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Discussion #12: The Bitcoin Standard: The Decentralized Alternative to Central Banking by Saifedean Ammous
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Discussion #12: The Bitcoin Standard: The Decentralized Alternative to Central Banking by Saifedean Ammous

What Will the Financial Future Look Like?

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Introduction

On October 20, 2021, Bitcoin exceeded its previous all-time high of $64,899 and quickly traded up to $66,909. As of this writing, the USD price of a Bitcoin has fallen back to ~$60,000. This isn’t a trading newsletter or a publication that gives investment advice in any way. Rather, Bitcoin, cryptocurrency, decentralized finance (DeFi), blockchain technology and Web 3.0 interest us as we seek to understand the economic present and future. In the near-term economists, politicians and many other individuals are debating whether recent inflation spikes are transitory or will be more enduring. In the long run, many enthusiasts argue that Bitcoin will fundamentally reshape financial services and thus the global economic structure.

To help inform our own investigation of the subject, we re-visited a core text favored by many Bitcoin enthusiasts: The Bitcoin Standard by Saifedean Ammous. MicroStrategy CEO and famous Bitcoiner, Michael Saylor, exemplified the book’s impact on the Bitcoin community when he credited it with influencing his decision to ultimately buy ~$3.2 billion worth of Bitcoin with MicroStrategy’s balance sheet. This pioneering use of a publicly traded company’s balance sheet beginning in mid-2020 blazed a trail for more traditional market incumbents to dip their toe into cryptocurrency and blockchain technology; these have included Tesla, Square and El Salvador, the first nation-state to adopt Bitcoin as legal tender last month. According to Saylor:

“It was this book, more than any other, that provided the holistic economic framework that I needed to interpret the macroeconomic forces reshaping our world.”

The Qualities and History of Money

The Bitcoin Standard can be broken in to two parts. The first two thirds explain the nature of money and the history of money from ancient times to the present, with extra attention paid to the gold standard which began in the nineteenth century. Ammous then discusses Bitcoin itself in the last third of the book.

To Ammous, money exists to efficiently move economic value over time and space. Barter becomes impractical in bigger groups for many well-understood reasons, such as the lack of coincidence in what people want at any given time. Sound forms of money encourage people to specialize and produce more value in order to get more of what they want. For example, they forego consumption in the present in the hope that they can produce more or invest in order to reap greater rewards later. “Loose” money, such as that created in ancient Rome when emperors began to decrease the precious metal content in coins, undermines this arrangement. The wealth of savers is eroded over time, which encourages shorter-term thinking and pleasure-seeking rather than longer-term, sustainable, productive behaviors.

Ammous views this importance of sound money as the central defining force in civilizational history. He goes on to explain numerous historical scenarios where the rise and fall of sound money caused a wide range of historical events, from the rise and fall of empires to the World Wars and Great Depression. The latter, more recent, events are described in relation to gold and bimetallic standards that dominated the late 19th and early 20th centuries. Ammous argued that the long relative peace in Europe from 1815 to 1914 was preserved by the gold standard rather than by other more conventional explanations. In his view, the gold standard imposed fiscal discipline on governments, which would have to levy unpopular taxes rather than print money if they wanted to fight long total wars. In contrast, many nations suspended the convertibility of their currency into precious metal at the start of World War I. Most of them printed money to fund the war effort, enabling them to wage a longer, bloody war but also leading to punishing inflation for their citizens. Ammous boldly contends that the war would necessarily have been shorter and less disastrous if governments could not print money.

While this may contain an element of truth, the author loses us a bit on such points; overall, we enjoy his skillful storytelling and can appreciate the importance of sound money policies. However, if World War 1 era governments thought security interests warranted it, they would have knocked down doors to confiscate gold and carry on the war effort. Materialist views of history that prioritize economic factors over everything else are helpful, but not objectively true in our opinion. If there is one master force driving mass human behavior, it’s more likely to be security or morality than sound money.

It’s important to note that the prologue on the nature and history of money employs a framework heavily influenced by the Austrian School of economics. Austrian School economists generally reject the assumptions and methodologies commonly accepted in most prominent universities, central banks and policy circles. While these varying assumptions and methodological disagreements are important, the lay mind tends to associate Austrian school policy recommendations with a handful of buzzwords: individualist, libertarian, laissez-faire, minimal government intervention, and sound money. We don’t wholeheartedly subscribe to the Austrian School or to one of the other quasi-religious sects cohabitating in economics departments but prefer to borrow elements we prefer from each. In The Bitcoin Standard, there are important lessons to be gleaned about the importance of sound money and the role of money in society, even if we don’t quite prioritize it as much as the author does.  

Bitcoin

Bitcoin was invented in 2008 by an anonymous person using the pseudonym Satoshi Nakamoto. Looking at history prior to 2008, Ammous favored gold as the best form of sound money available. Gold is more physically durable than other metals and has held its value for thousands of years due to near-universal recognition of its aesthetic, cosmetic and industrial uses. More importantly, gold has attractive stock-to-flow characteristics. The total supply of gold is consistent with how much our ancestors have taken out of the ground for thousands of years, while the flow of new gold is low given the perpetual toxicity and difficulty involved with mining new gold. The tangible stock of gold consistently grows at 1-2% per year, meaning that the productivity of a country on the gold standard can keep up with the slow dilution of the monetary base.

Bitcoin, however, has even more potential as a reserve currency for sound money according to the author. In its current state, Bitcoin’s stock-to-flow ratio is even more conservative over time than gold’s. The open-source software running the Bitcoin network caps the stock at 21 million Bitcoins – a majority of nodes on the network would have to vote to change this, which most proponents believe is functionally impossible. The flow of new Bitcoins is limited by incremental difficulty adjustments built into the code, which cause the number of Bitcoins produced to halve every four years at a predictable rate until the number of new Bitcoins produced reach zero in 2140.

Ammous skillfully describes the actual details of how the entire infrastructure works in a way that non-technical readers can readily understand. Nakamoto created a stable means of exchanging value that combined the ease of cash transactions with the power of intermediate payments (credit card networks, wire services) to safely transact large amounts across time and space. He achieved this via synthesis of four key components:

  • Distributed peer-to-peer network with no single point of failure

  • Hashing

  • Digital signatures

  • Proof-of-work

This infrastructure removed the need for trust in a third party by employing solid proof and verification. Every server running the Bitcoin software (node) cooperates with all other nodes to form a decentralized, self-perpetuating network. With this technological innovation, Satoshi Nakamoto, solved the well-known Byzantine Generals Problem – which describes the difficulty decentralized parties have in arriving at consensus without relying on a trusted central party – this problem has plagued money for thousands of years.  According to the author:

“Every transaction has to be recorded by every member of the network so that they all share one common ledger of balances and transactions. Whenever a member of the network transfers a sum to another member, all network members can verify the sender has a sufficient balance, and nodes compete to be the first to update the ledger with a new block of transactions every ten minutes. In order for a node to commit a block of transactions to the ledger, it has to expend processing power on solving complicated mathematical problems that are hard to solve but whose correct solution is easy to verify. This is the proof-of-work (PoW) system, and only with a correct solution can a block be committed and verified by all network members. While these mathematical problems are unrelated to the bitcoin transactions, they are indispensable to the operation of the system as they force the verifying nodes to expend processing power which would be wasted if they included fraudulent transactions. Once a node solves the proof-of-work correctly and announces the transactions, other nodes on the network vote for its validity, and once a majority has voted to approve the block, nodes begin committing transactions to a new block to be appended to the previous one and solving the new proof-of-work for it. Crucially, the node that commits a valid block of transactions to the network receives a block reward consisting of brand-new bitcoins added to the supply along with all the transaction fees paid by the people who are transacting. This process is what is referred to as mining, analogous to the mining of precious metals, and is why nodes that solve proof-of-work are known as miners. This block reward compensates the miners for the resources they committed to proof-of-work. Whereas in a modern central bank the new money created goes to finance lending and government spending, in bitcoin the new money goes only to those who spend resources on updating the ledger.”

This long excerpt is still one of the best, most concise explanations we’ve encountered for the actual detail on how the decentralized network both (a) produces new Bitcoin and (b) securely facilitates Bitcoin transactions. Bitcoin believers have confidence in the security and utility of this system. A large subset believe that Bitcoin could be the reserve currency of the future, potentially in a system where countries around the world peg their currencies to Bitcoin as they once did to gold. Effectively, they’ve assumed that large pools of USD and other fiat currencies will continue to be exchanged for a limited stock of 21 million Bitcoin.

This last section of The Bitcoin Standard also contains some of the author’s hypotheses about how this decentralized financial future could unfold, and how it could interact with the current banking system along with the implications for other “altcoins” like Ethereum and potential security threats. This speculation regarding the future is less worth discussing here as the book was published over three years ago, and a lot of progress has been made in addressing some of these points. For example, Strike’s Lightning Network has emerged to make Bitcoin-facilitated global payments a lot faster than they are on the network itself.

Alternative Points of View and Conclusion

Bitcoin supporters are an enthusiastic and vocal faction on the internet and in technology industry circles. The broader crypto / Web 3 ecosystem that Bitcoin laid the foundations for is attracting a large portion of new venture capital dollars and engineering talent excited to build a new economy built on blockchain technologies. Even so, there are alternative points of view that are more skeptical.

We’ve grown increasingly excited about Bitcoin’s potential as an inflation hedge and store of value amidst seemingly endless government money printing. Furthermore, we could envision a world where Bitcoin evolves into a medium of exchange and potentially, a unit of account. However, we won’t pretend that we can predict the future, nor do we wish to become so steadfast in a financial belief that we fail to listen to all perspectives on the matter. That being said, two examples reflect alternative perspectives from well-known financial thinkers. Successful tech investor Cathie Wood is bullish on Bitcoin itself but has made a case that the current bout of inflation is temporary and will soon give way to secular deflationary pressures in the economy. This could threaten inflows of capital into Bitcoin. Furthermore, the influential author and investor Nassim N. Taleb recently published an article arguing that Bitcoin’s value should actually be zero. Taleb’s article is a tough read with complicated ideas but worth examining to keep an open mind. Taleb likes to be a contrarian, even to contrarians like orange-pilled Bitcoin Maximalists. He wrote the foreword to the first edition of the very book that we’re writing about today but has since changed his mind and gotten into a public clash with the author, Saifedean Ammous. It’s an interesting debate, and we’ll end up seeing who’s right over the coming months, years and decades.

All the best,

The Citizen Scholar Team

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