What is Money, Anyway? by Lyn Alden Summary

Key takeaways and summary of What is Money, Anyway? – the best financial history book I've ever read.

What is Money, Anyway? by Lyn Alden Summary
Source: lynalden.com

Key Takeaways

  1. After thousands of years, two commodities beat all of the others in terms of maintaining their monetary attributes across multiple geographies; gold and silver.
  2. The stock-to-flow ratio is the best metric for determining the hardness of a money. Stock is the total supply. Flow is the amount being produced every year.
  3. Despite all of our technological progress, we still can’t reduce the stock-to-flow ratios of gold and silver by any meaningful degree.
  4. Most other commodities are below 1 for the stock-to-flow ratio, or are very flexible. Even the other rare elements, like platinum and rhodium, have very low stock-to-flow ratios due to how rapidly they are consumed by industry.
  5. Gold’s stock-to-flow is 67, on average.
  6. It remained illegal for Americans to own gold for about four decades until the mid-1970s.
  7. Making gold illegal to own was hard to enforce though.
  8. In the 1970s, the US made a deal with Saudi Arabia and other OPEC countries to only sell their oil in dollars, regardless of which country was buying. In return, the US would provide military protection and trade deals. And thus the petrodollar system was born. We’ve had to deal with the consequences of this awkward relationship ever since.
  9. The biggest benefit from the petrodollar system, as analyst Luke Gromen has argued, is that it contributed to the US’s Cold War victory over the Soviet Union during the 1970s and 1980s.
  10. The petrodollar deal helped create a global US dollar network effect.
  11. The petrodollar system gives the United States considerable geopolitical influence, because it can sanction any country and cut it off from the dollar-based system.
  12. The current fiat experiment is not as entrenched as most think. It’s only 50 years old and has caused many problems.
  13. Many prominent investment vehicles, like the dollar, bonds, the S&P 500, and real estate are touted as super long-standing and safe assets but they’re not. The dollar as we know it is only 50 years old. Bonds have had negative real returns since 2009. The S&P 500 became popular 20 years ago, after the dot com crash. And real estate has only been a great investment in recent decades. If you look at the past 300 years, real estate returns are flat.
  14. Ever since the world has been on the fiat/petrodollar standard, debt as a percentage of GDP has skyrocketed to record levels and seems to be getting unstable. Considering where we are in the long-term debt cycle, investors would do well to be creative with how they envision the future. Don’t take the past 40-50 years for granted and assume that’s how it’ll always be, whether for money or anything else. We don’t know what money will look like 50 years from now.
  15. The last time we were in a similar debt and monetary policy situation was the 1930s and 1940s, where currency devaluations and war occurred. That doesn’t mean those things have to happen, but basically, we’re in a very macro-heavy environment where structural currency changes tend to occur.
  16. In China, consumers aggressively monetize real estate. It became normal for families to own multiple homes.
  17. In the United States, consumers aggressively monetize stocks. We plow a percentage of each paycheck into broad equity indices without analyzing companies or doing any sort of due diligence, treating that basket of stocks as simply a better store of value than cash regardless of what is inside.
  18. Overall, the fiat system is showing more instability lately, and investors have to navigate a challenging environment of structurally negative inflation-adjusted cash and bond yields, along with many high asset valuations in equities and real estate.
  19. Russia’s foreign reserves were frozen in response to its invasion of Ukraine. Other governments will likely adopt Bitcoin to reduce their risk of having assets frozen.
  20. Currency acts like money most of the time until, one day, it doesn’t.
  21. Many people argue that bitcoin has achieved critical mass in terms of its network effect, security, immutability, and decentralization, such that while other digital assets may persist to fulfill other use-cases, none of them have a reasonable chance of competing with bitcoin in terms of being hard money.
  22. Bitcoin is insurance against inflation and authoritarian regimes.
  23. Kind of like how we don’t use Fedwire transfers to buy coffee, bitcoin base layer transactions are not well-suited to buying coffee. Visa transactions that run on top of Fedwire, or lightning transactions that run on top of bitcoin, can be used to efficiently buy coffee.
  24. Proof-of-stake systems need to be “always on” to function, and are highly complex. They have no inherent disaster recovery potential if the blockchain goes offline, because making alternative copies of the blockchain has no cost, and there’s no way to determine the “real” blockchain other than via agreement of major parties (a.k.a. a form of governance) if it is recovering from that offline state.
  25. Proof-of-stake cryptoassets trend towards oligopoly over time because the wealthy stake their coins to get more coins.

Fidelity Bitcoin First Article Takeaways:

  1. Bitcoin is best understood as a monetary good, and one of the primary investment theses for bitcoin is as the store of value asset in an increasingly digital world.
  2. Bitcoin is fundamentally different from any other digital asset. No other digital asset is likely to improve upon bitcoin as a monetary good because bitcoin is the most (relative to other digital assets) secure, decentralized, sound digital money and any “improvement” will necessarily face tradeoffs.
  3. There is not necessarily mutual exclusivity between the success of the Bitcoin network and all other digital asset networks. Rather, the rest of the digital asset ecosystem can fulfill different needs or solve other problems that bitcoin simply does not.
  4. Other non-bitcoin projects should be evaluated from a different perspective than bitcoin.
  5. Bitcoin should be considered an entry point for traditional allocators looking to gain exposure to digital assets.
  6. Investors should hold two distinctly separate frameworks for considering investment in this digital asset ecosystem. The first framework examines the inclusion of bitcoin as an emerging monetary good, and the second considers the addition of other digital assets that exhibit venture capital-like properties.

Summary

This article looks at the history of money, and examines this rather unusual period in time where we seem to be going through a gradual global transformation of what we define as money, comparable to the turning points of 1971-present (Petrodollar System), 1944-1971 (Bretton Woods System), the 1700s-1944 (Gold Standard System), and various commodity-money transition periods (pre-1700s). This type of occasion happens relatively rarely in history for any given society but has massive implications when it happens, so it’s worth being aware of.

If we condense those stages to the basics, the world has gone through three phases: commodity money, gold standard (the final form of commodity money), and fiat currency.

A fourth phase, digital money, is on the horizon. This includes private digital assets (e.g. bitcoin and stablecoins) and public digital currencies (e.g. central bank digital currencies) that can change how we do banking, and what economic tools policymakers have in terms of fiscal and monetary policy. These assets can be thought of as digital versions of gold, commodities, or fiat currency, but they also have their own unique aspects.

Some people whose work I’ve drawn from for this article, from the past and present, include Carl Menger, Warren Mosler, Friedrich Hayek, Satoshi Nakamoto, Adam Back, Saifdean Ammous, Vijay Boyapati, Stephanie Kelton, Ibn Battuta, Emil Sandstedt, Robert Breedlove, Ray Dalio, Alex Gladstein, Elizabeth Stark, Barry Eichengreen, Ross Stevens, Luke Gromen, Anita Posch, Jeff Booth, and Thomas Gresham.

Back in 1912, Mr. J.P. Morgan testified before Congress and is quoted as having said the famous line: Gold is money. Everything else is credit.

We can define currency as a liability of an institution, typically either a commercial bank or a central bank, that is used as a medium of exchange and unit of account.

In contrast to currency, we can define money as a liquid and fungible asset that is not also a liability. It’s something intrinsic, like gold. It’s recognized as a highly salable good in and of itself. In some eras, money was held by banks as a reserve asset in order to support the currency that they issue as liabilities. Unlike a dollar, which is an asset to you but a liability of some other entity, you can hold gold which is an asset to you and a liability to nobody else.

Scarcity is often what determines the winner between two competing commodity monies. However, it’s not just about how rare the asset is. A good concept to be familiar with here is the stock-to-flow ratio, which measures how much supply there currently exists in the region or world (the stock) divided by how much new supply can be produced in a year (the flow).

This gives gold a stock-to-flow ratio of 100/1.5 = 67 on average, which is the highest stock-to-flow ratio of any commodity.

On the other hand, if a commodity is so rare that barely anyone has it, then it may be extremely valuable if it has utility, but it has little useful role as money. It’s not liquid and widely-held, and so the frictional costs of buying and selling it are higher. Certain atomic elements like rhodium for example are rarer than gold, but have low stock-to-flow ratios because they are consumed by industry as quickly as they are mined. A rhodium coin or bar can be purchased as a niche collectible or store of value, but it’s not useful as societal money.

So, a long-lasting high stock-to-flow ratio tends to be the best way to measure scarcity for something to be considered money, along with the other attributes on the list above, rather than absolute rarity. A commodity with a high stock-to-flow ratio is hard to produce, and yet a lot of it has already been produced and is widely distributed and held, because it either isn’t rapidly consumed or isn’t consumed at all. That’s a relatively uncommon set of attributes.

Throughout history various stones, beads, feathers, shells, salt, furs, fabrics, sugar, coconuts, livestock, copper, silver, gold, and other things have served as money. They each have different scores for the various attributes of money, and tend to have certain strengths and weaknesses.

For a large portion of human history, silver has actually been the winner in terms of usage. It has the second-best score after gold across the board for most attributes, and the second highest stock-to-flow ratio, but beats gold in terms of divisibility, since small silver coins can be used for daily transactions. It’s the queen of commodities. And in chess, the king may be the most important piece, but the queen is the most useful piece.

Rai stones were used as money in the Yap islands in Micronesia.

Beads were used as money in places in African.

Emil Sandstedt’s book, Money Dethroned: A Historical Journey, catalogs the various types of money used over the past thousand years or so. The book often references the writings of Ibn Battuta, the 14th century Moroccan explorer across multiple continents, who may have been the furthest traveler of pre-modern times.

Central Asians at the time of Battuta, as a nomadic culture, used livestock as money. The unit of account was a sheep, and larger types of livestock would be worth a certain multiple of sheep. As they settled into towns, however, the storage costs of livestock became too high. They eat a lot, they need space, and they’re messy.

Russians had a history of using furs as a monetary good.

Seashells were used by a few different regions as money, and in some sense were like gold and beads in the sense that they were for both money and fashion.

Another great example is the idea of using blocks of high-quality Parmesan cheese as bank collateral. Since Parmesan cheese requires 18-36 months to mature, and is relatively expensive per unit of weight in block form, niche banks in Italy are able to accept it as collateral, as a form of attractive commodity money.

The Gold Standard

After thousands of years, two commodities beat all of the others in terms of maintaining their monetary attributes across multiple geographies; gold and silver.

Humans figured out how to make or acquire basically all of the beads, shells, stones, feathers, salt, furs, livestock, and industrial metals we need with our improved tools, and so we reduced their stock-to-flow ratios and they all fell out of use as money.

However, despite all of our technological progress, we still can’t reduce the stock-to-flow ratios of gold and silver by any meaningful degree, except for rare instances in which the developed world found new continents to draw from. Gold has maintained a stock-to-flow ratio averaging between 50 and 100 throughout modern history, meaning we can’t increase the existing supply by more than about 2% per year, even when the price goes up more than 10x in a decade. Silver generally has a stock-to-flow ratio of 10 to 20 or more.

Most other commodities are below 1 for the stock-to-flow ratio, or are very flexible. Even the other rare elements, like platinum and rhodium, have very low stock-to-flow ratios due to how rapidly they are consumed by industry.

We’ve gotten better at mining gold with new technologies, but it’s inherently rare and we’ve already tapped into the “easy” surface deposits. Only the deep and hard-to-reach deposits remain, which acts like an ongoing difficulty adjustment against our technological progress. One day we could eventually break this cycle with drone-based asteroid mining or ocean floor mining or something crazy like that, but until that day (if it ever comes), gold retains its high stock-to-flow ratio. Those environments are so inhospitable that the expense to acquire gold there would likely be extraordinarily high.

Basically, whenever any commodity money came into contact with gold and silver as money, it was always gold and silver that won. Between those two finalists, gold eventually beat silver for more monetary use-cases, particularly in the 19th century.

Improvements in communication and custody services eventually led to the abstraction of gold. People could deposit their gold into banks and receive paper credit representing redeemable claims on that gold. Banks, knowing that not everyone would redeem their gold at once, went ahead and issued more claims than the gold they held, beginning the practice of fractional reserve banking. The banking system then consolidated into central banking over time in various countries, with nationwide slips of paper representing a claim to a certain amount of gold.

Barry Eichengreen’s explanation for why gold beat silver, in his book Globalizing Capital: A History of the International Monetary System, is that the gold standard won out over the bimetallic standard mostly by accident. In 1717, England’s Master of the Mint (who was none other than Sir Isaac Newton himself) set the official ratio of gold and silver as it relates to money, and according to Eichengreen he set silver too low compared to gold. As a result, most silver coins went out of circulation (as they were hoarded rather than spent, as per Gresham’s law).

Then, with the UK rising to dominance as the strongest empire of the era, the network effect of the gold standard, rather than the silver standard, spread around the world, with the vast majority of countries putting their currencies in a gold standard. Countries that stuck to the silver standard for too long, like India and China, saw their currency weaken as demand for the metal dropped in North America and Europe, resulting in negative economic consequences.

On the other hand, Saifadean Ammous, in his book The Bitcoin Standard, focuses on the improved divisibility of gold due to banking technology. As previously mentioned, gold scores equal or higher than silver in most of the attributes of money, except for divisibility. Silver is better than gold for divisibility, which made silver the more “day to day” money for thousands of years while gold was best left for kings and merchants to keep in their vaults or use as ornamentation, which are stores and displays of value respectively.

However, the technology of paper banknotes in various denominations backed by gold improved gold’s divisibility. And then, in addition to exchanging paper, we could eventually “send” money over telecommunications lines to other parts of the world, using banks and their ledgers as custodial intermediaries. This was the gold standard—the backing of paper currencies and financial communication systems with gold. There was less reason to use silver at that point, with gold being the much scarcer metal, and now basically just as divisible and even more portable thanks to the paper/telco abstraction.

I think there is an element of truth in both explanations, although I consider the explanation of Ammous to be more complete, starting with a deeper axiom regarding the nature of money itself. Banknotes made gold more divisible and thus the harder money won out over time, but network effects from political decisions can impact the timing of these sorts of changes.

Central banks around the world still hold gold in their vaults, and many of them still buy more gold each year to this day as part of their foreign-exchange reserves. It’s classified as a tier one asset in the global banking system, under modern banking regulations. Thus, although government-issued currency is no longer backed by a certain amount of gold, it remains an indirect and important piece of the global monetary system as a reserve asset. There is so far no better naturally-occurring commodity to replace it.

Fiat currency

Historically, a number of cultures have attempted periods of paper currency, issued by the government and backed by nothing.

Often it was the result of currency that was once backed (a gold standard or silver standard), but the government created too much of the paper due to war or other issues, and had to default on the metal backing by eliminating its ability to be converted back into the metal upon request. In that sense, currency devaluation becomes a form of tax and/or wealth confiscation. The public holds their savings in the paper currency, and then the rug is pulled out from under them.

The earliest identified use of paper currency was in China over a thousand years ago, which makes sense considering that paper was invented in that region. They eventually shifted towards government monopoly on paper currency, and combined with an elimination of its ability to be converted back into silver, resulted in the first fiat currency, along with the inflation that comes with that. It didn’t last very long.

Currency debasement often happened gradually under metallic and bimetallic currency regimes, with history of it going back three or four thousand years. It took the form of reducing the amount of the valuable metal (such as gold or silver) and either adding base metal or putting decorative holes through the center of it to reduce the weight.

In other words, a ruler often found himself faced with budget deficits, and having to make the difficult choice between cutting spending or raising taxes. Finding both to be politically challenging, he would sometimes resort to keeping taxes the same, diluting the content of gold or silver in the coins, and spending more coins with less precious metal in each coin, while expecting it to still be treated with the same purchasing power per coin.

Gold-backed paper currencies and fiat currencies are the modern version of that, and so the debasement can happen much faster.

Throughout the 20th century, this tactic spread around the world like a virus. Prior to paper currencies, governments would run out of fighting capability if they ran low on gold. Governments would use up their gold reserves and raise additional war taxes, but there were limits in terms of how much gold they had and how much they could realistically tax for unpopular wars before the population would rebel. However, by having all of their citizens on a gold-backed paper currency, they could devalue everyone’s savings for the war without an official tax, by printing a lot of money, spending it into the economy, and then eliminating or reducing the gold peg before people knew what was happening to their money.

This allowed governments to fight much larger wars by extracting more savings from their citizens, which led their international opponents to debase their currencies with similar tactics as well if they wanted to win.

Bretton Woods

and the Petrodollar

After World War I, and throughout the tariff wars and World War II period thereafter, many countries went off the gold standard or devalued their currencies relative to gold.

John Maynard Keynes, the famous economist, said in 1924: In truth, the gold standard is already a barbarous relic.

By 1934, gold was made illegal to own. It was punishable by up to 10 years in prison for Americans to own it. The dollar was no longer redeemable for gold by American citizens, although it was still redeemable for official foreign creditors, which was an important part of maintaining the dollar’s credibility.

Shortly after Americans were forced to sell their gold to the government in exchange for dollars, the dollar was devalued relative to gold, which benefited the government at the expense of those who were forced to sell it.

It remained illegal for Americans to own gold for about four decades until the mid-1970s. Interestingly enough, that overlapped quite cleanly with the period where US Treasuries underperformed inflation. Basically, the main release valve that people could turn to instead of cash or Treasuries as savings assets, was made illegal to them.

It’s rather ironic—gold was a “barbarous relic” and yet apparently had to be confiscated and pushed out of use by the threat of imprisonment, and hoarded only by the government during a period of intentional currency devaluation. If it were truly such a relic, it would have fallen out of usage on its own and the government would have had little need to own any.

Making gold illegal to own was hard to enforce though. There were not many prosecutions for it, and it’s not as though authorities went door-to-door looking for it.

By 1944 towards the end of World War II after most currencies were sharply devalued, the Bretton Woods agreement was reached. Most countries pegged their currency to the dollar, and the United States dollar remained pegged to gold (but only redeemable to large foreign creditors, not American citizens). By extension, a pseudo gold standard was temporarily re-established.

This lasted only 27 years until 1971, when the United States no longer had enough gold to maintain redemption for its dollars, and thus ended the gold standard for itself and most of the world. There were too many dollar claims compared to how much gold the US had.

The Bretton Woods system was poorly-constructed from the beginning, because domestic and foreign banks could lend dollars into existence without having to maintain a certain amount of gold to back those dollars. De-pegging was inevitable.

Since that time, over 50 years now, virtually all countries in the world have been on a fiat currency system, which is the first time in history this has happened. Switzerland was an exception that kept their gold standard until 1999, but for most countries it has been over 50 years since they were on it.

In the 1970s, the US made a deal with Saudi Arabia and other OPEC countries to only sell their oil in dollars, regardless of which country was buying. In return, the US would provide military protection and trade deals. And thus the petrodollar system was born. We’ve had to deal with the consequences of this awkward relationship ever since.

While the dollar was not pegged to any specific price of oil in this system, this petrodollar system made it so that any country in the world that needed to import oil, needed dollars to do so. Thus, universal demand for dollars was established, as long as the US had enough military might and influence in the Middle East to maintain the agreement with the oil exporting nations.

Other countries continued to issue their own currencies but held gold, dollars (mainly in the form of US Treasuries), and other foreign currency assets as reserves to back up their currencies.

The biggest benefit from the petrodollar system, as analyst Luke Gromen has argued, is that it contributed to the US’s Cold War victory over the Soviet Union during the 1970s and 1980s. The petrodollar agreement and associated military buildup to enforce it was a strong chess move by the US to gain influence over the Middle East and its resources. However, Gromen also argues that when the Soviet Union fell in the early 1990s, the US should have pivoted and given up this system to avoid ongoing structural trade deficits, but did not, and so its industrial base was aggressively hollowed out. Since then, China and other countries have used the system against the US, and the US also bled out tremendous resources trying to maintain its hegemony in the Middle East with its wars in Afghanistan and Iraq.

what-is-money-gold-peg-chart.png


The Bretton Woods pseudo gold standard involved the dollar being backed by gold, but only redeemable to foreign creditors in limited amounts. Foreign currencies pegged themselves to the dollar, and held dollars/Treasuries and gold in reserve:

what-is-money-bretton-woods-chart.png

The petrodollar system made it so that only dollars could buy oil imports around the world, and so countries globally hold a combination of dollars, gold, and other major currencies as reserves, with an emphasis on dollars. If countries want to strengthen their currencies, they can sell some reserves and buy back their own currency. If countries want to weaken their currencies, they can print more of their currency and buy more reserve assets.

what-is-money-petrodollar-chart.png

Over time, that demand for dollars was broadened via trade and debt. If two countries trade goods or services, they often do so in dollars.

All of that dollar-denominated debt represents additional demand for dollars, since dollars are required to service that debt.

The petrodollar deal helped create a global US dollar network effect.

This system gives the United States considerable geopolitical influence, because it can sanction any country and cut it off from the dollar-based system.

One of the key flaws of the petrodollar system, however, is that all of this demand for the dollar makes US exports more expensive (less competitive) and makes imports less expensive, and so the US began running structural trade deficits once we established the system, totaling over $14 trillion in cumulative deficits as of this writing. From 1944-1971 the US drew down its gold reserves in order to maintain the Bretton Woods dollar system, whereas from 1974-present, the US instead drew down its industrial base to maintain the petrodollar system.

Dutch disease became widely used in economic circles as a shorthand way of describing the paradoxical situation in which seemingly good news, such as the discovery of large oil reserves, negatively impacts a country’s broader economy.

The petrodollar system ironically gave the United States a form of Dutch Disease.

Other countries like Japan, Germany, and China led in manufacturing and exports because the petrodollar system forced the US to import. Taiwan and South Korea became the hubs of the global semiconductor market, rather than the United States.

Foreigners take their persistent dollar surpluses and buy productive US assets with them like stocks, real estate, and land. In other words, the US sells its appreciating financial assets in exchange for depreciating consumer goods.

My article on the petrodollar system went into additional detail on the history of the US dollar as the global reserve currency, from the pre-Bretton Woods era to the petrodollar system.

Potential Post-Petrodollar Designs

There are proposals by policymakers and analysts to rebalance the global payments system, and the changing nature of geopolitics is pointing in that direction as well.

For example, Russia began pricing its oil partly in euros over the past few years, and China has put considerable work into launching a digital currency that may expand their global reach, at least with some of their most dependent trade partners. The United States is no longer the biggest commodity importer, and its share of global GDP continues to decrease, which makes the existing petrodollar system less tenable.

what-is-money-decentralized-model-chart.png

If a major scarce neutral reserve asset (e.g. gold or bitcoin or digital SDRs or something along these lines, depending on your conception of where trends are going over the next decade or two) is used as a globally-recognized form of money, then a decentralized model can also look like this:

what-is-money-neutral-reserve-asset-chart.png

Price Inflation

from a Negative Baseline

The long arc of human history is deflationary. As our technology improves over time, we become more productive, which reduces the labor/resource cost of most goods and services.

For an example of productivity, people used to farm by hand. By harnessing the utility of work horses and simple equipment, it empowered one person to do the work of several people. Then, the invention of the tractor and similar advanced equipment empowered one person to do the work of ten or more people. As tractor technology got bigger and better, this figure probably jumped to thirty or more people. And then, we can imagine a fleet of self-driving farming equipment allowing one person to do the work of a hundred people. As a result, a smaller and smaller percentage of the population needs to work in agriculture in order to feed the whole population. This makes food less expensive and frees up everyone else for other productive pursuits.

Monetary inflation is usually a bit faster than price inflation.

So, price inflation is not 3.1% from a baseline of zero; it’s 5.3% from a baseline of -2.2%. Actual resource costs for goods and services go down most years rather than stay flat, but due to our inflationary monetary framework, they go up in price anyway.

  • Deflation and inflation are simultaneously at work.

The reason this is only a rough measure [of inflation] is because 1) the CPI basket changes over time and may not be fully representative and 2) money supply can become more concentrated or less concentrated over time and thus does not always reflect the buying power of the median person. There is no way to directly measure technological deflation; it can only be estimated.

Another way to check inflation is to see how prices held up against different currencies and commodities like the British Pound, US dollar, and gold.

Higher-quality and scarcer goods like meat have roughly kept up with the price of gold (although you can’t store meat for very long), and select few assets like the absolute best/scarcest UK property locations may have appreciated a bit faster than gold (although they required continued maintenance costs along the way which makes up for that difference).

The takeaway from this section is that the growth in the broad money supply per capita is the “true” inflation rate. However, the baseline that we measure it against is not zero; it’s a mildly negative number which we can’t precisely measure, but that we can estimate and infer, that represents ongoing increases in productivity due to technology. Prices of most things stay relatively stable or preferably keep going down as priced in the most salable good (such as gold, historically) over the long run, but go up in most years when measured in a depreciating and weaker unit of account such as the British pound.

Fiat Currency

The MMT Description

Some economists disagree with the commodity view of money, and argue that money originates with the government. This is called Chartalism, and its origins go back more than a century.

Decades ago, Warren Mosler and others resurfaced this idea, into what is now popularly known as Modern Monetary Theory or MMT.

Mosler: The way we do it, is we slap on a tax for something that nobody has, and in order to get the funds to pay that tax, you have to come to the government for it, and so that way the government can spend its otherwise worthless currency and provision itself.

Now the way I like to explain that, is I’ll take out my business card here. Now I’ll ask this room does anybody want to buy- and this is called “how to turn litter into money”- does anybody want to buy one of these cards for a hundred dollars? No? Okay. Does anybody want to stay after hours and help vacuum the floor and clean the room and I’ll give you my cards? No? Alright. Oh by the way there’s only one door out of here and my guy is out there with a 9mm (handgun) and you can’t get out of here without one of these cards.

Can you feel the pressure now? You’re now unemployed! In terms of my cards, you were not unemployed before. You were not looking for a job that paid in my cards. Now you’re looking for a job that pays in my cards, or you’re looking to buy them from someone else that will take a job that pays in my cards.

The difference between money and litter is whether there’s a tax man [outside that door]. The guy with the 9mm is the tax man. If he can’t enforce tax collection, the value of the dollar goes to zero.

  • This is the argument that the government controls money. They create money because you need to use their money to pay their taxes otherwise you go to jail.

Nobel-laureate economist Paul Krugman put it rather similarly back in 2013: Fiat money, if you like, is backed by men with guns.

Of course, we could just as easily ask, since the government is using force to collect taxes to provision itself, why can’t it just collect commodity money like gold with a tax, and then spend that gold to acquire its necessary provisions? Why does it need to issue its own paper currency and then tax it back?

The answer is that it doesn’t have to, but it wants to. By issuing its own currency, it profits from seigniorage, which is the difference between the face value of the money and the cost to produce and distribute it. It is, basically, a subtle inflation tax that compounds over time.

A weak government, with an economy that can’t provision most of its needs, often fails to maintain a workable fiat currency for very long. People start using alternative monies out of necessity even if the government supposedly disallows them from doing so. This happens to many developing countries. Billions of people in the world today have experienced the effects of hyperinflation or near-hyperinflation within the past generation. It’s unfortunately quite common.

The Monetization of Other Assets

But when you step back and think about it from first principles, this period in history is really unusual. It’s a historical aberration, and like a fish in water doesn’t even notice the water, the monetary system we operate with now seems totally normal to us.

The current fiat experiment is not as old as most think. It’s only 50 years old and has caused many problems.

The Swiss dropped their gold standard when I was twelve years old, which was six years after Amazon was founded, and three years before Tesla was founded. The fiat/petrodollar standard is only four times older than bitcoin, and only two times older than the first internet browser. That’s pretty recent when you think about it like that.

Many prominent investment vehicles, like the dollar, the S&P 500, and real estate are touted as super long-standing and safe assets but they’re not. The dollar as we know it is only 50 years old. The S&P 500 became popular 20 years ago, after the dot com crash. And real estate has only been a great investment in recent decades. If you look at the past 300 years, real estate returns are flat.

Ever since the world has been on the fiat/petrodollar standard, debt as a percentage of GDP has skyrocketed to record levels and seems to be getting unstable. Considering where we are in the long-term debt cycle, investors would do well to be creative with how they envision the future. Don’t take the past 40-50 years for granted and assume that’s how it’ll always be, whether for money or anything else. We don’t know what money will look like 50 years from now.

The last time we were in a similar debt and monetary policy situation was the 1930s and 1940s, where currency devaluations and war occurred. That doesn’t mean those things have to happen, but basically, we’re in a very macro-heavy environment where structural currency changes tend to occur.

Basically, for lack of good money in this fiat currency petrodollar era, especially in the post-2009 era with interest rates below inflation rates, we monetize other things with higher stock-to-flow ratios and treat them as stores of value.

In China, consumers aggressively monetize real estate. It became normal for families to own multiple homes. In the United States, consumers aggressively monetize stocks. We plow a percentage of each paycheck into broad equity indices without analyzing companies or doing any sort of due diligence, treating that basket of stocks as simply a better store of value than cash regardless of what is inside.

Fungible pieces of corporations become our money, at least for the “store of value” portion of what money is, in large part because they pay higher earnings/dividend yields than bank/bond yields and many of them decrease in quantity (deflationary) rather than constantly increase in quantity.

Some technologists, like Jeff Booth, have argued that this system of perpetual currency debasement has a negative impact on the environment because it encourages us to spend and consume on short-sighted depreciating trinkets and malinvestment more than we would if our money appreciated in value over time like it used to. With appreciating money, we would be more selective with our purchases.

Proponents of the [current financial] system also argue that the system encourages more consumption and consider that to be a good thing because it keeps GDP up. By keeping people on a constant treadmill of currency debasement, it forces them to spend and invest rather than to save. If people begin to save, these policymakers often view it as “hoarding” or a “global savings glut” and consider it to be a problem. Monetary policy then is adjusted to convince people to save less, spend more, and borrow more.

From a developing market standpoint, the fiat/petrodollar standard contributes to massive booms and busts because a lot of their debt is denominated in dollars, and that debt fluctuates wildly in strength depending on the actions of US policymakers. Developing countries are often forced to tighten their monetary policy during a recession in order to defend their currency, and thus while the US gets to provide counter-cyclical support for its own economy, developing countries are forced to be pro-cyclical, contributing to a vicious cycle in their economies during recessions. In this view, the fiat/petrodollar system can be considered a form of neocolonialism; we push most of the costs of the system out into the developing countries in order to maximize the stability for the developed world.

Overall, the fiat system is showing more instability lately, and investors have to navigate a challenging environment of structurally negative inflation-adjusted cash and bond yields, along with many high asset valuations in equities and real estate.

The vast majority of sovereign official reserves, are permissioned assets rather than permissionless assets. They are non-sovereign; able to be frozen by foreign nations. War crystalizes this fact.

In February 2022, Russia invaded Ukraine. Russia had $630 billion USD-equivalents of sovereign international reserves prior to the war, representing decades of accumulated trade surpluses as sovereign savings to underpin their currency. Of this $630 billion, $130 billion consisted of gold, and the other $500 billion consisted of fiat currency and bonds. Of that $500 billion, maybe $70-$80 billion consisted of Chinese fiat assets, and the other $400+ billion consisted of European and other fiat assets. Europe subsequently froze that $400+ billion in Russian fiat assets in response to Russia’s invasion of Ukraine, which is equivalent to over 20% of Russian GDP and over five years of Russian military spending; an utterly massive economic confiscation. Russia is currently in a financial crisis, and it remains to be seen if they can exert enough commodity/military pressure to have their reserves unfrozen.

Some could argue that it’s a good thing that countries hold their reserves in each other’s assets and thus can be frozen. Along with trade sanctions, this practice gives countries another lever with which to control each others’ behavior away from extremes (such as war). We’re all interdependent to one degree or another anyway. But from a pragmatic point of view, countries tend to want to reduce their vulnerabilities and external risks where possible, and that can include minimizing the ability of their stored-up central bank reserves to be confiscated or frozen by other countries.

I began writing this longform article months ago, in late 2021. Things have accelerated since then, and for example the WSJ ran an article in early March 2022 called “If Russian Currency Reserves Aren’t Really Money, the World is in for a Shock.” Here’s the opening paragraph:

“What is money?” is a question that economists have pondered for centuries, but the blocking of Russia’s central-bank reserves has revived its relevance for the world’s biggest nations—particularly China. In a world in which accumulating foreign assets is seen as risky, military and economic blocs are set to drift farther apart.

What is money?

Well, the answer to that question ties into the difference between currency and money. Currency is some other entity’s liability, and they can choose whether or not to honor that particular liability. Money is something that is intrinsically valuable in its own right to other entities, and that has no counterparty risk if you custody it yourself (although it may have pricing risk related to supply and demand). In other words, Russia’s gold is money; their FX reserves are currency. The same is true for other countries.

Currency acts like money most of the time until, one day, it doesn’t. — Lyn Alden

Fiat Summarized

Overall, the key feature or bug of fiat currency (depending on how you look at it) is its flexible supply and its ability to be diluted. It allows governments to spend more than they tax, by diluting peoples’ existing holdings. With this feature, it can be used to re-liquify seized-up financial situations, and stimulate an economy in a counter-cyclical way. In addition, its volatility can be minimized compared to commodity monies most of the time through active management, in exchange for ensuring gradual devaluation over time.

When things go wrong, however, fiat currency can lose value explosively. Fiat currency tends to incentivize running bigger deficits (since spending doesn’t necessarily need to be taxed for), and generally requires some degree of hard or soft coercion in order to get people to use it over harder monies, although that coercion is often rather invisible to most people most of the time, until things go wrong. And its ability to be diluted can allow for longer wars, selective bailouts for influential groups, and other forms of government spending that aren’t always transparent to citizens.

Digital Assets

With the development of the internet and cryptography in the 1980s and 1990s, many people began working on internet-native money systems. Hash Cash, Bit Gold, and B-Money were some early examples.

Some of these early pioneers wanted to be able to easily pay on the internet, which wasn’t quite as easy back then. Others were part of the cypherpunk movement: people who responded to the information age and the lack of privacy it would increasingly bring, by advocating for transactional privacy through encryption.

Freedom House, a nonprofit organization founded in 1941 and originally chaired by Eleanor Roosevelt, has indeed noted that authoritarianism has been on the rise in recent decades. More than half the world’s population lives in an authoritarian or semi-authoritarian country. People in privileged areas often fail to recognize this trend.

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China in particular is a huge surveillance and control state now, with transactions and online behavior monitored and organized, social credit scores determined from the data, and consequently near-complete control over their citizens’ behavior.

The United States was ranked 94 for its freedom score back in 2010, but as of 2020 was ranked only 83. It has been reported for over a decade now, with increasing revelations over time, that the CIA and NSA have large spying operations on Americans.

The more digital the world is, the more authoritarian regimes, semi-authoritarian regimes, or would-be-authoritarian regimes are able to monitor and intervene in their subjects’ lives. Authoritarianism combined with 21st century digital surveillance technology and Big Data to organize it all, is a rather frightening prospect for a lot of people. This combination has been predicted by science fiction books for decades.

Digital Scarcity

and the Invention of Bitcoin

The ability to transact with others is a key part of individual liberty. The more that authoritarian regimes can control that, the more power they have over their citizens’ lives.

Nobel-laureate economist Friedrich Hayek once gave an interesting statement on the subject of money:

I don’t believe we shall ever have a good money again before we take the thing out of the hands of government, that is, we can’t take them violently out of the hands of government, all we can do is by some sly roundabout way introduce something that they can’t stop.-Friedrich Hayek, 1899-1992

Satoshi Nakamoto’s answer to that riddle in 2008 was to avoid a centralized cluster and make a peer-to-peer money system based on a distributed ledger.

I’ve been working on a new electronic cash system that’s fully peer-to-peer, with no trusted third party.

Governments are good at cutting off the heads of a centrally controlled networks like Napster, but pure P2P networks like Gnutella and Tor seem to be holding their own. – Satoshi Nakamoto, two separate quotes from 2008

The Bitcoin network is a distributed database, also known as a public ledger or “triple entry bookkeeping”. It’s a system that allows all participants around the world to come to a consensus on the state of the ledger every ten minutes on average. Because it’s highly distributed and relatively small in terms of data, participants can store a full copy of it and reconcile it constantly with the rest of the network, with a specific protocol for determining the consensus state of the ledger. In addition to storing the whole database, participants can store their own private keys, which allow them to move coins (or fractional coins) around to different public addresses on the ledger.

If participants hold their own private keys, then their bitcoins represent assets that are not also someone’s liability. In other words, like gold, they are money rather than currency, as long as other people recognize them as having value.

After Nakamoto showed the way, there have been over fifteen thousand other cryptocurrencies created. Some of them are competitors to the bitcoin network, while others are smart contract platforms to serve other purposes. So far, all of the ones directly trying to be money have not been able to gain any traction against the bitcoin network (with none of them sustaining above 5% of the network value of bitcoin), while a select few that aim to be used as smart contract utility tokens instead have retained rather large network valuations for longer periods of time.

  • Bitcoin is the clear hard money winner, but there are other cryptos, like Ethereum and Solana, that are successful for their other use cases.

Many people argue that bitcoin has achieved critical mass in terms of its network effect, security, immutability, and decentralization, such that while other digital assets may persist to fulfill other use-cases, none of them have a reasonable chance of competing with bitcoin in terms of being hard money. Fidelity published a good paper on this topic called Bitcoin First. Here’s the summary:

In this paper we propose:

-Bitcoin is best understood as a monetary good, and one of the primary investment theses for bitcoin is as the store of value asset in an increasingly digital world.

-Bitcoin is fundamentally different from any other digital asset. No other digital asset is likely to improve upon bitcoin as a monetary good because bitcoin is the most (relative to other digital assets) secure, decentralized, sound digital money and any “improvement” will necessarily face tradeoffs.

-There is not necessarily mutual exclusivity between the success of the Bitcoin network and all other digital asset networks. Rather, the rest of the digital asset ecosystem can fulfill different needs or solve other problems that bitcoin simply does not.

-Other non-bitcoin projects should be evaluated from a different perspective than bitcoin.

-Bitcoin should be considered an entry point for traditional allocators looking to gain exposure to digital assets.

-Investors should hold two distinctly separate frameworks for considering investment in this digital asset ecosystem. The first framework examines the inclusion of bitcoin as an emerging monetary good, and the second considers the addition of other digital assets that exhibit venture capital-like properties.

Other blockchains that attempt to increase transaction throughput on the base layer or add more computational functionality on the base layer, generally sacrifice some degree of decentralization and security to do so. Blockchains that attempt to have more privacy on the base layer generally sacrifice some degree of supply auditability.

Bitcoin is updated slowly over time via optional soft forks, but the underlying foundation is maximized towards decentralization and hardness, more so than throughput or additional functionality. Layers built on top of it can increase throughput, privacy, and functionality.

The discovery of a credible way to maintain digital scarcity, and an invention of a peer-to-peer money based on that discovery, was in some ways inevitable, although the specific form that it first appeared in could have been designed in a number of ways. The foundations of the internet were put forth in the 1970s, and so was the concept of a Merkle tree. Throughout the 1980s and 1990s the internet as we know it came into being, as more and more of the world’s computers were networked together. Proof-of-work using computer systems was invented in the 1990s, and the SHA-256 encryption was published in the early 2000s. Nakamoto put a bunch of these concepts together in a novel way in 2008, and had the right macroeconomic backdrop and right design decisions to have it succeed for well over a decade and counting.

Bitcoin’s Bottom-Up Monetization

If we go back to the gold standard for a moment, the key reason why paper claims were built on gold was to improve its medium-of-exchange capabilities. Ray Dalio described it well:

Because carrying a lot of metal money around is risky and inconvenient and creating credit is attractive to both lenders and borrowers, credible parties arise that put the hard money in a safe place and issue paper claims on it. These parties came to be known as “banks” though they initially included all sorts of institutions that people trusted, such as temples in China. Soon people treat these paper “claims on money” as if they are money itself. – Ray Dalio, The Changing World Order

Bitcoin on the other hand is a bearer asset that is safe to self-custody in large amounts and can be sent peer-to-peer around the world over the internet. Therefore, it removes the need for paper abstraction. Some holders will still prefer custodians to hold it for them, but it’s not necessary like it is with large amounts of gold, and thus the units of the network are less prone to centralization. Unlike gold, bitcoin in large quantities is easy to transfer globally, and take custody of.

From the start, the bitcoin network was designed as a peer-to-peer network for the purpose of being a self-custodial medium of exchange. It’s not the most efficient way to exchange value, but it’s the most unstoppable way to do so online. It has no centralized third parties, no centralized attack surfaces, and sophisticated ways of running it can even get around rather hostile networks. Compared to altcoins, it is far harder to attack due to its bigger network effect and larger hash rate.

Kind of like how a tank is designed to get from point A to point B through resistance, but is not well-suited for commuting to work everyday, the base layer of the bitcoin network is designed to make global payments through resistance, but is not well-suited for buying coffee on the way to work.

In that sense, the bitcoin network has utility, for both ethical and unethical participants (just like any powerful technology). And because it is broken up into 21 million units (each with eight decimal places, resulting in 2.1 quadrillion sub-units), it is a finite digital commodity.

And that’s how Satoshi described it:

As a thought experiment, imagine there was a base metal as scarce as gold but with the following properties:
– boring grey in colour
– not a good conductor of electricity
– not particularly strong, but not ductile or easily malleable either
– not useful for any practical or ornamental purpose

and one special, magical property:
– can be transported over a communications channel

If it somehow acquired any value at all for whatever reason, then anyone wanting to transfer wealth over a long distance could buy some, transmit it, and have the recipient sell it. – Satoshi Nakamoto, 2010

In addition to sending them online, bitcoins in the form of private keys can be physically brought with you globally. You can’t bring a lot of physical cash or gold through an airport and across borders. Banks can block wire transfers out of their country, or even within the country. But if you have bitcoins, you can bring an unlimited amount of value globally, either on your phone, or on a USB stick, or stored elsewhere on some cloud drive you can access from anywhere, or simply by memorizing a twelve-word seed phrase (which is an indirect way of memorizing a private key). It’s challenging for governments to prevent that without extremely draconian surveillance and control, especially for technically-savvy citizens.

This utility combined with an auditable and finite number of coins eventually attracted attention for its monetary properties, and so bitcoins acquired a monetary premium. When you hold bitcoins, especially in self-custody, what you are holding is the stored-up ability to perform global payments that are hard to block, and the stored-up ability to transfer your value globally if you want to. You are holding your slot on a global ledger, similar to holding valuable domain names, except that unlike domain names, bitcoins are decentralized, fungible, liquid, and self-custodial. It could be an insurance policy for yourself one day, or you could simply hold it because you recognize that capability to be valuable to others, and that you could sell that capability to someone else in the future.

It’s volatile, but that’s in large part because it monetized from zero to a trillion-dollar market capitalization in twelve years. The market is exploring this technology and trying to determine its total addressable market as more and more people buy into it over time. It’s an asset that is still only held by about 2% of the global population, and it’s a tiny fraction of global financial assets.

When Jews fled Nazi-controlled Europe, they had trouble bringing any valuables with them. When people left the failing Soviet Union, they could only bring the equivalent of $100 USD with them. When people today want to leave Venezuela, Syria, Iran, Nigeria, China, eastern Ukraine, or any number of countries, they sometimes have a rough time bringing a lot of value with them, unless they have self-custodied bitcoins. Millions (and arguably billions) of people today can understand the value of this feature.

Reuters has documented Putin’s domestic political opposition using bitcoins as Putin’s establishment cuts them off from their banking relationships. The Guardian has documented Nigerians using bitcoins as they protested their government against police violence and had their bank accounts frozen. Chinese people have used it to transfer value through capital controls. Venezuelans have used it to escape hyperinflation and transfer value out of their failed state. One of the earliest use-cases for it was to pay Afghani girls with a type of money that their male relatives could not confiscate, and that they could bring with them out of the country when they leave. I’ll dive more into these examples later. In 2022, Canada used emergency powers to freeze financial accounts of protestors, and people who donated to protestors, before charging them with any crimes.

The Lightning network, for example, is a series of smart contracts that run on top of the bitcoin network base layer and allow for custodial or non-custodial rapid payments online or in person with a mobile phone, to the point where they can easily be used to buy coffee, and with practically no limitation on transactions per second. The Liquid network, as another example, is a side chain that wraps bitcoins into a federated network for rapid transfers, better privacy, and additional features as well, in exchange for some security trade-offs.

Bitcoins began as digital commodities that had utility value as an internet-native and censorship-resistant medium of exchange for people that need that capability. Bitcoins eventually acquired a monetary premium as an emergent and volatile store of value (an increasingly salable good), and began to be held more-so for their scarcity than for their medium-of-exchange capabilities. And then over time, the network developed additional ways to enhance the network’s medium-of-exchange capabilities beyond their initial limitations.

Too many people look at bitcoin and say, “the base layer can’t scale so that everyone in the world can make all of their transactions with it”, but that’s not the point of what it’s for. The base layer is a censorship-resistant payments and settlement network with an auditable supply cap that has the capacity to handle hundreds of thousands of transactions per day, and layers built on top of it can be used for more frequent transactions than that if desired.

Kind of like how we don’t use Fedwire transfers to buy coffee, bitcoin base layer transactions are not well-suited to buying coffee. Visa transactions that run on top of Fedwire, or lightning transactions that run on top of bitcoin, can be used to efficiently buy coffee. Or even custodial payment methods like Cash App and Strike that run on top of the bitcoin/lightning network can be used if censorship-resistance is not needed. The base layer of the bitcoin network is not competing with things like Visa; it is competing with central bank settlements; the root of the global financial system. It’s an entirely separate root layer, built on computer networking technologies and internet protocols rather than channels between central banks and commercial banks.

It’s also worth understanding Gresham’s law, which proposes that “bad money drives out good”. Given the choice between two currencies, most people spend the weaker one and hoard the stronger one. Bitcoin’s low current usage as a medium of exchange is not a bug; it’s a feature of a system with low supply issuance and a hard cap at 21 million units, especially in places where it is not legal tender and so every transaction is a taxable event. When a tank-like medium of exchange is needed, or for certain other niche use-cases, bitcoin is useful for its payment utility. Otherwise, it’s most often held for its monetary premium as a scarcer asset than dollars and other fiat currencies, and represents the stored-up ability to perform tank-like payments in the future.

Corporate Stablecoins

Corporate custodial stablecoins were created via smart contracts to apply blockchain technology to fiat currency. With these systems, a custodian of dollars could issue tokens on a smart contract blockchain, and each of those tokens is redeemable 1-for-1 from the custodian for dollars.

From a user perspective, stablecoins are a significant technological leap over existing bank payment systems, especially for international payments, or large domestic payments.

They will naturally face ongoing government regulation and be controlled and surveilled as part of the banking system in many cases, but it’s clear that they have utility for actual payments and will probably get increasingly incorporated into financial systems, either in the form of central bank digital currencies or private-but-highly-regulated stablecoin issuers.

Central Bank Digital Currencies

Some countries want to take the stablecoin concept further, and completely nationalize it within their jurisdiction. This uses similar technology to stablecoins but doesn’t need a blockchain, because it’s not decentralized.

From the government perspective, the usefulness of a pure central bank digital currency is that the government can:

  1. send international payments without the SWIFT system
  2. try to give banking access to the non-banked or under-banked populations
  3. track and surveil any transaction, including with Big Data/AI technologies
  4. blacklist or block certain transactions that violate their rules
  5. add expiration dates or jurisdiction limitations to currency
  6. take away money from citizen wallets for various violations
  7. give money to citizen wallets for stimulus or rewards
  8. impose deeply negative interest rates on citizen account balances
  9. program money to have different rules for different groups
  10. reduce the control and fee pressure that commercial banks have over the system

A Spectrum of Control

Some digital assets, like bitcoins, reduce the government’s ability to interfere with your money, since you can self-custody it and send it to whoever you want. As the Guardian covered back in July, when Nigerans began protesting their government for police violence, and found their bank accounts frozen for doing so, many of them turned to using bitcoins to remain operational.

Last October, Nigeria was rocked by the largest protests in decades, as many thousands marched against police brutality, and the infamous Sars police unit. The “EndSars” protests saw abuses by security forces, who beat demonstrators, and used water cannon and teargas on them. More than 50 protesters were killed, at least 12 of them shot dead at the Lekki tollgate in Lagos on 20 October

The clampdown was financial too. Civil society organisations, protest groups and individuals in favour of the demonstrations who were raising funds to free protesters or supply demonstrators with first aid and food had their bank accounts suddenly suspended.

Feminist Coalition, a collective of 13 young women founded during the demonstrations, came to national attention as they raised funds for protest groups and supported demonstration efforts. When the women’s accounts were also suspended, the group began taking bitcoin donations, eventually raising $150,000 for its fighting fund through cryptocurrency.

And many merchants, facing sanctions, used bitcoins to trade internationally (also from the Guardian article):

His business – importing woven shoes from Guangzhou, China, to sell in the northern city of Kano and his home state of Abia, further south – had been suffering along with the country’s economy. The ban threatened to tip it over the edge. “It was a serious crisis: I had to act fast,” Awa says.

He turned to his younger brother, Osy, who had begun trading bitcoins. “He was just accumulating, accumulating crypto, saying that at some point years down the line it could be a great investment. When the forex ban happened, he showed me how much I needed it, too. I could pay my suppliers in bitcoins if they accepted – and they did.”

Similarly, Reuters has been reporting on a number of occasions that Russian opposition leader and anti-corruption lawyer Alexei Navalny uses bitcoins in his organization to get around government blockades:

Russian authorities periodically block the bank accounts of Navalny’s Anti-Corruption Foundation, a separate organisation he founded which conducts investigations into official corruption.

“They are always trying to close down our bank accounts – but we always find some kind of workaround,” said Volkov.

“We use bitcoin because it’s a good legal means of payment. The fact that we have bitcoin payments as an alternative helps to defend us from the Russian authorities. They see if they close down other more traditional channels, we will still have bitcoin. It’s like insurance.”

One of the most touching stories was reported by Reuters as well. In the early years of bitcoin, an Afghan woman paid many girls with bitcoins, because they were otherwise unbanked and their male relatives would often try to steal from them, since they didn’t necessarily have much of a right to their own property. The self-custodied aspects of bitcoin then allowed many of the girls over the years to leave the country with their funds, which would be impossible with most other assets:

When Roya Mahboob began paying her staff and freelancers in Afghanistan in bitcoin nearly 10 years ago, little did she know that for some of these women the digital currency would be their ticket out of the country after the fall of Kabul in August.

Mahboob, a founder of the non-profit Digital Citizen Fund along with her sister, taught thousands of girls and women basic computer skills in their centres in Herat and Kabul. Women also wrote blogs and made videos for which they were paid in cash.

Most girls and women did not have a bank account because they were not allowed to, or because they lacked the documentation for one, so Mahboob used the informal hawala broker system to send money – until she discovered bitcoin.

Alex Gladstein has a massive archive of articles reporting on the various emerging market use-cases for bitcoin over the past several years, ranging from Sudan to Palestine to Cuba to Iran to Venezuela and more.

Anita Posch also has a great interview series called Bitcoin in Africa that explores these use-cases in that region. Bitcoin is a tool that tech-savvy people often use as defense against either double digit currency inflation or authoritarian financial system control.

  • Bitcoin is insurance against inflation and authoritarian regimes.

We’re even seeing this topic pop up in developed markets. Truckers in Canada protested the government and occupied and disrupted the capitol, and received donations from supporters on crowdfunding sites. Those crowdfunding sites ended up freezing and reversing the payments, so many of the participants turned to bitcoin as peer-to-peer money. The government then invoked the 1988 Emergencies act to freeze bank accounts of certain protestors and donors, and to try to blacklist certain bitcoin addresses to being brought to exchanges for conversion back into Canadian dollars.

People may agree or disagree with aspects of those protests but the pragmatic point about money in this context is, those who had their money entirely in banks were indeed frozen. Those who self-custodied their own digital assets, such as bitcoins, had certain conveniences removed from them but could still hold, move, and transfer their money in various ways.

what-is-money-custody.png

Other digital assets, like CBDCs, are the opposite of this type of asset, and give the government more ability to surveil and censure your money, and in reality, it’s not even your money. It’s a liability of your country’s central bank, and as Carstens eloquently articulated, each central bank wants to be able to determine how you can use their liabilities. The full ramifications of that statement can mean very different things depending on whether you live in a place like Norway or a place like China.

At the end of the day, bitcoin is more of an anti-authoritarian monetary technology than it is a “left” or “right” monetary technology.

Critics of bitcoin often leave these humanitarian or anti-authoritarian use-cases out (or don’t even realize them), and instead refer to bitcoin as being primarily used to buy drugs or ransomware or money laundering, which is a really outdated (or deliberately misleading) view at this point. Firms such as Chainalysis that perform blockchain analysis for law enforcement and other clients have found that bitcoin and overall cryptocurrency usage for illicit activities involves less than 1.5% of bitcoin/crypto transaction volume over the past several years, which is less than the percentage of fiat transactions used for illicit activities.

The Bank Secrecy Act of 1970 required financial institutions to report transactions over $10k USD to the government, which back then was the equivalent of about $75k USD in today’s dollars. They never raised the threshold despite five decades of inflation, so over time without further laws being passed, their surveillance reporting requirements became applicable to smaller and smaller transactions.

One way or another, these various types of digital money or currency are clearly in our future in some form or another. Depending on where we live and choices we make, we are more likely to experience some than others, ranging from bitcoins to corporate stablecoins to central bank digital currencies.

Proof-of-Something

A topic popularized by bitcoin is the term “proof-of-work”.

The concept was invented in various ways by cryptographers in the late 1990s, including notably by Dr. Adam Back in the form of “Hashcash”- a money-like mechanism to reduce email spam and denial-of-service attacks by making them have a small computational cost.

Satoshi Nakamoto’s bitcoin white paper referenced Back’s work, and used proof-of-work as one of its core aspects.

Nowadays, various digital assets have expanded on this concept in the form of “proof-of-stake”, “proof-of-history”, “proof-of-transfer”, “proof-of-burn”, “proof-of-space” and so forth. There are multiple attempts at maintaining scarcity of digital networks.

In any form, money is proof of something. This section explores three popular examples of proof-of-work, proof-of-stake, and proof-of-force.

Proof-of-work assets are created or harvested from mining activities. Proof-of-stake assets are created by breaking a project into pieces and selling some of those pieces to others. Proof-of-force assets, or fiat currency, is created by governments and their designated commercial parties (holders of banking licenses).

In other words, something akin to the Labor Theory of Value doesn’t apply to utility goods, but does apply to monetary goods.

Basically, when it comes to money, a large amount of work to produce a unit, and a persistently high stock-to-flow ratio, are essentially the same thing. That work requirement is what keeps a commodity’s stock-to-flow ratio high, and any commodity that can’t maintain a high stock-to-flow ratio in the face of ever-advancing technology eventually fails as money.

Proof of Stake

Much like proof-of-work, we can translate it back into analog examples. In particular, proof-of-stake is commonly used in corporate ownership. The larger the number of shares of a company you own, the more say you have in terms of electing board members to run the company, and supporting or denying shareholder proposals. If you, or a group of entities that follow you, can control 51% of the shares, you effectively control the entire company.

However, unlike corporations, proof-of-stake blockchains require circular logic. Corporations use an external entity (a transfer agent and registrar) to keep track of who owns each share. In proof-of-stake blockchains, it’s like a corporation acting as its own transfer agent and registrar; the coinholders determine the state of the ledger, and the ledger is what says who the coinholders are.

Therefore, proof-of-stake systems need to be “always on” to function, and are highly complex. They have no inherent disaster recovery potential if the blockchain goes offline, because making alternative copies of the blockchain has no cost, and there’s no way to determine the “real” blockchain other than via agreement of major parties (a.k.a. a form of governance) if it is recovering from that offline state.

In contrast, proof-of-work systems are ledgers with decentralized and automated transfer agents and registrars. The coinholders do not determine the state of the ledger, the miners do, via energy expenditure. A proof-of-work system is not based on circular logic; even if the entire blockchain goes offline, can be restarted because the longest chain can be identified and continued.

Another risk with proof-of-stake systems in both the analog and digital world is that they tend to centralize over time into an oligopoly. Since it doesn’t require ongoing resource inputs to maintain your stake and to grow it over time, wealth tends to compound into more wealth, which they can then use to influence the system to give themselves even more wealth, and so on.

Adam Back described this succinctly a while ago:

You see that with other commodity money, like physical gold. It’s a system that works because money has a cost. I think money that doesn’t have a cost ultimately ends up being political in nature. So people closer to the money, the so-called Cantillon Effect, are going to be advantaged.

In digital systems specifically, another challenge is that proof-of-stake as a consensus model is a lot more complex than proof-of-work and prone to more attack surfaces. If a proof-of-stake chain gets split or maliciously copied, it’s not self-evident which chain is the real one, and it becomes a human/political decision among oligopolistic participants to canonize a chain. However, in a proof-of-work system, the real chain is instantly verifiable, because by definition the chain that follows the node-consensus ruleset and that has more work is the real one.

In other words, what makes proof-of-stake blockchains inherently equity-like is that they require some form of ongoing governance, whereas proof-of-work blockchains (especially ones decentralized enough that they can’t really change their monetary policies) are more commodity-like.

Proof-of-Force

As described by Warren Mosler, a founder of the MMT school of economic thought mentioned earlier in this article, fiat currency is basically proof-of-force, which is why it can win out over proof-of-work money for long stretches of time.

Demand for government paper (or digital equivalents) is created by the government’s taxes on the population, which can only be paid in units of that paper. Failure to pay taxes results in losing assets, going to jail, or if resisting those prior consequences, getting shot by police. Proof-of-force systems convince or coerce people in their jurisdiction to use a softer/devaluing money, by placing taxes, frictions, and other obstacles on any money that is harder than their own, or in some cases outright banning competing monies by making it a felony to use them.

When we say that the dollar is “backed up by the full faith and credit of the U.S. Government”, what we are really saying is that the dollar is backed up by the ability of that government to collect taxes by any means necessary including force (and backed up by the petrodollar system; the ability of the US government to maintain a currency monopoly on energy pricing worldwide).

To put it bluntly, if you don’t pay your taxes, and in a form of legal tender accepted by the government, you eventually get a knock on your door from people with guns, and/or you’ll have to leave and go somewhere else.

That remains the case unless or until the country’s legal tender breaks down enough that the majority of people can’t/won’t use it and the government is unable to enforce its use with that level of currency rebellion, which happens during hyperinflations and near-hyperinflations, including in many developing countries in modern times.

With a stock-to-flow ratio averaging somewhere between 5x to 20x in most cases, major fiat currencies have higher stock-to-flow ratios than most commodities, but lower stock-to-flow ratios than bitcoin and gold. However, in addition to having a moderately high stock-to-flow ratio, fiat currency benefits from the unique backing by the government, including active stabilization to try to reduce volatility, which is what gives it a degree of staying power.

Final Thoughts

Think Outside of the Box

When money changes in a society, it always feels weird for people who go through it.

What do we do in these situations where a new money is supposedly here?

Well, I think the first rational thing is to be skeptical. We can’t just dive all-in to anything new that people claim is money.

In fact, honestly at first we can probably ignore it, since the probability of any given new thing becoming money is low. It’s pretty rare in human history that a serious new form of money emerges. But then if it doesn’t go away, and indeed keeps surviving from multiple 80%+ drawdowns over more than a decade to greater and greater heights of increasing monetization, then realistically we need to research it, test its hardness, and envision all the ways it could conceivably fail.

As I close out this article, I’ll circle back to an earlier example of bitcoins being used as confiscation-resistant self-custodied payment for Afghani women and girls nearly a decade ago. Alex Gladstein documented what became of some of them:

A few of the women did keep their bitcoin from 2013. One of them was Laleh Farzan. Mahboob told me that Farzan worked for her as a network manager, and in her time at Citadel Software earned 2.5 BTC. At today’s exchange rate, Farzan’s earnings would now be worth more than 100 times the average Afghan annual income.

In 2016, Farzan received threats from the Taliban and other conservatives in Afghanistan because of her work with computers. When they attacked her house, she decided to escape, leaving with her family and selling their home and assets to pay brokers to take them on the treacherous road to Europe.

Like thousands of other Afghan refugees, Farzan and her family traveled by foot, car and train thousands of miles through Iran and Turkey, finally making it to Germany in 2017. Along the way, dishonest middlemen and common thieves stole everything they brought with them, including their jewelry and cash. At one point, their boat crashed, and more belongings sank to the bottom of the Mediterranean. It’s a tragic story familiar to so many refugees. But in this case, something was different. Through it all, Farzan was able to keep her bitcoin, because she hid the seed to her bitcoin wallet on a piece of tiny, innocuous-looking paper. Thieves could not take what they could not find.

That’s an example of bitcoin transporting value across borders in a circumstance where gold and cash would have failed. It can be done through a mobile phone, USB stick, piece of paper, cloud storage, or even just by memorizing a twelve-word seed phrase.