during wartime efforts. More importantly, the succeeding Truman administration chose to ease the strain on private investors and business, allowing the economy to revert back to equilibrium levels fueling a post war boom. The Great Depression was born from inflationary monetary policy, prolonged by a wall of government intervention in the form of tariffs, taxes, and price-controls, and relieved through the restoration of free markets, not the New Deal and American participation in World War II.

When it comes to sound money, violence and war impose high opportunity costs as free trade and unfettered commerce yield more wealth creation. Yet within modern Keynesian theory, war is viewed as an economic good, due to its power to bolster economic output and stimulate spending. Quantitatively, you can increase GDP by paying people to dig holes in the ground, though in reality that is not a wealth creating exercise that benefits society in any way. Many economists view the economic expenditures allocated toward the war effort during World War II as a positive, lifting us out of the stagnation of the Great Depression. Many fail to recognize the opportunity costs associated with the incredible amounts of human suffering that ensued, coupled with the zero-sum game of destructive economic behavior. We allocate a significant amount of time, energy and capital resources, but end up with negative economic output in the process.[10]

With sound money, government expenditures are limited by the taxes it can collect. With unsound money, it is restrained by how much money it can create before the currency is destroyed, allowing for a much more effective wealth transfer. Throughout the majority of WWI the United States remained neutral in the war effort, participating heavily in capital accumulation and acting as a creditor to its allies. Following the Bretton Woods conference years later, many allied countries opted into a system denominated in gold and USD, contributing hard assets and currency to the IMF in a quota-based system. The system was imperfect as witnessed in the massive trade surpluses afforded the United States. This among other factors led to a gradual movement away from the Bretton Woods system in the following decades.

European countries second guessed their decision to utilize the US dollar as a global reserve, largely due to the U.S.’ inability to resist the temptation to debase the dollar in order to achieve short run prosperity. The United States began engaging in a form of fractional reserve banking on gold, accruing value for themselves at the expense of the rest of the world. In response to growing fears of default, France sent naval carriers across the Atlantic to redeem their dollars for gold. This triggered a domino effect around the globe, and the US found itself in a challenging position. Ultimately, Nixon refused to honor their request and, citing foreign price gougers and assertions that European powers were attempting to tank the American economy, he frantically removed the dollar from the gold standard and replaced the monetary system with a more malleable fiat currency.[11]

In 1996, economist Paul Krugman (Nobel Memorial Prize in Economic Sciences, 2008) summarized the post-Nixon Shock era as follows:

The current world monetary system assigns no special role to gold; indeed, the Federal Reserve is not obliged to tie the dollar to anything. It can print as much or as little money as it deems appropriate. There are powerful advantages to such an unconstrained system. Above all, the Fed is free to respond to actual or threatened recessions by pumping in money. To take only one example, that flexibility is the reason the stock market crash of 1987 — which started out every bit as frightening as that of 1929 — did not cause a slump in the real economy.

Opting for the quick fix solution to a long-term problem, Nixon and his advisers ripped away foundational characteristics of the US dollar, impounded the gold of the public (in exchange for irredeemable notes), and replaced the collateralized monetary system with a system of centrally planned expansionism. This is referred to as the easy money trap; anything used as a store of value will have its supply increased, and anything whose supply can easily be increased will destroy the wealth of those who use it as a store of value. Human civilization flourished in times and places where sound money was widely adopted, while unsound money all too frequently coincides with civilizational decline and societal collapse.

This is not a hyperbolized assertion. Economists Steve Hanke and Charles Bushnell have verified 57 episodes of hyperinflation in history, only one of which occurred before the era of monetary nationalism, and that was the inflation in France in 1795, in the wake of the Mississippi Bubble.[12]

With no stabilizing stock to flow ratio in its way, the Federal Reserve and central banks around the world could print money with ease, affording endless opportunities to government spending, hyperinflation, and credit. Government/fiat money experiences the same instabilities of predecessors (shells, beads and rocks) such that the liability of having its supply expanded is high, leading to quick loss of stability, destruction of purchasing power, and impoverishment of its holders.

Keynes and the Issues of Inflation

Constantly increasing supply means a continuous devaluation of currency, expropriating the wealth of the holders to benefit those who print the currency, and those who receive it earliest. This is termed the Cantillon Effect. The better a form of money is at maintaining its purchasing power into the future, the more it incentivizes people to delay immediate gratification and instead dedicate towards stronger investment vehicles, leading to accumulation of capital and improvement of living standards. The only drivers of economic growth are delayed gratification, saving, and investing, which all prolong the length of the production cycle and increase productivity.[13]

In contrast, the intention of Keynesian economic theory is to facilitate spending and stabilize business cycles. A discounted consequence is that an economy stimulated through Keynesian policy becomes heavily reliant on consumption. Keynes himself argued that “in the long run we are all dead,” noting his preference for short run demand stimulation, and showing blatant disregard for future generations. If consumption is incentivized through inflation then GDP will be biased towards consumption rather than savings. If there are competing uses for dollars, namely consumption or investment, inflationary pressure deviates funds from savings and investments due to the erosion of value over time. This has major effects, namely that capital shifts to short term benefitting uses and long term economic prosperity is hampered. On a long enough time horizon, savings can approach zero which means long term capital investments are few and far between, limiting upward GDP growth. While GDP can still grow in dollar figures, the quality of that output is what is important for increasing the standard of living and ensuring systematic health within the economy.

Without a sound monetary system, the temptation to constantly inflate the money supply to finance short term programs becomes all too strong to resist. What is dangerous about steady deflation is the time lag from policy and its hampering effects on the economy. An expenditure financed through inflation is recognized immediately, but it may take years for the market to react and accurately price currency at its new supply. This works relatively well during periods of growth but fails catastrophically during market corrections. When such policy is implemented on a large enough scale, business become “too big to fail” and evolve into quasi government entities, as visualized in the 2008 financial crisis. So the saying goes: “If you owe the bank $10,000 the bank owns you, if you owe the bank $100 million, you own the bank.” Furthermore, once government attempts to influence or control the economy to a degree, it begets more intervention by tying the health of a government aided industry to the fiscal health of the government.[14]

Creating new pieces of paper and digital entries do not magically increase society’s physical capital stock, it only devalues the existing money supply and distorts price equilibrium. Unsound money is a particularly dangerous tool in the hands of modern democratic governments facing constant re-election pressure. Modern voters are unlikely to favor the candidates who are upfront about the costs and benefits of their schemes. Unsound money dangerously increases the scope of power afforded those in power, accruing them concentrated benefits of short term inflation while dispersing costs on the entire economic system. It is no coincidence that when reviewing the most horrific tyrants of history, one finds that every single one of them operated a system of government-issued money which was constantly inflated to finance often heinous government operations.

Misuse of Debt and Leverage

The misuse of fractional reserve banking has only amplified this problem. Through the money multiplier effect, banks can receive money from individuals, hold on to a small fraction of this capital, and then loan out the rest of the money at a profit, essentially creating money out of thin air. When banks overextend credit markets beyond sustainable risk profiles, there are no ensuing consequences for their misjudgments because their incentive structures have been mis-calibrated by centralized actors. While the fractional reserve system is not inherently destructive, the problem comes with increased government intervention. When the FDIC insures deposit balances and governments bail out banks, the incentive model gets turned on its head. A bank should typically be risk averse because if it fails, it fails its depositors; banks should give out strong loans and keep ample reserves. With this system however, the government is facilitating risky credit, because banks have insurance, and a guarantee of capital injection if they don’t accurately mark their risk. The only way out of the recession is for central banks to “stimulate” the economy through artificially low interest rates (exacerbating the problem) and inflation of the monetary supply, robbing existing monetary holders of their wealth. This treats the symptoms but does nothing to cure the underlying disease. While credit stands as a very important feature of the economy, and one which provides many benefits; the subsequent debt that this system has created is unsustainable, both on an individual and national level.[15]

With the US Total Debt tallying a gargantuan $70T, and Americans taking on more debt than ever to maintain their standard of living, it becomes difficult to foresee an end to this vicious cycle. According to metrics provided by NASDAQ, the total pool of consumer debt has surpassed $1.3 trillion. The median student loan debt for a person who has attended some college or graduated from college is more than $49,000. The average household credit card debt is about $5,000 with the median debt at more than $16,000. Average mortgage debt is nearly $173,000, while personal loans and other miscellaneous debt are more than $10,000 per household. Most shockingly, the total average of debt combined (including those who have no debt at all) is $139,500 per household, while the average amount of liquid assets per household in America, measures at around $5,259. This cultural inclination to take on debt creates an environment of debt slavery, perpetuated by social and market forces which encourage Americans to utilize credit to finance the costs of an ever-inflating standard of living.[16]

While personal, private, institutional, and governmental debt levels are all reaching new heights, federal monetary policy has merely exacerbated the situation. Through its interest rate manipulation, increasing of the money supply, and relaxed policy toward banking giants, the Federal Reserve is complicit in devaluing the currency and weakening our fragile monetary system. During the financial crisis of 2008, FASB Rule 157 was repealed allowing banks to mark bad assets to “face value” making balance sheets much stronger than they appear. This served the purpose of reducing panic in the system, supported “Too Big To Fail” banks, and kept many banks in operation. But if banks are once again so well capitalized, leverage reduced and the economy firing on all cylinders — why is that repeal still in place today? And, if the financial system and economic environment are so strong, then why are Central Banks globally still utilizing “emergency measures” to support their economies? The reason that many of these emergency economic measures are still in place can perhaps best be explained by economics and financial news site Zerohedge who stated,

“It is by now well known that consolidated leverage in the system is at an all-time high, with both the IMF and the IIF calculating in April that total global debt has hit a new all-time high of $237 trillion, up $70 trillion in the past decade, and equivalent to a record 382% of developed and 210% of emerging market GDP.”

Corporate leverage is at an all-time high as well, whether taken as a percentage of GDP or, on a net debt/EBITDA basis. The troubling truth remains, America and the world at large stands on the precipice of an impending economic event, whether it comes in the form of more bailouts and rampant inflationary spending, or in the form of a major market correction, is still to be decided. However, the current state of leverage, illiquidity, spending, and rate manipulation cannot proceed indefinitely, and neither can the nine-year bull market that the NYSE has been riding. ETFs and other passive vehicles have played a significant role fueling this growth, many of which have never been tested during a financial pullback of scale, opening up an entirely new chapter of potential black swan risks.

Look to inflation as another indicator; prices in 2014 were 2566.5% higher than prices in 1900. In other words, $100 in 1900 is equivalent in purchasing power to $2,666.46 in 2014, a difference of $2,566.46 in over 114 years. Inflation is a targeted metric at roughly 2% per year, meaning that any cash position held is being intentionally devalued on a yearly basis. This tax on savings dramatically affects the composition of our economy, encouraging consumption in the short term to outpace value erosion. Maintain that trend over a long enough time horizon, and the value of a singular dollar drops to near zero due to exponential decay.

Bitcoin and Digital Alternatives

With unsettling monetary policy signaling long term instability, it comes as no surprise that the market has introduced a competitive product. In 2009, an anonymous programmer going by the pseudonym Satoshi Nakomoto released a vision for an electronic currency system called Bitcoin. The system consists of features different from traditional electronic money schemes. Payments are done on a peer-to-peer basis without going through a series of intermediate processing parties. No central issuer exists; rather, inflation of new currency is algorithmically embedded into the source code of the software, creating the world’s first deterministic monetary policy. Finally, power is distributed on a horizontal axis, where each individual holds the same degree of sovereignty over their peers. In doing so, users are endowed with total autonomy over their funds. No group, corporation or government can exert censorship over transactions, nor seize user balances. Users act as enforcers of the protocol, relaying transactions that meet the specifications of the software, and refusing those which operate outside the network parameters. Rationally self-interested participants are incentivized to follow the rules through economic motives, instead of reliance on human altruism or coercive force.

Bitcoin’s significance is not classified by its disruption to day-to-day payments, but rather to the concept of money itself. In fact, Bitcoin is far less efficient than most of today’s existing payment infrastructure. When new information needs to be appended to the Bitcoin ledger, that information must be redundantly pushed through each participating server within the network. These nodes must then parse through the data and reach consensual agreement on which transactions they intend to accept and write to the database, and which to reject. In contrast, traditional payment services reach finality very quickly due to their centralized model: “clients” communicate directly with “master” servers, who make ledger alterations without the burdening requirement of universal consensus.

Bitcoin compromises on transactional throughput in exchange for higher degrees of decentralization. Bitcoin prioritizes store of value monetary characteristics in an effort to achieve a form of digital neo-gold. Proponents hope to lead a societal reversion away from systems of easy credit toward hard money fundamentals. Doing so could greatly reduce the overreach of governmental control and allocate freedom back to the individual.

If stocks represent claims on future cash flows of a corporation, money can be described as future claims on value. Money is a piece of social technology which allows us to transform an intangible, subjective good (utility) into a tangible, deterministic one. When two parties engage in trade, both extract value. One party captures a physical good/service immediately, while the other receives a claim on utility redeemable at some point in the future for a good/service of equivalent value. The technological innovation of money created a bearer instrument which not only compartmentalized this intangible value into physical form, but simultaneously eradicated subjectivity by allowing us to measure value mathematically as a unit of account.

When buying a stock, there is no inherent guarantee that the value of future cash flows (in the form of dividends) will outweigh the entry price paid for that share, or even exist at all. The same holds for money. There is no formidable guarantee that the currency unit will store an equivalent denomination of value at a later point in the future. In fact, with today’s monetary models grounded in inflationary policy, we can assert with high conviction that the monetary units we hold in our hand will have definitively less purchasing power at a future interval.

Strong store of value properties are the most critical components to the longevity of a currency. Money illustrates Darwinistic properties. There’s an evolutionary concept for why gold triumphed over its numerous commodity competitors as the de-facto store of value asset. Gold maintains a high stock to flow ratio, is extremely scarce, and impossible to synthesize. It is difficult to increase the float without expending significant amount of time, energy, and capital resources to extract more gold from the ground, all of which have a high opportunity cost. Thus, the cost of production puts a natural upper bound on its flow. Gold’s inability to be inflated easily has proven it to be the best system of money conceived throughout all of history because it hedges against human shortcomings. Nature provides the social scalability which keeps our [economically incentivized] temptations of debasement in check.

While different fiats have come in and out of favor, history illustrates a cyclical pattern of monetary decay over 100–200 year horizons. This systematic process stems from the transitional gains trap where temptation of governments to capitalize on short term economic expenditures and finance unsustainable social/economic programs for re-election points is too great, ultimately at the expense of future generations. Governments prefer inflationary economic models compared to disinflationary/deflationary ones because it is far easier to extract wealth from its citizens. Stripping wealth directly from individuals via taxation often leads to social revolt, but quietly eradicating purchasing power of the monetary supply in slow intervals has proved effective.

Bitcoin has introduced an organic market solution to traditional fiat monetary systems. Much like gold, Bitcoin contains the same “intrinsic properties” of hard money: scarcity, divisibility, portability, durability, recognizability and fungibility. However, Bitcoin has additional advantages compared to gold due to its decentralized and digital components. Gold’s physical clumsiness led to a chokehold of reserves in centralized vaults, allowing governments to confiscate the majority of its supply and issue certificates on a fractional reserve basis. Bitcoin by contrast can be transmitted across borders on a permissionless basis in mere seconds. Digital asset custody can be performed securely on a user autonomous level with relative ease. Furthermore, Bitcoin software is intentionally constructed to be extremely non-burdensome. Users can partake in the full validation process with a standard internet connection and hardware as primitive as a Raspberry Pi.

Most importantly, Bitcoin’s inflation schedule is highly deterministic. New bitcoins come into existence until a permanent hard cap of 21MM is reached, which will occur around 2140. Roughly 80% of the total supply has been injected into the ecosystem, with new liquidity being introduced roughly every 10 minutes. One of the most critical features of the protocol is the difficulty adjustment retargeting, which keeps the inflation schedule pegged in constant time intervals regardless of the computational resources being expended to the mining process. This procedure cannot be said for any other form of commodity extraction.

This prolific digital value exchange has also brought us something else extremely valuable: social scalability. Social scalability, a term coined by world renowned computer scientist Nick Szabo, is the ability of an institution, which typically has rules and incentives that direct patterns of consistency in behavior, to overcome shortcomings in human cognancy and “scale” the degree of interaction between the participants. The higher an institution’s reliance on traditions and customs unique to a specific geographical region, cultural dogma, or religious ideology, the less likely that institution is able to offer the same degree of benefit as the population expands into increasingly diverse population. The famous Dunbar number, often used by psychologists and anthropologists to estimate the number of meaningful relationships a person can adequately maintain, suggests a cognitive limit around 150. Institutions that rely on human altruism alone can often function quite adequately inside these parameters, but falter once this gate is expanded. As more participants are introduced, incumbent members must spend increasing amounts of cognitive resources worrying about behavior of other individuals they are directly exposed to, and how to protect themselves from potential nefarious actions.

Traditional institutions tend to alleviate some of these vulnerabilities by allocating trust into some delegate agency, who in turn use a variety of controls to mitigate counterparty risk for their beneficiaries, concentrating power. Paradoxically, these security frameworks consolidate the level of vulnerability, concentrating it from a generally disparate attack vector to a highly concentrated one. Trust may be reduced in certain areas but it is never fully revoked.

Additionally, institutions require the deployment of a vast range of human-related services in order to invoke trust from its beneficiaries, which often prove to be cognitively and fiscally expensive. The larger the institution expands, the greater its need to deploy further human capital and centralize information silos, increasing the possibilities of exploit. Technology is being used at exponential rates to increase the efficiency of institutions, but it is coming at the expense of security. As sensitive information becomes increasingly centralized to optimize throughput, the economic incentives to attack the system become increasingly motivating.

Cognitive resources are scarce, and thereby expensive. We as humans are good at performing abstract work but are definitively outmatched in comparison to a machine or computer when performing highly focused tasks. Human intelligence remains relatively flatlined, but the power of our computers roughly doubles every two years, while hardware costs subsequently plummet. Even more importantly, the output of a computer is highly predictable and replicable. Blockchains present an interesting value proposition to social scalability by replacing expensive human trust with verifiable, cheap computational power.

This structure comes at a tradeoff to throughput. The Bitcoin blockchain floods the network with loads of information packets that must be transmitted to each node within the ecosystem. Network participants aggregate around a canonical vision of the ledger by performing an astronomically large amount of computational hashing, utilizing an extensive amount of hardware, electricity and bandwidth in the process. On paper, Bitcoin may compartmentalize 1MB worth of transactions in a 10-minute time frame, but the total resource costs are exponentially higher due to system redundancy. In a world categorized by increasing levels of centralization, Satoshi’s radical tradeoff — prioritizing social scalability over computational throughput- seemed offensive to traditional network architects, but nonetheless unlocked a significant amount of hidden value. Institutional independence frees the network from reliance on geographically specific laws/customs, which often end at jurisdictional borders. Even greater, the system extends an open, free and deterministic monetary system to the entire planet, the same way that the internet offered readily and bountiful information to its interface users.

The juxtaposition of these two models becomes apparent when analyzing the effects of new participants- in blockchains, the incentive structures promote higher degrees of security as a larger and more diverse candidate set are added to the network; in trust-based models, the fault tolerance is tested. Satoshi’s legendary tradeoff proved to be brilliant in a world fostering global connectivity and value transfer, by replacing expensive, corruptible bureaucracies with computational integrity. In the end, the tradeoff is net positive. Scarce cognitive resources (reasoning, problem solving, abstract learning) no longer need to be designated towards remedial tasks, tasks which can be performed much more efficiently and with higher certainty guarantees using the technology we implement.

By allowing information to be distributed and transparent, but not altered, and on a trust-free basis, the blockchain is fundamentally changing how we transact, not just financially, but with virtually anything of value. And it could not have come along at a better time; the current fiat system of monetary exchange has been viciously debased for far too long. Sovereign currencies operate as a cartel that allows for a limited few to manipulate a system designed to include all market participants. Unlike a country or nation state, the internet has no local jurisdiction. Rather, it operates freely and openly for all participants. Value transfer should operate under similar principles, allowing for universal exchange that transcend localized barriers like language and geography. Such a system cannot exist under the control of one localized entity but must be agnostic to the machinations of those who would want to manipulate it for selfish and political ends.

[1] Strauss, Ilana “The Myth of the Barter Economy” The Atlantic 2/26/2016

[2] Salerno, Joseph. Money: Sound and Unsound

[3] Ammous, Saifedean. The Bitcoin Standard

[4] Ibid.

[5] Ammous, Saifedean. The Bitcoin Standard

[6] Murray Rothbard, America’s Great Depression, p. 89.

[7] Barry W. Poulson, Economic History of the United States p. 508

[8] Lawrence W. Reed, Great Myths of the Great Depression (Foundation for Economic Education)

[9] Robert Higgs, “Regime Uncertainty: Why the Great Depression Lasted So Long and Why Prosperity Resumed After the War,” The Independent Review, Spring 1997, p. 573.

[10] Von Mises, Ludwig, The Theory of Money and Credit, 2nd ed.

[11] Hoppe, Hans-Hermann, How is Fiat Money Possible?

[12] Hanke, Steve and Bushnell, Charles Studies in Applied Economics: Venezuela Enters The Record Book. 2016

[13] Cantillon, Richard Essai sur la Nature du Commerce en General

[14] De soto, Jesus huerta. Money, Bank Credit, and Economic Cycles

[15] Gilder, George. The Scandal of Money: Why Wall Street Recovers but the Economy Never Does

[16] Alton, Larry Household Debt Is Enslaving Americans — Nasdaq.com