Unit 10 Lecture Notes

There is a school of thought that argues Bitcoin must remain a niche and fringe payment network accessible globally, drawing inspiration from Esperanto as a niche global language. Their claim is that Bitcoin will not scale to become a global money given its capacity limitations and government opposition to it. It will only remain useful for people looking to escape capital controls or inflation, and won't ever grow to widespread adoption.

The first problem with this view is that hard money is by its very nature a viral and all-conquering technology that cannot be restricted or restrained from growing. As the first four chapters of my book explain, monetary history is but the history of harder moneys destroying the value of easier moneys and replacing them. A hard money cannot coexist peacefully with easier moneys around it. That state of affairs in itself is an unstable equilibrium that contains the dynamics to alter it. When Europeans found that west Africans were using beads as money, they took advantage of the fact that the beads are cheap to produce in Europe but expensive to produce in Africa, and brought very large quantities with them to purchase everything valuable in west Africa. There was no way for beads to remain as money in Africa, no matter what the feelings of their holders. Anybody who chose to continue using them as money completely lost their purchasing power; in effect, the beads ceased functioning as a money. The existence of a harder money and other human beings acting in their own self-interest will very severely limit your choice as to the type of money you can use. This is not just about finding someone willing to accept the money you have; more significantly, it is about the consequence to the money you hold from people able to produce it at a cost lower than its market value. As soon as a harder money is found, that money will store value and resist losing it through inflation due to the difficulty of producing it at a cost lower than its market value. That harder money will retain value better than the easy money over time, as its supply increases by relatively smaller quantities.

As the relative value of the two forms of money begins to change in opposite directions, the harder money's pool of available liquidity increases relative to the easier money's pool; in other words, the probability of wanting to trade with someone who is willing to pay with or accept hard money increases. The appreciation in the value of a money results in an increase in its salability, or the likelihood that an individual will be able to sell it when they need to dispose of it. Salability, as Carl Menger emphasized, is the key property of money. Hardness is key to salability because it constantly serves to increase the relative value of the pool of liquidity available for trade.

This process is of course accelerated when people understand it and rationally choose the hardest money. Over time, as more and more wealth goes toward the harder money, more people will want to use it, and demand for it must increase.

The other important example discussed in The Bitcoin Standard concerns the move from bimetallism to gold. For as long as trade in physical coins was the dominant form of trade, silver retained its monetary role due to its superior salability at small scales. But as technology advanced, new forms of money allowed payment in gold and silver without the need to physically move these metals. Paper notes backed by these metals were the most obvious such invention, and other forms of bank accounts and credit instruments also allowed for payment using gold or silver that laid dormant in vaults.

As gold started to also become liquid at small scales, even through intermediaries, there was little reason left to hold on to silver, and its use as a money began to collapse. Even though payments in gold began to increasingly be processed through banking intermediaries, the liquidity of gold continued to grow, along with its value. Even though small payments could still be made with physical silver coins without relying on banking intermediaries, the liquidity of silver continued to decline along with its value. Once silver lost its raison d'etre as a method of payment for small transactions, there was no reason for two forms of money to continue existing; everyone who used the less liquid money benefited from switching to the more liquid money (and the sooner they switched, the more they benefited).

The lessons from the collapse of bimetallism are applicable to bitcoin and other digital currencies. As soon as gold was usable for all scales of transactions, silver's fate was sealed. That it could still be used for small transactions was no match for the two inexorable forces against its monetary role: the faster supply increase depreciating its value relative to gold, and gold's larger liquidity pool attracting holders toward it and away from silver. Even though many governments had mandated silver as legal tender, they were helpless to stop it from losing its monetary role by the end of the nineteenth century (in yet another fatal blow to The State Theory of Money). Misguided attempts by governments to prop up the price of silver, such as the Silver Purchase Act in the United States, were futile in preserving silver's monetary role; as the value of the national currencies tied to silver plummeted, countries on a silver standard were impoverished.

By the early twentieth century the world was using gold-backed currency, and the growth of gold's liquidity pool further repeled holders away from silver. Even with silver's legally mandated monetary role, its superiority for in-person exchanges without reliance on intermediaries, a monetary role that had lasted for many millennia, and an enormous amount of liquidity held in it until the late nineteenth century, it was to be demonetized in favor of the harder and more liquid money as soon as technology allowed for it. There was simply no reason to hold a different currency less likely to retain its future value, and the market test determined that people preferred the hardness of gold even despite the reliance on an intermediary issuing banknotes (vs the physical silver coins that did not rely on this trust).

This brings us back to the initial comparison between Bitcoin and the World Payments Report statistics. The 482.6 billion transactions mentioned above were specifically called "non-cash transaction" for a reason: they involve intermediaries processing the payment. While these transactions are mostly digital today, that does not make them categorically similar to bitcoin transactions in economic terms. Even though it is digital, a bitcoin transaction is still a cash payment, because the payment is not the liability of anyone. Bitcoin is a form of cash because only the bearer is able to dispose of it, and they can do so without the need for the consent or permission of a third party intermediary. Bitcoin as digital cash is more comparable to the physical transfer of physical money, such as in-person cash payments, or movements of gold between gold clearing banks or central banks. It is not really comparable to the non-cash payments, even though the two might appear similar because they are both digital. The essential quality of bitcoin is that it is a form of payment free of counterparty risk, not that it is digital. Those who expect Bitcoin to grow by displacing intermediated non-cash payment have completely misunderstood its fundamental nature; fortunately, most of those people are no longer involved in Bitcoin, having moved on to some of its doomed forks. If Bitcoin is to continue to grow, it will grow primarily through an increase in the value of the cash payments, or final settlements, it performs.

Individual small payments will be built on top of it through secondary layers, and this process is already unfolding. The similarity of this transformation to that of the gold standard was the inspiration behind the title of my book. The movement of bitcoin on-chain is happening for increasingly higher value transactions, and many more transactions are happening on secondary layers (with both lower security and cost).