We are back to all-time high Bitcoin levels, and like in 2017/18, people are curious about it again. As I have been vocal about Bitcoin for a while, two friends asked me about it recently. They are both very smart, and work for tech and consulting firms - yet their understanding of cryptocurrencies is fuzzy.
Here are the the two most common objections that I've come across from people similar to my friends:
- Bitcoin can't be trusted, since it is not backed by a government
- Bitcoin is too volatile
I will address both of these issues, as well as a few more which I believe to be very important to the discussion. This post addresses the issue of why Bitcoin is important. In my next one, I will write about the 'how' - the mechanics of Bitcoin for the non-technical user.
Although I was an early adopter of Bitcoin, I am still just getting my head around the very concept of it. I have made many asinine assumptions over the years, stemming from a poor grasp of the underlying philosophies, as well as technologies. If your former self doesn't make you cringe now, you haven't grown enough. It took quite some time for my mental models to form.
Learning about Bitcoin made me pay more attention to concepts like money, scarcity, sovereignty, and Keynesian/Monetarist economics. Further, I realised that I needed at least a rudimentary understanding of Game Theory, Cryptography, and the history of violence and politics.
What is Money?
At the root of it, money is a medium for exchange. Our hunter-gatherer ancestors had no need for money, and merely exchanged goods they needed. Immediate family and tribe members were given gifts, something we do to this day - for example, (most) parents don't keep a ledger of resources spent on their children.
As we grew into an agricultural society, the need for trading emerged, as did the need to keep an account of who owed what, and to whom. Our agriculturist ancestors also needed to invest and plan for the future, even if only to plan for next season's crop.
Money solved a few problems:
- Mismatch of Scale: You want to sell your oranges, I am selling tractors
- Mismatch of Time Frames: You want to sell apples now, my wheat will be ready only in three months
- Mismatch of Locations: Your rice farm is in India, my sake brewery is in Japan
The invention of money solved all of these problems. It prevented a "double coincidence of wants" where two people would miraculously have wanted each others' items at the same time. This allowed trade to scale beyond a village and into the global behemoth it is today. We could now engage in trade, holding on to a medium to exchange at a time and place of our choosing.
The problem then was, what to use as a medium. This medium would have to be:
- Divisible into smaller units
- Easy to transport
- Able to hold value across time
- Not easy to manufacture at scale
- Something easily accepted and trusted by the majority of people, i.e., salable.
At various times in our history, people across the world have used a variety of items as money. These range from Rai Stones, to Cowry Shells, and glass beads. Over time, many places had a bi-metallic (Gold, Silver) or a tri-metallic (Gold, Silver, Copper) standard, with the value of the coin reflective of the amount of metal it contained. The important thing to remember is that people settled on what item to use as a medium of exchange by themselves, using free-market principles and not via a Central Bank.
We are not accustomed to thinking about absolute scarcity. Every now and then, we come across fear mongering about some resource nearing depletion levels. This could be oil, metals, water, food, or some other commodity. Oil is one of the more prominent commodities in this group - with many doomsday predictions over the years. For example, in 1874, the state geologist of Pennsylvania estimated that US Oil would run out in 4 years. The Chief Geologist of the United States Geological Survey, David White, published a report in 1919 stating that peak oil production would be reached by 1921, perhaps as soon as 1920. In more recent times, M. King Hubbert predicted that peak oil production in the United States would happen some time between 1965 and 1971. There have been similar pronouncements in the 1970s, 80s, 90s, and beyond.
Such scarcity is relative. At the limits of whatever current technology we possess, it seems like we will run out of a commodity. Technological advances ensure that we overcome that limit.
In reality, the only absolute scarcity we have is time. And Bitcoin. Our time on the planet is limited, which is why speed is so valued across cultures. Quoting GP at Andreessen Horowitz and former CTO of Coinbase Balaji Srinivasan on this,
If we had infinite time, we would be less concerned with whether something was faster. The reason speed has value is because time has value; the reason time has value is because human life has value, and lifespans are finite. If you made lifespans much longer, you'd reduce the effective cost of everything.
When it comes to money, or money-like items, one part of its value comes from how hard it is to produce. Relative to other metals on the planet, gold is scarce. At the limits of our current technology, it also costs a certain amount of money to go extract more gold. Further, it is impossible to synthesise gold from other metals, despite best efforts from well-meaning alchemists. Hence, gold itself, or money backed by gold had immense value.
However, we no longer have gold backed currencies. In the modern world, governments can create money out of thin air. Increasing money supply constantly, devalues it.
This created money doesn't flow evenly into the economy like water into a tank. As the economics Nobel laurate Friedrich Hayek explained, it flows like honey into a cup - forms a mound of honey at the centre, before slowly spreading out to the periphery. This is known as the Cantillon Effect - those closest to the source of money are able to extract the maximum value out of it. In our modern context, that means banks, financial institutions, and large corporations.
As individuals and institutions closer to the source of wealth get loans and other forms of investment capital, they are able to buy assets at bargain prices while the rest of the population waits for the benefits to accrue. By the time the average man on the street gets his share, asset prices have inflated, and he has been priced out of the market. The politicians can of course, pat themselves on their collective backs and tell everyone how much they did for the common, everyday folks.
Violence and Sovereignty
Every individual is sovereign. But are they really?
Historically, the allocation of scarce resources has been driven by the application of violence. The one who could apply violence skilfully, and at scale, could control a greater amount of resources.
Modern day nation-states continue this trend, with a monopoly on violence. This can be a good thing too. If you are an ordinary citizen, with no political power or musclemen to do you bidding, a state that exercises its monopoly on violence gives you the feeling that those who wrong you will meet their violent end at the hands of the state.
The state provides protection against other violent elements, by imposing its own monopoly on it. This way trade can prosper, and citizens can be reasonably assured of a decent life. The drawback is that the state can also use its power to inflict violence on you - the tax paying, non-criminal, good citizen. It can confiscate your assets. It can devalue your wealth. Its power is absolute. Absolute monarchs have now been replaced by the absolute state. Do you think I am exaggerating? Argentina just passed a one-time tax on people with assets exceeding roughly the equivalent of US$2.5 mm. Assets - not Net Worth.
A person’s Net Worth is what’s left after you deduct liabilities from your assets. For example, if you own a home worth $500,000, but you also have a mortgage worth $250,000, Student Loans worth $100,000 and Credit Card debts worth $50,000, your Net Worth will be:
$500,000 - ($250,000 + $100,000 + $50,000) = $100,000
So in effect, you would pay tax even on what you owe. Not to mention that one usually has already paid tax once at the time of buying such assets. Trust a politician to make it sound voluntary.
“This is a unique, one-time contribution”
Senator Carlos Caserio
Similarly, in the "Land of the free, home of the brave", Executive Order 6102 made the possession of gold illegal.
All persons are hereby required to deliver on or before May 1, 1933, to a Federal Reserve Bank or a branch or agency thereof or to any member bank of the Federal Reserve System all gold coin, gold bullion and gold certificates now owned by them or coming into their ownership on or before April 28, 1933
The treasury forced citizens to sell their gold at a price of $20.67 per ounce. One year later, in 1934, President Roosevelt revalued gold to $35. That's roughly a 45% devaluation of wealth in a year. You might think that this incident being nearly a century old, may not happen again in the US.
Thankfully Congresswoman Rashida Tlaib has introduced a hairbrained bill to keep everyone on their toes, with provisions such as this:
“Unlawful for any person to issue a stablecoin or stablecoin-related product, to provide any stablecoin-related service, or otherwise engage in any stablecoin-related commercial activity, including activity involving stablecoins issued by other persons.”
Stablecoins, as I noted in my previous post, can be a tool to enable financial access to a wide variety of people. As usual, magnanimous politicians insist that such regulations are to protect us plebeians from big bad corporations.
The state has encroached into just about every aspect of life. And with the nanny state comes boundless power - from regulating the kind of straws you can have, to the size of plastic cups, to what kind of video games you can play. And, as we saw above, the ability to seize your wealth.
Bitcoin is unconfiscatable, in that it is decentralised code, that cannot be physically taken away in a truck. There are no servers to confiscate, no code to ban. It is decentralised, and on a resilient, censorship resistant network.Of course, you can still lose access to your hardware wallet, or forget the password to it, or be extorted to pay ransom in Bitcoin.
It is also beyond the purview of Central Banks. The bankers can inflate their own fiat currencies, but Bitcoin has its own monetary policy set in stone. There will only ever be 21 Million Bitcoins. No more.
All this might make it sound like something only accessible to people in Silicon Valley, NYC, or London, but this is not the case.
Coindesk has this story about the use of Bitcoin in Nigeria to protect against corrupt police officials. Reuters has another wonderful story on how Bitcoin usage has really taken off in Nigeria, Botswana and Kenya.
Odunjo is one of many people at the heart of a quiet bitcoin boom in Africa, driven by payments from small businesses as well as remittances sent home from migrant workers, according to data shared exclusively with Reuters and interviews with around 20 bitcoin users and five cryptocurrency exchanges.
Monthly cryptocurrency transfers to and from Africa of under $10,000 - typically made by individuals and small businesses - jumped more than 55% in a year to reach $316 million in June, the data from U.S. blockchain research firm Chainalysis shows.
Small businessmen like Odunjo, find Bitcoin to be a medium that allows for unfettered trade - “Free trade” in its most real sense. It enables ordinary individuals to trade on their own terms, without interference from a government. The fact that it is not government backed is its best feature. Which government would you completely trust to ensure your well being? Which government would you completely trust to never confiscate your wealth through force, or via tools of monetary policy?
Bitcoin is undoubtedly volatile at this stage. It is not uncommon for its price to fluctuate 5-15% in a day, and that is bound to make people nervous. This volatility is also the result of its inflexible supply. Saifdean Ammous in The Bitcoin Standard says,
“Bitcoin’s volatility derives from the fact that its supply is utterly inflexible and not responsive to demand changes, because it is programmed to grow at a predetermined rate.”
As Bitcoin's usage matures, and the players and institutions involved get more sophisticated, this volatility will decrease. While Bitcoin's supply is fixed and predictable, its demand is not.
One week, it is a pariah with the likes of Janet Yellen calling it inefficient, or a tool for terrorism. Another week, Goldman Sachs and JP Morgan are contemplating Bitcoin ETFs. We still have a long way to go before everyone who wishes to kill Bitcoin has tried to. When we get to that point, the overall liquidity of the market will also have increased. This is analogous to a stock with low trading volume that is very sensitive to large buy or sell orders. As trading volumes grow, large orders won't significantly impact its price movement.
Bitcoin may not even end up as the principal cryptocurrency that we use in our daily lives. It's still in its infancy.
What it has done, however, is to make many people go down the rabbit hole of learning about our financial, economic, and political systems. This greater awareness will shape the direction of many future technologies, and that journey is just beginning.