Unit 10 Lecture Notes

The ultimate risk involved in scaling Bitcoin is its growing centralization, and history has a great example of that threat: the demise of the gold standard into modern government-controlled debt based money. The move toward 'second layer' gold payments was its achilles heal in that demise. When payment was predominantly performed in gold and silver coins, individuals had real money in their hands, and governments and banks could not devalue it. As gold-backed notes began to replace physical gold and silver coins for circulation, it became easier for banks and governments to increase the supply of notes beyond their gold backing, which was the root cause for the business cycles (not to mention the unprecedented growth in the size of government and its mandate).

It is too soon to tell if Bitcoin could face a similar fate, but there is one fundamental reason why it has a better chance of resisting this fate than gold: the cost of running a Bitcoin full node is infinitely cheaper than the cost of running a 'gold full node'. I believe the ability of any global settlement system to resist capture or censorship can best be understood as a function of the ease of being able to build an entity that can conduct final settlement with the asset across the world.

The movement of physical gold is expensive, risky, and time-consuming. As trade, technology, and transportation all advanced in the nineteenth century, there was a greater need for transactions, and for netting and settling payments. The inherent nature of the high costs of moving and transporting gold made it inevitable that larger and more centralized banks would have a large advantage over small banks: the larger the bank, the more likely it is to be able to facilitate transactions between two of its clients and avoid the physical movement of gold. Banks also benefited immensely from establishing clearing houses, which later developed into central banks. Eventually the global system of payments around gold was centralized over a few dozen national central banks, each with a de facto monopoly on the clearance of payments into and out of its country. As these reserves became centralized, it became easier for banks to issue fiduciary media unbacked by gold, and for governments to finance themselves through central bank credit. As discussed in TBSRB1, the reason fractional reserve banking developed on top of gold was because its expensive clearance gave settlement banks a privileged quasi-monopoly position they could exploit. As reserves were centralized, governments around the world confiscated large amounts of gold from their population by taking over the banking system, where these reserves lay. Since governments co-opted the functions of central banking and forced the acceptance of their currencies, it became effectively illegal to create banking and monetary systems that utilize gold (through many laws and rules discussed in more detail in The Bitcoin Standard). Even today, it is impossible to build a gold-based financial or monetary system, as was seen with the case of e-gold. The cost of setting up a business able to clear gold internationally must also include the steep cost of fighting off the United States government agencies that will attempt to force you to close down one way or another.

The astonishing technical achievement of Bitcoin is that it significantly reduces the cost and duration of international settlement, and more importantly, drastically reduces the set-up cost for performing international clearance. The cost of setting up a bitcoin full node is a few hundred dollars in hardware and bandwidth, and allows anyone to send transactions anywhere in the world. It is even quite possible to perform final clearance with it behind encrypted and undetectable online traffic. Further, recent advancements make it possible to send transactions via radio, satellite, and mesh networks without a regular internet connection. In contrast, any business that wants to clear gold internationally must have a physical location in which the reserves are centralized (and thus subject to government capture).

Transaction costs to settle an international payment using bitcoin is currently far cheaper than using gold. For only a few cents, one can send billions of dollars worth of bitcoin anywhere in the world and achieve final settlement in around an hour or two. And as mentioned above, the more significant advantage bitcoin has is that the cost of setting up a full node is much lower than the cost of setting up a gold clearance bank. Even if bitcoin transaction costs were to rise to many thousands of dollars per transaction, it would still be cheaper and more accessible for millions of people worldwide than the international clearance of gold, which is practically impossible for anyone but central banks and governments.

It is this difference in the initial costs needed to perform international settlement that give Bitcoin the best chance at resisting government control and capture. Whereas with gold we had a system of central banks for settlement, Bitcoin currently has tens of thousands of nodes worldwide each able to perform final settlement. To compromise gold clearance requires a government to infiltrate one building in its territory. To compromise Bitcoin clearance is a herculean task that involves simultaneously quashing many thousands of nodes worldwide that are not very easy to find, but very cheap to replace.

Bitcoin also has the benefit of its public and transparent nature. A bank may be able to easily lie about the amount of reserves it keeps on hand, buts it would have a much harder time credibly claiming ownership of non-existent bitcoin. Individuals depositing bitcoin at financial institutions can keep a close watch on the addresses of that institution, and can publicly audit them. Clients can also place funds in segregated bitcoin addresses under their banks' custody and continue to monitor them. For extra security, multisig solutions can even ensure that the bank is unable to access the funds without consent of the owner.