The Best Invention of Money is Called Bitcoin. What is Money? II
With the time I have spent studying economics there are a few fundamental omissions in the mainstream body of knowledge. Two of which stand out in their relevance to our commerce and wellbeing. These two omissions are money and distribution. For example, Neoclassical models assume a bartering system where we exchange goods amongst ourselves, and the role of money is that of an illusion. Within this framework we have what is called a money illusion such that there is a cognitive bias to confuse nominal money with real wealth, hence a greater amount of money shifts our budget constraints upwards and vice versa but has no change to the preferences on our indifference curves. Firstly, this is a gross underestimate to the impact money has on our preferences, most importantly our time preferences. Secondly, this framework omits how newly created money through the banking system under the guidance of the central bank or government concentrates wealth to those who are first to receive this newly created money, this is known as the Cantillon effect. Thus, we have a tight interlink between money and distribution, however within Neoclassical Economics it’s the efficient allocation of resources that is considered and not the distribution of resources. Thus, within this paradigm poorer households must consider maximising their utility subject to their budget constraints and not concern themselves with the share of the economic pie. Ironically a significant proportion of research journals in the economic literature focuses on income distribution, wealth disparities and inequality despite the mainstream economics curriculum omitting the role of money and distribution.
Against this backdrop I argue from first principles that the distributed peer-to-peer network, called Bitcoin is the greatest form of money ever invented. To make this argument a quick exploration of what Bitcoin is necessary, as well as showing the way the cryptocurrency fulfils the functions and properties of money, and then lastly to distinguish Bitcoin from other cryptocurrencies. Bitcoin is digital property whereby the transfer and supply of this digital property is validated by members of its community. Validation in this community is only granted when a member solves an energy consumptive problem that other members can identify as the true solution, this is called the Proof of Work. Members that successfully solve this problem are rewarded with what is called a block reward and for transparency a publicly distributed ledger is available to all members. So, to become a member of this community is to either buy the digital property or to participate in solving the problems to the network. Unfortunately, the distributive effects of this decentralized medium of exchange are outside the scope of this article.
How Bitcoin satisfies the three functions of money.
From the standpoint of exchange value, Bitcoin over the past 5 years has outperformed all the currencies of the top 10 economies of the world as well Gold, Silver, and its closest crypto competitor Euthereum. Despite having short term volatility Bitcoin exhibits long-term growth whereas the fiat currencies display lower short-term volatility with a long-term decline in purchasing power. This makes Bitcoin the most salable currency available in the market. Salability is to be understood as the Father of Austrian Economics Carl Menger put it, the ease with which a good can be sold on the market whenever its holder desires, with the least loss in its price.
The second function of money is that of a unit of account, this function solves the complex problem of pricing and facilitates the market to prioritise and allocate resources. As of the writing of this article the market cap for Bitcoin ($ 439.60 Billion) constitutes less than 1% of the world's money. Therefore, the function of Bitcoin being a unit of account becomes a placeholder until such a time the rate of acquisition of Bitcoin is sufficient to price goods and services with it. Fiat currency has widespread use as a unit of account because it instituted by decree to be the medium of legal tender. In other words, it is backed by the force of its issuer (Central Bank or Government).
The third function of money is to be a store of value. What determines how well this function is performed is the quality of money. When the existing stockpiles of money (current stock minus what has been consumed/destroyed) to flow ratio is high then this is high quality money, also known as hard money (Ammous, 2018). A low stockpile to flow ratio is low quality money and it known as soft money. Historically Gold has been the hardest money known to man, with 1.32% to 1.58% of the total above ground stock of gold getting mined each year means the hardness of gold is between 75.76 to 63.29. Compared to Bitcoin that has had a flow of new tokens of 1.75% from a year ago, meaning that the hardness of Bitcoin in 2022 was 57.14. If the average time to solve a block remains at ten minutes, then by the year 2140 the last Bitcoin will be mined, capping the total supply at 21 million, at this time the hardness of Bitcoin will be infinite. It is predicted that by 2024 the hardness of Bitcoin will exceed that of Gold at 79.36, with a growth supply rate of 1.26%. Lastly, consider how the US M2 Money Supply before the Covid pandemic was at $15.99 trillionto where it is $21.21 trillion in December 2022, this means that the hardness of US Dollar during this time has been 3.064.
How well does Bitcoin satisfy the 5 properties of Money?
The advantage Bitcoin has in terms of its portability is that it can move a significant amount of value across the world without any centralized control. However, with the maximum capacity of a block (a group of transactions) capped at 1MB on the Bitcoin blockchain, the maximum number of transactions possible are 4 transactions per second. This is admittedly far behind what Visa and MasterCard can process at 3200 transactions per second. This feature enables Bitcoin to be a reserve currency as opposed to a cash instrument for small daily settlement,(Ammous, 2018).
This property is intertwined with the second function of money. Fiat currency is divisible up to two decimal places for our everyday use, whilst Bitcoin is divisible by up to 8 decimal places, with each constituent unit called a Satoshi. Allowing for goods and services to be easily expressed in terms of Bitcoin.
The United States Department of Treasury has only been able to find 1 to 3 counterfeit US currency per 10 000 genuine ones in circulation of the US economy. Counterfeiting therefore introduces the adverse selection problem (knowing you have the real deal or a lemon) to currency. Bitcoin on the other hand incentivises members on the community to show Proof of Work then to falsify a transaction. This is because the cost of falsifying a transaction on the network is way higher than the benefit such that one would need at least 51% of the processing power on the network, an exorbitant amount of energy, a staff to maintain the equipment, a building, and a cooling system. This incentive constraint has allowed Bitcoin to solve the double spend problem.
For the most part the Bitcoin community has remain unchanged with regards to its protocol. It has only been changes to improve the efficiency of the network that have been approved by this community. Such as the Segregated Witness (SegWit) update to improve the speed of transactions by rearranging the data contained within a block. This update did not change the core operation of the network, which is also known as a soft fork. The update is optional to the members of the community, the mandatory update is known as a hard fork. The block size war of August 2017 enabled a hard fork to where another protocol Bitcoin Cash (BCH) arouse. This split within the Bitcoin community was quite profitable to the members that remained loyal to the original protocol, whereby in less than 4 months Bitcoin (BTC) had more than a 500% increase in its price. This speaks to the antifragility of Bitcoin where time and time again, attacks to the network enable it to come back stronger than it was before.
The salability of Bitcoin across scales, space, time, and its immutable monetary supply policy in the protocol are the main drivers that enable it to be a scarce commodity. Subsequently, the cryptocurrency has been adopted by the market as a store of value more than other function.
What differentiates Bitcoin from other cryptocurrencies is that Bitcoin is a commodity while the rest are securities. Quite simply, the former has no issuer while the latter does. An investment of money in a common enterprise, reliant upon the efforts of others and an expectation of profit is de facto a security. The issuers of these securities are always tempted to fall into the easy money trap.